In brief

As South Africa (‘SA’) 's financial markets anticipate the shift from the Johannesburg Interbank Average Rate (‘JIBAR’) to the SA Rand Overnight Index Average (‘ZARONIA’), market participants must prepare themselves for notable operational and tax implications. This change is a segment of the global initiative aimed at improving the reliability and resilience of financial benchmarks, addressing the prevalent worries over the dependability of conventional interbank rates. The tax industry has been exploring the related tax consequences that taxpayers will need to address during this transition.

Background

In the evolving landscape of global finance, reference rates serve as the backbone of countless financial instruments, from corporate loans to complex derivatives. These benchmark interest rates—such as JIBAR, London Interbank Offered Rate (‘LIBOR’), Euro Overnight Index Average (‘Eonia’) and Euro Interbank Offered Rate (‘Euribor’)—are critical in determining the cost of borrowing and the valuation of financial contracts. However, in the wake of manipulation scandals and declining market relevance, the global financial community has embarked on a sweeping transition toward more transparent and transaction-based alternatives.

The transition to alternative reference rates marks a pivotal development in global finance, addressing the significant vulnerabilities that plagued traditional benchmarks. Key reference rates like LIBOR, JIBAR, and Eonia faced intense criticism for their susceptibility to manipulation, which cast doubts on their credibility and reliability.

At the heart of these challenges was the methodology used to determine these rates. Traditionally, benchmarks were often based on estimates rather than actual transaction data, opening the door to potential manipulation. Banks could potentially influence their submissions to reflect more favorable borrowing rates, distorting the true cost of borrowing and lending. This manipulation was most evident during the early 2000s and became glaring during the global financial crisis when banks reported borrowing at misleadingly lower rates, therefore masking their financial instability.

This prompted a shift towards more robust, and transparent alternatives. The United States moved from LIBOR to the Secured Overnight Financing Rate (‘SOFR’), the UK to the Sterling Overnight Index Average (‘SONIA’), and Europe shifted from Eonia to the Euro Short-Term Rate (‘ESTR’). The alternative rates are all underpinned by similar principles of transparency and resilience. These alternative rates make use of extensive actual transaction data from the financial market thereby reducing the scope for artificial influence. Notwithstanding the ESTR, Europe has maintained the use of Euribor albeit, with enhanced methodologies to boost its credibility and transparency in line with modern standards. This highlights the importance of reference rates aligning with contemporary benchmarks.

Collectively, these reforms signal a transformative era in financial markets, fostering increased confidence through more reliable and transparent reference rates. By prioritizing actual market transactions, these new benchmarks guard against manipulation and enhance the financial system's integrity—essential foundations for future financial stability and investor trust.

SA has also made momentous strides in aligning to contemporary benchmarks and has shown a proactive embrace of a more credible and stable reference rate environment. The Financial Stability Board (‘FSB’) recommended improvements in 2014, prompting SA to evaluate its own benchmarks under the guidance of the SA Reserve Bank (‘SARB’) and the Market Practitioners Group (‘MPG’). Their recommendation to adopt ZARONIA, an overnight risk-free rate, will see JIBAR be phased out by 2026, and we see key market players already taking steps in this regard as evidenced by Standard Bank’s issuance of SA’s first ZARONIA-linked bond.

As a money market term reference rate used in SA, JIBAR is constructed using quoted rates for Negotiable Certificates of Deposits by JIBAR contributing banks. It was introduced in 1999 and has since been used in the calculations of interest and other payments under many loans, derivatives, bonds and financial transactions. The calculations are published daily across a range of maturities by the SARB based on submissions from the JIBAR contributing banks.

The move from JIBAR, a term rate incorporating a risk premium, to ZARONIA necessitates modifications to existing financial instruments. These changes, while anticipated to be minor and maintain the original economic substance of transactions, raise related tax questions. The transition affects both issuers and holders of JIBAR-referenced financial instruments across various industries, impacting both corporate and individual taxpayers.

