SARS proposes tax relief for dormant group companies
11 Sep 2017
Typically, companies in financial distress that wish to reduce their debt may enter into arrangements with their creditors, which may form part of the same group of companies as the debtor company, to either reduce, cancel, waive, forgive, discharge or convert the debt (into equity). These arrangements can trigger the “debt reductions rules”, contained in section 19 of the Income Tax Act, 1962 (the “Act”) and paragraph 12A of the Eighth Schedule to the Act, resulting in tax consequences for the debtor company.
The tax consequence arising from a debt reduction depend on the purposes for which the debt was used by the debtor, for instance if the debt was used for operating expenditure or trading stock, section 19 of the Act provides that there will be a recoupment equal to the “reduction amount” which will be included in the taxpayers income tax. If however, the debt was used to acquire capital or allowance assets then the reduction amount is subject to capital gains tax in terms of paragraph 12A of the Eighth Schedule to the Act. The rules in section 19 and paragraph 12A only apply to the extent that there is a reduction amount, which is an amount equal to the amount by which the debt is reduced less any consideration paid for the reduction of the debt.
Debt that is reduced, cancelled, waived, forgiven or discharged between South African groups companies is exempt from the debt reduction provisions in paragraph 12A of the Eighth Schedule, which applies only to the capital gains tax consequences. However, this exemption is limited to instances where the debt was used to fund capital or allowance assets and does not apply to instances where a debt was used to fund operating expenditure as envisaged in section 19 of the Act.
The absence of an exemption in instances where group company debts are used for operating expenditure or trading stock, results in a technical impediment for groups of companies that wish to wind up dormant companies within the same group of companies. As such, National Treasury and SARS propose in the 2017 Taxation Laws Amendment Bill (“2017 TLAB”) that the group company exclusion in paragraph 12A be extended to cover instances where there is a debt that is converted to equity, which debt was originally used to fund working capital and/or trading stock, as contemplated in section 19 of the Act. However, this will only apply to debt-to-equity conversions between South African group companies and therefore where non-group companies enter into similar arrangements the normal consequences arising from section 19 and paragraph 12A of the Eighth Schedule and should be considered.
Furthermore, as an anti-avoidance measure, the 2017 TLAB proposes that the debtor and creditor must remain part of the same group of companies for a period of at least 5 years after the debt-to equity-conversion has taken place, in order for such a transaction to fall within the ambit of the exemption. Therefore, to the extent that there is a de-grouping between the companies, the tax consequences arising from section 19 and paragraph 12A of the Eighth Schedule will apply.
It is further proposed that interest that was claimed as a deduction in respect of debt that is previously converted into equity, and to which the debt reduction rules do not apply, must be recouped and included in the debtor’s income.
The proposed amendments are intended to come into effect on 1 January 2018.(This article is provided for informational purposes only and not for the purpose of providing legal advice. For more information on the topic, please contact the author/s or the relevant provider.)