Tax experts and industry bodies have made an urgent plea for an amendment to and a postponement of new debt waiver rules which became effective last month (January 2018).
The requests stem from real concerns that the rules will have significantly adverse implications for transactions aimed at assisting companies in financial distress.
The latest changes relate to the triggering of “debt benefits” when changes are made to the terms and conditions of the debt.
The changes were introduced in the Taxation Laws Amendment Bill and did not follow the usual legislative participation process. It effectively expanded the existing debt reduction rules, which were initially mentioned in last year’s budget.
Pieter van der Zwan, associate professor in taxation at the North West University, wrote in a technical article that although the revised regime appears to tackle tax avoidance, in reality it will place struggling companies in a worse position because of the tax payment when they get relief from borrowers.
The South African Institute of Tax Professionals (Sait) made a submission to National Treasury this week, asking for a postponement of the effective date to January 2019, with retrospective effect.
Sait CEO Keith Engel and Erika de Villiers, head of tax policy at Sait, say in the submission that the concerns which have been raised are “significant”.
“Further consultation is likely to shine more light on the potentially adverse consequences to the economy,” they remark.
Joon Chong, tax partner at law firm Webber Wentzel, says the new rules now deal with “any change” in the terms and conditions of debt because of the increased scope in the definition of “concession and compromise”.
The Webber Wentzel tax team says in its submission to Treasury the policy intent provides for a “tax trigger event” for any common debt restructuring or refinancing strategies.
“In our view, applying this rationale would be a departure from the tax policy and purpose behind the debt relief provisions, which was initially legislated to assist companies in financial distress and prevent the creation of adverse tax consequences.”
Sait says under the old rules only an actual debt reduction due to the waiver of a loan triggered a tax consequence. Under the new rules, even the extension of the repayment of a loan triggers a tax consequence, regardless of whether any tax benefits arise.
It also notes that under the old rules, the tax consequences were based on the amount of the actual debt reduction. However, under the new rules, the tax consequences are based on a “notional amount”, being the excess of face value of the debt over the market value of the debt after the change in the terms and condition of the loan.
“The current rules are actually punishing efforts to restore value of troubled companies where the value of their loans have already declined by the time the debt restructuring takes place. Banks mainly provide relief in the hope of obtaining full repayment – not to manipulate tax consequences,” Sait says in its submission.
Webber Wentzel says the requirement to have the “debt benefit” valued, will require the company (owing the debt) to incur the expense of obtaining complex valuations each time it enters into a concession or compromise that may result in a debt benefit.
“Again, applying this rationale would be a departure from the tax policy and purpose behind the debt relief provisions, which was initially legislated to assist companies in financial distress,” the law firm notes.
“A requirement for an independent valuation would be an expensive and burdensome task for a company in financial distress.”
Group relief in the final bill has been narrowed to apply only when the debtor and creditor companies are both South African companies.
A South African company in financial distress, receiving a debt reduction or a change in the terms and conditions of the debt repayment from its foreign holding company, will suffer adverse tax consequences.
Sait says there is also no longer group relief from capital gains tax unless the borrowing company has been dormant for a few years.
Sait says many groups have been streamlining and clearing intra-group debt to improve management efficiencies so as to better cope with the “current period of ongoing domestic challenges”.
“We see no reason to target this improvement of efficiencies when the current system eliminates both intra-group gains as well as losses.”
Van der Zwan says the revised regime will have an adverse effect on transactions which are negotiated with the commercial objective of reviving businesses, rather than achieving any tax benefits.
“The South African economy is in need of activities that contribute to economic growth. A tax policy that requires viable (even though possibly struggling) businesses to utilise available funds to pay tax, due to the fact that their own credit risk has deteriorated, rather than being able to plough these funds back into reviving and growing the business is hard to understand,” he wrote in the Tax Talk article.