With the almost non-existent growth in the economy in the last few years, it has become a common practice for taxpayers with foreign shareholding to receive financial assistance from their holding companies. This assistance is generally in the form of loans, with favourable repayment and interest terms.

There are however sections within the Income Tax Act which have consequences for both the lender and borrower which are briefly outlined below.

Withholding tax on Interest – implication for lender

Sections 50A to 50H of the Income Tax Act impose a 15% withholding tax on South African source interest paid to non-resident persons. This would typically be interest on a loan paid by a South African company to a foreign connected person and is a final tax, meaning that there would be no further tax on the interest earned by the non-resident.

Section 50C states that the foreign person would be liable for the tax, while the South African resident would withhold the tax.

Section 50D sets out the exemptions from the withholding tax on interest. Of particular mention would be the exemption of interest paid to a foreign person, in respect of a debt claim that is effectively connected with a permanent establishment of the foreign person in South Africa (if that person is registered as a taxpayer).

The withholding tax on interest may be subject to the provisions of a double tax agreement where the rate of withholding potentially could be adjusted.

Tax payable in respect of international transactions to be based on arm’s length principle – implication for borrower

Section 31 of the Income Tax Act is an anti-avoidance section dealing with transfer pricing and thin capitalisation and requires that tax payable in respect of international transactions be based on arm’s length principles.

Should the terms of a loan from a foreign connected person represent an “affected transaction” (ie. a transaction which results in a tax benefit for either of the parties as a result of their relation to each other), SARS will have the ability to amend the terms of the loan agreement to represent an arm’s length transaction.

Limitation of interest deductions in respect of debts owed to persons not subject to tax – implication for borrower

Section 23M of the Income Tax Act limits the deduction of interest in respect of debts owed to persons not subject to tax. This refers to the scenario where the deductibility of interest paid by the South African resident to a foreign connected party on a loan received, would be limited (presuming that the foreign connected party does not pay tax on the interest received).

The limitation is determined in terms of a formula set out in Section 23M and any interest disallowed as a deduction may be carried forward to future years of assessment.

While the above is a brief outline of the tax implications surrounding cross border loans, taxpayers should seek detailed professional advice when structuring cross border loan agreements.

Ozeyr Ahmed

Manager | Corporate Tax Compliance, Johannesburg

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