Global Tax Alert | 6 March 2014

South Africa presents 2014 Budget

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On 26 February 2014, South Africa’s Minister of Finance, Pravin Gordhan, presented his annual budget for the 2014/2015 financial year. In terms of larger domestic and cross-border operations, the budget largely maintains the status quo. Draft legislation bringing these announcements into effect will be released in June or July.

This Alert summarizes the significant domestic company tax and cross-border tax announcements in the budget.

Domestic Company Tax

Limitation on interest deductions for leveraged acquisitions

In 2013, legislation was enacted that generally limited deductible interest when making loans to acquire target companies. This limitation equals 40% of the adjusted taxable income of the target company with adjusted taxable income seeking to mirror financial “earnings before interest, taxes and depreciation.” Prior to the change, the level of deductible interest in the case of leveraged acquisitions was permitted only to the extent of the discretion of the South African Revenue Service (SARS). While the new 40% rule was largely viewed as a positive development by taxpayers, the 40% amount was overly restrictive and not reflective of cash-flows used in financing. It is accordingly proposed that the rules be revised to better reflect cash-flows and for the 40% ratio to be more flexibly increased if overall South African interest rates increase.

Refinements to the hybrid share anti-avoidance legislation

In 2012, hybrid share legislation came into effect that treats dividends as ordinary revenue if: (i) the shares bear certain interest-like features, or (ii) the shares are backed by certain third party guarantees. However, hybrid share rules do not apply if the funding for these shares (typically preference shares) is used to acquire the shares of an operating target company. In 2013, certain legislative adjustments were made to allow for a greater level of third-party backed guarantees without triggering the anti-avoidance rule. The proposed 2014 budget proposals will additionally allow for the refinancing of third-party backed shares if the initial shares qualified for relief, the target acquisition involves exploration or the third-party backed shares are backed only by a limited pledge.

Clinical trials as research and development

The budget contains a proposal allowing for clinical trials to fully qualify for the research and development incentive. At present, clinical trials often fall outside the incentive because the local offices engaged in this activity often do not have the power to alter the methodology of the underlying research.

Tenant construction of buildings and other improvement on leased land

In 2013, the Government proposed that tenant improvements on landlord be fully depreciable even though these improvements are “owned” by the landlord under Roman-Dutch law. This relief was formalized in the initial draft tax bill but effectively withdrawn. The Government is now proposing relief only for government infrastructure projects with only possible relief for wholly private relationships.

Cross-Border Tax

Secondary adjustments for transfer pricing

Under current law, secondary adjustments to transfer pricing are always treated as a perpetual deemed loan. The budget proposes to abandon this approach in favor of “dividend” or “capital contribution” treatment, depending on the facts and circumstances.

Application of the high-tax and business establishment exemptions

Under current law, taxpayers with controlled foreign companies do not have tainted taxable controlled foreign company income under a variety of exceptions. These exceptions include an exception for income attributable to a foreign business establishment or to high-taxed foreign income. The exemption for foreign business establishment is fairly easy to apply but the high-taxed exemption requires a complex set of hypothetical South African income tax calculations. It is proposed that taxpayers be allowed to apply the foreign business establishment exemption before having to rely on the high-taxed exemption.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Advisory Services Ltd., Johannesburg
  • Keith Engel
    +27 11 772 5082
    keith.engel@za.ey.com
  • Justin Liebenberg
    +27 11 772 3907
    justin.liebenberg@za.ey.com
  • Cornelia Wolff
    +27 11 772 3157
    cornelia.wolff@za.ey.com
Ernst & Young (China) Advisory Services Limited, Pan African Tax Desk, Beijing
  • Rendani Neluvhalani
    +86 10 5815 2831
    rendani.neluvhalani@cn.ey.com
Ernst & Young LLP, Pan African Tax Desk, New York
  • Dele A. Olaogun
    +1 212 773 2546
    dele.olaogun@ey.com
  • Mzukisi Ndzipo
    +1 212 773 9917
    mzukisi.ndzipo@ey.com
Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London
  • Leon Steenkamp
    +44 20 7951 1976
    lsteenkamp@uk.ey.com

EYG no. CM4227