The South African Income Tax Act contains a number of rules which give rise to onerous tax consequences where a taxpayer’s debts owing is forgiven. These rules were in recent years the subject of comprehensive legislative amendments.
During the 2018 budget process, National Treasury indicated that it was aware of unintended tax consequences that arise from these new debt relief rules in the Income Tax Act that became effective for years of assessment beginning on or after 1 January 2018. On 31 May 2018, the South African Institute of Chartered Accountants (SAICA) published a feedback summary report from a recent National Treasury workshop to consider proposals for amendments to these rules.
The proposal from that workshop is that the scope of the debt forgiveness rules will be changed through an amendment to the definition of the term ‘concession or compromise’ to focus on rationalisation events. A number of transactions that were previously subject to the onerous rules will from now on fall outside of its scope in future, such as where changes to the terms and conditions of a debt are made only.
One of the most significant proposed changes is the degree to which the conversion of debts to shares (debt capitalisation) are subject to the debt forgiveness rules. Currently, capitalisation of all debts is subject to the rules. A new definition for ‘interest-bearing debt’ will be introduced, to make only interest-bearing debt that is capitalised subject to the rules. This proposal is commercially friendly and provides taxpayer-companies in distress with more options for debt restructures without the fear of triggering adverse tax consequences in the process. Group companies will also have the benefit of its interest-bearing debt excluded from the rules; however, interest thereon may be recouped on capitalisation.
Very significantly, changes will be made to the valuation requirements of the debt forgiveness rules. It will no longer be required to consider the valuation of debt, only that of the shares issued in consideration. Determining the value of debt is currently one of the more contentious matters in the debt reduction regime, given that there are often constraints in obtaining an objective valuation for debt if it is not traded publically. This is a welcome proposal. The concepts of ‘market value’ and ‘face value’ which are used to determine whether any debt benefit arises because of a forgiveness of debt will also be clarified.
National Treasury also indicated that it will provide clarity on certain anti-avoidance matters relating to debt forgiveness, as well as indicating that the donations tax exclusion currently in place, will be removed.
Although feedback from the workshop is at a high level, initial indications are that many of the uncertainties and unintended consequences in the debt forgiveness rules will be addressed when the draft Taxation Laws Amendment Bill is published early in July 2018. No invitation has been made for public comment on the proposals, since this will be dealt with during the 2018 legislative amendment cycle. The effective date of the proposals will be 1 January 2018.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)