It has become well known through case law and practice that interest on loans used to acquire shares may not be deducted by the taxpayer. This is because taxpayers earn exempt dividend income and it is impossible to show that the interest deduction is directly connected with the production of taxable income. This practice has resulted in the use of complex structures that enable full or partial interest deductions becoming the norm in share acquisition transactions and which hampered many acquisition deal structures. However, tax legislation has been introduced which will simplify the tax treatment and accordingly negate the need for these complex structures in many cases.
During the 2012 fiscal year, SARS partially came to the assistance of the taxpayer – without the fanfare usually associated with major changes – through the introduction of Section 24O of the Income Tax Act. It allows the taxpayer to deduct interest on the purchase of shares, if the following requirements are satisfied:
•The target company must be an operating company i.e. the target company must be a business that provides goods or services for consideration and carries on that business on a continuous basis; or
•The target company is a controlling group company of an operating company; and
•When the transaction concludes, the purchaser must become a controlling group company with at least a 70% interest; and
•The deductions are only available in respect of wholly domestic acquisitions.
Section 23K, which requires an application to SARS for a directive that covers a specific interest deduction, has been extended with the inclusion of a further subsection. It now includes acquisition transactions conducted under section 24O. As a result, prior to the deduction of any interest balance, taxpayers have to submit an application timeously that provides:
•support for the proposed interest deduction; and
•full details of the parties involved and the proposed transaction.
Section 23K was extended to allow SARS to obtain full detail of the transaction and it is possible these directives will only be granted where there is no loss to the South African fiscus (e.g. foreign debt will not result in a taxable income within the SA tax net and it is considered prudent that these will be disallowed).
Allow time to reap the benefits
The concerned taxpayer should understand that the process to obtain a section 23K directive, although not complex, would require time for both the preparation of the application and the approval process and adequate time must therefore be allowed.
The principals contained in section 24O are a welcome relief to the corporate environment and should result in the ability to avoid complex structures being required by the taxpayer. However some structuring may still be required by moving the deduction to the entity which is deriving the taxable income, in order to optimise the deduction for the group.
The provisions of this section are only applicable from 1 January 2013 and can only apply to acquisition transactions where interest-bearing or debt arrangements are effected after this date. The deduction is also only available for as long as the requirements stipulated above are met and the conditions as stipulated in the Section 23K directive are applicable.
It is hoped that further tax proposals encouraging investment and specifically international transactions will be encouraged by SARS in the future.