ZARONIA, unlike JIBAR, is a near-risk-free rate, lacking the built-in credit and term premium components that JIBAR includes, resulting in a generally lower rate compared to JIBAR. As a result, transitioning from JIBAR to ZARONIA necessitates a credit adjustment spread (‘CAS’) to compensate for the additional yield investors might require due to credit risk, ensuring economic equivalence is maintained. Since this adjustment aims to maintain economic equivalence, no substantial modification or derecognition of contracts is expected due to the transition. New contracts are typically exempt from credit adjustments, as the terms can be negotiated by both parties at inception.

Tax and exchange control considerations

The tax implications are still being debated within the tax industry and will hinge on various factors, which we will briefly explore in this article. Unless otherwise indicated, references to sections in this article are to sections of the Income Tax Act No 58 of 1962 as amended (‘the Act’) and references to paragraphs are to the paragraphs of the Eighth Schedule to the Act.

Disposal of an asset

The definition of an ‘asset’ in the Eighth Schedule is broad, encompassing any right or interest in property, whether movable, immovable, corporeal or incorporeal. In the context of loan instruments, a lender's right to receive interest is considered an asset for Capital Gains Tax (‘CGT’) purposes. Courts have established that rights or interests with monetary value, such as contractual rights, qualify as assets.

When amendments to financial instruments occur, especially in the context of rate reform, it becomes important to determine if such changes result in a ‘disposal’ of an asset under the Eighth Schedule, which could trigger tax implications. A disposal, under paragraph 11(1) of the Eighth Schedule, encompasses events leading to the creation, variation, transfer, discharge, or extinction of an asset. The transition from JIBAR to ZARONIA raises questions about whether such changes represent a ‘variation’ or ‘discharge’ under the Eighth Schedule.

The SARS1 Comprehensive Guide to CGT (Issue 9) suggests that variations should involve a change in ownership or the property's base cost to constitute a disposal. Therefore, modifications driven solely by rate reform, without substantial changes to the economic characteristics or rights, should not generally constitute a ‘disposal’ for CGT purposes. Conversely, substantial changes beyond rate reform requirements may result in a disposal if they significantly alter the asset's economic characteristics.

Taxpayers are advised to document their intentions when varying contracts, demonstrating compliance with market standard practices to merely reflect rate reform adjustments. This approach aligns with ensuring that economic equivalence is maintained, mitigating the risk of tax implications related to asset disposals under the Act.

Section 24J interest

Section 24J covers interest-bearing arrangements and the tax principles of incurral and accrual of interest, providing a framework for how interest should be treated for tax purposes. The section, in simple words, spreads interest, including any premium or discount, over the term of a financial instrument using the 'yield to maturity' or accrual method. Changes like rate reforms may necessitate redetermination of the yield to maturity with the effect that the new interest amounts are spread going forward over the remaining term of the instrument. Under section 24J, an alternative calculation method is permitted, aligning with IFRS standards, provided it substantially mirrors the yield to maturity outcomes, defined as achieving approximately a 90 percent correlation.

Changes in benchmark interest rates, such as JIBAR to ZARONIA, will therefore require a recalculation of the section 24J interest to be taxed or deducted going forward, reflected in its effective interest rate.

Other considerations would include an assessment of the impact on interest rate swap and preference share agreements which references JIBAR in the yield, as well as the possible impact on the interest limitation and hybrid interest rules provided for in the Act.

Transfer pricing

The pending change from JIBAR to ZARONIA has transfer pricing implications for multinational enterprises (‘MNEs’) that have intercompany financing arrangements tied to JIBAR. As such, MNEs would have to evaluate the impact on existing transactions and policies and prepare a transition plan that addresses the anticipated impact from JIBAR’s discontinuation.

MNEs that price intercompany financing transactions or have financing structures e.g., inhouse banks, cash pools (although cash pools are not that common in SA), and back-to-back lending arrangements based on JIBAR will be impacted by the move to ZARONIA. While many of the aspects of these changes will depend on how capital markets adopt and adapt to these changes, we discuss below some of the key transfer pricing items that require attention before JIBAR is discontinued.

Intercompany agreements

Parties to existing intercompany loans with JIBAR as a base rate and that mature after 2026 (when JIBAR is set to be discontinued) should consider amending their intercompany agreements to include alternative reference rates with the agreed actions and timeline by the parties to adjust the pricing in order to determine the equivalent interest rate based on the ZARONIA.

Parties to new intercompany loans issued between now and 2026 should consider including alternative interest rates as well.

