20 June 2011

The draft Taxation Laws Amendment Bill, 2011

The draft Taxation Laws Amendment Bill, 2011 contains some interesting (and startling) proposals relating to debt.

Cancellation of debt

Currently, if a creditor cancels a debt, income tax or capital gains tax (CGT) consequences may arise for the debtor, and donations tax consequences for the creditor.

For instance: C sold stock to D on credit. D claimed the cost of the stock as a deduction for income tax purposes. C cancels the debt owing by D. D suffers an income tax recoupment ie D must pay income tax on the amount of the debt cancelled. C must also pay donations tax if he cancelled the debt gratuitously.

National Treasury says that the current income tax and donations consequences relating to the cancellation of debt are confusing.

It proposes that a person will, from 1 January 2012, include in "gross income" (as defined in section 1 of the Income Tax Act, 1962 (the Act)) any amount "by way of partial or full relief from any liability". The amount to be included is the face value of the liability. But if the liability is contingent, the amount included is the fair market value of the liability.

So, it appears that the cancellation of any liability will be subject to income tax in the hands of the debtor. In other words, the debtor will have to account for income tax irrespective of whether the liability arose as a result of say, a loan, or goods or services delivered on credit.

For purposes of donations tax, section 62 of the Act will be changed to provide that the value of property is "in the case of any reduction or discharge of any debt owed by a person to a creditor, the amount of that reduction or discharge". National Treasury says that this means that donations must be calculated on the face value of the debt reduced or discharged and not the fair market value of the debt.

In my view, the proposed changes don't remove confusion but instead simply create more uncertainty, based on the following factors:

  • Firstly, the term "relief from liability" does not tie into existing wording used in the Act.
  • Secondly, no concomitant changes are proposed to sections 8 and 20 of the Act (dealing with recoupments and the reduction of assessed losses when creditors grant concessions to debtors), or to paragraph 12(5) of the Eighth Schedule to the Act (dealing with CGT when debts are waived for inadequate consideration). Will these provisions be defunct?
  • Thirdly, as to donations tax, the proposed wording is wrong. A creditor may discharge a debt because it has been settled by the creditor. Surely the provision should state that the debt must be discharged for no, or inadequate consideration.

For now, taxpayers must be very careful if they are involved in any reduction or cancellation of a liability as a debtor or creditor.

Debts with no maturity dates

The rules for the calculation of interest on interest-bearing instruments are set out in section 24J of the Act. Simply put, the rules require that the incurral and accrual of interest in relation to interest-bearing instruments must be determined on the basis of "yield to maturity".

National Treasury says that taxpayers are distorting the rules by manipulating the maturity dates of those instruments.

It is proposed that the following anti-avoidance rules be introduced to cover instruments with uncertain or no maturity dates:

  • Instruments with no maturity dates ("perpetual debt"): From 1 April 2012, payments under these instruments will be deemed to be dividends in the hands of both the debtor and the creditor.

The creditor will no longer be able to qualify for a tax deduction in respect of interest paid on those instruments. And the creditor will have to pay secondary tax on companies (and withhold dividends tax when this is introduced). A new section 8G will be introduced into the Act to this end.

  • Instruments with uncertain maturity dates: From 1 January 2012, the yield to maturity calculation for these debt instruments with reference to the likely dates of maturity. Section 24J of the Act will be amended to provide for this.
  • Instruments payable on demand: From 1 January 2012, the yield to maturity will simply be calculated as if the instrument will mature within one year. Again, section 24J of the Act will be amended to provide for this.

The proposals may have very important consequences for the property loan stock (PLS) sector. Simply put, a PLS company owns immovable properties that it lets to tenants. The company issues linked units (shares which are linked to interest-bearing debentures) to investors. The PLS company pays little or no income tax: it deducts the interest it pays to investors on the linked units against its rental income.

The terms of the PLS debentures vary. But if the debentures have no maturity date, they may be hit by the proposals above. In particular, if the debentures constitute "perpetual debt", the PLS company would not be able to deduct interest paid to investors for income tax purposes.

It is not apparent that the proposals are aimed at the PLS sector in particular.

The proposed amendments to the Act are confusing because the word "amount" is used loosely. For instance, in the case of "perpetual debt" not any amount paid under an interest-bearing instrument should constitute a dividend; it should only be amounts paid on account of interest (not capital).

Finally, it should be noted that the proposed amendments are aimed at interest-bearing instruments. Long-term, interest-free loans (eg between group companies) are not affected by the proposed rules.

Ben Strauss, Director, Tax

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