Ins and outs of tax on repos
• Some differences between repos and collateral arrangements
Although the overall economics of repurchase arrangements (repos) and collateral arrangements may be comparable in certain instances, the legal nature of these transactions and the SA tax implications arising in respect of these transactions are quite different.
The legal form of a repo entails a sale of the underlying shares or bonds by a party who agrees to repurchase identical shares or bonds from the counterparty at the end of a specified time period. In comparison, a collateral arrangement is a funding arrangement in terms of which funding is advanced by a lender to a borrower, with the borrower providing security in respect of the amount owed by transferring shares or bonds to the lender on an out-and-out basis. At the end of the term of the arrangement, the borrower will repay the funding and the lender will return identical shares or bonds.
From a SA tax perspective, a specific dispensation is granted for transactions entered into over SA-listed shares or certain bonds which meet the requirement of a “collateral arrangement” as defined in the Securities Transfer Tax Act (STT Act).
Broadly speaking, in respect of qualifying collateral arrangements, the collateral provider will, from an income tax and capital gains tax perspective, disregard the disposal of the shares or bonds to the collateral receiver upon inception of the collateral arrangement and disregard the acquisition of the shares or bonds from the collateral receiver at the end of the term.
The collateral receiver will similarly disregard the initial acquisition of the shares or bonds from the collateral provider as well as the subsequent disposal of the shares or bonds to the collateral provider at the end of the term.
With regard to a repo, the tax treatment thereof will depend on, for example, whether the arrangement is treated as an interest-bearing instrument in terms of section 24J of the Income Tax Act for SA tax purposes. In such cases, the seller of the shares or bonds may be required to account for interest income in respect of the arrangement, while the purchaser of the shares or bonds would need to meet various requirements to claim a deduction of “interest” in respect of the recharacterised loan.
IMPLICATIONS
Repos are not afforded the income and capital gains tax dispensation that is provided to collateral arrangements as discussed above so, the parties will need to consider the income tax and capital gains tax implications arising upon the various disposal and acquisition legs of the repo.
From a securities transfer tax (STT) perspective, an exemption from STT applies to the transfer of shares between the parties in the event that the transaction qualifies as a collateral arrangement.
No such exemption applies to a repo over shares and the parties would need to consider if any other STT exemption may apply in the circumstances.
STT is not imposed in respect of the transfer of bonds and, as such, no STT implications should arise in respect of a repo or collateral arrangement entered into in respect of bonds.
The dividend withholding tax regime addresses collateral arrangements and repos involving SA-listed shares. Manufactured payments made by a recipient of collateral to the collateral provider over the term of the collateral arrangement may be subject to dividends tax at the rate of 20% in the event that collateral arrangement spans a dividend date in respect of the underlying shares and certain other requirements are met.
In respect of repos, the seller of shares may be deemed to be the beneficial owner of the dividend for dividends tax purposes in instances where the shares are acquired and held by the purchaser of shares over a dividend date, and where such purchaser receives the dividend.
Dividends received by both the recipient of collateral and the purchaser of shares under a repo are subject to provisions which may render such dividends or portions thereof as taxable in the hands of the recipient.
Understanding the SA tax treatment of repos and collateral arrangements which are commonly used in financial markets requires careful consideration despite such transactions having comparable economic outcomes in some instances.
THE BORROWER WILL REPAY THE FUNDING AND THE LENDER WILL RETURN IDENTICAL SHARES OR BONDS