Scrip lending and VAT in South Africa

By Seelan Muthayan, Partner

Scrip lending presents a recurring VAT difficulty because the commercial description of a “loan” does not align neatly with the legal effect of the arrangement. Title to the securities passes to the borrower, who must later return equivalent securities. This has long complicated the VAT characterisation. The issue became more significant when SARS moved away from Practice Note 5/1999 and adopted a new interpretive position in Binding General Ruling (VAT) 62 (BGR 62), requiring vendors to reassess the treatment of lending fees, input tax recovery and related compliance.

The commercial structure of a scrip-lending arrangement

In a typical scrip-lending arrangement, one party transfers securities to another on terms requiring the borrower to return securities of the same class and quality at a later date. During the term, the borrower holds legal title and usually provides collateral to mitigate counterparty risk. The commercial bargain is reflected in a lending fee for access to the securities and, where relevant, compensatory payments for dividends or interest that would otherwise have accrued to the lender. Those compensatory amounts are commonly described as manufactured dividends or manufactured interest.

The legislative framework and the earlier SARS view

The analysis starts with the definition of “financial services” in section 2(1) of the VAT Act. Depending on the form of the arrangement, the transfer of debt securities, equity securities or the provision of credit may fall within that definition, and financial services are generally exempt under section 12(a). The difficulty lies in the proviso to section 2(1), which withdraws the exemption to the extent that the consideration takes the form of a fee, commission, merchant’s discount or similar charge. Under Practice Note 5/1999, SARS accepted that the arrangement involved an exempt financial service, but treated the separate lending fee as taxable because it fell within the proviso. Manufactured dividends and manufactured interest were generally treated differently and remained part of the exempt financial service.

Binding General Ruling 62 and the shift in administrative treatment

That position changed with BGR 62, issued on 12 December 2022 and effective from 1 April 2023. SARS now treats the arrangement as falling within section 2(1)(f), which deals with the provision of credit where money or money’s worth is advanced in return for a greater amount being repaid later. On this view, the transfer of the securities and the return of equivalent securities are not taxed separately, but form part of a single exempt financial service. SARS also regards the lending fee as consideration for that exempt service, rather than for a separate taxable service. On that basis, no output tax is levied on the fee.

Manufactured payments and areas of continuing uncertainty

The ruling defines the scrip-lending fee broadly enough to include manufactured payments, suggesting that compensatory amounts linked to dividends or interest follow the same exempt treatment. That creates a more coherent administrative outcome. Even so, a legal question remains whether a separately identified charge for the temporary use of securities could still fall within the proviso to section 2(1), particularly where the pricing reflects a distinct commercial charge.

Practical implications for VAT vendors

For vendors, the immediate consequence of SARS’s revised approach is that receipts under a qualifying scrip-lending arrangement will generally be treated as exempt rather than standard-rated. That may affect input tax entitlement and apportionment where the lender makes both taxable and exempt supplies. The drafting of the underlying agreements is therefore important: transaction documents should clearly separate amounts forming part of the lending arrangement from consideration for any distinct taxable services.

Concluding observations

The South African VAT treatment of scrip lending now rests on a materially different administrative footing from the position reflected in Practice Note 5/1999. Since 1 April 2023, SARS has taken the view in BGR 62 that the arrangement falls within section 2(1)(f) and that the related consideration forms part of an exempt financial service under section 12(a). That reduces output tax exposure on lending fees, but may affect input tax recovery and VAT governance. Vendors should therefore ensure that their documentation, accounting treatment and apportionment methodology align with SARS’s current approach, while remaining alert to the interpretive questions that continue to surround the proviso to section 2(1).