Abstract
Tax legislation traditionally distinguishes between returns on investment paid on equity and debt instruments. In the main, returns on debt instruments (interest payments) are deductible for the paying company, while distributions on equity instruments (dividends) are not. This difference in taxation can be exploited using hybrid instruments and often leads to a debt bias in investment patterns. South Africa, Australia and Canada have specific rules designed to prevent the circumvention of tax liability when company distributions are made in respect of hybrid instruments. In principle, Australia and Canada apply a more robust approach to prevent tax avoidance and also tend to include a wider range of transactions, as well as an unlimited time period in their regulation of the taxation of distributions on hybrid instruments. In addition to the anti-avoidance function, a strong incentive is created for taxpayers in Australia and Canada to invest in equity instruments as opposed to debt. This article suggests that South Africa should align certain principles in its specific rules regulating hybrid instruments with those in Australia and Canada to ensure optimal functionality of the South African tax legislation. The strengthening of domestic tax law will protect the South African tax base against base erosion and profit shifting through the use of hybrid instruments.
Highlights
Economic globalisation and the development of innovative investment instruments in modern financial markets tend to outpace the domestic legislative frameworks regulating their taxation.[1]
A taxpayer may benefit from a distribution on a hybrid equity instrument as it cannot be classified as an amount transferred "in respect of a share" as required for dividends tax liability.[108]
Shaviro and Messere state that the only sensible way of reforming tax legislation in this context is to apply a reactive piecemeal method that discourages specific transactions.[179]. This approach is evident from the tax legislation of Australia, Canada and South Africa, where rules were developed and adjusted from time to time to suit each jurisdiction's unique tax environment
Summary
Economic globalisation and the development of innovative investment instruments in modern financial markets tend to outpace the domestic legislative frameworks regulating their taxation.[1]. This article analyses the taxation of company distributions on hybrid instruments in South Africa from a functional perspective It considers the application of these rules in comparison with similar provisions in Australia and Canada to determine whether the principles applied in these jurisdictions could be adjusted for South Africa in order to protect the tax base and curb tax avoidance whilst adhering to the principles of fair taxation and stimulating equity investment. The Australian and Canadian corporate tax structures differ from that of South Africa, the rules on hybrid instruments have a similar aim as the expressed intention of the Minister of Finance in South Africa, namely to reduce the debt bias[16] in investment patterns, which is considered undesirable.[17] We consider Australia and Canada first
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