South Africa: New thin capitalisation rules

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South Africa: New thin capitalisation rules

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Peter Dachs

Previously South Africa had separate thin capitalisation rules and a practice note that dealt both with how to calculate the quantum of loan funding to equity (3:1 debt-to-equity ratio) as well as the interest in respect of such loan funding between related parties on a cross-border basis. There are no longer separate thin capitalisation rules and thin capitalisation is now dealt with under the transfer pricing rules. There is a draft interpretation note on thin capitalisation. It should be noted that interpretation notes do not have any binding effect. However, they generally provide an indication of how SARS will treat certain transactions.

The transfer pricing rules are set out in section 31(1) of the Income Tax Act (the Act). Assume a loan from a South African bank to a South African subsidiary (SA Sub) of an offshore parent (Parent Co) where Parent Co provides a guarantee to the SA bank.

The first issue is whether there is a "transaction, operation, scheme, agreement or understanding" between, inter alia, SA Sub and Parent Co who are connected persons in relation to each other.

The next issue is whether any term or condition of that transaction, operation, scheme, agreement or understanding is different from any term or condition that would have existed had the parties (Parent Co and SA Sub) been independent persons dealing at arm's-length.

If these criteria are met then there is an 'affected transaction' as defined in section 31(1) of the Act.

In terms of section 31(2) of the Act where the arrangement constitutes an affected transaction the first question is whether the non-arm's-length term or condition results in a tax benefit for any party to the transaction.

The concept of a tax benefit refers to the avoidance, postponement or reduction of an anticipated tax liability. In particular the liability for the payment of any tax, levy or duty that a taxpayer must seek to avoid, postpone or reduce is not an accrued or existing liability, but an anticipated liability. The avoidance of liability in this sense is "to get out of the way of, escape or prevent an anticipated liability".

If there is a tax benefit, then the taxable income of the person deriving the tax benefit must be calculated as if that arrangement was entered into on arm's-length terms.

Guarantee

In respect of the guarantee, it seems that the terms thereof must be arm's-length since, if Parent Co were not related to SA Sub, it would require an arm's-length guarantee fee.

Loan

In terms of the draft interpretation note it must also be ensured that all the terms and conditions of the loan are arm's-length on a standalone basis. This means that the quantum of the loan funding as well as the interest rate charged thereon should be arm's-length on a standalone basis.

Peter Dachs (pdachs@ensafrica.com)

ENSafrica – Taxand Africa

Tel: +27 21 410 2500

Website: www.ensafrica.com

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