Update on proposed amendments to the Income Tax Act

We previously covered the notable amendments in the draft Taxation Laws Amendment Bill, 2017 (DTLAB) and draft Tax Administration Laws Amendment Bill, 2017 (DTALAB) in our newsletter which can be found here. We also actively contributed to the public participation process by making written and oral submissions on both bills to the National Treasury and the Standing Committee of Finance, as well as at National Treasury workshops on specific aspects of the DTLAB.

As is customary in the legislation process, National Treasury circulated the Draft Response Document on 14 September 2017, which records their responses on the submissions made on the draft bills. In this eAlert, we share some of the responses in the Draft Response Document and discussions at workshops on notable proposed amendments in the DTLAB. The responses and discussions provide a useful (but not final) indication of the wording in the final bill.

All references to "section" below are to sections in the Income Tax Act 58 of 1962 (ITA) and to "para" are to paragraphs of the Eighth Schedule of the ITA.

Repeal of foreign employment income exemption (section 10(1)(o)(ii))

• The first ZAR 1 million of foreign remuneration would be exempt from tax in South Africa if the individual is outside South Africa for more than 183 days, including being outside South Africa for a continuous period of at least 60 days during a 12 month period.
• The effective date of the repeal would be 1 March 2020.
  
• Submissions made on the practical difficulties of claiming foreign tax credits, increased costs of employing South African residents, and high costs of living in foreign countries were not accepted.

Proposed amendments on share buy-backs and dividend stripping (section 22B and para 43A)

• "Extraordinary dividends", as defined, distributed within 18 months of the share disposal would be deemed to be income or proceeds on the disposal of the shares. Extraordinary dividends would be any dividends received that exceed 15% of the higher of the market value of shares disposed of (i) at the beginning of the 18 month period; or (ii) on the date of disposal of the shares.
• Preference share dividends would be excluded if they are determined with reference to a specified rate of interest which is less than 15%. Rates higher than 15% would be treated as extraordinary dividends.
• The effective date of the amendments would be changed. These amendments would not apply to arrangements where the terms had been finally agreed by 19 July 2017. (In our view, the amendments should not apply to agreements which had been signed by 19 July 2017, although not yet unconditional on that date.)
• The proposed amendments currently provide for the amendments to apply to a shareholder company holding 50%, or 20% where no other shareholder holds a majority. In a listed company context, the 20% threshold would be reduced to any shareholder company holding 10%.
• The amendments would be clarified to apply only to shareholder companies holding a direct interest in the company distributing the extraordinary dividends.
• Submissions on the interaction of the corporate roll-over rules and the proposed amendments were not accepted. It would not be possible to defer the deemed income or proceeds in section 22B and para 43A by using the rollover relief in the corporate rules.
• Submissions on potential double taxation in the context of distributions in specie were not accepted.

Debt relief for dormant group companies (section 19 and para 12A)

• A reduction / waiver of debt for more than the fair value of the consideration paid by the debtor for such waiver would currently result in, mainly, income tax recoupments (section 19) or reductions of base costs of assets or capital losses (para 12A).
• Section 19 and para 12A would be amended to allow for group exemptions where the resident creditor and debtor form part of the same group (i.e. as defined in Section 41), and the debtor is a dormant company which did not trade in the year of and immediately preceding year of assessment that the debt waiver takes place.
• The amendments would apply to any debt that is reduced, cancelled, waived, forgiven or discharged in respect of years of assessment commencing on or after 1 January 2018.

Conversion of debt to equity and artificial repayments of debt (sections 19, 19A, 19B and para 12A)

• It appears from the responses in the Draft Response Document that various submissions made on these proposed amendments were noted and largely accepted.
• Webber Wentzel participated in the workshop on 26 September 2017 where National Treasury discussed further proposals on these amendments which are set out below.
• The initial claw-back provisions in sections 19A and 19B which provided for recoupment of interest and on de-grouping would be removed from the final bill.
• Section 19 and para 12A would be amended to include all forms of debt restructuring including debt waivers, debt compromises, subordination agreements, debt concessions and conversions of debt to equity.
• The definition of "reduction amount" in section 19 and para 12A would be deleted. Section 19 and para 12A would be amended to include two new concepts - "debt benefit" and "concession or compromise".
• A "concession or compromise" would include a waiver of debt, a change in any condition or term of debt, and any direct or indirect settlement of debt with equity (including conversions of debt to equity). A change of terms on interest may be excluded.
• A "debt benefit" arises for the debtor where the face value of the debt exceeds:
  1. in the context of debt waivers and change of conditions or terms of debt, the market value of the debt after the waiver or change;
  2. in the context of conversions of debt to equity:(Para (b) may exclude section 8F hybrid debt instruments.)
     1. the market value of the shares issued on the conversion, where the creditor did not hold any shares in the debtor prior to conversion; or
     2. the difference between the aggregate market value of shares held before and after the conversion, where the creditor held shares in the debtor prior to the conversion.

• A debt benefit would result in a recoupment for the debtor.
• There would only be group exemption where there is conversion of debt to equity between resident debtors and creditors in the same group (i.e. "group" as defined in section 41). There is no proposal for group relief for debt waivers or debt subordinations but this may be reconsidered in 2018.
• The amendments would apply for years of assessment commencing on or after 1 January 2018.
• A number of issues have been highlighted to the National Treasury on the above proposals, including the practical difficulty of valuing the market value of debt (relative to its face value).

Extending the application of controlled foreign company (CFC) rules to foreign companies held via foreign trusts and foundations (new definition of CFC in section 9D and new section 25BC)

• It appears from the responses in the Draft Response Document that various submissions made on the new definition of CFC and section 25BC were noted, and mostly accepted.
• Webber Wentzel participated in the National Treasury workshop on this specific amendment on 19 September 2017, where participants were requested to suggest how the amendments should be formulated in the final bill.
• It appears from the workshop that National Treasury are considering two possible options for these amendments in the final bill:
  • Option 1 involves deleting the extension of the new definition of CFC to foreign trusts and foundations holding more than 50% of participation or voting rights in a foreign company, and also deleting section 25BC. Section 25BC may be revisited in 2018.
  • Option 2 involves retaining the extension to foreign trusts and foundations with clearer references to beneficiaries of the foreign trust. The concept of "foreign foundation" would also be defined. Section 25BC would be amended to deal with potential double taxation of income, foreign tax credits, philanthropic distributions, and exemptions in section 9D. Section 25BC would also be amended to clarify the interaction between this section and section 7, section 25B(2A) and the Eighth Schedule.
  • In both options above, the extension of the new definition of CFC to include any foreign company where the financial results of this company are reflected in the consolidated financial statements of a resident company in terms of IFRS 10 would be retained. The proposed further proviso to section 9D(2) would, however, be amended to include only the financial results of the foreign company to the resident company on a net percentage basis.

National Treasury has indicated that they are working towards introducing the final bills to Parliament on 25 October 2017, which is the date that the Medium Term Budget Policy Statement is also expected to be tabled.​