Transfer pricing policy

Under SA’s transfer pricing rules, intercompany loans should be priced contemporaneously and on an arm’s length basis. The differences in information contained in the JIBAR and the ZARONIA—e.g., historical vs future, overnight vs terms quoted, near risk-free vs bank credit risk inclusive—may create comparability differences with the benchmarks applied to price intercompany loans that still apply JIBAR as the reference/base rate. MNEs therefore should reassess their transfer pricing policies to evaluate consistency with and to produce arm’s length results.

i) Debt capacity and interest rate

In the event MNEs make amendments to the pricing or terms of the agreements, they should reassess whether the amount of the loan and cost of debt is arm’s length.

Even if this issue may have been evaluated at the time the original loans were issued, if the change in pricing could be considered a significant modification to the original agreement and a new debt instrument, MNEs should document that prior conclusions remain applicable in the current market environment.

ii) Hedging

MNEs with in-house banks or treasury companies often enter into hedging contracts to mitigate foreign currency risk on behalf of other affiliates or as part of managing the risk they bear as part of their funding functions. Given the common use of JIBAR as a reference rate, hedging contracts often also are tied to this rate. Treasury companies and inhouse banks thus should plan for the discontinuance of JIBAR and the resulting impact on their existing intercompany funding and hedging structures.

iii) Systems and processes

The aforementioned change in transfer pricing policies required once JIBAR is replaced will impact the systems and processes for calculating intercompany interest rates. Depending on the degree of automation, this may include reprogramming enterprise resource planning systems, updating process manuals, and training finance or tax individuals involved in transfer pricing execution.

In addition, MNEs that rely on a labour-intensive process to manage intercompany financing and liquidity will need to re-evaluate existing models, define the sources from which market information will be retrieved, and identify the corresponding adjustments that may be needed to convert to rates that will be consistent with new arm’s length policies. This process will require coordination among Treasury, Tax, Transfer Pricing, Legal, Finance, and Technology.

Other considerations

From a VAT perspective, the change in rate from JIBAR to ZARIONIA will have an impact on the standard turnover-based apportionment method as set out in Binding General Ruling 16 (“BGR 16”). This method currently applies the margin between the Prime Interest Rate and JIBAR to determine the proxy to be used for the inclusion of dividend and interest income (with certain specific adjustments and formulas). The ZARONIA rate is generally lower than the current JIBAR rate and will therefore negatively impact the expected proxy inclusion in the formula such that the percentage inclusion in the method will be higher than what it currently is. As much as it is not expected to result in a drastic difference, it will impact the ratio obtained. The ZARONIA rate does not adjust for the credit component which raises the question as to whether this remains the most appropriate proxy to use in the method.

Finally, per SA’s Exchange Control Regulations, additional SARB approvals may be required once material changes have been made to contractual terms approved by the SARB. To be clear, intercompany financing agreements/arrangements which were priced and approved with express reference to JIBAR may need to be resubmitted for evaluation by the SARB.

Takeaway

The transition from JIBAR to ZARONIA requires careful consideration of the practical tax implications. Taxpayers should assess their specific circumstances, including the classification and nature of their financial instruments, and the extent of contract modifications, to navigate the transition effectively from a legal, accounting and tax perspective.

Additionally, the transfer pricing impact from the discontinuance of JIBAR will require analysis and planning on how to adapt to that change. To allow for a smooth transition, MNEs should start identifying the impacted transactions and structures and develop a transition plan before JIBAR is no longer available. This article provides a general overview, and specific advice should be sought for individual facts and circumstances.

The information contained in this article by PwC is provided for discussion purposes only and is intended to provide the reader or his/her entity with general information of interest. The information is supplied on an “as is” basis and has not been compiled to meet the reader’s or his/her entity’s individual requirements. It is the reader’s responsibility to satisfy him or her that the content meets the individual or his/ her entity’s requirements. The information should not be regarded as professional or legal advice or the official opinion of PwC. No action should be taken on the strength of the information without obtaining professional advice. Although PwC take all reasonable steps to ensure the quality and accuracy of the information, accuracy is not guaranteed. PwC, shall not be liable for any damage, loss or liability of any nature incurred directly or indirectly by whomever and resulting from any cause in connection with the information contained herein.