Page 139 - SAIT Compendium 2016 Volume2

PN 5/1999 Income Tax acT: PracTIce noTes PN 5/1999 PRACTICE NOTE 5 OF 1999 – TAX IMPLICATIONS OF LENDING ARRANGEMENTS IN RESPECT OF
1 Introduction
MARKETABLE SECURITIES
Issued by the
COMMISSIONER FOR THE SOUTH AFRICAN REVENUE SERVICE
In drawing up standards for clearance and settlement procedures an international working committee found that the settlement status in South African equity markets differed from the settlement status adopted by most countries internationally. The committee recommended that securities lending be encouraged as a method of expediting the settlement of security transactions. Securities lending also improves liquidity, encourages investment and increases pricing ef ciency.
Consequently, in 1996 certain amendments were effected to the Stamp Duties Act 77 of 1968 (the SD Act) and Income Tax Act 58 of 1962 (the IT Act), to introduce the concept of a lending arrangement. The amendments to the IT Act are based on the principles contained in the tax systems of various other countries, such as Australia, Canada, Japan, the United Kingdom and the United States. According to those tax systems the lender of the loaned securities is deemed still to be the owner thereof and no gain or loss arises in the hands of the lender or borrower as a result of the transfer of the loaned securities between the lender and borrower. Payments made in respect of such securities will, however, have certain tax implications.
The provisions of this Practice Note are applicable to residents and non-residents who are subject to the taxes imposed in terms of the various Acts addressed in this Practice Note.
2 Stamp duty
[Omitted]
3 Income tax
3.1 Manufactured interest
Securities lending arrangements in respect of interest-bearing instruments normally provide that the borrower will compensate the lender for any coupon or other interest received by the borrower who is the registered owner of the interest-bearing instrument during the term of the lending arrangement. The ‘manufactured interest’ is speci cally provided for in the de nition of ‘interest’ in section 24J(1) of the IT Act and is, therefore, to be treated as such for the purposes of section 24J. This provision will apply, irrespective of whether the lending arrangement is entered into for a period of less than 12 months, or not.
If all the requirements of section 10(1)(hA) of the IT Act are met, the ‘manufactured interest’ contemplated in the de nition of ‘interest’ in section 24J(1) may be exempted in the hands of the recipient who is a non-resident.
3.2 Manufactured dividends
Securities lending arrangements also normally provide that the borrower shall pay to the lender a ‘manufactured dividend’ in lieu of any dividends declared in respect of the security borrowed from the lender. The ‘manufactured dividend’ may include adjustments for the effects of Income Tax or Secondary Tax on Companies (STC). Any payment made by the borrower to the lender as a ‘manufactured dividend’ is not a dividend for Income Tax purposes and must not be treated as a dividend by either the lender or the borrower. The ‘manufactured dividend’ will constitute gross income in the hands of the lender and will not qualify for the exemption in terms of section 10(1)(k). The person who is responsible for the payment of a ‘manufactured dividend’ will only be allowed a deduction in the determination of his taxable income of the amount paid, if the amount meets the requirements of section 11(a) of the IT Act.
3.3 Secondary Tax on Companies
The lender may not reduce the amount on which its liability for STC is calculated by the ‘manufactured dividend’ received. The borrower will, therefore, not be liable for the payment of STC on the ‘manufactured dividend’ paid to the lender.
3.4 Trading stock
Although the lender of marketable securities which constitute trading stock in his or her hands, is not the registered owner of the marketable security loaned to the borrower in terms of a lending arrangement, the lender is, in substance, the owner of a marketable security of the same kind, quantity and quality as the marketable security loaned to the borrower.
In terms of section 22(4A) of the IT Act the marketable security which has been loaned in terms of a lending arrangement, as de ned, is therefore, for the purposes of section 22(4), deemed not to have been acquired by the borrower thereof. The marketable security which is returned to the lender by the borrower within the period of 12 months, as replacement for the marketable security loaned, is deemed not to have been acquired by the lender for the purposes of section 22(4).
Section 22(9) of the IT Act deems the marketable security, which has been loaned by the lender and has not been returned by the borrower at year-end, to remain closing stock in the hands of the lender. Such marketable security is also excluded from the closing stock of the borrower if he or she is in possession of such a marketable security at his or her year-end
Where a marketable security loaned does not comply with the requirements of a ‘lending arrangement’, as de ned in the SD Act, the provisions of sections 22(4A) and 22(9) will not be applicable.
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