Refining rules for debt-financed acquisitions of controlling interest in an operating company

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Section 24O of the Income Tax Act 58 of 1962 (ITA) was introduced in 2012 and was aimed at discouraging the use of so called "debt push-down" structures (using section 45) by deeming interest incurred on a loan used by a taxpayer to acquire shares in a resident operating company (as defined in section 24O), to be incurred in the production of the income of that taxpayer and laid out for the purposes of its trade. This deeming provision allowed such taxpayer to claim interest expenses as a deduction (subject to certain interest limitation provisions).

As mentioned in the Budget Review 2018 (Budget), there were amendments to section 24O in 2015 (2015 Amendments), which were aimed at preventing the perceived abuse of allowing a deduction of the interest expenses for an acquirer, where the operating company itself did not produce taxable income. Consequently, the 2015 Amendments resulted in an amendment to the definition of operating company, which is now defined as a company in which at least 80% of its receipts and accruals constitute taxable income.

The Webber Wentzel Tax Team welcomes the Budget proposal to clarify the position as to when the 80% test should be applied and whether the test should be applied when the operating company transfers its business as a going concern to another company in the same group.

Unfortunately, the Budget did not mention any potential extension of the relief for the acquisition of shares in a foreign company. While the provisions of section 24O should apply when a taxpayer acquires shares in a foreign company which meets the definition of an operating company, section 24O provides that an interest deduction will not be allowed during any period where the taxpayer and the operating company do not form part of the same group of companies. A "group of companies" in the circumstances does not include a resident company and a non-resident company, and the provisions of section 24O will accordingly not apply where a taxpayer acquires shares in a non-resident company, even if South African debt has been used to achieve this. To the extent that South African debt is used to acquire shares in a non- resident company, there is no reason to limit the application of section 24O to the scenario where a resident company acquires shares in a non-resident company, particularly considering that the non-resident company will, in any event, become a controlled foreign company (CFC) in relation to the resident company and be subject to the provisions of section 9D, notwithstanding that it should qualify as having a foreign business establishment.

In our view, section 24O should additionally be amended to allow for the deduction of interest (subject to the limitations of section 23N) incurred on a loan used to acquire shares in a non-resident company where that company qualifies as an operating company for purposes of section 24O, and a CFC for purposes of section 9D (despite having a foreign business establishment).