Relief in relation to acquisition debt

debt instrumentAuthor: Webber Wentzel

Relief in relation to acquisition debt

Section 23N contains rules to cap allowable interest incurred by an acquirer of a business pursuant to a Section 45 intra-group transfer or a Section 47 liquidation distribution. It replaces Section 23K from 1 April 2014 and also applies to the refinancing of debt that was subject to Section 23K.

In terms of Section 23N, the acquisition debt interest incurred by the acquiring company must, in any year of assessment and for a period of five years of assessment thereafter, not exceed the sum of the amount of interest received by or accrued to the new operating company plus 40% of the higher of the “adjusted taxable income” incurred in the first year in which the acquisition occurred or the year being tested.

It has been conceded that there are various teething problems with this new legislation which will be addressed in the 2014 tax amendments. The following three amendments are specifically mentioned:

– The dual approach of being able to use the higher of the adjusted taxable income of the first year or the year being tested is to ensure that cyclical dips in financial performance that occur post-acquisition do not distort the amount of allowable interest. However, acquisitions invariably occur partly through a financial year and the acquirer’s first year of assessment therefore reflects less than 12 months of trading. The solution proposed in the Budget is that the immediately preceding year be used as the base year for the purpose of the dual test;

- Section 23N currently provides for an indexing of the allowable percentage (currently 40%) to the extent that South Africa’s average repo rate increases beyond 10%. This means that come 1 April 2014, the repo rate will need to increase by more than 5%, before the allowable cap is increased. This creates significant uncertainty for lenders and borrowers and will materially impair the ability to raise third party debt. It also creates inequity in the tax system as local lenders will be taxable on the interest income, yet the borrower will be disallowed a deduction. National Treasury has indicated that the 10% threshold be reduced to 8%. In our view this still does not go far enough. The repo rate would have to increase from its current level of about 5.5% to 8%, before there is relief for borrowers; and

- Adjusted taxable income is currently net of assessed losses. This will distort the calculation of the interest deduction cap as timing differences and cyclical downturns will severely prejudice the borrower. It has therefore been proposed that assessed losses be excluded from the calculation of adjusted taxable income.

There are other fundamental problems with Section 23N that have not been mentioned. For example, Section 23N applies to all Section 45 intra-group transfers, regardless of whether or not they follow a share acquisition. Normal group restructurings will therefore be caught by Section 23N. For example, the assumption of interest-bearing debt as part of a business transfer in a group restructuring will fall within Section 23N. Alternatively, the consideration for an intra-group transfer could simply be left outstanding as an interest-bearing intercompany loan, resulting in Section 23N being applicable. This is a common structure to facilitate BEE shareholders in an entity that is fully geared to internal group debt. The ambit of Section 23N is too wide and may become a material hindrance to normal group restructuring and the implementation of certain BEE structures.

This article first appeared on