The draft Taxation Laws Amendment Bill issued on 28 July 2021 (Draft 2021 Bill) included certain proposed changes to the tax legislation to:
- strengthen the rules that limit a tax deduction for interest paid to persons not subject to tax in South Africa; and
- restrict the ability to offset an assessed loss carried forward against taxable income arising in a year.
The overriding purpose of these proposed changes was always framed as a means to allow South Africa some leeway to reduce its headline corporate tax rate, which has been out of sync for some time now with the global trend that has seen significant reductions in the rates of tax imposed on corporates by almost all of South Africa’s major trading partners.
In this article we revisit these proposals with an emphasis on recent developments in the final Taxation Laws Amendment Bill issued on 10 November 2021 (Final 2021 Bill).
Strengthen the rules that limit a tax deduction of interest paid to tax exempt persons
The rules that limit the tax deductibility of interest paid to tax exempt persons are encapsulated in section 23M of the Income Tax Act 58 of 1962 (ITA) and first became effective for interest incurred on or after 1 January 2015. In order to strengthen the application of these rules (i.e. to increase the amount of “interest” that does not qualify for a tax deduction) the Draft 2021 Bill included proposed amendments to section 23M to:
- broaden the definition of interest for purposes of these rules to include payments made under interest rate swap agreements, the finance cost element of finance leases, and foreign exchange differences;
- introduce a fixed ratio limitation of 30% of adjusted taxable income, which is essentially a form of earnings before interest, taxes, depreciation, and amortization for purposes of the rules in section 23M of the ITA;
- curb the circumvention of the rules by using back-to-back loans; and
- ensure that the rules apply to some extent even if the interest is subject to interest withholding tax in South Africa.
Under the current regime section 23M will not apply where the interest is subject to any amount of withholding tax in South Africa.
These proposals elicited many comments from corporates, tax professionals, and associations/bodies countrywide, particularly in relation to the first and last proposals listed above. The comments made have for the most part seemingly been rejected by the National Treasury as the only meaningful relaxation of the proposed amendments is the carve-out of interest that is already subject to the hybrid debt rules.
Corporate taxpayers are thus advised to revisit the application of section 23M to interest paid when the revised rules become effective, which is linked to the date from which a reduced headline corporate tax rate will apply to the relevant company.
Strangely, the fact that the application of these revised rules will only come into effect when the headline corporate tax rate is reduced is positioned as a concession of sorts, but this was always the intention. What is perhaps implicit in this message is that the headline corporate tax rate will not be reduced next year as announced in the 2021 Budget Speech.
Restricting the ability to offset an assessed loss carried forward against taxable income arising in a year
The ITA currently allows corporate taxpayers to carry forward an assessed loss indefinitely with the only requirement being that it should continue to trade. However, the Draft 2021 Bill proposed that this be restricted for tax years commencing on or after 1 April 2022 to the effect that only 80% of taxable income arising in a year can be offset by an assessed loss.
To illustrate, if Company A has an assessed loss of R2,000,000 carried forward and makes taxable income of R1,100,000 in the year then, in terms of the proposed restriction, only R880,000 (80% of R1,100,000) of that income can be offset by the assessed loss. Company A will then pay tax on R220,000 and will carry forward an assessed loss of R1,120,000 to the following tax year.
The overall aim of this proposal, being to provide some leeway for a reduction in the headline corporate tax, is generally appreciated by the tax paying public but concerns were raised that the timing of this restriction may be unfortunate as it will likely burden many businesses still trying to recover from the effects of the COVID-19 pandemic. These concerns were acknowledged, and a concession has thus been made to introduce a de minimis threshold before the restriction applies. In terms of the Final 2021 Bill then a company can offset the higher of R1,000,000 or 80% of taxable income by an assessed loss.
Applying this de minimis threshold to the example above, Company A can offset the higher of R1,000,000 or R880,000 (80% of R1,100,000) by the assessed loss of R2,000,000. Company A will then pay tax on R100,000 and will carry forward an assessed loss of R1,000,000 to the following tax year.
Finally, the fact that effective date of the revised rules will ultimately be linked to the same date that a reduced headline corporate tax rate applies was again positioned as a concession here, but this was always the intention. This again implies that a reduction of South Africa’s headline corporate tax rate will not occur next year. as promised by the Minister of Finance in this year’s Budget Speech and, while this may help to settle some accounting scores regarding whether a rate change should have been applied for deferred tax purposes, South Africa’s high corporate tax rate arguably remains a deterrent for investors and out of sync with global trends.