Global Tax Alert | 13 May 2016

South African Treasury revisits hybrid debt rules to prevent double non-taxation

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Executive summary

On 12 May 2016, the South African National Treasury and the South African Revenue Service (SARS) hosted an industry workshop to share initial views on hybrid debt rules avoidance schemes which they perceive to be of concern and the proposed measures that will be taken.

This follows the announcement in the 2016 Budget Review, published on 24 February 2016, that measures will be taken to address double non-taxation arising in respect of hybrid debt instruments and surprisingly, that these new measures would come into effect on 24 February 2016 (i.e. retrospectively).

This Alert notes some of the issues highlighted in the workshop. It must however be noted that nothing has been finalized as yet and developments in this area should be monitored.

Detailed discussion

Hybrid debt instrument treatment

The hybrid debt rules in section 8F of the Income Tax Act reclassify interest paid by a company on debt with equity-like features (hybrid debt instrument) as deemed dividends in specie declared and paid by that company at the end of the relevant year of assessment. The dividend treatment applies in the hands of both the borrower and the lender. The interest paid is thus not deductible for income tax purposes in the hands of the company (borrower) and furthermore the borrower company is liable for dividends tax (rate of 15%). The dividends tax rate may be reduced by the applicable tax treaties.

A hybrid debt instrument is specifically defined as any interest bearing arrangement or debt with specified ”equity” features such as convertibility to shares, subordination (payment conditional on the market value of assets being equal to or exceeding liabilities) longer maturity dates (30 years), and convertible features. As a result, even what is generally perceived as a plain vanilla loan may be covered if it has the prescribed low hanging fruit features.

Issue of concern

At issue is the double non-taxation that arises in respect of a hybrid debt instrument between a resident and a nonresident. Treasury is concerned that interest paid by a nonresident to a resident in respect of a hybrid debt instrument is re-characterized as a foreign dividend and hence subject to a lower dividends tax treatment (15%) or exemption while the nonresident will claim a deduction for the payment. This encourages parties to structure their loans to specifically meet the hybrid debt instrument definition in order to benefit from the tax arbitrage.

Proposed solution

The first proposal considered is to include a proviso (exception) in the definition of a hybrid debt instrument so as to limit the re-characterization to interest that would have been deductible in South Africa. This will effectively exclude foreign interest receipts from re-characterization and will result in the interest receipt retaining its taxable character in South Africa.

The second proposal seeks to revert to the 2013 proposed draft definition of hybrid debt instrument, which effectively limits the re-characterization to resident issuers.

The BEPS alignment still considered

The OECD Base Erosion and Profit Shifting (BEPS) proposals on measures to neutralize the effect of hybrid instruments remains under consideration but are not part of the current legislative cycle agenda.

Action 2 of the BEPS Reports recommends a form of coordination rules for hybrids. That is, at a domestic level, the priority for adjusting a hybrid mismatch is given to one jurisdiction in the first instance (the “primary” rule) to deny the taxpayer’s deduction for a payment to the extent that it is not included in the taxable income of the recipient in the counterparty jurisdiction or it is also deductible in the counterparty jurisdiction. Where that jurisdiction does not invoke a response, then the counterparty jurisdiction can apply a defensive rule, requiring the deductible payment to be included in income or denying the duplicate deduction. The effect is that there is only one tax deduction for each payment and there is no deduction where there is no taxable receipt.


Companies with existing intra-group financing arrangements will need to assess the impact if the recommended rules are to be introduced. There is currently no commitment by the Treasury on whether it will reverse its position on retrospective application of the proposed changes.

Groups will also need to consider whether financing structures containing hybrid instruments will remain appropriate in the future.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Advisory Services (Pty) Ltd., Johannesburg
  • Justin Liebenberg
    +27 11 772 3907
  • Charles Makola
    +27 11 772 3146
  • Wendy Gardner
    +27 11 772 3988
  • Botlhale Joel
    +27 11 772 3775
Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London
  • Leon Steenkamp
    +44 20 7951 1976
  • Gonçalo Dorotea Cevada
    +44 20 7951 2162
Ernst & Young LLP, Pan African Tax Desk, New York
  • Dele A. Olaogun
    +1 212 773 2546
  • Jacob Shipalane
    +1 212 773 2587

EYG no. 01001-161Gbl