Section 24I – deferral of exchange gains and losses

taxation4Section 24I of the Income Tax Act No. 58 of 1962 (the Act) was amended in 2012 in respect of exchange items arising between connected persons or groups of companies. The purpose of this amendment was to address the problem of liquidity in the case of intra-group loans or loans between connected persons. This liquidity challenge necessitated that the tax treatment of the exchange items deviates from the accounting treatment for these exchange items by excluding long term loans from the mark-to-market regime. Therefore, if an exchange item arises between a person and a connected person in relation to that person or another entity within the group (if that person is part of a group of companies), the exchange gains or losses arising from that exchange item are not subject to tax until:

  • The person is no longer connected to the other party; or
  • The person is not part of the same group companies with the other party; or
  • The exchange item is paid.

The above deferral of tax on exchange items does not apply to the short term portion of the exchange item. In addition, where the exchange items are indirectly funded by a third party, the deferral principle does not apply and the accounting mark-to-market principle applies.

Practical challenges of section 24I(10A)
Taxpayers who fall within the ambit of section 24I(10A) need to understand that they have an obligation to keep an eye on the following:

Connected person principle
The definition of a connected person in section 1(1) of the Act in relation to a company includes any other company if at least 20% of the equity shares or voting rights in the company are held by that other company, and no holder of shares holds majority voting rights in the company. The challenges of tracking the connected person principle can be illustrated by the example below.

Strange Bunch (Pty) Ltd (SB) wants to acquire Bunch of Losers (Pty) Ltd (BoL) and SB requires assistance with the tax due diligence review of BoL. BoL received a loan of AU$100m in January 2014 from Clever Chap (Pty) Ltd (CP), a company based in Botswana, which held 25% of the shares when BoL received the funding. The rest of the shares in BoL were held by 10 South African individuals (7,5% each). BoL has a December year end. In compliance with section 24I(10A), BoL did not calculate tax on the gain of R10m on this exchange item. In determining its second provisional tax liability in December 2014, BoL calculated a taxable income of R1m and paid a second provisional tax payment of R200 000 (the first provisional tax paid was R80 000). As you perform the due diligence review of BoL, you realise that CP disposed of 10% of BoL in December 2014 as part of reducing its exposure in South African investments.

In the above scenario, CP and BoL were no longer connected persons after the disposal of shares by CP. Therefore the exchange gain should have been subject to tax in determining the second provisional tax payment. The second provisional tax payment should have been R3m . The tax liability of BoL is understated by R2, 8m. In addition to the understatement of the tax liability, BoL is liable for the understatement penalty in terms of paragraph 20(1)(a) of the Fourth Schedule to the Act.

It is clear from the above example that the person who performs the tax calculations should have a clear knowledge and understanding of every relevant business transaction in their organisations.


Short term portion of the exchange item
In 2014 section 24I was amended to clarify that the short term portion (current asset or current liability) of the exchange item is not subject to the deferral provisions of subsection 24I(10A). The challenge is that the short term portion of the exchange item should be determined in terms of International Financial Reporting Standards (IFRS). The classification of the exchange item between the current portion and the long term portion is a function of payment terms and other covenants included in the funding agreement. For example, a funder who is a connected person and who holds 20% of the shares can include a condition that the liability is payable immediately if the interest cover ratio is less than 5. More often than not, this interest cover ratio is determined once the audit of the annual financial statements is finalised after year end. Similar to the case of a change in the connected person status of the other party above, a change in the classification of an exchange item (liability or asset) from long term to current could have a material tax impact on the taxpayer.

Tracing the indirect funders
The deferral of tax for exchange gains and losses in terms of subsection 24I(10A) also applies in respect of indirect foreign currency denominated exchange items given to or by a South African, unless such exchange item is directly or indirectly funded by any debt owed to any person who is not a connected person in relation to either the ultimate lender or the borrower. This is obviously an anti-avoidance provision intended to avoid the abuse of the deferral system which could be done by simply interposing a third party in a funding transaction. The practical question is how does one trace the funding of the loan? Sometimes, the funding of the loan can be identified by reviewing the cash flow statement or the funding agreements. However, at the time the provisional tax is calculated, the cash flows may not have been finalised by the company. On the other hand, the legal teams who are involved in finalising the funding agreements may not be aware that the tax team needs to know about direct and indirect flow of funds in order to make certain tax decisions.

Things to ponder

  • Subsection 24I(10A) refers to a person rather than a taxpayer. Does this mean that the provisions of this paragraph do not apply to branches that are operating in South Africa and registered for tax in South Africa? There is a view that a branch is not a person.
  • Sometimes taxpayers renegotiate and extend the payment terms of their funding arrangement. This means that a current asset or a current liability which is already subject to tax will now be subject to the deferral provisions of subsection 24I(10A). Taxpayers should make sure that the amount already taxed or deducted is not double-accounted.
  • Loans that are payable on demand may be classified as short-term loans for accounting purposes. This means that any exchange gains or losses on these loans (if these are foreign currency denominated) cannot be deferred.

Premier Priority Tax Solutions
ITA: Sections 1 (1) definition of a connected person, 24I(10A) and paragraph 20 of the Fourth Schedule.