Tax consequences arising from the writing off of loans
25 September 2014
Posted by: Author: Peter Dachs
Author: Peter Dachs (ENSafrica)
often spoken of as an economy with high levels of debt. Even when interest rates are high, we have never been scared of gearing ourselves so that
we can buy that expensive car or holiday house in Hermanus. Companies too often
have high levels of debt.
In addition, in virtually every
corporate structure there are a multitude of intercompany loan accounts. These
loan accounts often arise either through funding being provided by one company
to another or in circumstances where, for example, a company provides services
or sells goods to another company and the consideration remains outstanding on
such loan accounts are written off, particularly in circumstances where the
borrower is not able to repay the loan or, in a group context where the group
wishes to "clean up” its inter-group transactions.
Debt is also written off in many other
circumstances. One just needs to look at the African Bank scenario to find an
example of debt being written off or reducing in value.
article focuses on certain tax consequences arising from the writing off or
waiving of debt. Assume for the purposes of this article that Company A has
advanced interest-bearing loans to Company B. It is now proposed that the loan
will be waived.
Section 24J of the Income Tax Act
On the basis that the loans
are interest-bearing, the provisions of section 24J of the Income Tax Act (the
Act) should be considered.
A gain on
redemption of the loan will arise for the borrower (Company B) upon the waiver
of the loan. This gain will be deemed to accrue to Company B for tax purposes in terms of section
Conversely, a loss on redemption of
the loan will arise for the lender (Company A) upon the waiver of the loan.
This will be deemed to have been incurred by Company A for tax purposes in
terms of section 24J(4).
However, section 24J(4) only deems
such gain or loss to accrue to, or be incurred by, the taxpayer. It must still
be determined whether such gain or loss is to be of a capital or a revenue
Generally, unless the taxpayer is a
money-lender, an adjusted gain or loss should be capital in nature, in which
case section 24J should not apply.
loss is revenue in nature, then Company A may obtain a deduction in relation to
A gain which is revenue in nature and
which has not already been taken into account in terms of section 19 (see below),
will be included in its income.
section 24J(12) states that section 24J does not apply in respect of a loan,
inter alia, which is repayable on demand. Therefore, if the loan is repayable
on demand, then no gain or loss arises in terms of the provisions of section
24J of the Act.
reduction provisions” contained in section 19 and paragraph 12A of the Eighth
Schedule should also be considered in the context of any proposed waiver of
loans. Essentially, section 19 deals with the income tax consequences of a loan
waiver, while 12A deals with the capital gains tax (CGT) implications thereof.
Broadly speaking, section 19 applies
* A debt that is owed by a person is
* The amount of the debt was used to fund deductible expenditure,
acquire allowance assets or trading stock; and
*There is a difference between the amount advanced under the loan
and the amount repaid in terms of the loan (Reduction Amount).
Paragraph 12A of the Eighth Schedule
represents the capital gains tax equivalent of section 19. It essentially
applies where the debtor applied the loan to acquire an asset which is held on
capital account and there is a Reduction Amount.
Income tax implications for the borrower: section 19
to determine the tax implications in respect of section 19, it must be
determined how the debtor applied the debt proceeds and, in particular, whether
such proceeds were used to fund:
* Expenditure incurred in the acquisition of trading stock that is
held and has not been disposed of by the debtor at the time of the reduction of
the debt; or
* Expenditure incurred in the acquisition, creation or improvement
of an allowance asset; or
* Deductible expenditure other than set out above.
In summary, section 19 of the Act
essentially functions on the following "two-step” approach:
Step 1 - Cost price
Reduction Amount will firstly reduce the cost price of the trading stock held
by the debtor.
However, this cost price reduction
will apply only to the extent that:
* The borrowed funds were used to acquire trading stock still held
by the debtor; and
* That trading stock has a remaining cost price.
Step 2 - Ordinary revenue
If the Reduction Amount falls outside
the cost price reduction rules mentioned above, any residual amount will
trigger a taxable recoupment. Amounts of this nature can, for example,
* Debt funding related to trading stock where the cost price has
already been reduced to zero, or where the trading stock is no longer held;
* Debt funding for allowance assets to the extent of prior
depreciation (after their base cost is reduced to zero in terms of paragraph
* Debt relating to operating expenses which have been deducted for
In respect of the borrower (Company
A), paragraph 12A(3)(b) provides that in relation to an asset held at the time
of the debt reduction, the base cost of the relevant asset held by the borrower
must be reduced by the Reduction Amount.
Where the Reduction Amount exceeds the
base cost, such excess amount must be applied to reduce any assessed capital
loss of the borrower for the year of assessment in which the reduction takes
Paragraph 12A(6)(d) provides that the
provisions of paragraph 12A do not apply to, inter alia, any debt owed by a
person to another person where that person and that other person are companies
that form part of the same group of companies, unless they form part of any
transaction, operation or scheme entered into to avoid any tax imposed by the
waiver of a loan by a lender should constitute a disposal of an asset in the
hands of the lender.
It should then be
determined whether a capital loss arises from
Paragraph 56(1) provides that where acreditor disposes of a debt owed by a debtor who is a connected
person in relation to the creditor, that creditor must disregard any capital
loss determined in respect of the disposal.
paragraph 56(1) does not apply to the extent that the amount of that debt so
disposed of represents inter alia, an amount which is applied to reduce the
expenditure in respect of an asset of the debtor or any assessed capital loss
of the debtor in terms of paragraph 12A, or an amount that must be or was
included in the gross income of the debtor.
A donation is defined as any
gratuitous disposal of property including the gratuitous waiver or renunciation
of a right.
A waiver of a loan may
constitute a donation.
However, section 56(1)(r) provides
that no donations tax shall be payable in respect of a donation by a company to
another company that is a resident and is a member of the same group of
companies as the company making the donations.
In respect of the example set out
above, it is unlikely that Company A will make a tax deductible loss on
redemption or Company B will make a taxable gain on redemption in terms of
section 24J of the Act. This is because Company A and Company B will likely
hold the loans on capital account and potentially also because section 24J does
not apply since the loan is repayable on demand.
The capital gains tax provisions of
paragraph 12A should also not apply if the loans are waived between group
However, the income tax provisions of
paragraph 19 may apply to the loan if Company B used the loan proceeds to
acquire allowance assets and/or fund deductible expenditure. To the extent that
any amount is included in the gross income of Company B in terms of section 19,
Company A would then obtain a capital loss on the loan waiver.
No donations tax implications should
arise from the waiver of the loan if, inter alia, Company A and Company B form
part of a group of companies.
It can be
seen from the above high-level analysis that a multitude of tax issues must be
considered before writing off a loan.
This article first appeared on ensafrica.co.za.