Most Read Contributor in South Africa, September 2016
With effect from 1 January 2013, new rules were introduced
in the Income Tax Act No. 58 of 1962 ('the Act') governing
the tax consequences flowing from the reduction or waiver of debts.
According to the Explanatory Memorandum, the amendments were
prompted in response to the global financial crisis and the
unusually large number of companies facing financial distress. The
intention was therefore to establish a mechanism which facilitated
debt reductions without creating an additional obligation to pay
In terms of the amended provisions, it is important to identify
the purpose for which the funds were borrowed. The reason for this
is that if the debt was used to fund deductible expenditure
or an allowance, the debt reduction or
discharge will be taken into account in terms of the
ordinary revenue rules. The rules for capital
gains apply as a residual category. Once the
purpose of the debt is
identified, then the relevant ordering
rules will apply in determining the tax
treatment of the debt reduction or waiver, namely
section 19 in the case of debt used to
fund deductible expenditure or an allowance and
paragraph 12A of the Eighth Schedule
to the Act in the case of debt used to acquire
The effect of section 19 is that it deems any
deduction or allowance granted in terms of the Act in
respect of the expenditure to be an amount that has been
recovered or recouped by that person for the year of
assessment in which the debt is reduced.
In accordance with the provisions of paragraph 12A, the
base cost of the capital asset must be
reduced by an amount equal to the amount by which the debt
is reduced. If the amount of the base cost of the capital
asset is reduced to Rnil, the excess of
the reduction amount over the base cost of the capital
asset will be utilised to reduce any assessed capital
losses of the taxpayer. If the taxpayer does not
have assessed capital losses, then the remainder
of the reduction amount will not be
The above rules are relatively easily applied in circumstances
where there is a clear delineation of the purpose for which the
debt was incurred. However, in practice it may not always
be apparent as to the purpose for which the funds
were borrowed. For example, a taxpayer acquires a
business on loan account in terms of an
intra-group transaction. It can be assumed that
the loan was allocated to the various
components of the business. Subsequently, a third
party purchases a portion of the loan account together
with shares in the taxpayer. At a later stage, it
is determined that there is little likelihood that
the third partywill be able to
repay that portion of the loan account
acquired from the taxpayer.
The practical question which arises is what was the
purpose of the loan account acquired by the third party? A
claim was bought by the third party which
originally arose in relation to the acquisition of a business
comprising both capital assets and items on revenue
account. Does the nature of the claimretain the same purpose for which it was
originally created? Or is there a different
purpose associated with the third parties' acquisition
of the loan account?
The Explanatory Memorandum issued by the South
African Revenue Service does not provide any
indication as to what will occur in the
circumstances as described above. In addition, there is no
case law at this stage addressing the operation of the
provisions in the Act in such a scenario. It therefore seems that a
practical way of determining the purpose of the debt is to
consider the original purpose of the debt in acquiring the
business. It is assumed that such purpose will not
be altered when a portion of the debt is acquired by the
third party from the taxpayer. The third party effectively
assumes an obligation as opposed to advancing any
debt for a specific purpose.
It is then necessary to separate the various
components of the business into capital
assets on the one hand, and those components which are
treated on revenue account and in respect of which
a deduction has been claimed on the other. In so
doing, it is possible to allocate the debt
proportionately to each of these components and
determine the purpose for which the debt was
incurred. Once the allocation has been completed, then the
debt reduction ordering rules will be applied.
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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