Re­vised rules on tax take nar­rower view

Cur­rent rules that de­fer tax ef­fects for re­lated party debts and other ex­change items are to be re­placed

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - DAVID WARNEKE

THE cur­rent in­come tax rules that de­fer tax ef­fects for re­lated party debts and other ex­change items are to be re­placed with new, re­vised rules. The re­vised rules are gen­er­ally nar­rower than the cur­rent rules and the re­place­ment of the old rules will trig­ger both one-off and on­go­ing tax ef­fects for many tax­pay­ers, the ma­jor­ity of which, one sus­pects, are un­aware of the con­se­quences.

The cur­rent rules are con­tained in sec­tion 24I(10) of the In­come Tax Act. If, for ex­am­ple, a forex gain arises on a loan ow­ing by a South African res­i­dent sub­sidiary and its non-res­i­dent par­ent that is hedged by a for­ward ex­change con­tract or a for­eign cur­rency op­tion con­tract, the gain is de­ferred un­til re­al­i­sa­tion in terms of th­ese rules.

How­ever, a re­cent amend­ment to sec­tion 24I(10) pro­vides that such a gain will be deemed to have been re­alised and will have to be ac­counted for on “the last day of the last year of as­sess­ment... end­ing be­fore the year of as­sess­ment ... com­menc­ing on or af­ter 1 Jan­uary 2014”.

This means that such gain will have to be ac­counted for on such last day if it has not been re­alised by such last day. For tax­pay­ers with a year of as­sess­ment that ends on De­cem­ber 31, such last day will be De­cem­ber 31 2013. For tax­pay­ers with a year of as­sess­ment that ends on the last day of Fe­bru­ary, it will be Fe­bru­ary 28 2014.

By con­trast, the new rules are ef­fec­tive in re­spect of years of as­sess­ment com­menc­ing on or af­ter Jan­uary 1 2013. There is there­fore a tim­ing over­lap be­tween the rules. Where the loan is fully hedged the as­so­ci­ated loss on the hedge will also be trig­gered, thereby off­set­ting the fi­nan­cial ef­fect of the deemed re­al­i­sa­tion treat­ment. How­ever, if the loan is only par­tially hedged, the deemed re­al­i­sa­tion treat­ment will ap­ply to the full amount of the loan and the par­tial hedge, with po­ten­tially se­vere con­se­quences.

It should how­ever be noted that if the forex gain or loss falls within the pro­tec­tion af­forded by the new rules, it would ap­pear to be the in­ten­tion that this deemed re­al­i­sa­tion treat­ment will not ap­ply and the pro­tec­tion af­forded by the new rules, which also amount to a de­fer­ral of un­re­alised forex gains and losses, will kick in.

The new rules are con­tained in sec­tion 241(10A) of the act.

The new rules are gen­er­ally more limited in scope than the cur­rent rules and there are a num­ber of in­stances in which the new rules will not ap­ply. In such in­stances, the deemed re­al­i­sa­tion treat­ment re­ferred to above will be trig­gered. The aim of the new rules ap­pears to be to more closely align the de­fer­ral treat­ment with that un­der the In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dards (IFRS).

Un­like the old rules, the new rules ap­ply to debts only, and not to other types of ex­change items. The old rules cater for ex­change dif­fer­ences aris­ing be­tween a res­i­dent and a con­trolled for­eign com­pany in re­la­tion to the res­i­dent or in re­la­tion to any other res­i­dent com­pany which is part of the same group of com­pa­nies as the res­i­dent and to ex­change dif­fer­ences aris­ing on ex­change items be­tween two con­trolled for­eign com­pa­nies of the same res­i­dent.

The new rules, how­ever, re­quire that the par­ties to the ex­change item must, at the end of the year of as­sess­ment, ei­ther be con­nected per­sons in re­la­tion to each other or form part of the same group of com­pa­nies. There­fore, the new rules will not af­ford pro­tec­tion in cir­cum­stances where an ex­change item arises be­tween a res­i­dent (“A”) and a con­trolled for­eign com­pany (“B”) that is not a con­nected per­son and does not form part of the same group of com­pa­nies as A. For ex­am­ple, if B is a con­trolled for­eign com­pany by virtue of the hold­ing of the ma­jor­ity of the par­tic­i­pa­tion rights by other un­con­nected res­i­dents, but the hold­ing of the par­tic­i­pa­tion rights in B by A (and other com­pa­nies in the same group as A) is in­suf­fi­cient to make B a con­nected per­son in re­la­tion to A.

The word­ing of the new rules sug­gests that the de­fer­ral treat­ment will not ap­ply at all to debts that are hedged, even if only par­tially. In other words, the de­fer­ral will not ap­ply to any amount of such debts.

The pro­vi­sion hous­ing the old rules, sec­tion 241(10), suf­fers from the de­fect that, al­though it trig­gers the deemed re­al­i­sa­tion treat­ment re­ferred to above, it does not state that it ceases to ap­ply there­after. How­ever the in­ten­tion ap­pears to be for the new rules to take the place of the old and hence I have re­ferred to the re­place­ment of the old rules with the new rules.

An am­bi­gu­ity in sec­tion 241(10) has been ad­dressed in sec­tion 241(10A) in that the new pro­vi­sion makes it clear that if the par­ties to the con­trac­tual pro­vi­sions of the ex­change item are not con­nected per­sons in re­la­tion to each other and no longer form part of the same group of com­pa­nies at the end of the year of as­sess­ment, the ex­change item is deemed to be re­alised. Un­der sec­tion 241(10) it was un­clear at which stage the de­ter­mi­na­tion of whether the par­ties were con­nected per­sons, or oth­er­wise met the re­quire­ments of the pro­vi­sion, had to be made.

It should also be noted that in the case of debts that are cur­rent as­sets or cur­rent li­a­bil­i­ties for pur­poses of IFRS, the new rules only give de­fer­ral if the debt is not funded ex­ter­nally. In other words, if the debt is not di­rectly or in­di­rectly funded by any debt owed to a per­son that does not form part of the same group or is not a con­nected per­son in re­la­tion to ei­ther of the par­ties to the con­trac­tual pro­vi­sions of the debt. By con­trast, the old rules po­ten­tially af­forded de­fer­ral treat­ment un­der th­ese cir­cum­stances.

The new rules are wider than the old in that the de­fer­ral treat­ment un­der the old rules only ap­plied where the res­i­dent and a com­pany were party to the ex­change item. The new rules merely re­quire the par­ties to be con­nected per­sons.

In sum­mary, where a tax­payer cur­rently en­joys de­fer­ral treat­ment un­der sec­tion 241(10) it is im­por­tant to as­cer­tain whether or not the de­fer­ral can con­tinue to be en­joyed un­der sec­tion 241(10A). In par­tic­u­lar it should be noted that the new rules will not af­ford de­fer­ral treat­ment in re­spect of ex­change items that are: Hedged; Cur­rent as­sets or cur­rent li­a­bil­i­ties that are funded ex­ter­nally; or

Con­trac­tu­ally be­tween a con­trolled for­eign com­pany and an­other per­son where the con­trolled for­eign com­pany is nei­ther a con­nected per­son nor a mem­ber of the same group of com­pa­nies as the other per­son.

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