Section 23M caught SARS’ interest

Section 23M of the ITA applies where tax-deductible interest is incurred by a taxpayer on a loan advanced by a person not subject to tax (i.e. where that interest will not be caught by the South African income tax net in the creditor’s hands). In effect, this section limits the amount of this interest which that taxpayer may claim as a tax deduction, which aligns with Government’s Base Erosion Profit Shifting (BEPS) initiatives. National Treasury has now proposed amendments to section 23M to clarify its application and interaction with other sections of the ITA.

1 Mar 2023 3 min read Special Edition Budget Speech Alert Article

At a glance

  • Section 23M of the ITA limits the tax deduction for interest incurred on loans from non-taxable entities. Amendments are proposed to clarify its application and interaction with other ITA sections.
  • Proposed changes to section 23M(1) would clarify that only assessed losses carried forward from the prior year of assessment should be added back when calculating "adjusted taxable income," resolving a potential conflict with section 20.
  • National Treasury also suggests defining "creditor" and clarifying that the interest withholding tax reduction applies only to interest paid to non-resident creditors (section 23M(2)), exempting funding sourced from South African banks (section 23M(6)), and treating foreign exchange gains as interest received (section 23M(7)).

Section 23M(1): Adjusted taxable income

Section 23M limits the deductibility of interest to an amount calculated as a portion of a taxpayer’s “adjusted taxable income”, a term defined in section 23M(1). Therefore calculating a taxpayer’s “adjusted taxable income” is integral to applying this section.

Currently, this “adjusted taxable income” must be calculated after taking into account all other sections of the ITA, and then adding back any assessed losses already deducted under section 20 of the ITA. Given that section 20 itself requires all other sections of the ITA to have been taken into account in determining a taxpayer’s deductible assessed losses for a year of assessment, there is a potential conflict between section 20 and section 23M.

National Treasury now proposes that section 23M(1) be clarified to indicate that only the balance of assessed losses carried forward from a taxpayer’s prior year of assessment be added back when calculating that taxpayer’s “adjusted taxable income”. This would mean that a taxpayer’s “adjusted taxable income” for a current year of assessment would be calculated with reference to its assessed losses carried forward from its prior year of assessment only, and not its assessed losses from its current year of assessment as well.

Lacking a definition of “creditor” to date, National Treasury has also proposed including a definition of this term in section 23M(1).

Section 23M(2): Interest withholding tax

Also integral to applying section 23M is the amount of interest incurred by a taxpayer, the deductibility of which is being limited. Here section 23M reduces this interest by the amount of interest withholding tax paid on it. National Treasury proposes this be clarified so that this withholding tax reduction is only applicable where the interest is paid to a non-resident creditor.

Section 23M(6): Funding sourced from South African banks

Section 23M(6) provides the various exemptions from the interest limitation rules in section 23M. One of these is where a creditor lends funds to a taxpayer, but itself procured these funds from a “lending institution” (i.e. a foreign bank). National Treasury now proposes that this be amended to clarify that where a creditor obtains funds to on-lend to a taxpayer from a South African bank, this will also qualify for the exemption provided in section 23M(6)(a).

Section 23M(7): Foreign exchange gains and losses

Losses made on foreign exchange instruments are currently taken into account under section 23M(7) in so far as these losses have qualified for a tax deduction in a taxpayer’s hands. Currently, no similar treatment exists for gains made by a taxpayer on foreign exchange instruments. Therefore, National Treasury proposes section 23M(7) be amended so that any foreign exchange gains included in a taxpayer’s income under the ITA for a year of assessment be regarded as interest received by that taxpayer for purposes of section 23M.

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