Pro­posed rules: tax con­ver­sions of debt in same com­pany

The Star Early Edition - - LETTERS - Conor McFad­den

THE NA­TIONAL Trea­sury has pro­posed the in­tro­duc­tion of new rules for the tax treat­ment of con­ver­sions of debt into eq­uity within the same group of com­pa­nies.

The pro­pos­als in the Tax­a­tion Laws Amend­ment Bill 2017 re­leased on July 19 comes on the back of con­cerns that tax­pay­ers are en­ter­ing into short-term share­hold­ing struc­tures that seek to thwart the debt-re­duc­tion rules.

The In­come Tax Act con­tains pro­vi­sions that deal with the way in which a tax­payer has to ac­count for any ben­e­fit re­sult­ing from a waiver, can­cel­la­tion or re­duc­tion of a debt they owe. The pro­vi­sions ap­ply only where the debt was used to fund de­ductible ex­pen­di­ture or cap­i­tal as­sets and the amount of debt re­duced ex­ceeds any con­sid­er­a­tion re­ceived by the cred­i­tor for the re­duc­tion.

De­pend­ing upon what the fund­ing was used for, the debtor might have a re­coup­ment for in­come tax pur­poses or a re­duc­tion in base cost for cap­i­tal gains tax pur­poses.

Over re­cent years, and ow­ing to dif­fi­cult mar­ket con­di­tions, tax­pay­ers have “cap­i­talised” their loans in their sub­sidiary com­pa­nies, ef­fec­tively con­vert­ing debt into eq­uity which re­sults in a health­ier-look­ing bal­ance sheet for the sub­sidiary.

Although it is not tech­ni­cally pos­si­ble to con­vert debt into eq­uity un­der our law, what oc­curs in prac­tice is that the cred­i­tor (hold­ing com­pany) sub­scribes for shares in the debtor (the sub­sidiary) for an amount equiv­a­lent to the debt out­stand­ing at that point. The debtor then uses the sub­scrip­tion pro­ceeds to set­tle the out­stand­ing debt or the par­ties set off the two claims.

This re­sults in no debt re­duc­tion and con­se­quently no adverse tax con­se­quences for the par­ties. Sars has is­sued a num­ber of bind­ing pri­vate rul­ings on the is­sue and has re­leased an in­ter­pre­ta­tion note con­firm­ing that the debt re­duc­tion pro­vi­sions would not ap­ply in these cases.

The lat­est pro­pos­als ap­ply only where the debtor and cred­i­tor form part of the same group of com­pa­nies (70% or more share­hold­ing). Trea­sury is propos­ing that where a debt ow­ing is set­tled, di­rectly or in­di­rectly, by means of shares is­sued by that com­pany to an­other com­pany in the group then the debt re­duc­tion pro­vi­sions will not ap­ply. This is the case un­der the cur­rent law.

How­ever, should the debtor and cred­i­tor no longer form part of the same group of com­pa­nies within at least five years from the date of con­ver­sion and the mar­ket value of the shares is­sued is less than the debt, the dif­fer­ence will be re­couped in the debtor’s hands.

The mar­ket value of the shares must be mea­sured at the stage of the de­group­ing and not at the time the shares were is­sued. This is an im­por­tant con­sid­er­a­tion if one is pur­chas­ing shares in a com­pany which has cap­i­talised any of its debt in the pre­ced­ing five years. The pur­chaser will need to as­sess if the sale will trig­ger this pro­vi­sion by as­sess­ing the mar­ket value of the shares on dis­posal against the face value of the old debt, then de­ter­min­ing whether or not the seller will be ex­it­ing the same group of com­pa­nies by virtue of the sale.

Where the debt re­duc­tion pro­vi­sions do not ap­ply, Trea­sury has pro­posed that any in­ter­est pre­vi­ously de­ducted by the debtor that is sub­se­quently con­verted into eq­uity must then be treated as a re­coup­ment in the hands of the debtor to the ex­tent that the in­ter­est was not sub­ject to nor­mal tax in the hands of the cred­i­tor.

This is cru­cial as un­der cer­tain multi­na­tional struc­tures the par­ent com­pany will not al­ways be sub­ject to tax in South Africa on the in­ter­est ac­crued as a re­sult of the ap­pli­ca­tion of a dou­ble tax treaty. The lo­cal com­pany will then re­coup all such in­ter­est. Such a re­coup­ment is to be used firstly to re­duce any as­sessed loss of the debtor and then a third of any bal­ance re­main­ing must then be treated as a re­coup­ment in each of the three im­me­di­ately suc­ceed­ing years of assess­ment.

These pro­pos­als are open for pub­lic com­ment un­til Fri­day. The pro­posed date of op­er­a­tion of these pro­pos­als is set at Jan­uary 1, 2018.

SARS has is­sued a num­ber of bind­ing pri­vate rul­ings

Part­ner at Fasken Martineau

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