The concept of a “collateral arrangement” was inserted into South African tax legislation and came into force on 1 January 2016. The provisions contained in the Income Tax Act, 1962 (“Act”) and the Securities Transfer Tax Act, 2007 (”STT Act”) effectively provide for income tax and securities transfer tax (“STT”) relief in respect of collateral arrangements, ie. where an outright transfer of collateral of, inter alia, South African equities is executed in respect of an amount owed.

This dispensation was provided in addition to that provided for in respect of securities lending arrangements and, in terms of the 2015 Explanatory Memorandum on the Taxation Laws Amendment Bill was introduced for the purposes of:

  • assisting the financial sector industry in meeting regulatory changes and demands;
  • increasing the availability of high quality liquid assets, thereby increasing market liquidity;
  • reducing transaction costs and market pricing because of the ability to rehypothecate collateral and reduce tax costs; and
  • making South Africa more attractive as an investment destination.

2021 Budget Speech

In the 2021 Budget Speech which was delivered in February 2021, the matter of collateral arrangements was raised. The 2021 Budget Review stated that in issue was the rehypothecation of collateral, ie. where the collateral taker reuses collateral received for trading or as security for its own borrowing through a tax‐neutral collateral arrangement.

It was proposed that changes be made to the legislation to clarify the policy intention that further rehypothecation of the collateral received by the collateral taker can only form part of subsequent collateral arrangement transactions.

2021 Draft Taxation Laws Amendment Bill

The Draft Taxation Laws Amendment Bill 2021 (“2021 draft TLAB”) was published in July 2021 and indicated the proposed amendments to the collateral arrangement definition contained in section 1 of the STT Act.

In essence, these proposed amendments restrict the manner in which the recipient of collateral is able to rephypothecate such collateral. In particular, in terms of the proposed changes, the recipient of collateral is only permitted to

  • hold the collateral for the duration of the collateral arrangement; or
  • utilise the collateral by providing same as security in respect of an amount owed (ie. a further collateral arrangement). Any transfer of the collateral by the recipient thereof in a manner other than in this respect, would result in the entire underlying collateral arrangement being excluded from the tax dispensation.

In addition, the proposed changes require a contractual undertaking by the collateral recipient to this effect.

In terms of the 2021 draft TLAB it is proposed that the amendments come into operation on the date on which the 2021 draft TLAB was published for public comment (ie 28 July 2021) and apply in respect of any collateral arrangements entered into on or after that date.

The Draft Explanatory Memorandum on the 2021 draft TLAB states that the use of collateral for purposes other than subsequent collateral arrangements is against the policy rationale for the introduction of these provisions and could result in the avoidance of STT or capital gains tax. It is proposed that changes be made to the legislation to clarify the policy intention that the shares or bonds transferred as collateral in terms of a collateral arrangement may subsequently only be used for collateral and not be used for trading or in other financial transactions.

Looking forward

Due to the impact of the proposed amendments on the financial industry, representations were made by various parties.

Based on recent interactions with SARS and National Treasury we anticipate that further amendments will be made to the collateral arrangement definition. The ability of the collateral recipient to rephypothecate the collateral may be retained without having an impact on the tax treatment of the underlying collateral arrangement it being understood that the tax implications of the rehypothecation would need to be separately considered and accounted for by the recipient of the collateral. In addition, it appears that the requirement that the relevant contractual undertakings be made by the collateral recipient is also under review, given the practical difficulties in amending market standard documentation.

In our view it is likely that the position in respect of collateral arrangements, as well as the effective date of any proposed changes in this respect, will soon be clarified in the response document to the 2021 draft TLAB.

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.