South Africa: The Imaginary World Of Notional Vendor Finance

Last Updated: 27 March 2013
Article by Stephan Spamer

Most Read Contributor in South Africa, September 2018

Many share acquisition transactions implemented in South Africa are vendor financed, i.e. money is lent by the company to a prospective shareholder in order to enable the acquisition of shares in such company.  Particularly in the Black Economic Empowerment ("BEE") environment and share incentive trusts, it is common for companies to vendor finance the transaction, and to this end the transaction is usually structured as either a physically funded transaction, or with what is commonly referred to as notional vendor finance.  Physically funded transactions include traditional loan or preference funding structures which have established tax principles attached to them.  This article, however, focuses on the concept of notional vendor financing and the potential risk associated therewith.

A notional vendor finance transaction in the context of a BEE transaction can be illustrated as follows:

  • Vendor issues "A" ordinary shares ("the A-Shares") to BEE SPV (Pty) Ltd ("BEE SPV") at nominal value.
  • A Notional Vendor Finance ("NVF") balance is established by Vendor at the fair value of the A-Shares, less a Black Economic Empowerment ("BEE") discount.  The NVF balance will increase at a notional growth rate which may be fixed or floating.  The terms of the A-Shares will provide that the A-Shares will not carry any rights to dividends until such time as the NVF balance is reduced to nil.  In order to reduce the NVF balance, Vendor will calculate the amount of dividends which would ordinarily have been declared on the ordinary shares in Vendor, and apply such amount as a credit against the NVF balance.  Once the NVF balance is reduced to nil, the A-Shares will be converted to ordinary shares in Vendor ("Ordinary Shares").
  • Vendor will be granted a call option in terms of which it will be entitled to call and redeem a variable number of A-Shares, say 20 years from the date of issue ("the Maturity Date").  The A-Shares will be redeemed at nominal value and the number of A-Shares to be redeemed will be determined by using a prescribed formula ("the Formula").  Accordingly, immediately after the call option is exercised:
    1. Vendor will cancel the calculated number of A-Shares at their nominal value ("the Cancellation Shares").  In respect of the Cancellation Shares, Vendor will grant BEE SPV a right to subscribe for the same number of Ordinary Shares as the number of Cancellation Shares, however, such subscription will take place at market value.
    2. Vendor will procure the conversion of the balance of the A-Shares, which have not been cancelled ("the Conversion Shares") into Ordinary Shares.
  • In addition to the A-Shares and to ensure a continuous flow of dividends (trickle dividends) to the BEE Partners, Vendor shall simultaneously issue a special class of preference shares to BEE SPV at nominal value ("the Trickle Prefs").  The Trickle Prefs will:
    1. carry a fixed dividend rate that will be used to pay the BEE SPV costs and BEE SPV ordinary dividends; and
    2. be redeemed by Vendor at nominal value at the earlier of Maturity Date or the date on which the NVF balance is reduced to nil.

The typical tax consequences relating to a notional vendor finance transaction can be summarised as follows:

  • The issue of the A-Shares will not attract Capital Gains Tax in the hands of Vendor.  Furthermore, the issue by Vendor of its shares at a discount will not give rise to a deemed donation as there is no "disposal of property'" as required for donations tax purposes.
  • The creation of the NVF balance and the increase of such balance will not be subject to tax as it is a notional concept and used solely as a mechanism to determine the amount of A-Shares that Vendor will be entitled to cancel at Maturity Date.  In addition, and on the basis that the terms of the A-Shares are structured in such a manner that BEE SPV does not acquire any rights to dividends until after the conversion of the A-Shares, BEE SPV will not waive any rights and according there will be no disposal of an asset for CGT purposes.
  • The granting of an option constitutes a disposal for CGT purposes.  However, on the basis that no proceeds are received in respect of this option, no CGT liability will arise. Upon the exercise of the call option Vendor acquires a right to redeem A-Shares, the number of which is determined in accordance with the Formula, at their nominal value.  The redemption of the A-Shares will constitute a disposal for CGT purposes in BEE SPV's hands.  As BEE SPV and Vendor will ordinarily not be "connected persons" for purposes of the Act, the proceeds will be equal to the base cost and the CGT liability will be Rnil. The fact that BEE SPV is disposing of the A-Shares for nominal value should not trigger any donations tax under section 58 of the Act, provided it can be shown that the redemption price is an adequate consideration given the surrounding facts and circumstances of the transaction.
  • The conversion of shares would generally constitute a disposal for CGT purposes. However, if the time, terms and conditions relating to the conversion of the A-Shares are fixed upfront, save for the number of A-Shares to be converted which will only be established at the conversion date by virtue of the application of the Formula, the conversion is akin to a compulsory conversion.  Accordingly, no disposal will take place on the date of conversion for CGT purposes.

