The securities lending industry has seen many changes to the taxation of share lending arrangements in South Africa during the last couple of years. In particular, since the introduction of dividends tax on 1 April 2012, the provisions in the Income Tax Act (the “Act”) which relate to the income tax and dividends tax treatment of dividends received by borrowers of JSE listed shares and payments made by such borrowers have been regularly amended, often with retrospective effect. The Draft Taxation Laws Amendment Bill which was released on 17 July 2014 (“2014 Draft Bill”) is no exception, and again contains changes to the dividends tax provisions relating to payments made by such borrowers.
In order to place the proposed amendments by the 2014 Draft Bill in context, the income and dividends tax treatment of dividends on JSE listed shares borrowed and related payments made by borrowers are summarised below. The summary only deals with amendments to the income and dividends tax treatment relevant for securities lending arrangements in respect of JSE listed shares where such shares are borrowed after the announcement or declaration of a dividend.
Securities lending arrangements would typically result in a transfer of the beneficial ownership of the securities from the lender to the borrower and the borrower may accrue the dividend on the listed shares to the extent that such borrower holds the shares on record date. However, the borrower would not necessarily accrue the dividend as it may have on-delivered the shares to another party (e.g. a purchaser).
In instances where the borrower has accrued the dividend, the income tax treatment of such dividend is relevant. Although dividends which are declared by South African tax resident companies are generally exempt from income tax in the hands of the recipient, since 1 April 2012 such dividends would not be exempt from income tax in the hands of a borrower if the borrower is a company. This is due to one of the provisos to the exemption in section 10(1)(k) of the Act which provides that dividends received by a company in respect of a share borrowed by that company would not be exempt from normal tax (i.e. income tax). The borrower would be able to deduct expenditure incurred by it to the extent that such payments comply with the so-called general deduction formula in section 11(a) read with section 23(g) of the Act.
In addition to the income tax treatment of the dividend in the hands of the borrower, the dividends tax treatment of the dividend also requires consideration.
As noted above, from 1 April 2012 dividends declared by South African resident companies are subject to dividends tax at the rate of 15%. If the dividend is a cash dividend, the dividend’s tax liability is that of the beneficial owner of the dividend and the payor of the dividend has a withholding tax liability, subject to certain exemptions. If the dividend were to consist of a distribution of an asset in specie, the liability is on the company declaring and paying the dividend. The dividends tax is further levied on foreign dividends (as defined in the Act) paid by a foreign company (i.e. a non-resident company) if the share in respect of which the dividend is paid is a listed share (i.e. listed on the JSE) and it is a cash dividend.
Section 64F(1) of the Act contains various exemptions for beneficial owners of dividends. For example South African tax resident companies are exempt from the dividends tax, dividends which have been included in a taxpayer’s “income” (as defined) are exempt from dividends tax and foreign dividends which are subject to the dividends tax and are received by a non-resident are exempt from dividends tax.
Therefore, to the extent that the borrower in a securities lending arrangement is a South African resident company or has included the dividend in its income in doing its normal tax calculation, the dividend such borrower receives would be exempt from dividends tax. Similarly, where the borrower is a non-resident company and the JSE listed share was issued by a non-resident company, the borrower would be exempt from dividends tax.
However, section 64EB(2) of the Act was introduced with effect from 1 September 2012 and it was applicable to transactions entered into on or after that date and to amounts paid on or after 1 October 2012 in respect of transactions entered into before 1 September 2012. It is provided that where a person that is a beneficial owner of a dividend contemplated in section 64F, borrows a share in a listed company from another person and a dividend is either announced or declared before that share is borrowed, so much of any amount paid by the person in respect of such borrowed share as does not exceed the amount of the dividend, is deemed to be a dividend paid for the benefit of that other person.
Therefore, section 64EB(2) was aimed at levying dividends tax on manufactured dividends paid by borrowers of listed shares. This section was intended as an anti-tax avoidance section in order to levy dividends tax on manufactured dividend payments in transactions where the securities lending arrangement is entered into by, say a non-resident lender, after announcement of a dividend but before record date in order to enable a resident borrower to claim an exemption from dividends tax by being the beneficial owner of the dividend on record date.
On 12 December 2013 the Taxation Laws Amendment Act, No 31 of 2013, was promulgated which introduced amendments to section 64EB(2). These amendments were deemed to come into operation on 4 July 2013 and applied to amounts paid on or after that date. The amendments to section 64EB(2) removed the “beneficial owner” requirement in that they applied where a person listed in section 64EB(2)(a) (such as a resident company or a person that included the dividend in its income) borrowed a share in a listed company and a dividend was either announced or declared before that share is borrowed. If the amended section 64EB(2) applied, the dividend which was announced or declared before the share was borrowed, is deemed to have been paid by the borrower to the lender and the lender is deemed to have received a dividend equal to the amount paid by the borrower to the lender.
The amended section 64EB(2) effectively results in the dividends tax liability being placed on both the borrower (or beneficial owner if another party accrued the actual dividend) and the lender. As noted above, the borrower would have been the beneficial owner of the dividend if it held the shares on record date. As the provisions of section 64EB(2) deem the borrower to have paid the dividend, it picks up a withholding obligation and a secondary liability for the dividends tax on such payment. The provisions apply notwithstanding the fact that the borrower may not have been the beneficial owner of the dividend. As such, in instances where say, a resident borrower entered into a securities lending arrangement over JSE listed shares with a non-resident lender after the date on which the dividend was announced it would have a dividend tax withholding obligation on payments made to the non-resident lender irrespective whether it accrued the dividend or not.
The 2014 Draft Bill now proposes to amend the provisions of section 64EB(2) which amendments, if promulgated in their current form, will have been deemed to come into operation on 4 July 2013 and will apply in respect of amounts paid on or after that date. The latest proposed amendments will result in deeming the amount paid by the borrower to the lender to be a dividend paid for the benefit of the lender. As such, it changes the section by removing the reference to the dividend which was declared by the listed company being deemed to be paid by the borrower and replacing it with deeming the manufactured dividend to be a dividend paid by the borrower. It still does not require the borrower to the beneficial owner of the dividend which was declared by the listed company. As such a borrower can still pick up a withholding obligation notwithstanding that it did not accrue the dividend.
In the light of the above, borrowers and lenders of JSE listed securities should ensure that they understand the tax implications of the lending arrangements that they enter into and keep an eye on the tax amendments as these may impact on current and previous transactions.