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Uncertainty around interest deductibility for foreign funded acquisitions

18 June 2014   (0 Comments)
Posted by: Author: Peter Dachs
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Author: Peter Dachs (ENSAfrica)

Following the debacle with the suspension of section 45 of the Income Tax Act ("the Act”) and interest deductibility a few years ago, section 23K was introduced into the Act as a first step to limit the amount of tax deductible interest in qualifying circumstances.  This was followed by section 23N which applies to limit interest deductions in respect of reorganisation and acquisition transactions and which became effective on 1 April 2014.  In addition, section 23M will limit interest deductions in respect of debts owed to persons not subject to tax in South Africa (non-residents as well as resident tax exempt entities). This section becomes effective on 1 January 2015.  Whilst the provisions of these sections were aimed at providing certainty with regard to interest deductibility, the wording of sections 23K and 23M are not aligned and this creates uncertainty in particular where foreign funding is used in acquisition transactions.

Many taxpayers were in a last minute dash to meet the 31 March 2014 deadline earlier this year to obtain a directive under section 23K ("the directive”).  In essence the directive allows a taxpayer to deduct interest in accordance with this directive, the terms of which may be more advantageous than the limitations provided for in sections 23N and 23M.  The limitations of section 23N do not apply if a taxpayer obtained the directive in terms of section 23K.  This exemption will, however, be deleted with effect from 31 December 2015 and all interest incurred in respect of acquisition or reorganisation transactions on or after that date will be subject to the limitations of section 23N.  Any directive obtained under section 23K therefore effectively loses its benefit with effect from 31 December 2015 as the limitations of section 23N will apply from that date onwards.

Section 23M on the other hand does not contain a similar provision to suspend the application of the interest limitations if the taxpayer obtained a section 23K directive.  Section 23M becomes effective on 1 January 2015.  As legislation currently reads the interest deductibility limitations contained in section 23M will apply for the period 1 January 2015 to 31 December 2015 regardless of whether the taxpayer has a section 23K directive.  This will effectively, with effect from 1 January 2015, nullify beneficial terms granted in a section 23K directive.  This does not make sense as the method of calculation used by SARS in issuing the directive is specifically based on the percentage non-resident (or tax exempt) entities to which interest is paid.  Section 23M seeks to achieve the same result but applies a different test (which is effectively an EBITDA based test) to limit the interest deduction.

In discussions with senior SARS officials SARS have indicated that they acknowledge this discrepancy and that it was not the intent of the Commissioner to have a second bite at the cherry with regard to interest paid to foreign lenders in these circumstances.  SARS indicated that they also do not intend to apply the legislation in this manner.  Whilst this is comforting to know, we would feel a lot more comfortable if a legislative amendment is effected to section 23M, to include an exemption similar to that contained in section 23N which effectively suspends the application of the section until 31 December 2015. This proposal will be submitted for the next round of amendments. 

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