News / Legal Brief
Sep 1,2021
In 2019 Treasury released a discussion document dealing with the proposed interest limitation rules that would apply where a South African company with foreign group members has borrowed money. This kind of proposal is very common throughout the world, especially as part of giving effect to the OECD’s and G20’s initiative to curb Base Erosion and Profit Shifting (BEPS). This occurs inter alia by means of payment of, what is considered to be, excessive amounts of interest that legitimately rank as deductions, but where the interest is taxed at lower rates in a foreign country.
It was intended that, following assessment of the responses to the discussion document, the legislation would be passed last year to take effect this year. However, because of COVID 19 and the lockdown, it was decided to defer the legislation for a year, and also give additional time for response to the discussion document.
On 28 July 2021 a draft of the Taxation Laws Amendment Bill, 2021 was published for comment, which inter alia dealt with proposed amendments to the Income Tax Act, 1962 (the Act) in relation to interest limitation. At the outset, it must be said that the approach as evidenced by the proposed amendments – assuming that the final amendment is substantially the same as this – is to be welcomed, as it represents a considerably softer touch than was originally proposed, and adopts a far more sensible and practical approach. The fact is that the original approach in the discussion document followed too closely the approaches of more developed and capital-exporting countries in Europe and North America, as opposed to considering the more unique requirements of the South African economy.
It does not serve any purpose to go into a detailed analysis of the discussion document at this time. Suffice it to say that there were a number of key issues contained therein, some of which were, in the view of many in the private sector, problematic.
The following were the core issues:
Currently, apart from section 31, there are two specific interest limitation provisions contained in the Act, being sections 23M and 23N. The latter applies purely domestically in relation to borrowed funds being used to acquire new subsidiaries or their businesses, and nothing further needs to be said in this section.
Section 23M, however, was designed to limit deductibility of interest where a company had borrowed abroad from a person who directly or indirectly holds 50% or more of the equity shares or voting rights, such person being in, what is defined as, a “controlling relationship”. The provision applies where the interest received is not subject to South African tax in the hands of the recipient, and, as far as foreign lenders are concerned, this would occur only if, under a relevant double tax agreement with the foreign country, no withholding tax in South Africa is payable on that interest. (It should be noted, however, that section 23M does not apply only in respect of interest paid tax-free to a foreign lender – it can apply even where the lender is in South Africa but does not pay tax, for example, a pension fund or a PBO.)
Section 23M also limits interest to a percentage of Tax EBITDA, but the percentage was somewhat more generous, in that it was based on 40% of the repo rate plus 400 basis points. So, for example, if the repo rate was at 5%, the interest was effectively limited to (40% of 9%) * 10 = 36% of Tax EBITDA.
Rather than introducing a completely new section into the Act, the decision has been taken to amend section 23M.
The main features of the amendments are as follows:
It is evident that some of the more unfortunate proposals have not been included in the legislation, including the fact that it would apply even where the South African company has not borrowed from a foreign affiliate but has merely invested abroad. There is also no de minimis exemption, but given the fact that the scope of the limitation has been reduced so dramatically, the absence of a de minimis exemption is not that serious.
What is a little disappointing is that there is no indication of any further legislation to harmonise the interaction between this interest limitation rule and the transfer pricing rules under section 31 of the Act.
by Ernest Mazansky, Head of Tax Practice, Werksmans Attorneys
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