The Taxation Laws Amendment Bill of 2018 contains amendments that are designed to reduce certain loopholes that previously existed in the debt relief provisions that are contained in Section 19 of the Income Tax Act (“the Act”) and paragraph 12A of the 8th Schedule to the Act (hereinafter referred to as section 19 and paragraph12A).
Section 19 essentially provides that, in the event of a cancellation, waiver or extinction of a debt, or conversion or exchange of a debt (hereinafter referred to as the debt relief), a recoupment will arise of so much of the loan account that gave rise to tax-deductible expenditure in the current and/or previous years of assessment. Such recoupment is included in taxable income and taxed at the normal rate.
To the extent that such a loan was used to finance a capital asset or an allowance asset (e.g. plant and machinery), paragraph 12A provides for a reduction in the base cost of a capital asset or allowance asset.
However, in terms of the previous legislation, where the debt reduction was subject to the provisions of donations tax, then the debt relief provisions contained in section 19 and paragraph 12A would not apply, even if no donations tax was payable as a result of the exemptions contained in such donations tax provisions. This resulted in a situation where no tax may have been payable in respect of a debt relief and the legislation has now been amended to provide that the donations tax provisions will not override section 19 and paragraph 12A in situations where no donations tax is payable as a result of such exemptions.
Furthermore, the reduction in the base cost of a capital asset or allowance asset was, in terms of the old legislation, only applicable if such asset was still on hand at the time of the relief and provided the debtor did not have an assessed capital loss in the year of the relief.
A further amendment has now provided that, even if such capital or allowance asset(s) were disposed of prior to the date of the debt reduction, it will be necessary to calculate the capital gain that would have arisen on the disposal of such asset, had the asset been on hand at the time of the debt relief, and to include any recalculated capital gain in taxable income in the year that the debt is reduced.
This amendment is best illustrated by a simple example:
Assume Lender (L) advanced an amount of R1 million to Borrower (B) in Year 1 and that B utilises R 300 000 of the loan to finance tax-deductible expenditure of R 150 000 in Years 1 and 2 respectively. The balance of the loan account is used by B to acquire plant and machinery at a cost of R700 000 and B claims a section 12C allowance of R140 000 in each of Years 1 and 2. At the end of Year 2, B disposes of the plant and machinery for an amount of R 900 000. In Year 3 L waives the loan of R 1 million in full.
The tax effects for B in years 1-3 are as follows:
B obtains a tax deduction of R 150 000 in respect of the tax-deductible expenditure incurred as well as R140 000 in respect of the section 12C allowance.
B obtains a further tax deduction of R 150 000 and R140 000 on the same basis as for year 1. In addition, B is taxed on a recoupment of the section 12C allowances claimed in Years 1 and 2 of R280 000. No capital gain arises in Year 2 as the plant and machinery was disposed of for an amount that was less than the base cost thereof.
As a result of the waiver of the loan by L, B is subject to a recoupment of R 300 000 in respect of the tax-deductible expenditure incurred in Years 1 and 2, in terms of section 19.
In addition, in terms of the amendment to paragraph 12A, B is subject to a further capital gain in respect of the plant and machinery that was disposed of in Year 2. This is because the amendment to section 12A provides that the base cost of the plant and machinery that was disposed of in Year 2, needs to be recalculated at the date of the debt relief and reduced by a further R 700 000 as a result of the debt reduction.
A capital gain in Year 3 is therefore calculated by deeming the base cost of the plant and machinery in Year 2 to have been reduced to R 0 at the date of sale thereof as a result of the subsequent waiver in year 3. B is accordingly subjected to a recoupment of R 300 000 in Year 2 (being the section 12 C allowances claimed up until date of sale of the asset), as well as a capital gain of R 700 000 in Year 3.
From the above it is clear that, in the event of a debt reduction it is necessary to carefully analyse the loan that has been waived to establish not only whether there is a recoupment of tax-deductible expenditure, but also whether there is a possible capital gain in respect of any assets that may have been disposed of prior to the reduction.
The amendments came into operation on 1 January 2019 and apply in respect of years of assessment commencing on or after that date.
Consultant: Corporate Tax Compliance, Johannesburg