South African Budget 2017 - Corporate tax proposals

Debt forgiveness

The taxation of debts which are forgiven or discharged for less than face value has been subject to complex rules for some time. The revenue authorities have grappled with different methods to be applied, particularly in an environment where a number of companies are failing. 

The proposed changes include –

• aligning the tax treatment of debt forgiveness in mining companies with the rules applied in the ordinary course. This will result in mining companies reducing the base cost of the allowance assets funded with forgiven debt rather than recouping deductions claimed;

• new rules will be introduced relating to dormant group companies or group companies which are under business rescue to allow them to ignore debts waived by other group companies even where the funding was provided for expenditure which was deductible for tax purposes.

Anti-avoidance rules

• Share buybacks
  In recent times, it has been popular for companies disinvesting from a company to exit by way of a share buyback by the investee company, rather than by selling their shares to the new investor. The tax effect of this has been a substantial capital gains tax saving for the selling party. This will be addressed.

• The “in duplum” rule and tax debts
  The in duplum rule is a legal principle which provides that interest on a debt ceases to accrue where the total amount of the interest equals the outstanding principal debt.  It has come to Government’s attention that taxpayers are avoiding tax by relying on this rule in a number of scenarios, usually involving an interest-free or low interest loan.  It is proposed that amendments dealing with low-interest or interest-free loans will explicitly exclude the in duplum rule.

• Dividend-stripping rules
  Dividend-stripping rules exist to prevent avoidance schemes involving excessive dividend distributions. In particular, they apply to situations where the buyer or a connected party to the buyer introduces loan funding to the target company, and the loan funding is distributed as a dividend shortly thereafter to the seller.  Avoidance transactions have been identified where these rules are circumvented through the debt being introduced by a third party, such as a bank.  These transactions will be addressed. 

• Contributed tax capital (CTC)
  Government has identified schemes whereby companies with a foreign parent increase their CTC and potentially avoid paying dividends tax when a distribution of return of capital is made to the foreign parent. These capital distributions are not subject to capital gains tax in the hands of the foreign parent company if the underlying investment is not immovable property in South Africa. Appropriate amendments will be made to the definition of CTC.

Corporate reorganisation rules

• Assumption of contingent debt
  Currently, as part of the corporate reorganisation rules, the consideration in a corporate reorganisation transaction may include the buyer assuming certain of the seller’s debts. With respect to debt, only unconditional obligations are currently catered for in the Income Tax Act in this situation.  It is proposed that the assumption of future contingent liabilities will be considered acceptable consideration under the corporate reorganisation rules.

• Real estate investment trusts (REITs)
  REITs are subject to a special tax dispensation that allows them to deduct their shareholder distributions against rental income as the shareholders bear the tax liability in terms of section 25BB of the Income Tax Act. Furthermore, a REITis prohibited from claiming allowances on its assets, which means that an anomaly arises when a REIT is party to a reorganisation transaction, because its assets would not qualify as allowance assets.  It is proposed that the legislation be amended to make provision for corporate reorganisation rules to apply to transactions involving REITs.

Third-party backed shares

The hybrid instruments rules have been in place for some time and seek to tax instruments on their substance rather than their form. The third party backed share rules apply to equities which are “secured” or de-risked by a third party (i.e. other than the issuer).  These rules do not apply where the equity in question is issued for a “qualifying purpose”, normally a direct or indirect investment in an operating company.  It is suggested that the current qualifying purpose exemption is not broad enough and it will be expanded.

Changes to the tax treatment of financial institutions

The income tax treatment of financial assets and liabilities of banks and other financial institutions currently follows the accounting treatment contemplated in International Accounting Standard 39. With the impending replacement of IAS 39 with IFRS 9 in 2018, the tax treatment of the financial assets and liabilities of banks and other financial institutions is to be aligned with IFRS 9 (except for the treatment of impairments). 

It has also been raised that the hybrid debt rules contained in section 8F of the Income Tax Act do not apply to certain banks and financial institutions. Rules will be introduced to make it clear that the hybrid debt rules will apply to a bank and financial institutions. 

In certain circumstances it was argued that mismatches in the application of the debt reduction rules arise where debt is cancelled, waived, forgiven or discharged between a financial institution and another company that is part of the same group of companies as the financial institution. Rules will be introduced to prohibit any mismatches which may arise in these circumstances.

Mining environmental funds

The income tax legislation currently allows for contributions made to mining rehabilitation trusts to be tax deductible, subject to conditions. New regulations have recently been introduced in the National Environmental Management Act, 1998 for the financial provisioning of the rehabilitation, management and effects of mine closures for mining companies.  Amendments will be made to the

tax legislation to align with the proposals in the financial provisioning regulations. In addition, rules will be introduced to curb the abuse of tax-deductible contributions which are used for purposes other than mining rehabilitation.

Refinement of the venture capital company regime

The venture capital company (VCC) regime was introduced into the income tax legislation to promote investment in small and medium-sized enterprises. Further changes will be made to the regime to remove any perceived impediments to making VCC investments, which will hopefully encourage further participation in the regime.

Assisting micro businesses growing into small and medium-sized enterprises

Currently, qualifying micro businesses and small business corporations are eligible for preferential corporate income tax rates. There are however no measures which allow for the smooth transition for micro businesses that grow sufficiently to migrate to the small business corporation tax regime, which may result in the imposition of penalties in certain circumstances.  Rules will be introduced to allow for the reduction of any administrative penalties which may arise from the transition of micro businesses to the small business corporation regime.