Securities Transfer Tax (STT) is levied in terms of the Securities Transfer Tax Act Number 25 of 2007 (STT Act) and is the often forgotten poorer cousin of the better known and publicised taxes such Income Tax, Capital Gains Tax and Value-Added Tax. The main reason for this is that STT is levied at 0.25% of the taxable amount whereas Income Tax (40%-28%), CGT (20%-10%) and VAT (14%) are levied at much higher rates. Generally, STT in an M&A transaction is merely factored in as a cost to the purchaser acquiring the shares in a company and given its small percentage is not usually a deterrent to the transaction. However, in certain industries, STT can be a significant cost and play a real role in the viability of transactions and thus the industry. Perhaps the industry that has the potential to be affected the most by STT is the derivatives industry, and more specifically, those industry participants whose underlying exposure relates to shares in companies.
STT is levied in terms of section 2 of the STT Act in respect of every transfer of any security issued by, inter alia, a company at a rate of 0.25% of the taxable amount (generally the cost of the shares). A “security” is in turn defined as, inter alia, any share or depositary receipt in a company or any right or entitlement to receive any distribution from a company. Section 8 of the STT Act contains a number of exemptions. For the purposes of this article a notable exemption is contained in section 8(1)(q) which provides that the transfer of a security is exempt from STT “if the person to whom that security is transferred is a member who has purchased the security for the account and benefit of that person.” A member is any person who is an authorised user as defined in section 1 of the Securities Services Act, 2004 and includes members of a stock exchange (brokers). In short, where a broker purchases a share for its own “account and benefit” then the broker will be exempt from STT in respect of such acquisition.
There are certain complex transactions which are entered into by brokers which require an in-depth analysis as to the application of the exemption in section 8(1)(q). However, generally speaking, it is well accepted that where brokers acquire shares as principal, the exemption will apply.
In the recently released budget review, on page 194, National Treasury has intimated that it is going to clarify the broker exemption (ie. section 8(1)(q)). To quote the extract from Annexure C:
“Members of a stock exchange (brokers) are exempt from securities transfer tax. While the exemption has existed for years, its initial intent is not entirely clear. Upon review of industry practice, it appears that the exemption is used by brokers as market makers for shares to enhance liquidity and to facilitate the role of banking institutions. It is now proposed that the exemption be revised to clarify that it applies solely to players engaged as market makers.”
Unfortunately, it is not clear from Annexure C as to what the clarification aims to achieve and a concern exists amongst industry participants that “the baby may get thrown out with the bath water.”
Let’s take a typical example of a transaction where the exemption is important and probably vital. The market for contracts-for-difference (CFDs) has exploded since the 1990’s. A CFD is a contract between a trader and a CFD provider, who will at the close of the contract, exchange the difference between the opening price and the closing price of the underlying index, share, commodity, multiplied by the number of specified CFD contracts. A CFD differs from the traditional trading methods as it is not a purchase of the underlying investment, such as a share, but rather a trade on the speculated price movement (up or down) of such underlying investment. The main purpose of CFDs is the ability to be able to trade higher volumes than traditional trading while using less initial capital ie. leveraging or gearing. CFDs may be written by CFD providers who may take a naked position in the underlying share but generally the CFD provider will hedge its exposure to the CFD by holding or short-selling the underlying shares. This is true for almost any derivative position where somewhere down the chain of derivative contracts is a person holding the underlying investments which ultimately hedge out the exposure under the derivative contract.
The proliferation of trading in CFDs, options, warrants, single stock futures and indices, has resulted in a significant increase in the trade of the underlying investments including shares. These shares are being acquired by brokers to hedge their exposure under the CFDs or other derivative contracts which they have entered into with banks or traders. It is at this point worth mentioning that the long term view of a derivatives trader can be hours or minutes as opposed to years and as a result thereof, these derivative contracts can be closed out and re-entered into numerous times in a day resulting in the underlying broker having to acquire and dispose of the underlying shares frequently. Obviously, were the broker to be subject to STT on the acquisition of the underlying shares each time that those shares were acquired then the trading costs would increase significantly, such cost having to be passed on to the ultimate trader in the derivative concerned which would result in reduced trading and therefore reduced liquidity on the JSE.
As we are all aware, liquidity is an essential feature to the functioning of an efficient market, liquid markets attract much needed investment including foreign investment and plays a significant role in reducing the ultimate cost of capital.
I prefer to comment on the effect of the proposed amendments to the legislation once having had sight of the draft amendments which are to be contained in the Revenue Laws Amendment Bill which is expected to be released some time in May of 2011. Let us hope that the amendments do not impact negatively on the efficient functioning of the derivatives market which has taken many years to build and which can be severely impacted by the stroke of a legislative pen. No doubt our market savvy friends in the National Treasury will consider the impact on the market in addition to revenue collections before putting pen to paper.