The South African Revenue Service (SARS) published Binding Private Ruling No. 193 (BPR 193) on 15 June 2015, which deals with the repayment of a shareholder loan by way of set-off with an outstanding loan under a subscription agreement.
The applicable provisions in the Income Tax Act, No 58 of 1962 (Act) are s19 of the Act and paragraphs 12A and 20(3)(b) of the Eighth Schedule to the Act.
The applicant in the transaction to which BPR 193 applies is a company incorporated in and resident of South Africa (Applicant). The second party to the transaction is the holding company of the Applicant and a non-resident for South African tax purposes (Holdco).
The facts are as follows: Holdco, being a shareholder of the Applicant, provided loan funding to the Applicant (Shareholder Loan). The Shareholder Loan was interest-bearing and remained owing to Holdco. The Applicant used the Shareholder Loan to fund the acquisition of fixed property, erect improvements, acquire operating equipment and finance deductible expenditure. In other words, the Shareholder Loan was used for working capital purposes or to fund the acquisition of assets for which allowances can be claimed.
The Applicant faced the following difficulties:
- From a cash-flow perspective, the Applicant found itself unable to operate effectively and to pay off the interest on the Shareholder Loan.
- The Applicant realised that the Shareholder Loan would fall foul of the South African thin capitalisation provisions with the result that not all interest due and payable to Holdco on the Shareholder Loan would qualify for a tax deduction.
- The Applicant further realised that its balance sheet could impair its ability to obtain credit for working capital requirements.
It was therefore decided that the Applicant and Holdco would enter into the following transaction:
- Step 1: Holdco would demand repayment of a portion of the capital of the Shareholder Loan as well as payment of arrear interest owed by the Applicant.
- Step 2: Holdco and the Applicant would enter into a subscription agreement. Holdco would subscribe for 1 ordinary share with a par value of R1 in the Applicant, to be issued at a premium. The value of the share would be equal to the portion of the debt (which would include capital and interest) that is due to be settled by the Applicant. The subscription amount would remain outstanding on loan account (Subscription Loan).
- Step 3: Upon the subscription agreement becoming unconditional, the Shareholder Loan and the Subscription Loan would be set-off.
- Step 4: The Applicant would issue the 1 share to Holdco. The portion of the Shareholder Loan not settled would remain outstanding.
The ruling made in respect of the aforementioned transaction is that the proposed subscription for the 1 share in the Applicant by Holdco and subsequent settlement of the corresponding loan accounts would not fall foul of s19 of the Act, nor paragraphs 12A and 20(3)(b) of the Eighth Schedule to the Act.
BPR 193 is valid for one year from 3 March 2015.