By Mark Preiss
Debt instruments containing certain features will be re-characterised as shares. The underlying interest yield will also be re-characterised (probably as dividends). The debt instruments which will be impacted are those which realistically are not repayable within 30 years of issue, or debt convertible into shares at the request of the issuer. Banks and insurers will be excluded from these rules. These rules were proposed as part of the 2012 Budget and are additional to existing rules recently legislated for the purposes of preventing base erosion.
Excessive debt issued to connected persons (e.g. the issuer and the holder of the debt are part of the same group) creates concern for the fiscus where the interest charge is deductible for the issuer and the holder is exempt on the corresponding interest income. The proposal is that interest on such connected party debt will not be deductible to the extent such interest exceeds 40% of earnings after interest on other debt. The disallowed interest may be rolled over and potentially claimed as a deduction over the subsequent 5 year period. It will be interesting to see whether this proposal is an indication of the approach which may be adopted with respect to restrictions imposed on interest deductions in terms of thin capitalization rules.
In corporate acquisition transactions, the use of interest bearing debt to fund the acquisition of a target is perceived to significantly reduce the earnings and therefore the tax liability of the target for years to come. The proposal is that interest on these types of debt will be disallowed to the extent the interest is excessive. The disallowed interest may be rolled over and potentially claimed as a deduction over the subsequent 5 year period. There is no indication of what will be regarded as excessive. It appears this proposal will replace the existing system in terms of which the interest deduction on acquisition debt is disallowed unless the South African Revenue Service approves the deduction.