Since the suspension of the application of section 45 (intra-group transactions) and section 47 (liquidations) to corporate restructuring rules during June and July 2011 there has been a continued focus on the use of excessive debt in corporate restructuring transactions. It has now been mentioned that the main problem is the erroneous classification of certain instruments as debt to generate interest deductions for the debtor, where these types of instruments more accurately represent equity. This would for instance be the case with reference to so-called subordinated shareholders loans or so-called junior loans that are made available to companies. It has also been indicated that, should the creditor be a non-resident, there is currently a tax mismatch given the fact that the debtor can deduct the interest whereas the creditor would not be subject to tax. One of the consequences is the introduction of a withholding tax on interest at the rate of 15% on 1 January 2013.

It has also been indicated that, in 2013, National Treasury will consider a so-called "across-the-board" percentage ceiling on interest deductions, relative to earnings before interest and depreciation. This will limit excessive debt financing.

Related to the aforegoing, it has long been a bone of contention that no interest deduction is afforded to taxpayers in circumstances where debt is raised to acquire shares. The reason is that the shares are only expected to render exempt returns in the form of dividends thus prohibiting the interest deduction.

Pursuant to the introduction of section 23K to the Income Tax Act in circumstances where taxpayers had to make application to have transactions approved, including the level of debt, it has now been announced that the use of debt to acquire controlling share interests of at least 70% be allowed. The interest associated with this form debt acquisition is still subject to the same controls applied to section 45 acquisitions. In other words, even though there may be an interest deduction pursuant to the acquisition of shares, one will still have to make application to the Revenue Authorities so as to have the level of debt and equity approved, the rate of interest, the identity of the debtor and the fact that non-South African residents will effectively not be able to fund these types of transactions.

The question as to whether debt can be used to fund share acquisitions, has been the subject matter of much debate between taxpayers and the Revenue Authorities over the years. To the extent that an interest deduction will now be allowed, it is interesting to establish whether dividends will also become taxable in these circumstances so as to provide for reciprocity. Ultimately, however, taxpayers will have to realise that these types of transactions will be subject to a pre-approval process, apart from the fact that they will have to be reported to the Revenue Authorities. Apart from the fact that certain shareholders loans may in future be treated as equity, especially if they are subordinated in favour of senior lenders, the actual rate applicable to loans will also be closely scrutinised. The moment a premium is attached to an interest rate in view of the fact that the loan is subordinated in favour of other lenders, it may well at some stage be treated as equity, resulting in a non-deduction of interest by the debtor.

Written by Emil Brincker, Director, National Practice Head, Tax, Cliffe Dekker Hofmeyr