The Taxation Laws Amendment Act, 2012, has amended the tax
consequences of debt reduction transactions (i.e. transactions
whereby the value of an outstanding debt is reduced for less than
full consideration) entered on or after 1 January 2013.
The tax consequences of debt reduction can be summarised briefly
In respect of debt used to fund the acquisition of trading
stock on hand, the debt reduction amount reduces the cost price of
the trading stock, taken into account for tax purposes, and the
balance of the reduction amount once the trading stock cost has
been reduced to zero, results in a recoupment to the extent of any
deduction or allowance granted in respect of trading stock
In respect of debt used to fund trading stock disposed of, or
other expenditure other than expenditure relating to allowance
assets, the amount of the debt reduction results in a recoupment to
the extent that the debt-funded expenditure was claimed as a
deduction or an allowance.
In respect of debt used to fund an allowance asset, the
reduction amount will reduce the base cost of such allowance asset
to zero for capital gains tax purposes. Thereafter, the reduction
amount will result in an income tax recoupment. In addition, the
aggregate amount of allowances or deductions which will be
allowable to the taxpayer in the future will be limited to the
actual amount incurred by the taxpayer, less the sum of the
reduction amount and the aggregate amount of all previous
allowances or deductions claimed on such asset by the
In respect of debt used to fund an asset where no allowances or
deductions are claimed, for example acquisition of goodwill, the
base cost of the asset for capital gains tax (CGT) purposes must be
reduced by the reduction amount. If the base cost is reduced to
zero and there remains an amount (i.e. after the reduction amount
has been used to reduce the base of the asset to zero), such a
balance remaining of the reduction amount will reduce the assessed
capital loss of that person.
The significance of these rules is that the tax consequences of
debt reduction turns on the allocation of the debt reduction amount
to specific expenditure types under a "waterfall"
Practically, these "waterfall" rules pose a challenge
in the case of partial debt reductions, for example where a single
debt is used to fund different expenditure items, such as trading
stock, interest, wages and capital assets. In such a case it may be
preferential for taxpayers to allocate the debt reduction amount
first to allowance assets, or other capital assets, which have high
base cost – which could shield immediate tax liability. Since
the new rules do not provide for a method of allocating the debt
reduction in the above circumstances, it remains to be seen whether
South African Revenue Service (SARS) will consent to any specific
allocation which may be more advantageous to taxpayers.
It is also worthwhile pointing out that the tax reduction rules
do not apply in certain circumstances, and one of the reasons is to
eliminate "hardship" that may arise by virtue of the tax
claw-backs. One such exception applies in circumstances where the
debt is disposed of under a "donation". In the context of
business, the implication is that debts between independent parties
are unlikely to be disposed of under a donation. Where a debt is
waived, there may well be other tax consequences which may
The real benefit of the exemption of the debt reduction rules
seems to be directed at debt waivers in corporate group scenarios,
where it is more common for fellow group entities to assist each
other. In such scenarios, it not uncommon for a holding company to
waive a debt owed by its subsidiary. That brings one to the vexed
question of whether debt reductions (mostly effected by connected
party creditors) supposedly in the form of a donation, can truly be
said to be driven by a gratuitous disinterested benevolence? Often
the need to waive a group debt may be driven by other reasons such
as establishing liquidity or solvency in the debtor entity,
improving the debtor entity's balance sheet, etc. In a scenario
where a debtor is a wholly-owned subsidiary of the creditor, waiver
of a debt by the creditor may be off-set against an increase in the
value of the shares in the debtor subsidiary, therefore questioning
whether a true donation is present.
While the objective of the new tax reduction rules is to make it
easier for companies, especially ones which are financially
distressed, to eliminate group debts in a tax neutral fashion, the
rules are complex. Taxpayers would need to be well advised to take
proper advice before embarking on any debt reductions
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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