As we are aware our Minister of Finance, Tito Mboweni presented his annual budget speech to the country on 26 February 2020. As expected the budget speech, and all the publications that go therewith, contained a number of proposed amendments to the tax legislation. Many of these will be focused on the clarification of the treatment of certain transactions and certain administrative aspects which need modification. However there are some proposals which could have a significant impact on corporate taxpayers and, although the legislation specific to these proposals has yet to be released, these need to be considered earlier rather than later.
The first of these is a proposal to restrict the ability of a company to fully offset assessed losses which have arisen in previous years against the company’s current year’s taxable income. An assessed loss is created in a particular tax year of assessment when a company’s allowable deductions are greater than its income earned from trade.
As a broad general principle, covered by section 20 of the Income Tax Act No. 58 of 1962 (“the Tax Act”), a company may offset against its taxable income from trade the balance of any assessed loss brought forward from the company’s previous year of assessment.
The proposal put forward in the Budget Speech will be to limit this offset of assessed losses carried forward to an amount of 80% of the taxable income generated in a particular year of assessment. The effect of this is that any company that generates taxable income, even where it’s carried forward assessed losses exceed such taxable income, will be in a position where it will still be required to pay taxation. This could have fairly significant implications for companies with large historical assessed losses carried forward as they will, in all likelihood, be placed in a positon where they will be required to deal with an unanticipated cash outflow to South African Revenue Services (“SARS”).
It is proposed that this amendment will come into effect for years of assessment commencing on or after 1 January 2021, so the impact of this will need to be considered fairly soon to ensure there are no unexpected surprises.
The second significant proposed amendment is to further limit interest deductions for corporate entities in an attempt to combat ongoing basis erosion and profit shifting. South Africa already has in place a number of interest limitation rules starting firstly with the application of the arm’s length test to cross border loans from connected persons, as set out in section 31 of the Tax Act. This allows SARS to assess whether debt is excessive, closer to being equity rather than debt and whether the interest rate being applied is not excessive.
In addition to the tests applied through section 31 there are then further limitations which may be applied as set out in section 23M of the Tax Act, together with the application of withholdings tax on interest where applicable.
Further support for the legislation set out in the Tax Act is provided by the South African Reserve Bank via the foreign exchange control regime currently in place in South Africa.
The proposal put forward is to limit “net interest” expense deductions to 30% of earnings before interest, taxation, dividends and amortisation (“EBITDA”) and is likely to affect all companies operating in South Africa who form part of a foreign or multinational group. Net interest is regarded as interest and economically equivalent expenses paid to external and related parties net of any interest income.
This proposed amendment may have a significant impact on the deductibility of interest expenditure incurred by companies and it may therefore be necessary to carefully reconsider financing structures that are currently in place.
Director: Corporate & International Taxation, Johannesburg