Written by Joon Chong and Brian Dennehy, both Partners at Webber Wentzel
In this article covering the Taxation Laws Amendment Bill, 2017 (TLAB), we discuss amendments in the Income Tax Act, 1962 (ITA) on the new debt relief measures and the meaning of "debt" in the corporate rules. We also discuss amendments relevant to real estate investment trusts (REITs), securities lending arrangements and third-party backed shares, as well as the additional relief provided to venture capital companies (VCC) for returns of capital.
All references to "section" below are to sections in the ITA, and references to "para" are to paragraphs in the Eighth Schedule of the ITA.
Existing "debt reduction" concept replaced with "concession or compromise"
- The scope of the current "debt reduction" rules in section 19 and para 12A will be expanded significantly to apply to any "concession and compromise" of debt which gives rise to a "debt benefit" to a debtor.
- The definition of "concession and compromise" is widely defined to cover all forms of debt restructuring including any changes and waivers of terms and conditions of debt, an exchange of any obligation for the debt obligation, and direct or indirect settlements of debt with shares in the debtor.
- "Debt" is defined to exclude interest. This is relevant to valuing a "debt benefit" for the debtor.
- A "debt benefit" arises for the debtor if the face value of the claim before, exceeds the market value of the claim after the concession or compromise. Where debt is settled with shares, a debt benefit arises for the debtor if the face value of the claim before the settlement is greater than the market value of the shares.
- Depending on the use of the debt and tax effect of such use, a debt benefit results in income tax recoupments (section 19), or reductions of base costs of assets or capital losses (para 12A) for the debtor. (Recoupment is a tax concept which provides for amounts previously claimed as deductions to be included in income and subject to income tax.)
- Group relief is available between resident debtors and creditors in the same group where:
- the debt benefit arises as a result of direct and indirect settlements of debt with shares; or
- the debtor did not trade in the year of assessment that the debt benefit arises, and the previous year.
- A debt benefit arising from a reduction of debt in the course of the winding-up of a debtor, where the creditor is a connected person, is excluded from para 12A implications, but not section 19.
Debt relief measures for mining companies
- The TLAB proposes to provide debt relief measures specific to mining companies.
- Any debt amount waived which is used to fund capital expenditure of mining operations will first be used to reduce any capital expenditure actually incurred, or deemed to be incurred, in the current year of assessment that has not yet been deducted.
- Any excess of the debt waived will then be included in the gross income of the mining company.
Meaning of "debt" in the corporate rules
- The corporate rules in the ITA (sections 41 to 47) provide for tax rollover relief only if any debt, assumed as consideration for the sale or transfer of assets, meets the specified criteria.
- The uncertainty around the type of "debt" which is included in these transactions is clarified to include contingent liabilities. For purposes of the corporate rules, a contingent liability would be deemed to be a debt actually incurred.
Amendments relevant to REITs
- Section 25BB provides that REITs are not entitled to claim certain capital allowances as REITs are subject to a special tax dispensation which allows them to claim shareholder distributions against their rental income.
- This gives rise to an anomaly where REITs are party to reorganisation transactions in terms of the corporate rules as their assets would not qualify as "allowance assets".
- The corporate rules are amended to provide for the rules to apply in respect of allowance assets transferred to REITs and for REITs to acquire these assets as capital assets.
- Another amendment proposes to deem the year of assessment of a company which ceases to qualify as a REIT, to end on the day before the date the company ceases to qualify. This is to enable the company to still claim for the specified deductions in the year it ceases to qualify, as was the policy intent.
Securities lending arrangements widened
- There are no securities transfer tax, income tax and capital gains tax implications if listed shares or government bonds are transferred in terms of securities and collateral lending arrangements.
- The scope of these arrangements is extended to include foreign government listed bonds.
Relief for returns of capital in VCC shares
- The VCC regime allows investors an upfront tax deduction for their subscription in shares in the VCC, with a recoupment of the deduction if the shares are not held for at least five years.
- There is no difference between realisation of the investment through a disposal of the shares or a return of capital. Therefore, the investor will also not have a recoupment of the initial tax deduction if there is a return of capital on the shares if the shares are held for at least five years.
Qualifying purpose exemption widened in section 8EA
- This section is an anti-avoidance provision targeting preference shares with dividend yields backed by third parties. These dividends are treated as income unless the funds derived from the issue of these shares were used for a "qualifying purpose", for instance, the direct or indirect acquisition of an equity share in an operating company.
- The TLAB proposes to widen the qualifying purpose exemption to remove the requirement that the company issuing these shares is to use the funds solely for the acquisition of shares in an operating company.
- The "solely" requirement was overly restrictive as the current exemption would not apply to situations where the cash raised from the issue of these shares was used to refinance debt or other preference share funding that was used for a qualifying purpose.