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  • Proposed Amendment to Tax Treatment of Interest on Subordinated Debt

Proposed Amendment to Tax Treatment of Interest on Subordinated Debt

21 July 2016

By David Warneke, Head of Technical Tax

Since their amendment with effect from 1 April 2014, the hybrid debt rules contained in section 8F of the Income Tax Act have created problems for companies that are the issuers of debt that is subordinated. The consequence of the hybrid debt rule is to reclassify interest on such debt to a dividend in specie in the hands of both the issuer and the holder of the debt. The payment of the dividends tax on such dividends creates cash flow problems where the issuer is in financial distress. Furthermore, the issuer obtains no tax deduction for the interest due to the reclassification thereof to a dividend in specie.

The 2016 Budget proposed that a concession be made to exclude debt instruments subject to a subordination agreement from being regarded as hybrid debt instruments. The Draft Taxation Laws Amendment Bill of 2016 contains the wording to give effect to this proposal.

It proposes that the reclassification of the interest to a dividend in specie will not occur where the holder and the issuer of the debt are part of the same South African group of companies as defined. The definition of “group of companies” envisages an equity holding of 70% or more. The solvency and liquidity tests contained in section 46 of the Companies Act will also have to be conducted, since it is also proposed that if the company could have declared a dividend in terms of such tests, the non-reclassification will only apply to the excess of interest over this amount.

Unfortunately the legislation is not clear as to the timing of such tests, which are sure to become a burdensome administrative requirement for the issuer.

The proposal would apply with effect from the date of promulgation of the Taxation Laws Amendment Act of 2016.

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