In line with recent pronouncements by the OECD relating to so-called Base Erosion and Profit Shifting Project (BEPS), section 23M was introduced by the Taxation Laws Amendment Act, 31 of 2013. Section 23M of the Income Tax Act, 58 of 1962 (“the Act”) will come into effect on 1 January 2015 and has a similar purpose to the thin capitalisation provisions of section 31 of the Act. The Taxation Laws Amendment Bill, 13 of 2014, as tabled in parliament, contains a number of substantial amendments to the current provisions of section 23M. A summary of the provisions of section 23M following these amendments is set out below.
Section 23M sets an interest deduction limitation for a debtor and will apply if a “controlling relationship” exists between the debtor and the creditor. A controlling relationship will exist where a person directly or indirectly holds at least 50 per cent of the equity shares or voting rights in a company. The interest deduction limitation will also apply in respect of a debt owed to a creditor that is not in a controlling relationship with the debtor where the creditor obtained the funding for the debt advanced from a person that is in a controlling relationship with the debtor. The interest deduction limitation will, however, only apply if the amount of interest is not subject to tax in the hands of the recipient or not included in the net income of a controlled foreign company and also not disallowed under the provisions of section 23N dealing with the limitation of interest deductions in respect of reorganisation and acquisition transactions.
The interest deduction limitation will be calculated on the aggregate of:
- the amount of interest received by or accrued to the debtor; and
- a percentage of the adjusted taxable income of the debtor to be determined in accordance with a formula which links deductible interest to the average repo rate for the year.
The formula will be, therefore, adjusted where there is a change to the average repo rate together with a 400 basis point addition to the average repo rate. The interest deduction limitation will have ceiling of 60 per cent of the adjusted taxable income of the debtor which will exclude the previous year’s assessed loss. Any interest in excess of the limitation may be carried forward to the following year. The interest deduction limitation will not apply to any interest incurred by a debtor in relation to back-to-back loans where the creditor obtained those funds from an unconnected lending institution in relation to the debtor and the interest is determined with reference to a rate that does not exceed the official rate of interest as defined in the Seventh Schedule plus 100 basis points.
National Treasury and SARS are of the opinion that section 23M has a broader objective than the thin capitalisation provisions of section 31 and that section 31 will first apply to determine the correct pricing of the debt owed. Where the amount of interest is taken into account in terms of a reorganisation and acquisition transaction under section 23N, the provisions of section 23M must be applied to any amount not already disallowed under section 23N.