As we should all be aware the Income Tax Act 58 of 1962 (the Tax Act), in the form of various amendments over the last few years, has been changed significantly in the way the South African Revenue Services has looked at the tax deductibility of interest.

We have seen the introduction of Sections 23O and 23N and now the implementation of the Withholdings Tax on Interest (WTI) and Section 23M.

WTI was introduced with effect from 01 March 2015 and applies to any interest from a South African source which is paid or becomes due and payable to a foreign person.

WTI is withheld at a rate of 15% unless this rate is reduced in terms of a Double Taxation Agreement (DTA).

If a reduced rate is applicable, a Withholdings Tax on Interest Declaration (WTID) form needs to be completed.

This must be sent to the recipient of the interest prior to the date of such payment.

In addition to the WTI regime, Section 23M has also been introduced into our legislation.

Section 23M has a similar effect to the Transfer Pricing provisions set out in Section 31 of the Tax Act, specific to thin capitalisation.

Although potentially similar in effect it is the expressed view of SARS that the provisions of Section 31 should be applied before considering those as set out in Section 23M as Section 31 must be applied in order to establish the correct pricing around the interest charged.

What Section 23M does is then sets an interest deductibility limitation where interest is incurred on a debt owing to a creditor where the creditor is in a “controlling relationship” with the debtor concerned, or the loan is owing to a third party creditor that has obtained the funding from a debt advanced from a person that is in such a controlling interest.

A controlling relationship arises where a person holds at least 50% of the equity shares or voting rights in a company

The interest limitation is calculated by establishing the amount of interest received by the debtor, adding thereto an amount calculated in terms of a formulae and deducting therefrom interest incurred to other parties.

What is important to note is that Section 23M only applies where the interest paid to the creditor is not subject to tax in South Africa.

Thus if the interest paid falls within the requirements of the WTI, it is subject to tax and Section 23M does not apply.

What is uncertain is the situation where in terms of a DTA interest is subjected to the WTI but the DTA reduces the rate charged to 0%.

It could be argued that in this situation interest has been subject to tax but at a rate of 0% (As we apply, for example, in the case of zero rated sales for Value-added Taxation).

It is doubtful that this would be the intention of SARS and that it is likely their view would be that if a DTA reduces the rate of taxation to 0%, Section 23M should be considered.

However, the term “subject to tax” is not defined in South African tax legislation and has not been tested through the courts so this does create a grey area which will need to be considered.

What is vitally important for taxpayers to understand is that, with the introduction of Sections 23M, 23N, 23O and the WTI, the treatment of interest deductibility within the South African tax framework has changed dramatically.

This means that whenever debt structures are being put in place, no matter what the nature of the transaction, the potential effects of these sections must be kept in mind at all times.

John Jones

Corporate and International Taxation Partner, Johannesburg