The current s19 and paragraph 12A of the Eighth Schedule (Eighth Schedule) were introduced into the Income Tax Act, No 58 of 1962 (Act) with effect from years of assessment commencing on or after 1 January 2013. In essence, these provisions contain the debt reduction rules which attempt to create a uniform system that provides relief to persons under financial distress in certain circumstances. In simple terms, the relevant provisions set out the tax implications arising in respect of a debt that is reduced, cancelled, waived, or discharged by a creditor. The tax implications are dependent on what the debt originally funded, for instance trading stock, other deductible expenditure, allowance assets or capital assets.
The debt reduction provisions have been the subject of some debate since their introduction. The amount of rulings published by SARS since the introduction of these provisions is indicative of this. As a result, one of the notable proposals by National Treasury (Treasury) in the first draft Taxation Laws Amendment Bill, 2017 (Bill) published on 19 July 2017 (First Bill), included various proposed changes to the debt reduction provisions. The first round of amendments broadly addressed three issues:
- first, Treasury proposed to introduce specific rules dealing with debt foregone in respect of mining companies as contemplated in s36 of the Act;
- second, Treasury proposed to extend the paragraph 12A(6)(d) group exemption to also apply in the context of s19, however, such group exemption would be limited to dormant group companies (as defined); and
- lastly, in order to cater for the lacunae in the law which had thus far been mainly developed by way of various rulings issued by SARS, Treasury proposed to introduce definitive rules dealing with the tax treatment of conversions of debt into equity.
Subsequent to its publication, the First Bill went through the ordinary public consultation process, which resulted in Treasury publishing the revised Bill on 25 October 2017 (Revised Bill). The Revised Bill now contains further significant amendments to both s19 and paragraph 12A, such that the relevant provisions are to be substituted in their entirety. While the three issues mentioned above are still to be addressed in the proposed amendments, albeit with certain refinements and clarifications, one of the notable additional changes includes the proposal to amend what triggers the debt reduction provisions. Currently, the provisions are only triggered to the extent that, in simple terms, the amount by which a debt is reduced, exceeds any amount applied by that person as consideration for the reduction, namely the ‘reduction amount’. However, the proposed amendments now include new definitions such as ‘concession or compromise’ and ‘debt benefit’. Importantly, the Revised Bill provides that the debt reduction rules are only triggered to the extent that, amongst others, a ‘debt benefit’ arises by reason of ‘a concession or compromise’. ‘Concession or compromise’ is specifically defined as any arrangement in terms of which:
(i) term or condition applying in respect of a debt is changed or waived; or
(ii) obligation is substituted, whether by means of novation or otherwise, for the obligation in terms of which that debt is owed;
(b) a debt owed by a company is settled, directly or indirectly, by:
(i) being converted to or exchanged for shares in that company; or
(ii) applying the proceeds from shares issued by that company.
The rationale behind this additional amendment is found in the Draft Response Document on the Bill issued by Treasury on 14 September 2017 (Draft Response Document) which states the following at page 29:
The current definition of a reduction amount has technical limitations in respect of covering all instances of debt concessions. Debt compromises such as, for example, subordination agreements that recognise, in effect, that the value of the claim that the creditor holds is less than the face value of that claim are arguably not covered in all instances. The same applies in respect of conversions of debt into equity. The benefits arising from any concession or compromise or debt restructuring arrangement should, from a policy point of view, be subject to the same rules. As such, amendments will be proposed in respect of the definition of a reduction amount in the 2017 Draft TLAB to ensure that the debt reduction rules apply in respect of all forms of debt restructuring arrangements.
The inclusion of the new concepts concerning the trigger of the debt reduction rules is a fundamental shift and encompasses a much wider set of circumstances. For instance, even an amendment of the relevant interest rate, repayment terms or period of the loan could potentially trigger the debt reduction provisions.
While the Bill is nevertheless still in draft form, it will be interesting to carefully consider the new provisions once they are published and come into force in early January 2018. It is difficult to predict what the final legislation may look like, however, taxpayers would be well advised to carefully monitor ongoing developments in this regard, particularly where debt restructuring is anticipated.