Global Tax Alert | 29 April 2013
South Africa issues draft rules on excessive debt; comments requested by 24 May 2013
South Africa's National Treasury released draft legislation for public comment on 29 April 2013 in which it proposes certain limitations to counter excessive debt deductions. Citing sources such as the OECD's paper on Base Erosion and Profit Shifting, the National Treasury identified four concerns including hybrid debt, connected party debt, transfer pricing, and acquisition debt.
New legislation is proposed that aims to combat the use of hybrid debt instruments effective 1 January 2014. The broader set of hybrid rules apply two-fold. In the first instance, the debt instrument will be reclassified as equity in its entirety. Instruments falling under this dispensation are the typical open ended shareholder loans that do not have a maturity date or maturity date of more than 30 years, the issuer may discharge its obligation by issuing shares (capitalizing the loan claim), or the obligation to settle the loan claim is dependent on the solvency of the company. In the second instance, the yield is reclassified as a dividend. Instruments falling under this dispensation include profit participation loans (i.e., the yield is not determined with reference to the time value of money or a specified rate of interest) or the obligation to settle the interest claim is dependent on the solvency of the company. Any amount of tainted interest is deemed a dividend in relation to the issuer and the holder. Certain exemptions are also proposed for short and long-term insurers, and regulated bank capital.
Connected party debt
Excessive debt remains a concern where the creditor falls outside the South African tax net. It is proposed that where a company pays interest to another entity within the same IFRS (International Financial Reporting Standards) group and the interest is untaxed or taxed at a lower rate when received or accrued by the other entity, the interest will be subject to the following interest limitation: 40% of the debtor's taxable income (ignoring interest incurred or accrued) plus interest accrued less interest incurred in respect of debt falling outside the limitation. Interest deductions on excess debt will be denied and rolled forward for five years.
It is interesting to note in the proposals that the connected party debt and transfer pricing rules are split, and more guidance is sought in this regard. A potential safe harbor is proposed in terms of which interest on the connected person debt may not exceed 30% of taxable income with no adjustment for other interest received, accrued, interest paid or incurred, and interest on the debt may not exceed the foreign equivalent of the South African prime rate if denominated in foreign currency, or the South African prime rate if denominated in Rand.
The acquisition debt rules will follow similar principles as the connected party debt rules. If, for instance, a debt pushdown transaction is used, the following interest limitation applies: 40% of the debtor's taxable income (ignoring interest incurred or accrued) plus interest accrued less interest incurred. The five year roll forward continues to apply. The interest limitation taking into account a share acquisition will also follow the 40% rule, and will be further adjusted in accordance with the percentage stake being acquired if the purchaser is not acquiring all the shares of Target Company. If the acquisition debt was funded or secured by another entity within the same IFRS group and the interest thereon is untaxed when received or accrued by that other entity, the limitation will be the lesser of (i) 40% of the target company's taxable income or, (ii) 40 percent of the acquirer's taxable income.
For additional information with respect to this Alert, please contact the following:
EY Advisory Services Ltd, Johannesburg, South Africa
- • Justin Liebenberg
+27 11 772 3907
- • Ide Louw
+27 11 502 0438
EYG no. CM3400