The introduction of new debt reduction rules seems hell-bent on taxing companies in financial distress when they receive any form of debt relief.
New rules were introduced as late as October and expand significantly on the existing debt reduction rules, which were initially mentioned in the February budget.
The expanded rules have not gone through the usual legislative participation process where public submissions, presentations or additional workshops were allowed to discuss practical issues.
Joon Chong, tax partner at law firm Webber Wentzel, says the new rules include the wording “concessions and compromise” which is so broadly defined that it catches every possible debt restructuring structure.
“In our view it not only deals with debt reduction it now deals with any change in the terms and conditions of debt. Any form of business rescue, or refinancing of debt restructuring will be captured in the provision of concession and compromise.”
The policy approach by National Treasury and the South African Revenue Service (Sars) is that debtors appear to receive a form of relief or benefit when creditors provide them with any form of debt restructuring.
“The policy intent appears to be that any benefit to the debtor from the concession or compromise is taxed at the earliest point of when the debt benefit is received. That seems to be counterintuitive,” she says.
“The whole point of having the amendment was to assist distressed companies, but debt relief has now been made more uncertain and complicated, because the concession or compromise definition is so wide it captures every possible debt restructuring.”
Ernest Mazansky, head of tax at Werksmans Attorneys, writes in the firms’ tax newsletter that the Income Tax Act already contains various rules where debt is reduced by less than its face value. This gives rise to certain tax consequences for the taxpayer, in relation to its losses or its expenditure or the tax values of its assets.
In order to broaden the reach of these provisions they have now been completely re-enacted, and now apply where there is a “debt benefit”, he says.
Erika de Villiers, head of tax policy at the South African Institute of Tax Professionals (Sait), says their main concern arises from the late addition of the trigger (a change in the terms and conditions of a debt which may give rise to a debt benefit) without full public consultation.
“Small changes in debt in order to rescue a company could easily trigger adverse tax consequences. The face value of debt will be measured against market value even though the full debt remains payable and no avoidance was involved,” argues De Villiers.
“We question whether this is not a significant policy change rolled into the debt benefit amendment,” notes De Villiers.
Sait (South African Institute of Tax Professionals) has subsequently made a submission to the Standing Committee on Finance to request that this trigger stand over for further consultation in the new legislative cycle.
However, the amendments will be introduced into law as they stand and further amendments may be made in future once the consequences have become apparent in practice.
“In my view there should not be a rush to introduce this amendment at the expense of adequate consultation aimed at getting to a good workable approach,” says De Villiers.
According to Chong there is the practical difficulty of valuing the debt benefit which arose from the waiver, conversion or change in terms of conditions.
This requires a complicated valuation method to determine the difference between the face value of the debt or shares before the waiver, conversion or concession or compromise, and the market value of the debt or shares used to settle the debt.
Andrew Wellsted, tax director at Norton Rose Fulbright, says it is a costly and problematic exercise to comply with the valuation requirements on a number of levels.
“Our view is that the provisions are now excessively complex in numerous respects and will create substantial uncertainty for taxpayers. Complexity undermines certainty.”
He says some debt restructuring does “smell of base erosion and profit shifting”. However, the country needs foreign investment. Some investments do not initially take off and may need reinvestment.
“I do not think one should discourage non-resident companies or local parties from taking a heavily indebted company and waiving, writing off, or refinancing debt. Once the debt is off the balance sheet, the company looks much more healthy and can re-energise itself again.”
Such complex and onerous rules regarding debt forgiveness in our current economic climate are arguably not warranted. The balance should be towards allowing companies to restructure their balance sheets without incurring unwanted tax complications, he says.
Treasury has been grappling with debt relief for a long time. Unfortunately this latest salvo is really complicated. “I am not sure if all the consequential impact of what has been done is yet understood,” says Wellsted.
The exclusion rules are as complicated, and any company who considers restructuring their debt should really look carefully if they will be caught in the new provisions or not, he warns.
Chong says a “concession or compromise” is widely defined and the costs associated with the new rules may be a frequent occurrence for a distressed debtor, which offers no relief at all. “If you are already distressed this is not something you would want,” she stresses.
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