Complex corporate financing under microscope due to tax leakage concerns

THE GOVERNMENT is continuing to look into ways of addressing its concerns relating to the extensive tax leakage the fiscus has suffered as a result of complex corporate restructurings that use section 45 of the Income Tax Act.

It intends revising the reclassification rules to restrict the tax leakage resulting from the use of debt in corporate restructurings and is looking at placing a ceiling on interest deductions.

Last year, in a move that caused much consternation within the corporate finance community, the Treasury announced it was suspending the use of section 45 for the implementation of corporate restructurings. The suspension was lifted after a few months and limited restrictions were introduced.

In the Budget Review, the Treasury referred to last year’s public debate, which it said highlighted the need to improve the classification of corporate financing.

“The main problem is the erroneous classification of certain instruments as ‘debt’ to generate interest deductions for the debtor when such instruments more accurately represent equity financing.”

It noted that in some private equity transactions, where creditors receive exempt interest income, the deductibility of interest payments deprives the fiscus of revenue.

“Excessive debt can also give rise to excessively risky transactions that may represent ‘credit risk’ for the domestic market,” it noted.

In addition to revising its classification rules, “in 2013 government will also consider an ‘across-the-board’ percentage ceiling on interest deductions, relative to earnings before interest and depreciation, to limit excessive debt financing”.

“Section 45 has been used as an indirect acquisition technique to facilitate the deduction of interest payments by allowing debt to be formally matched against underlying assets as opposed to shares… it is now proposed that the use of debt to directly acquire controlling shares, interests of at least 70 percent be allowed.”