Under the anti-tax avoidance provisions, interest costs on hybrid debt are not deductible and constitute a cash dividend subject to a dividend tax of 20%. Of the three types of hybrid debt, one is triggered when a subordination agreement is entered into to carry forward the taxpayer`s debt. To speak to an MMS tax advisor for personalized advice on your subordination agreements, visit www.mmsgroup.co.za/tax-consultant/ or contact us on 011 672 0020 or 021 410 8709. In some cases, including an audit certificate confirming that the deferral is due to technical insolvency, anti-tax avoidance provisions may not apply. However, it is strongly recommended, especially in light of government interventions to support distressed businesses, to use tax advisory services before assuming that a subordination agreement would satisfy the SARS audit. Subordination agreements may have hybrid debt characteristics – debts with equity characteristics – and may therefore fall victim to anti-avoidance provisions (of the Income Tax Act No. 58 of 1962), which aim to nullify the effects of hybrid debt instruments. Subordinated debt has the advantage that the ownership share in the company is not diluted by additional equity. The money raised can be used for any purpose permitted by the terms of the loan agreement, but generally companies use subordinated debt to finance growth. For example, a retail business might use subordinated debt to add new stores. Banks that hold senior corporate debt may view subordinated debt positively because they increase the total assets on the balance sheet that are available to repay debt in the event of a company`s bankruptcy.

On the other hand, subordinated debt carries a higher risk for lenders and therefore tends to have high interest rates. In addition, management must ensure that the company`s cash flow is sufficient to service the additional debt. In this article, we explain the subordinate agreements where they have value and discuss THE SARS position on these vehicles in light of hybrid debt. We strongly recommend that tax advisory services be used for the reasons listed below before implementing subordination protocols. Interest on subordinated debt securities must be paid regularly. For example, bond interest payments are usually due every six months. Interest is an expense, not a liability. Subordinated interest on debt is recognised as an expense in a company`s income statement and not in the balance sheet. Interest on subordinated debt is a tax-deductible expense in the income statement. In addition, the money received does not increase the company`s equity, which means that it is not income and therefore there is no tax payable that must be reported in the income statement. The balance sheet lists the assets of a company, followed by its liabilities and the equity of its owners or shareholders.

As borrowed money, subordinated debts go to the Liabilities section. Current liabilities are listed first. As a general rule, senior debt is then shown on the balance sheet. Subordinated debt securities are listed last in the “Liabilities” section in descending order of priority. When a business takes out a loan or sells bonds that are subordinated debts, the money or property acquired with the borrowed funds is added as additional capital and included in the “Assets” section. If a business becomes insolvent, creditors are paid first before owners receive money. Debts owed by the company are ranked, with the highest priority or senior debt being paid first. Lower-priority debt securities are subordinated to senior debt because they are paid only after the reduction of senior debt in the event of the liquidation of the business.

Each debt is subordinated to all other debts with a higher priority. For example, a secured bank loan is a senior debt and the bonds are subordinated to it. A business needs capital to grow, but owners may be reluctant to dilute their stake in the company by issuing shares to raise funds. In the meantime, banks may be reluctant to take the risk of lending money to a small or medium-sized business. In these situations, subordinated debt is a financing option that your business may want to use to raise the capital it needs if other sources are not available. .