Currently, debt waiver provisions in the Income Tax Act 58 of 1962 (ITA) are dealt with in section 19 and paragraph 12A of the Eighth Schedule.
A reduction / waiver of debt for more than the fair value of the consideration paid by the debtor for such waiver could result in, mainly, income tax recoupments (section 19) or reductions of base costs of assets or capital losses (paragraph 12A). For example, where a creditor waives a debt owed of ZAR 100 and the debtor has not paid anything for the waiver, the recoupment to income, or reduction to base cost or capital loss would be the full debt amount of ZAR 100.
Dormant companies which have ceased active operations often still have debt owed to other group companies. The DTLAB proposes new requirements in section 19 and paragraph 12A(6)(d) which would apply to debt reductions or waivers owed by dormant companies where the debtor and creditor companies are in the same group.
Paragraph 12A(6)(d) currently excludes debt waived from the tax implications of paragraph 12A (reduction of base cost, etc.) if the debt reduced or waived is between South African group companies. There was no equivalent exception in section 19.
The DTLAB proposes an exception in section 19 for waiver of debt for dormant companies in the same group. This is welcomed. We note, however, that the scope of the proposed exception is too limited. The new section 19 exception will only apply to scenarios where the debtor is a dormant group company which has not traded, received or accrued any amounts, incurred any liability, received or transferred any assets from itself, for the preceding three years and the year assessment in which the debt waiver takes place.
The DTLAB further proposes to narrow the existing unqualified group exception in paragraph 12A(6)(d) by introducing the same requirements in section 19 to this subparagraph.
These new requirements are impractical for the reasons set out below.
Dormant companies being wound up are likely to receive amounts over years as final receivables are collected from the debtor company's own debtors. The debtor company may dispose of written-off stock or capital assets and this would constitute trading. Any assets sold would also be assets transferred from the dormant company.
The dormant company could also need to pay tax or receive refunds from SARS. A tax amount outstanding may be subject to a dispute. A refund may be subject to an audit. Refunds can only be paid to the debtor company's bank account, which would mean that the waiver of debt can only take place three years after the refund is received from SARS.
A liquidator appointed to wind-up a company would claim liquidator fees from the final accounts of the company prepared. The liability for the liquidator's fees would be a liability incurred by the dormant company.
All of the above are common occurrences in companies which are considered dormant or in their last stages of commercial existence. In terms of the proposed amendments, these companies would have to wait for three years of assessments to pass after the last payment or transfers are received before the exceptions could apply and the debt waiver would be tax neutral for the debtor. This could result in debt reductions and group reorganisations taking an extraordinary amount of time before finality.
The Webber Wentzel Tax team had made various submissions on the above proposed amendments. We had suggested, amongst others, that there should only be one requirement that the dormant company will need to meet, i.e. that the dormant company has not carried on trade in the year of assessment in which the debt waiver takes place. This is a requirement which will also align the requirement in section 19 to the existing section 20 of the ITA on carrying forward balance of assessed losses.
We note that the Draft Response Document issued by the National Treasury on 14 September 2017 provides that it has accepted comments made on the requirement for a company to be dormant for 4 years of assessment before the exception applies as being too long. The wording in the DTLAB will be amended to allow the group exemptions to apply if the company did not trade in the year of and immediately preceding year of assessment that the debt waiver takes place. The proposed amendments in the final bill will also be clarified to apply to any debt that is reduced, cancelled, waived, forgiven or discharged in respect of years of assessment commencing on or after 1 January 2018.
Written By Joon Chong, Partner at Webber Wentzel