In the 2011 budget speech, the Minister of Finance announced that the Government will consider exempting taxable capital gains or ordinary revenue imposed on an insolvent debtor if the debt owing by the debtor is cancelled or reduced.
Currently, the cancellation, waiver or reduction of a loan by a creditor will result in a taxpayer paying capital gains tax ("CGT") at an effective rate of 14% and the reduction of a trade debt owing by a taxpayer to a creditor will either be added to the taxable income of the taxpayer, which would result in income tax at the rate of 28% on the amount of the trade debt waived, as more fully set out below.
Waiver of a loan
Where a loan is waived by a creditor, this waiver will be subject to the provisions of the Eighth Schedule to the Income Tax Act, 58 of 1962 ("the Act").
Paragraph 12(5) of the Eighth Schedule to the Act ("Eighth Schedule") specifically deals with the situation in which a debt owed by a person to a creditor has been reduced or discharged by that creditor:
- for no consideration; or
- for a consideration which is less than the amount by which the face value of the debt has been reduced or discharged.
The purpose of paragraph 12(5) of the Eighth Schedule is to ensure that a debtor who is relieved of the obligation to pay any portion of any amount owing will be subject to CGT on a capital gain equal to the amount discharged.
The words "debt owed" as used in paragraph 12(5) of the Eighth Schedule refer to amounts in respect of which there is an unconditional liability to pay, including debts incurred which are not yet due and payable.
Therefore, a loan granted by a creditor, to a taxpayer, would be regarded as a debt owed to the creditor and would fall within the provisions of paragraph 12(5) of the Eighth Schedule. Accordingly, where a creditor waives the loan, the taxpayer will be deemed to:
- have acquired a claim to so much of the debt as was reduced or discharged for no consideration;
- to have disposed of that claim for proceeds equal to that reduction or discharge; and
- the claim will have a base cost of nil.
Therefore, a taxpayer will have a deemed capital gain equal to the amount of the debt that was discharged by the creditor and 50% of that capital gain (i.e. the taxable capital gain) will be subject to income tax at a rate of 28%.
In terms of paragraph 13(1)(g)(ii) of the Eighth Schedule, the time of the disposal will be the date the event under paragraph 12(5) of the Eighth Schedule occurs. In other words, the date of the disposal will be the date on which the creditor discharges the debt and therefore a taxpayer will be required to record a capital gain equal to the amount of the debt so discharged on such date.
The capital gain arising from the deemed disposal will be included in the taxable income of a taxpayer in accordance with section 26A of the Act.
Relief for members of the same "group of companies"
The provisions of paragraph 12(5)(a)(bb) of the Eighth Schedule, provide that the provisions of paragraph 12(5) of the Eighth Schedule do not apply where that person and that creditor are members of the same "group of companies" as defined in section 41 of the Act.
Section 41 of the Act, defines a "group of companies" as a group of companies as defined in section 1 of the Act, but excluding, any company contemplated in paragraph (b) of the definition of "company" in section 1 of the Act. This essentially excludes any company which is a foreign company, from being regarded as forming part of a "group of companies" as defined in section 41 of the Act.
Therefore, although the provisions of paragraph 12(5)(a)(bb) of the Eighth Schedule, provide relief for a debt waived by a South African creditor which is part of the same "group of companies" as the taxpayer, a foreign creditor will not qualify for this relief. As a result, where a foreign creditor waives a loan owing by a taxpayer, the taxpayer will realise a capital gain which will be subject to CGT at an effective rate of 14% on the amount of the loan waived by the foreign creditor.
However, this rule is subject to one exception, that is, where the debt is waived by the foreign creditor, during the course of or in anticipation of the taxpayer's liquidation, winding up, deregistration or final termination. This exception is provided for in paragraph 12(5)(a)(cc) of the Eighth Schedule, which states that the provisions of paragraph 12(5) of the Eighth Schedule do not apply where:
- the taxpayer is a company;
- the taxpayer is a connected person in relation to the creditor;
- the taxpayer and the creditor were connected persons before the loan was granted;
- the waiver of the loan was made in the course of or in anticipation of a liquidation, winding up, deregistration or final termination of the corporate existence of the taxpayer;
- the amount of the waiver does not exceed the actual amount advanced by the creditor; and
- the waiver was not done as part of a scheme to avoid any taxes imposed by the Act.
Waiver of trade debt
The provisions of paragraph 12(5) of the Eighth Schedule, as set out above, will not apply where the provisions of section 8(4)(m) of the Act, apply. Section 8(4)(m) of the Act, deems the cancellation of a debt to be a recoupment in the hands of the debtor. The section provides that where:
- due to the prescription, waiver or release of a claim for payment, any person was during any year of assessment relieved from the obligation to make payment of any expenditure actually incurred;
- such expenditure was not paid; and
- the expenditure or any related allowance was claimed as a deduction from the taxpayer's income in the current or any previous year of assessment;
the taxpayer is deemed to have recovered or recouped an amount equal to the amount of the obligation from which the taxpayer was relieved.
Accordingly, on the date a trade debt is waived by a creditor, a taxpayer will be deemed to have recouped an amount equal to the amount of the trade debt waived by the creditor as:
- the taxpayer will be released from the obligation to make payment in respect of the expenditure actually incurred;
- the expenditure was not paid for by the taxpayer; and
- the expenditure was claimed by the taxpayer as a deduction from the income of the taxpayer in the current or a prior year of assessment.
Accordingly, where a taxpayer is in a taxable position the taxpayer will be required to include the amount of the trade debt waived by the creditor as a recoupment in its taxable income in the year of assessment in which the trade debt is waived.
However, section 8(4)(m) of the Act, is subject to the provisions of section 20 of the Act, which deals with assessed losses. In terms of section 20(1)(a)(ii) of the Act, any balance of an assessed loss of a taxpayer must be reduced to the extent to which the taxpayer's liabilities incurred in the ordinary course of his trade have been reduced or extinguished, to the extent that:
- the amount advanced by the creditor was used, directly or indirectly to fund expenditure or an asset; and
- a deduction was allowed, in terms of section 11 of the Act, in respect of such expenditure or asset.
Accordingly, where a taxpayer is in an assessed loss position and where the taxpayer has:
- incurred expenditure in respect of goods and services rendered by the creditor; and
- such expenditure was claimed by the taxpayer as a deduction in terms of section 11 of the Act;
the balance of the assessed loss carried forward by the taxpayer will be reduced by the amount of the benefit received by the taxpayer, resulting from the waiver of the trade debt by the creditor.
As an insolvent debtor has no ability to pay the deemed CGT arising on the waiver of a loan or the income tax levied in respect of the waiver of a trade debt, we welcome the proposed exemption and await the specific details thereof.