Substance-Over-Form Doctrine

In several cases involving tax avoidance schemes, the South African courts have considered whether a scheme is in fact what it purports to be, or whether it is a disguised transaction.  This is known as the "substance-over-form" doctrine, whereby courts will not be deceived by the form of a transaction, but to render aside the veil in which the transaction is wrapped and examine its true nature and substance. 

Because of the 2010 case of CSARS v NWK (27/10) [2010] ZASCA 168 (1 December 2010) and the court's apparent different approach to this principle, it has to be considered whether the NVF structure could be attacked in future under the "substance-over-form" doctrine.   The principles laid down in the NWK case can be summarised as follows:

  • A taxpayer must have two different intentions that is, his real intention vs. the simulated intention.  The real intention will always override the simulated intention, and where there are two intentions, the courts will disregard the simulated intention.
  • In determining the real intention the mere production of agreements does not prove that the parties genuinely intended them to have the effect they appear to have. Put differently, the agreements do not always reflect the real intention. To determine the real intention all the facts and surrounding circumstances must be considered.
  • Invariably because even a simulated transaction requires an intention, it is necessary to determine the commercial sense of the transaction, that is, its real substance and purpose. If the purpose of a transaction is only to evade tax, then it will be regarded as simulated.
  • In determining the commercial sense of the transaction the court will look at:
    1. whether there is an underlying difference or implicit agreement between parties;
    2. what the normal characteristics of similar transactions are;
    3. what the economic substance of transaction is;
    4. what the net effect of the transaction is; and
    5. what else did the transaction achieve other than the tax benefit.

The NWK case has confirmed that the onus is on the taxpayer to prove that the transaction is not a simulated transaction if challenged by SARS. Accordingly, the onus will be on Vendor to prove that:

  • The real intention of the parties was not to fund the acquisition of the A-Shares through a growth-bearing instrument. If the intention was to fund the purchase of the A-Shares through an interest-bearing instrument, the courts will give effect to that real intention and regard the notional interest as actual interest.  The fact that the written agreements do not reflect an interest-bearing arrangement cannot be relied upon as indicative of the real intention. However, if the notional interest component is reflected in these agreements and or any other documents of Vendor giving effect to the transaction (e.g. the articles of association), it could indicative of the real intention being the funding of the acquisition of the A-Shares through an interest-bearing instrument.
  • If it can be shown, through evidence, that Vendor did not have the intention to fund the acquisition of the A-Shares through an interest-bearing instrument, the courts will consider what the commercial rationale of the transaction is and, more specifically, whether the purpose of the transaction was to evade tax.  
  • Even it can be shown that the NVF does not include a notional interest rate; the structure could contain a dividends tax benefit as loans from companies to its shareholders are in certain instances still regarded as deemed dividends and attract dividends tax.   Accordingly, if dividends tax is not payable as a result of the NVF there is a substantial tax benefit in using the NVF, and even more so if the structure includes a notional interest rate.
  • Following the NWK case, Vendor will have to be able to demonstrate convincingly that there is a real and sensible commercial purpose for using the NVF structure, other than the tax benefit referred to above.

Considering that:

  • in our experience vendor finance transactions are generally structured through the use of preference shares or loan funding;

  • the economic substance of transaction is to fund the purchase of the A-Shares;

  • the net effect of the transaction is that Vendor is funding the acquisition of the A-Shares through a return that exceeds the market value of the A-Shares at the date of issue; and

  • the transaction includes the objective of obtaining a tax benefit,

in our view there is a risk that SARS will be able to demonstrate that the NVF is a disguised loan funding structure, thereby imputing the notional interest as taxable income in Vendor's hands.

It is noted that Binding Private Ruling 103, which was issued on 20 May 2011, contained a notional loan funding structure.  However, because this Ruling was issued on the set of facts of that particular case and did not specifically address the application of the "substance-over-form" doctrine, because of the risks referred to above it is recommended that this Ruling should not be generally applied to all NVF transactions.  Instead, it is recommended that all NVF transactions be considered carefully to ensure that any potential risks are mitigated.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions