Reference documents available on the SARS website; www.sars.gov.za:
Income Tax Act of 1962 as amended
2020 draft Taxation Laws Amendment Bill (“DTLAB”) was released on 31 July 2020 Draft Response Document on the 2020 Draft Rates and Monetary Amounts and Amendment of Revenue Laws Bill, 2020 Draft Taxation Laws Amendment Bill, 2020 Draft Tax Administration Laws Amendment Bill – 13 October 2020 Securities Transfer Tax Act
This article focuses on one aspect of tax only; that of proposed amendments related to “manufactured dividends” as referred to in the draft Taxation Laws Amendment Bill of 31 July 2020.
What is a “Manufactured Dividend”?
It is a payment received by a securities lender for a dividend distributed on a loaned security. By agreement, the borrower, in securities lending, remits to the lender any dividends, interest, or other distributions that are paid during the time that the securities are on loan. The lender is not entitled to receive any dividends from the ownership while a security is on loan. However, it is usual for the lender and the borrower to agree that the borrower must pay a manufactured dividend to the lender as a compensation for such a loss of income. Conventionally, securities lending arrangements provide that the borrower must pay to the lender a manufactured dividend in lieu of any dividends distributed on the loaned security.
National Treasury and SARS published documents listing several proposed amendments in July 2020 and made these documents available for public comment which were since received by Treasury and SARS to review. Some responses from the public sector were accepted but some were not. One such example relates to manufactured dividends.
From the “response document” published on the SARS website an extract is given below. Note that the amendment is based on closing tax avoidance loopholes as was previously done in 2018 but strengthened by the proposed amendment.
“Addressing tax avoidance involving lending and collateral arrangement provisions (Main reference: Section 64EB(2) of the Income Tax Act: clause37 of the Draft TLAB), The Income Tax Act and the Securities Transfer Tax Act contains rules that provide relief in respect of an outright transfer of beneficial ownership in specific financial instruments for both collateral arrangements and lending arrangements, hereafter collectively referred to as “securities arrangements”.
“As a result, if a listed share is transferred as a part of a security arrangement, there are no income tax (including capital gains tax) and securities transfer tax implications, provided that identical shares are returned to the borrower by the lender within a limited period of time from the date on which the security arrangement was entered into. The anti-avoidance provisions in section 64EB of the Income Tax Act were expanded in 2018 to also apply to dividend conversion schemes using collateral arrangements. Despite these anti-avoidance measures, Government has identified certain dividend conversion transactions that are circumventing these anti-avoidance measures. In order to address this, changes were made in section 64EB(2) in the 2020 Draft TLAB to adjust the anti-avoidance trigger that currently requires the person paying a manufactured dividend to a person that is subject to dividends tax to hold a share in the company declaring the dividend. The holding of a share requirement is to be deleted.”
Feedback from the public sector:
“The proposed amendment would significantly increase the administrative burden on affected South African resident companies which would be required to submit Dividends Tax Returns, even though no dividends tax is payable.”
Treasury and SARS response:
“Not accepted. Security arrangement transaction mostly remains the tool of larger financial institutions and large corporates. When government expanded the relief measures in respect of an outright transfer in beneficial ownership of specific financial instruments for both collateral arrangements and lending arrangements in 2015 it was made clear in consultation by the major financial institutions that they do have the administrative capacity to track and account for security arrangement transactions in order to fulfil their administrative obligations towards SARS.”
The South African Income Tax Act, 1962 (the “Act”) levies dividends tax of 20% on dividends paid by South African resident companies and non-resident companies (but in the latter case, only if the shares are listed in South Africa).
Where a company borrows listed shares, the lender would typically be entitled to a manufactured dividend paid by the borrower to the extent that a dividend was declared on the shares. The manufactured dividend is not regarded as a dividend as defined in the Act (whether for income tax or dividends tax purposes). This is because the manufactured dividend is paid in terms of a contractual arrangement between the lender and the borrower and not in respect of shares held by the lender in the borrower.
In order to levy dividends tax on certain manufactured dividend payments, section 64EB(2) was introduced into the Act in 2012. This section has since been amended on a number of occasions.
Currently, section 64EB(2) deems any amount paid by a borrower of a listed share or by the recipient of a listed share in terms of a collateral arrangement, to be a dividend paid by that borrower or recipient of the collateral, if the borrower or recipient of the collateral:
is a resident company or includes the dividend in its income;
holds the listed shares; and receives or accrues a dividend in respect of those shares.
If section 64EB(2) applies to a payment, then that payment is deemed to be a dividend paid by the borrower or recipient of the collateral and subject to dividends tax and the payor has a withholding obligation. If the payor incorrectly withholds (or fails to withhold) then it may be liable for the withholding tax.
In the February 2020 Budget Review, the following was stated in respect of the lending of listed shares and the transfer of listed shares as collateral:
“Refining the tax treatment of transfer of collateral in securities lending arrangements. The Income Tax Act contains rules to address dividend tax avoidance transactions whereby listed shares are lent or transferred as collateral from a person that would be liable for the tax to a tax-exempt person. The borrower or recipient of the collateral receives the exempt dividend and pays a manufactured dividend to the lender or provider of the collateral. It is proposed that the anti-avoidance rules be extended to also cover situations where additional exempt parties are involved to facilitate the avoidance transactions.”
Following on from the 2020 Budget announcements, the 2020 draft Taxation Laws Amendment Bill (“DTLAB”) was released on 31 July 2020 and proposed certain amendments to section 64EB(2) of the Act in terms of which payments are deemed to be dividends for purposes of the dividends tax.
The draft Explanatory Memorandum to the DTLAB states that:
“…it is proposed that the current provisions of section 64EB(2) of the Act be amended to adjust the anti-avoidance trigger that currently requires the person paying a manufactured dividend to a person that is subject to dividends tax, to hold a share in the company declaring the dividend. The holding of a share requirement is to be deleted.”
In terms of the DTLAB it is proposed that the relevant provisions of section 64EB(2) be amended to apply where, inter alia, a person that is a resident company or a person that includes the dividend in its income:
borrow a listed share or acquire a listed share in terms of a collateral arrangement; and a dividend in respect of that share or any amount determined with reference to a dividend in respect of that share is received by or accrues to that person.
If these requirements are met, then for purposes of the dividends tax provisions, any amount paid by that person (i.e. the borrower/collateral recipient) to that other person (i.e. the lender/collateral provider) not exceeding that dividend or amount determined with reference to a dividend in respect of that share will be deemed to be a dividend paid by that person for the benefit of that other person.
The proposed amendments therefore delete the current requirement that the listed share be held by the borrower/collateral recipient.
These provisions may apply to cross-border arrangements where the lender or collateral provider is not subject to income tax on the receipt of the manufactured dividend.
As such, the payor of a manufactured dividend should take note and consider whether it may have a withholding obligation and the recipient of the manufactured payment should consider if it is liable for the dividends tax or whether it may qualify for relief in terms of a double taxation agreement and what it should to in order to obtain such relief.
In terms of the DTLAB, it is proposed that the amendments come into operation on 1 January 2021 and apply in respect of amounts paid on or after that date in respect of shares that are borrowed or acquired in terms of a collateral arrangement.
Author Craig Tonkin