Financial Services Editor

THE South African Revenue Service (SARS) is poised to close the net further on structured finance transactions in a move that could also affect the way empowerment deals are put together.

A draft notice published by Finance Minister Trevor Manuel has identified certain structured finance transactions which companies will be required to report to revenue.

Section 76A of the Income Tax Act forms part of the reportable arrangements legislation that was introduced in 2003 but has yet to be gazetted. The notice setting out the arrangements is open for comment until the end of the month.

In terms of the arrangements, deals involving redeemable preference shares and convertible debt instruments will be affected. Redeemable preference shares include shares the issuing company has the right to buy back, and generally provide the holders with a specified dividend. Dividends received are not taxed.

In the case of convertible debt instruments, the interest payments are tax deductible. On conversion to equity, the borrower is no longer obliged to repay the amount borrowed and the lender receives tax-free dividends.

The publication of the notice follows Manuel's announcement in last year's budget that laws would be introduced to deal with the tax treatment of structured finance loans, notably convertible loans and other hybrid financial instruments.

According to Peter Dachs, tax partner at Sonnenberg Hoffmann Galombik, the proposed arrangements, which will take a closer look at how deals are structured using these instruments, could be introduced early this year.

"Basically it affects all financial institutions and corporates who have entered into transactions using redeemable preference shares or convertible debt instruments which are redeemable within 10 years," Dachs said.

Revenue says section 76A is being introduced to address current limitations in the Income Tax Act:

"(It) is designed, inter alia, to address the deficiencies in this regard and to act as an early warning system to the commissioner as to the type of tax structuring taking place in the market."

Dachs said the change would "affect a lot of the empowerment funding transactions, as a lot of them are structured using redeemable preference shares. They will become reportable, with onerous disclosure requirements."

He said it was hoped that the SARS would go easy on empowerment deals using preference shares.

Although they would still be required to report such transactions, they might not be pursued by the receiver.

Last year, Absa's empowerment deal, in which it sold a 10% stake, was structured by issuing redeemable preference shares with attached options to the Batho Bonke consortium. Dividends earned on the shares will be used to help service the debt raised to fund the deal.

Revenue said there should be no negative effect on empowerment deals .

But Dachs said the new rules introduced an element of uncertainty.

"If (SARS) thinks there is an element of tax structuring, they can use their anti-abuse rules to reclassify the dividend income as something that is taxable," he said. But it was unclear which deals "will be viewed as tax aggressive".

Jan 18 2005 07:09:01:000AM Stephen Gunnion Business Day 1st Edition