South Africa: Reorganisation Transactions And The Deduction Of Interest In Terms Of The New Section 23K

Last Updated: 23 November 2011
Article by Lavina Daya and Janel Strauss

Most Read Contributor in South Africa, September 2018

Following the drastic 18-month suspension of the intra-group relief available in section 45 of the Income Tax Act 58 of 1962 ("the Act") announced on 2 June 2011 in the Draft Taxations Laws Amendment Bill, 2011, which caused much concern in the business community, with many pointing out that this not only sent a negative message to the foreign investors but was widely disruptive to legitimate transactions, National Treasury and the South African Revenue Service ("SARS") have proposed interim measures to deal with these concerns.

In particular, on 3 August 2011 National Treasury and SARS issued a joint press release in which they announced that the suspension of section 45 would be lifted. They also proposed that a new section be introduced to control the interest deductions associated with debt used to fund the acquisition of assets in terms of section 44 (amalgamation transaction), 45 (intra-group transaction) or 47 (liquidation distributions) of the Act.

Against this background, the new section 23K will be inserted into the Act and will be deemed to have come into operation on 3 June 2011 with respect to any amount of interest incurred in terms of any debt instrument issued or used for the purposes of procuring, facilitating or funding the acquisition of an asset in terms of section 45, where such interest is incurred after 3 June 2011 and before 31 December 2013 and from 3 August 2011 in respect of interest-bearing debt arising from section 44 and 47 transactions where interest is incurred after 3 August and before 31 December 2013.

Broadly speaking and subject to the specific provisions of section 23K, section 44, 45 and 47 reorganisations can now be categorised in two categories, namely so-called "green transactions" and "amber transactions.

  • Green transactions are those reorganisations that do not involve interest-bearing debt, in other words transactions that are cash funded or financed by another company within the same group of company as the acquiring company. Green transactions will automatically qualify for roll-over relief and no pre-approval of the transaction is required.
  • Amber transactions are in essence reorganisations that utilise interest-bearing debt. Interest deductions on associated debt from amber transactions will only be permitted if prior approval for such deduction is obtained from SARS. 

Amber transactions will furthermore fall within two broad categories. Firstly, if the interest-bearing debt associated with these transactions is funded within the group of companies and results in no revenue loss (or the possibility of loss), automatic pre-approval is envisioned. Secondly, a discretionary approval process will apply only if the interest-bearing debt within the arrangement may result in a revenue loss. 

A taxpayer wishing to enter into an amber transaction should therefore apply for approval from SARS prior to entering into the section 44, 45 or 47 transaction. Applications can be brought by completing and submitting prescribed documentation and information either directly to the SARS head office in Pretoria or via a special email account created for this purpose. SARS will then consider the information supplied against prescribed criteria and may consult the Minister of Finance, whereafter the approval may be given.

SARS acknowledges that a longer-term set of solutions to deal with excessive debt and the characterisation of debt is planned for 2012 and beyond and that they will continue to investigate what they refer to as "pre-existing aggressive transactions that deliberately avoided paying their fair share of the tax burden". 

We have previously written on the practical and commercial difficulties arising from the sudden suspension of section 45. Although section 23K is aimed at providing certainty in respect of reorganisation transactions, the fact that section 23K will be introduced with retrospective effect in respect of section 45 transactions and the immediate application of section 23K to sections 44 and 47 arguably intensified the uncertainty, in particular with regards to corporates that were in the process of evaluating the most appropriate manner in which to rationalise their businesses.

In this regard we note the following comments made in the Draft Guide on the Disclosure of Reorganisation Transactions released by SARS on 3 August 2011:

"It is in the taxpayer's best interest to apply for approval well before entering into transactions subject to section 23K to allow the Commissioner sufficient time to consider the application. This will ensure certainty on the tax treatment of the transaction. Approval, if applicable, will be effective from the date the Commissioner grants the approval, hence interest incurred before that date will not be deductible."

Corporates currently underway with reorganisation transactions should, therefore, be aware of the risk that their proposed transaction could now qualify as an "amber transaction" in terms of which prior approval for interest deductions must be obtained by SARS in terms of section 23K. Should this be the case, an application to SARS should be made as soon as possible. Obtaining and compiling the information and documentation prescribed for completing and submitting the application will be a time consuming and costly exercise. It is also uncertain how long SARS will take to review such an application and reach a decision. This puts the taxpayer in an unfortunate position as there may be a substantial delay in the reorganisation.

Also, where a transaction was entered into immediately before or simultaneously with the introduction of section 23K, the parties to the transaction may be at risk that interest already incurred would not be deductible, as interest incurred before the date that SARS grants an approval will not be deductible. Even if an application is successfully brought to SARS, the deductibility of interest incurred pending the approval would be at risk.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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