S.Africa: the thin capitalisation provisions of section 23M and further amendments proposed thereto

the thin capitalisation provisions of section 23M and further amendments proposed thereto

In line with recent pronouncements by the OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... relating to so-called Base Erosion and Profit ShiftingBEPS stands for "Base Erosion and Profit Shifting". BEPS refers to tax avoidance strategies used by multinational enterprises (MNEs) to exploit gaps and mismatches in the international tax system. By shifting profits from high-tax jurisdictions to low- or no-tax locations, MNEs reduce their overall tax burden, even if little to no economic activity occurs in the low-tax jurisdictions. These practices erode... Project (BEPSBEPS stands for "Base Erosion and Profit Shifting". BEPS refers to tax avoidance strategies used by multinational enterprises (MNEs) to exploit gaps and mismatches in the international tax system. By shifting profits from high-tax jurisdictions to low- or no-tax locations, MNEs reduce their overall tax burden, even if little to no economic activity occurs in the low-tax jurisdictions. These practices erode...), section 23M was introduced by the Taxation LawsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public... Amendment Act, 31 of 2013.  Section 23M of the Income TaxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable... Act, 58 of 1962 (“the Act”) will come into effect on 1 January 2015 and has a similar purpose to the thin capitalisation provisions of section 31 of the Act. The Taxation LawsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public... Amendment Bill, 13 of 2014, as tabled in parliament, contains a number of substantial amendments to the current provisions of section 23M. A summary of the provisions of section 23M following these amendments is set out below.

Section 23M sets an interest deduction limitation for a debtor and will apply if a “controlling relationship” exists between the debtor and the creditor. A controlling relationship will exist where a person directly or indirectly holds at least 50 per cent of the equity shares or voting rights in a company. The interest deduction limitation will also apply in respect of a debt owed to a creditor that is not in a controlling relationship with the debtor where the creditor obtained the funding for the debt advanced from a person that is in a controlling relationship with the debtor. The interest deduction limitation will, however, only apply if the amount of interest is not subject to tax in the hands of the recipient or not included in the net income of a controlled foreign company and also not disallowed under the provisions of section 23N dealing with the limitation of interest deductions in respect of reorganisation and acquisition transactions.

The interest deduction limitation will be calculated on the aggregate of:

1. the amount of interest received by or accrued to the debtor; and
2. a percentage of the adjusted taxable incomeThe tax base is a fundamental concept in taxation, representing the total amount of economic activity or assets upon which a tax is levied. It is the foundation upon which governments calculate the amount of tax owed, based on factors like income, property value, sales, or corporate profits. Understanding the tax base is essential for tax professionals, businesses, and policymakers,... of the debtor to be determined in accordance with a formula which links deductible interest to the average repo rate for the year.

The formula will be, therefore, adjusted where there is a change to the average repo rate together with a 400 basis point addition to the average repo rate. The interest deduction limitation will have ceiling of 60 per cent of the adjusted taxable incomeThe tax base is a fundamental concept in taxation, representing the total amount of economic activity or assets upon which a tax is levied. It is the foundation upon which governments calculate the amount of tax owed, based on factors like income, property value, sales, or corporate profits. Understanding the tax base is essential for tax professionals, businesses, and policymakers,... of the debtor which will exclude the previous year’s assessed loss. Any interest in excess of the limitation may be carried forward to the following year. The interest deduction limitation will not apply to any interest incurred by a debtor in relation to back-to-back loans where the creditor obtained those funds from an unconnected lending institution in relation to the debtor and the interest is determined with reference to a rate that does not exceed the official rate of interest as defined in the Seventh Schedule plus 100 basis points.

National Treasury and SARSThe South African Revenue Service (SARS) is the official tax authority responsible for the administration and enforcement of tax laws in South Africa. It plays a crucial role in managing the country’s fiscal policy by collecting revenue, administering customs, and ensuring compliance with tax legislation. Established under the South African Revenue Service Act, No. 34 of 1997, SARS functions independently... are of the opinion that section 23M has a broader objective than the thin capitalisation provisions of section 31 and that section 31 will first apply to determine the correct pricing of the debt owed. Where the amount of interest is taken into account in terms of a reorganisation and acquisition transaction under section 23N, the provisions of section 23M must be applied to any amount not already disallowed under section 23N.