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Securities lending arrangements back in the spotlight

Monday, 04 June 2018   (0 Comments)
Posted by: Author: Jerome Brink
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Author: Jerome Brink (Cliffe Dekker Hofmeyr)

Recently the South African Revenue Service (SARS) issued Binding Private Ruling 301 dated 20 April 2018 (Ruling) which determined whether a South African sourced dividend received by a borrower in terms of a securities lending arrangement should be included in the “income” of the borrower and whether any related securities lending expenditure would be deductible.

By way of background, in a typical securities lending transaction, equities are lent to a borrower usually to facilitate the borrower to on-deliver or sell such equities within a short space of time. The borrower is then obliged to return the same security (or something similar) to the lender within a stipulated period and to compensate the lender for any distributions (ie dividends) declared on such equities during such period. Ordinarily the borrower also has to put up collateral (often cash) as security for the underlying equities lent. Such arrangements are common in the financial services industry and are entered into for a variety of reasons including for speculating (eg short selling), arbitrage and hedging purposes.

The background facts of the proposed transaction pursuant to the Ruling were similar in that the applicant, a non-resident company (Applicant) would enter into a securities lending arrangement (SLA), in terms of which it would borrow South African equities (SA Equities) from the lender, also a non-resident company (Lender). Importantly, it was assumed that the SA Equities would be borrowed prior to any interim or final dividend on the relevant SA Equity being announced or declared.

The Applicant would then on-deliver (either by way of another securities lending arrangement or collateral arrangement) the SA Equities to independent third-party entities. In anticipation of dividends being declared on the SA Equities, the Applicant would recall the SA Equities prior to the dividend record date which was on average, envisaged to be 20-30 days after the date of on-delivery.

The Applicant, as the owner of the SA Equity on the record date, would receive any dividend paid in respect of the SA Equity. Contractually, the Applicant would be required to pay a “manufactured dividend” to the Lender in terms of the SLA. To the extent that any dividend or interest would be paid on the collateral provided in terms of the SLA, the Lender would make payment to the Applicant of a “manufactured payment” in respect of the collateral. On the close-out date of the SLA, the Lender would return the collateral to the Applicant; and the Applicant would return the SA Equity to the Lender.

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