The Taxation Laws Amendment Bill, Bill 19 of 2011 introduced to Parliament on 25 October 2011, contains the proposals of the South African Revenue Service ("SARS") and the National Treasury relating to debt-funded reorganisation transactions as contained in their joint press release of 3 August 2011. Such proposals are contained in the proposed new section 23K of the Income Tax Act No. 58 of 1962 ("the Act") which provides for the limitation of deductions in respect of specific debt-funded reorganisation transactions.
In accordance with the proposed section 23K(2), no deduction is to be allowed in respect of any amount of interest incurred by an entity (hereinafter referred to as "PurchaserCo") in terms of a debt instrument if that debt instrument was issued or used directly or indirectly -
- for the purpose of procuring, facilitating or funding the acquisition by PurchaserCo of an asset in terms of a reorganisation transaction; or
- in substitution for any debt instrument issued or used for the purpose of procuring, facilitating or funding the acquisition by PurchaserCo of an asset in terms of a reorganisation transaction.
It is proposed that a "reorganisation transaction" as defined in section 23K of the Act means:
- an amalgamation transaction in respect of which section 44 of the Act applies;
- an intra-group transaction in respect of which section 45 of the Act applies; or
- a liquidation distribution in respect of which section 47 of the Act applies.
Accordingly, the enactment of the proposed section 23K may have a bearing on the deductibility of interest incurred by PurchaserCo in respect of the loan funding it obtained, whether directly or indirectly, in order to finance any asset acquired pursuant to a reorganisation transaction as contemplated above.
The purpose of the proposed section 23K is to disallow or limit the deductibility of interest in specific circumstances so as to limit the loss to the fiscus which may arise in situations where PurchaserCo would directly or indirectly obtain funding from, inter alia, a tax exempt entity in order to fund the acquisition of an asset on a roll-over and, broadly speaking, tax free basis in accordance with a reorganisation transaction.
In accordance with the proposed section 23K(3), however, the Commissioner may, on application by PurchaserCo, issue a directive that section 23K(2) will not be applicable in respect of an amount of interest incurred. The Commissioner may only issue a directive in terms of section 23K(3) if and to the extent that the Commissioner is, having regard to criteria prescribed by the Minister by regulation, satisfied that the issuing of the directive will not lead to nor be likely to lead to a significant reduction of the aggregate taxable income of all parties who incur, receive or accrue interest in respect of (and for all periods during which any amounts are outstanding in terms of) the debt instruments concerned. Accordingly, in determining whether there will be a significant reduction in taxable income of all parties, all of the debt associated (whether directly or indirectly) with the acquisition of assets in terms of a reorganisation transaction should be taken into account as well as the tax position of the creditors.
An application in terms of the proposed section 23K(3) requires that PurchaserCo as well as the holders of the debt instruments disclose extensive supporting information. The process of drafting such application and compiling all the necessary supporting documentation can be quite onerous. In particular, the debt holder would be required to disclose the source of such funding to SARS. In this regard, should the source of the funding provided by a commercial bank be the general "pool of funds" of the bank, SARS requires an analysis of such general pool of funds in order to determine the extent to which, for example, such funds arise from investments/deposits made by tax exempt pension funds.
Accordingly, a potential economic risk associated with the proposed section 23K is that it may discriminate against banks with large pension fund depositors (or other exempt depositors) as opposed to banks with limited pension fund depositors.
In our experience, however, we find both SARS and commercial banks to be efficient and helpful in processing section 23K applications. Although the application process may be time-consuming and requires extensive information, it appears as though commercial banks and SARS are generally cognisant of the fact that the "wheels of commerce" are not to be stopped by virtue of section 23K(2) and, as far as possible, the application process is expedited in order to the ensure the implementation of debt-funded reorganisation transactions which do not give rise to a significant erosion of the tax base. The proposed section 23K is therefore a welcome proposal in light of the previously proposed moratorium on intra-group transactions as contemplated in section 45 of the Act.
Furthermore, from a theoretical perspective, subsequent to the joint press release of SARS and National Treasury relating to the proposed section 23K, doubts were expressed as to the enforceability of a directive issued in terms of the proposed section 23K prior to the enactment of this provision. In this regard, in terms of the draft section 23K(6), a directive issued by the Commissioner in terms of section 23K(3) in respect of an amount of interest incurred in terms of a debt instrument must be effective from either the date upon which the debt instrument was issued or the date upon which the section 23K(3) application is made - depending on the exact date of issue of the instrument and the date upon which the application is made. For example, the directive will be effective from the date on which that debt instrument was issued if the application for the directive is made on or before 31 December 2011, where that debt instrument was issued before 25 October 2011.
In our experience, provided a section 23K application grants SARS permission to consult with National Treasury in relation to the application, SARS will consider applications while the proposed section 23K is in draft form. In addition, section 23K applications approved by SARS prior to the enactment of section 23K indicate that once section 23K has been enacted a new directive will have to be obtained from SARS subsequent to confirmation being given that the factual circumstances have not changed. This will no doubt ensure the enforceability of the directive. Presumably, the process whereby a new directive is requested from the Commissioner will be a simple process merely requiring the applicant to confirm that the relevant factual circumstances have not changed.
It is recommended that taxpayers contemplating debt-funded reorganisation transactions seek legal advice as to the impact of the proposed section 23K. In particular, highly geared reorganisation transactions or reorganisation transactions concerning non-resident debt instrument holders or exempt persons, should be carefully managed.
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