The Taxation Laws Amendment Act of 2021 was published and promulgated on 19 January 2022.
One of the potentially most significant changes arising are amendments specific to the rules around the limitation of interest deductions in respect of debts owed to persons not subject to tax.
The current rules are set out in section 23M of the South African income tax act with the objective of limiting excessive interest deductions in respect of debts owed to persons not subject to tax in South Africa.
Section 23M limits the deductibility of interest incurred on such debt in terms of a formula, being: the total interest received or accrued to the debtor plus a percentage of adjusted taxable income, linked to the average repo rate, less interest incurred in respect of debt owed (excluding debts to creditors in a controlling relationship).
For the section to apply, two fundamental conditions must be met:
- There must be a controlling relationship between the debtor and the creditor, and
- The interest must not be subject to tax in the hands of the recipient in South Africa
Any interest disallowed can be carried forward indefinitely for possible deduction in later periods.
Government has considered it appropriate to review the current rules and to align with the OECD/G20 BEPS Action 4 recommendations on interest deductions.
Arising from this review, the outcomes presented were as follows:
- Existing rules are narrow
- Interest is too narrowly defined and does not consider tax avoidance opportunities
- The application of a fixed formula principle is unusual and the 40% currently applied in the formula is potentially too high
- Although the current rules do provide for back-to-back loans (loans made to a debtor from a creditor that is not in a controlling relationship with that debtor, if that creditor obtained funding for the debt advanced to the debtor from a person that is in a controlling relationship with that debtor) these rules do result in anomalous results in some cases
- In the context of the principle of not being subject to tax, in which case section 23M cannot apply, companies may seek to route interest payments through countries with the lowest possible interest withholdings tax (utilising double taxation agreements) that are greater than zero. This results in section 23M not being applicable while potentially reducing withholdings taxes from 15% to 5%.
Given the above, certain amendments have now been made to section 23M as follows:
- The definition of interest has been expanded to include:
- payments under interest rate swap agreements
- the finance cost element of lease arrangements included in or deducted from income and recognised as finance leases in terms of IFRS 16
- taxable foreign exchange gains or losses arising in respect of such debt
- amounts deemed to be interest under Sharia compliant financing arrangements
- Changes have been made to the deduction formula in that the deduction of interest expenditure is now limited to 30% of adjusted taxable income
- To curb the circumvention of the rules specific to back-to-back loans, interest limitation rules will now also apply in the cases where a debtor incurs an amount of interest owed to a creditor that:
- forms part of the same group of companies as that debtor, and
- is in a controlling relationship with that debtor and the interest is taxable in the hands of the immediate creditor, but is not fully subject to tax in the hands of the ultimate creditor, if that creditor, directly or indirectly through another creditor that is in a controlling relationship with that creditor, obtained the funding for the debt advanced to the debtor from a person that is in a controlling relationship with that creditor and that other creditor would not be taxed on the interest so accrued
- The calculation of adjusted taxable income will now consider a “qualifying distribution of a REIT”
- In the context of interest not subject to tax, such interest would result in the application of section 23M. In terms of the current rules the section has now been broadened to incorporate cases where payments do attract withholdings taxation at a rate higher than 0% but lower than the current standard rate being applied.