Interest deduction limits on debts owed to nonresidents
02 March 2015
Posted by: Author: PwC South Africa
Author: PwC South Africa
Section 23M of the Income Tax Act, which provides for interest deduction limitations on debts owed to persons not subject to SA tax, became effective on 1 January 2015 and applies to interest incurred on or after that date. In what follows, two aspects of the new provision is highlighted, i.e. the future interaction with withholding tax on interest and adjustments of the formula.
Application of the interest deduction limitation
In terms of section 23M, limits are placed on the aggregate deductions for interest incurred by a SA borrower in favour of a foreign lender, if there is a ‘controlling relationship’ between the two entities.
A controlling relationship exists when the foreign lender directly or indirectly owns at least 50% of the equity shares or voting rights in the SA borrower, or vice versa. If the interest is not subject to SA tax in the hands of the foreign lender in the tax year when it is incurred by the SA borrower, the interest will be subject to an interest limitation.
If the foreign lender is taxed in SA, the interest limitation will not apply. It should be noted that the new withholding tax on interest will represent a qualifying SA tax. However, as the withholding tax on interest will only become effective on 1 March 2015, companies should consider whether this may impact them based on individual circumstances.
As a result, companies should consider whether interest incurred between 1 January 2015 and 1 March 2015 may be subject to the interest limitation provisions.
A further consideration is the question of whether SA might be prevented from charging the withholding tax at all, in terms of certain double tax agreements. In these cases, the section 23M limitation may still apply notwithstanding that the interest is paid out after the interest withholding tax has already come into effect.
The formula and adjustments thereto
The interest limitation is calculated based on 40% of the debtor's ‘adjusted taxable income', which is taxable income before:
- interest received or paid;
- section 9D income (controlled foreign companies); and
- recoupments or allowances on capital assets.
To determine the limit, interest received is added to the 40% of adjusted taxable income figure and interest paid on debts not subject to section 23M is subtracted.
However, provision has been made for the 40% limit to be adjusted, either upwards (capped at 60%) or downwards, based on the average repo rate for the year of assessment. On the current repo rate of 5.75%, the section 23M formula produces a limit of 39%.
This article first appeared on pwc.com.