Deduction for interest expense relating to acquisition of shares
The general principle in South Africa is that interest on funds borrowed to buy shares is not tax deductible. However, section 24O of the Income Tax Act provides an exception by deeming interest incurred on a loan to acquire shares in a resident 'operating company', as defined, to be incurred in the production of the income of that taxpayer, and hence tax deductible (subject to certain interest limitation provisions).
For a company to qualify as an operating company, at least 80% of its receipts and accruals must constitute taxable income. In the February 2018 budget, National Treasury stated its intention to provide further clarity on the application in practice of this test.
Unfortunately, the budget did not mention any potential extension of the interest deduction to interest incurred to acquire foreign shares. Section 24O only applies where the taxpayer and the operating company form part of the same group of companies. A 'group of companies' in this context does not include any non-resident company. Taxpayers have been lobbying for some time for the broadening of section 24O to cover foreign share acquisitions. It remains to be seen whether the 2018 amending legislation to be issued for comment shortly will take cognisance of this.
The 2018 budget also noted that a discussion document on the tax treatment of excessive debt financing in the context of cross-border loans is to be circulated for comment.
In addition to potentially falling within certain specific interest limitation provisions in South African law, inbound debt funding from connected persons also falls within the ambit of South Africa's transfer pricing rules. Historically, taxpayers could rely on the approach in Practice Note 2 (PN 2) which provided inter alia for a safe harbour 3:1 debt-to-equity ratio and specified maximum interest rates.
In 2013, the South African Revenue Service (SARS) released a draft interpretation note (draft IN) which was intended to replace PN 2. The draft IN moved away from the safe harbour approach, although it does state that a borrower with debt to earnings before interest, tax, depreciation and amortisation (EBITDA) ratio of 3:1 is less likely to be subject to an audit, and that interest rates of weighted average Johannesburg Interbank average rate (JIBAR) plus 2% or weighted average of the relevant base rate plus 2% are also considered to be lower risk. The draft IN however, remains a draft and has no legal effect. Taxpayers and foreign investors will therefore welcome additional official guidance in this context.
Exchange control developments
A number of exchange control reforms were announced in the 2018 budget.
'Loop structures', under which South African companies invest indirectly into the Common Monetary Area comprising South Africa, Namibia, Lesotho and Swaziland (CMA) through a non-CMA intermediary company, were previously only allowed if the stake held in the foreign intermediary was between 10% and 20%.
South African companies are now allowed to acquire up to 40% of the equity or voting rights (whichever is higher) in a foreign intermediary which holds investments in the CMA, provided this is done in the context of bona fide business investment. The previous minimum shareholding requirement of 10% is abolished. Loop structures that exceed the 40% threshold will require approval from the South African Reserve Bank (SARB).
Limits in place for foreign investment by qualifying South African holding/treasury companies have been increased. Qualifying companies are now permitted to transfer ZAR 3 billion ($249 million) offshore annually in the context of listed groups, while unlisted companies are now permitted to transfer ZAR 2 billion offshore. All transfers are subject to the usual SARB reporting requirements.
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