Section 19 and Paragraph 12A of the Eighth Schedule to the Income Tax Act (58/1962) were introduced with effect from assessment years commencing on or after January 1 2013. In essence, these provisions contain debt reduction rules, which attempt to create a uniform system that provides relief to parties in financial distress under 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 or allowances or capital assets.
The debt reduction provisions have been the subject of significant debate since their introduction, as demonstrated by the number of rulings which the South African Revenue Service (SARS) has published in this regard since their introduction. As a result, the National Treasury included various proposed changes to the provisions in the first draft of the Taxation Laws Amendment Bill 2017, which was published on July 19 2017. The first round of amendments broadly addressed the following issues:
- The National Treasury proposed to introduce specific rules concerning debt foregone in respect of mining companies, as contemplated in Section 36 of the act.
- The National Treasury also proposed to extend the Paragraph 12A(6)(d) group exemption to apply in the context of Section 19. However, such group exemption would be limited to 'dormant group companies' (as defined in the bill).
- In order to cater for the gap in the law, which had predominantly stemmed from the various SARS rulings, the National Treasury proposed to introduce definitive rules addressing the tax treatment of conversions of debt into equity.
Subsequent to its publication, the first draft of the bill underwent the ordinary public consultation process, which resulted in the National Treasury publishing a revised bill on October 25 2017. The revised bill contains further significant amendments to both Section 19 and Paragraph 12A, such that the relevant provisions are to be substituted in their entirety. While the three abovementioned issues will still be addressed in the proposed amendments – albeit with certain refinements and clarifications – a notable additional change includes the proposal to amend what triggers the debt reduction provisions. At present, the provisions are triggered only 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'. Notably, the revised bill provides that the debt reduction rules are triggered only to the extent that, among other things, a debt benefit arises by reason of a concession or compromise. A 'concession or compromise' is specifically defined as any arrangement in terms of which:
- a term or condition applying in respect of a debt is changed or waived;
- an obligation is substituted, whether by means of novation or otherwise, for the obligation in terms of which that debt is owed; or
- a debt owed by a company is settled, directly or indirectly, by:
- being converted to or exchanged for shares in that company; or
- 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, which the National Treasury issued on September 14 2017. Page 29 of this document states that:
"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 a loan could potentially trigger the debt reduction provisions.
The bill is still in draft form and it will be worthwhile to consider the new provisions once they have been published and enacted in early January 2018. Although it is difficult to predict what the final legislation will look like, taxpayers are well advised to monitor ongoing developments in this regard carefully, particularly where debt restructuring is anticipated.
For further information on this topic please contact Jerome Brink at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email (email@example.com). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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