The anticipated note followed concerns by the Treasury and the South African Revenue Service (SARS) last year that relief offered in the Income Tax Act through section 45 was abused to indirectly facilitate the deduction of interest through leveraged buyouts and other abusive company restructuring.
Unlike most countries, SA did not allow for interest to be deductible from income when debt was used to acquire shares. A stir ensued last year when Section 45 of the act that allowed for tax relief in company restructuring was first suspended and then restricted.
Concerns were raised that legitimate intra-group restructuring and the financing of black economic empowerment transactions could be jeopardised in the process. The disallowing of interest deductions increased the financing cost of transactions. The Treasury and SARS said at the time they were fully aware that anti-avoidance legislation should not come at the expense of non-tax motivated transactions, but that it was necessary to protect the fiscus from excessive interest payouts leaving the country.
Brandt said in the absence of the practice note, investors were in the dark in terms of how anti-avoidance legislation could affect the safe harbour rule of a debt to equity ratio of 3:1. The rule implied that if a foreign company's debt did not exceed its equity by three times, interest would be deductible for tax purposes. Only when it exceeded the safe harbour ratio would it not be allowed to deduct the interest on the debt beyond the 3:1 ratio.
Since the restriction of section 45 and the possibility of the ratio being limited to 2:1 or even potentially 1:1, companies with debt in SA have serious questions on what would be happening to existing debt should the ratio change.
"People are asking whether they will be told to fix their debt to equity ratio within a certain time, or if SARS will allow debt at the existing ratio," Brandt said.
He said when the thin capitalisation practice note came into effect in July 1995 the limitation on financial assistance before that date did not apply. If the same approach is followed, it may mean that even if the safe-harbour ratio drops below 3:1, taxpayers who have existing debt in place will not have to correct their position. Brandt said it was difficult to say what the effect of the uncertainty was and whether that would make SA less attractive to invest in, as other countries were also trying to counter the erosion of their tax base through excessive cross-border interest payments.
Finance Minister Pravin Gordhan had announced a withholding tax of 15% on interest earned by foreigners in SA that would come into effect next year.
PwC's Ibikunle Olatunji said: "Africa wants investors, yet there is still a disconnect between the people who make the financial rules and those who are in political power."
Source: Business Day via I-Net Bridge
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