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The tax implications of securities lending
South African residents are taxed on their worldwide income. In particular, the Income Tax Act includes in “gross income” any amount received or accrued that is not of a capital nature. Taxand South Africa discusses securities lending and the tax implications arising from the taking of cash collateral.
Where a taxpayer receives collateral from another party under a securities lending agreement in the form of an outright transfer of cash, it is necessary to consider if such amount of cash collateral should be included in the taxpayer’s “gross income”.
On the basis of the principles established in the Genn case (supra) where the Appellate Division held that borrowed money is not received or accrued by the borrower within the meaning of such terms in the definition of “gross income”, the receipt of cash collateral should be no different.
As is the case with a borrower of money, the recipient of cash collateral is obliged to return the collateral once the collateral giver has discharged its obligations in terms of the securities lending agreement. Therefore where a taxpayer receives cash collateral under a securities lending agreement, such amount should not be included in the taxpayer’s gross income.
In addition, a further requirement for inclusion in the gross income definition is that such amount is not of a capital nature. The cash collateral should therefore be received as part of a scheme of profit making in order for it to qualify as gross income. As the recipient of the cash collateral is typically required to pay interest on the cash collateral to the collateral giver, the mere receipt of the collateral would not in itself be an indication of a revenue intent.
If contrary to what is set out above, the cash collateral is included in a taxpayer’s gross income, then the taxpayer should be entitled to deduct the value of its obligation to return the cash collateral. To the extent that this is in the same year of assessment, the taxpayer should be neutral on the receipt of the collateral. On this basis the receipt of cash collateral on an outright transfer basis should be no different from a tax perspective compared to the receipt of collateral under a cession in securitatem debiti.
Also published in Thomson Reuters' Taxnet Pro, 15 November 2013
Where cash is pledged and ceded in securitatem debiti, procedural steps must be taken in order to take over the cash collateral, which steps may result in delays and losses for the secured party. Given that the tax treatment of cash collateral should be the same whether transferred outright or ceded in securitatem debiti, parties to securities lending agreements would be prudent to continue receiving cash collateral by outright transfer.