By Ben Strauss, a director in Cliffe Dekker Hofmeyr’s Tax and Corporate and Commercial practice areas
The issue of ‘converting’ loans into share capital remains a vexing one.
The matter was again the subject in Binding Private Ruling 213 (Ruling) issued by the South African Revenue Service (SARS).
The facts of the Ruling are common. To fund its operational expenditure, a company resident in South Africa borrowed money from its non-resident holding company and other non-resident companies related to the holding company.
The holding company proposed to subscribe for further ordinary no par value shares in the local company. The subscription price would be equal to the total amount of the local company’s indebtedness to the holding company and the related companies. Notably, the subscription price would be paid in cash.
The local company would then use the cash to settle the capital of, and the interest on, the loans.
SARS ruled as follows in relation to the proposed transaction:
- The issue of the further ordinary no par value shares will not constitute a ‘transfer’ as defined in s1 of the Securities Transfer Tax Act, 2007 (STT Act). The issue of the shares would therefore not be subject to securities transfer tax.
- Section 8(4)(a) of the Income Tax Act, No 58 of 1962 (ITA) states that, if a taxpayer recovers any amount it previously deducted for income tax purposes, the taxpayer must include the amount in its income. For example, if a creditor of a taxpayer waives interest on a loan and the taxpayer previously claimed the interest as a deduction, then the taxpayer must include the amount of the waived interest in its taxable income. SARS ruled that this provision will not apply to the payment of the capitalised interest on the intercompany loans.
- Section 19 of the ITA and paragraph 12A of the Eighth Schedule to the ITA also apply where a creditor waives a debt (in cases other than those applying under s8(4)(a) of the ITA). Simply put, the taxpayer must account for income tax or capital gains tax on the amount waived. SARS ruled that these provisions will not apply to the repayment of the intercompany loans, or to the payment of the interest on the intercompany loans.
It is not clear why the taxpayer applied to SARS for a ruling. Firstly, in respect of securities transfer tax, the issue of shares is specifically excluded from the definition of ‘transfer’ in s1 of the STT Act. Secondly, it is clear that there is no question of a waiver of the capital or interest on the intercompany loans as these would be settled in cash.
Perhaps the taxpayer was looking for a ruling from SARS to the effect that the scheme as a whole, that is, the subscription for shares together with the settlement of the loans did not constitute impermissible tax avoidance under the general anti-avoidance rules (GAAR) in Part IIA of the ITA. However, SARS specifically included a note in the Ruling stating that it did not consider the application of the GAAR on the proposed transaction.
In other words, SARS did not commit itself to stating whether or not transactions of this kind give rise to impermissible tax avoidance under GAAR. Taxpayers are therefore still in the dark as to whether the ‘conversion’ of loans to equity are struck by the GAAR.
SARS has now issued a number of rulings indicating that the capitalisation of shareholder loans will not trigger the debt reduction provisions. However, these rulings apply only to the specific applicants, and the particular facts contained in the rulings. It accordingly remains to be seen what SARS’s overall view is of transactions of this kind.
It would greatly assist if SARS were to issue some definitive guidelines. SARS has issued a draft Interpretation Note dealing with the reduction of debt. Under that draft document SARS does appear to accept in principle that the reduction of debt through the issue of shares may not trigger adverse tax consequences. However, SARS does say at page 9 of the draft document that its comments:
‘must not be construed as sanctioning a situation in which the issue of shares, whether for cash or by set-off, is simply a sham transaction intended to disguise a waiver of debt. The facts and circumstances of each case will therefore have to be considered before it can be determined whether the issue of shares gives rise to a reduction amount.’
Taxpayers should, accordingly, continue to exercise caution when entering into transactions for the ‘conversion’ of loans into equity.