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Thin capitalisation assessment where company has a negative equity

Friday, 07 March 2014   (0 Comments)
Posted by: Author: SAIT Technical
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Author: SAIT Technical

The answer to this query is based on legislation as at 2014/03/07.

Q: In terms of the changes made to thin capitalization rules, we need to consider whether the loan advanced by a connected party is at arm’s length (follow S31 of the ITA). Given the current situation of my client, where they are in a loss situation and have negative equity – the question arises as to how I should do the assessment. In terms of the draft interpretation note issued by SARS in 2013 (to become retroactively effective from April 2012 once it comes into effect) I need to do the following:

1) Assess whether the loan amount is an arm’s length amount (from the perspective of the lender and the borrower - the arm’s length amount would be the lower of the two)

2) Assess whether the interest charge is arm’s length

3) Should the amount/interest be deemed not to be arm’s length, the interest on the excessive loan amount as well as any excessive interest based on the interest rate charge would be denied for tax purposes

4) The denial of interest deduction would result in a secondary adjustment , of a deemed loan on which interest income would need to be accrued until the excess interest is deemed to be repaid by the foreign party In light of my client’s situation, how would I go about doing the assessment; 1) A third party would not lend them the money with the current balance sheet and the fact that they are incurring current losses 2) Consequently any loan amount (as well as interest charge) would be deemed not to be arm’s length 3) It is difficult to calculate the respective ratios even if I use the old practice note 2 of 1996 since they have negative equity and their EBIT and EBITDA are both negative.


A: SAIT has previously taken this specific matter up with SARS, and once again on Tuesday in Parliament but unfortunately we’ve had no response to our requests. For now all that we can suggest is that the OECD guidelines be used even though SARS does not always agree with those guidelines.



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