which deals with intra-group transactions, was suspended for a period. The main reason why section 45 was suspended was to allow National Treasury to put in place measures to curb the perceived erosion of South Africa’s tax base through numerous debt funded private equity transactions that occurred utilising the provisions of section 45 to avoid triggering any taxation.
When the suspension of section 45 was lifted, an interim measure in the form of Section 23K of the Act was introduced. Section 23K denies the deduction of interest incurred in respect of debt utilised to fund reorganisation transactions (involving intra-group transactions (in terms of section 45) and liquidation transactions (in terms of section 47)). Section 23K does however, provide for the Commissioner of SARS (“the Commissioner”) to approve the deductibility of interest incurred in respect of such debt, if it is satisfied that the level of debt and interest incurred does not pose a significant threat to the South African tax base. The Commissioner considers various factors in such an assessment. However, section 23K was not intended to be a long-term solution, but was initially expected to apply only until 31 December 2013.
New provisions
The TLAA now contains a long-term solution to the base erosion problem, identified by National Treasury, in the form of a new section 23N. Unlike section 23K, which rendered the deductibility of interest subject to the discretion of the Commissioner, section 23N now proposes a more objective test, thereby negating the requirement for affected taxpayers to apply for a directive from the Commissioner. If a taxpayer meets the qualifying criteria, the interest incurred in affected reorganisation transactions will be tax deductible, subject to the stipulated deductibility thresholds.
In essence, section 23N provides that when the acquisition of assets in terms of a reorganisation transaction is funded through debt, the interest incurred will be allowed as a deduction, subject to a formula, which equals:
Interest received by, or accrued to, the acquiring company
Add: 40% of the adjusted taxable income of the acquiring company
Less: Interest incurred by the acquiring company, other than interest incurred that is the subject of the section 23N limitation
The adjusted taxable income used in this formula is the higher of the adjusted taxable income of the acquiring company for the year of assessment in which the reorganisation transaction is entered into or the year of assessment in which the interest is incurred. This establishes a base for determining the interest deduction limitation.
Adjusted taxable income is determined as follows:
Taxable income
Less: Interest received or accrued
Less: Net income of a controlled foreign company
Less: Capital asset recoupments
Add: Interest incurred
Add: Any deduction or allowance in respect of a capital asset
Add: 75% of gross income from the letting of any immovable property
In principle, adjusted taxable income is similar to an accounting EBITDA (earnings before interest, tax, depreciation and amortisation) number.
Section 23N provides that the interest deduction limitation described above, must be applied for the year of assessment in which the reorganisation transaction is entered into and the five years of assessment immediately thereafter.
The introduction of a defined set of rules governing the deductibility of interest incurred in respect of debt funded reorganisation transactions is welcomed as it removes the need to obtain pre-approval from the Commissioner. However, the application of these rules in practice, and whether or not they will result in an equitable outcome remains to be seen.
Section 23N will apply to any reorganisation transaction (i.e. an intra-group or liquidation transaction) entered into on or after 1 April 2014. For reorganisation transactions entered into prior to 1 April 2014 any directive issued by the Commissioner in terms of section 23K will continue to apply to interest incurred on any debt utilised or assumed to fund such transactions. However, should any new debt be issued, assumed or used after 1 April 2014 to redeem, refinance, substitute or settle any debt utilised / applied in a reorganisation transaction which was subject to a section 23K directive, section 23N will be applicable to the interest incurred on such new debt.
Section 23N also applies to acquisition transactions in terms of section 24O of the Act where a controlling interest in an operating company is acquired, i.e. the acquisition of shares in specific circumstances.
Anyone involved in reorganisation transactions is advised to consider the amendments carefully as they could have a significant (positive or negative) effect on future transactions.
Grant Thornton
ITA: Sections 23K, 23M, 23N, 23O, 23P, 45 and 47