Business rescue will not be a viable option for companies in distress, until amendments are made to the Income Tax Act and VAT requirements.
Any benefit that financially distressed companies could potentially derive from business rescue might be nullified by the tax implications of certain common business rescue processes. “In fact, unless amendments are made to the Income Tax Act and VAT requirements, successful business rescue will often not be possible,” says Dawid van der Berg of tax, auditing and business advisory company BDO.
He says some of the most popular mechanisms used to assist ailing companies could effectively leave them even worse off because of the tax consequences. “Just as a company is starting to recover, tax could deal it a fatal blow,” says van der Berg. According to van der Berg, a common path followed by companies in distress to revive their flagging fortunes is to reach a compromise with their creditors. “For example, they might agree to postpone payment or waive a percentage of it. Alternatively, inter-company or even third party loans may be written off or converted into equity in order to strengthen the balance sheet.”
These mechanisms are not necessarily the financial lifelines they might appear to be. “Within the very first year after going into business rescue, a company could find itself saddled with a significant VAT and income tax burdens that cannot be deferred without penalties becoming payable,” van der Berg says.
How VAT and income tax can be triggered
He uses the example of a company that goes into business rescue on 1 March of a year, owing its creditors R50 million.
“Let’s say the creditors agree to waive 50% of that debt, providing relief of R25 million. Under the VAT Act, that will immediately trigger VAT of approximately R3.07 million payable at the end of the relevant VAT cycle, assuming that the R25 million waived gave rise to input deductions in the hands of the debtor. This is unless the compromise is pursuant to the VAT vendor’s registration being cancelled altogether, in which case relief in respect of the timing of the payment of R3.07 million output tax may apply ” van der Berg says.
The waiving of 50% of the debt has an additional tax consequence in that it will reduce the company’s assessed loss, if any, and/or result in a recoupment of approximately R21.92 million (i.e. R25 million less the VAT portion) if the R21.92 directly funded income tax deductions or allowances. “If the company does not have an assessed income tax loss, the company will need to pay R6.14 million in income tax as a result of the waiver.”
In this example, both the VAT of R3.07 million and income tax of R6.14 million will impact the company’s cash flow within a year of going into business rescue. Should there not be cash to pay these amounts when due, the penalties and interest that will become payable should be kept in mind.
He adds that non-payment or non-declaration is not an option for distressed companies. “This will of course harsh trigger penalties and interest”. Van der Berg says it is quite clear that the VAT and Income Tax Acts are in urgent need of reform if business rescue is to succeed in South Africa. “One of SARS’s research projects, as stated in the 2013 Budget Review, is the VAT claw-back provision referred to above in the case of distressed debtors. Unfortunately, however, changes need to be implemented speedily in order to prevent further hardship. Without it, there is little hope that our much-hailed business rescue regime will have much meaning for companies in distress.”
* This article was prepared by BDO