Interest deduction limitation provisions have been enacted in terms of s23N of the Income Tax Act, No 58 of 1962 (Act), which apply to so called ‘reorganisation and acquisition transactions’. These provisions have been in effect since 1 April 2014. The purpose of these provisions (as the heading suggests) is to limit interest deductions in respect of certain debt arrangements that National Treasury consider as being susceptible to excessive gearing.
In addition, a new s23M of the Act will have effect from 1 January 2015, which will essentially apply to debts owed by a debtor to a creditor in a ‘controlling relationship’ and the amount of interest incurred by the debtor is not subject to tax in the hands of the creditor (eg a non-resident creditor). National Treasury contends that these interest deduction limitation provisions are necessary to avoid the erosion of the South African tax base.
The provisions of s23M and s23N of the Act are complex and require careful analysis to fully understand the tax consequences thereof. Recent amendments have been proposed to these sections in the draft Taxation Laws Amendment Bill 2014 (Bill) and some interesting comments have been made in respect of these sections.
For example, some of the important comments that were made by various stakeholders at the parliamentary public hearing on the draft Bill (held on 26 August 2014) and at a recent workshop hosted by National Treasury and the South African Revenue Service (SARS), include the following:
- It is possible that an arrangement could be subject to: i) the transfer pricing and thin capitalisation provisions in s31 of the Act; ii) section 23N of the Act; and iii) section 23M of the Act. While s23N is subject to s23M of the Act, it is not clear which section should take precedence (eg s23M or s31 of the Act) and, if an adjustment is made to an interest deduction in terms of s31 of the Act, is s23M of the Act still applicable?
- The current proposal is for s23M of the Act to also apply to a debt that is guaranteed by a person that is in a controlling relationship with the debtor. It was contended by a number of stakeholders that this amendment is too wide and includes arrangements which should not fall within s23M of the Act. The following basic example was cited by a number of stakeholders:
“An operating company borrows from an unrelated third-party financier which is exempt from tax (eg a pension fund). Section 23M of the Act should not apply to the interest expenses as there is no ‘controlling relationship’. If a third-party financier requires security in the form of a guarantee from the borrower’s parent, the loan would then be subject to s23M of the Act (if the proposed amendment is enacted).”
In the workshop it was indicated that the proposed amendment to include guarantees from persons in a controlling relationship will be reconsidered. It does not necessarily mean that this proposed amendment to s23M will be deleted and taxpayers should pay careful attention to this provision in the final Bill, 2014.
- Section 23N of the Act should only apply to new debt used to finance a ‘reorganisation transaction’ or ‘acquisition transaction’ and should not apply to debt assumed as part of the settlement of the purchase consideration (ie ‘existing debt’). Unless amendments are made to s23N, taxpayers should therefore be aware of this issue when implementing any ‘reorganisation or acquisition transactions’;
- No policy decision appears to have been given for allowing a taxpayer to roll forward any interest deductions disallowed in terms of s23M of the Act but any interest deduction disallowed in s23N of the Act may only be carried forward for the five years following the ‘acquisition transaction’ or ‘reorganisation transaction’; and
- From a practical perspective, the application of s23M and s23N of the Act could have adverse provisional tax consequences as a taxpayer will not necessarily be able to calculate its ‘adjustable taxable income’ until the year-end audit has been completed, which will obviously impact the determination of a taxpayers’ second provisional tax payment.
It was difficult to establish from the workshop whether these (and other) comments by the various stakeholders will be incorporated in the final Bill 2014, other than the request for s23M(2)(b)(ii) to be deleted (ie the request for expansion of s23M to guarantees furnished by persons in a controlling relationship to be deleted).
It is anticipated that taxpayers can expect to see a number of amendments to both s23M and s23N in the future as they have a significant impact on business transactions in South Africa. There has also been indication from National Treasury that an interest deduction limitation of 40% of the ‘adjusted taxable income’ may in fact be lenient if one has regard to international data. The business community will no doubt raise a number of concerns if the interest deduction limitation rate is reduced from the current 40% of the ‘adjusted taxable income’.