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Have the debt waiver provisions become easier to implement?

By Elizabeth Lombaard and Nishtha Bhoola

Have the debt waiver provisions become easier to implement?

One of the main changes introduced in the draft Taxation Laws Amendment Bill relates to the debt relief provisions set out in section 19 (which determines the income tax implications of debt relief) and paragraph 12A of the 8th Schedule to the Income Tax Act (which determines the capital gains tax (CGT) implications of debt relief).

Currently, without taking into consideration the proposed amendments, the words ‘concession or compromise’ are widely defined to include any amendment to the terms or conditions of a debt. The definition also includes debt substitution as a concession or compromise. As an example, if a company enters into a debt subordination agreement with one of its shareholders which provides that the loan only be repaid when the company is in a position to do so while the original terms required settlement on a monthly basis, it would mean that the terms of the loan have been altered. Therefore, a concession or compromise has taken place. If this concession or compromise results in a ‘debt benefit’ (as defined), the debtor would potentially have an income tax or CGT event on its hands.

Another example of a concession or compromise currently is where one debt is substituted by another debt. As the legislation reads today, that would include the scenario where a bridging loan is replaced with a more permanent or long-term debt.

National Treasury has become aware of the unintended tax consequences which arise when legitimate transactions − such as a subordination or substitution − take place. Accordingly, it has proposed certain amendments to address these. We agree that fine-tuning of the legislation is needed.

One of the proposed changes relates to the definition of ‘concession or compromise’. These amendments will be effected to both section 19 as well as paragraph 12A of the 8th Schedule.

It is, first, proposed that the debt relief rules should only apply to realisation events − the proposed amended definition of ‘concession or compromise’ is supposed to reflect this. The following events are to form the definition of a concession or compromise:

  • The cancellation, waiver or remittance of a debt
  • When a debt is extinguished by way of a redemption of the debt claim or by way of a merger by reason of the acquisition of the debt claim by the person owing that debt, or
  • When an interest-bearing debt owed by a company to a person is settled by way of a conversion or exchange for shares in that company or by applying the proceeds from shares issued by that company to a person in the instance that immediately after this arrangement, the company is a connected person in relation to that person

We believe that some of the words in the proposed amendment are duplicitous and leave room for misinterpretation. For example, the word ‘remittance’ is defined in the Merriam Webster dictionary as ‘an amount of money that is sent as payment for something’ and includes ‘payment’ as a synonym. The word ‘redemption’ is defined in the same dictionary as ‘the act of exchanging something for money’ and therefore has a similar meaning as ‘remittance’ in the context of debt. It seems unnecessarily wide and certainly confusing to include words that mean actual payment into a definition that is being used with reference to debt waivers or debt relief. It would mean that whenever a payment of debt is made, the taxpayer should consider the debt relief rules – just another thing to add to an already overwhelming compliance burden!

In addition, the proposed draft legislation has introduced a definition of ‘interest-bearing debt’. This definition will effectively ensure that the settlement or conversion of any equity loan (here meaning an interest-free loan) with shares will not result in a tax implication for the debtor.

Amendments are also proposed in respect of the definition of a ‘debt benefit’. The proposed additions to this definition are:

  • If the debt has been cancelled, remitted or waived, then the debt benefit will be the amount that has been waived, cancelled or remitted.
  • With respect to a debt that has been extinguished through a redemption or merger, the debt benefit is the amount by which the face value of the claim exceeds the expenditure incurred in respect of the redemption or acquisition of the debt.

The rest of the definition remains unchanged.

From the above proposed changes to ‘debt benefit’ it is clear that the proposed definition of ‘concession or compromise’ is now too wide. If any payment is made on a debt, such payment will, on a strict reading of the draft legislation, be considered the remittance of a debt and therefore a potentially taxable debt benefit may arise in the hands of the taxpayer. Based on National Treasury’s commentary in the explanatory memorandum, and their reasons for wanting to make the debt relief rules simpler to apply, triggering a tax event on settlement of a debt could surely not have been their intention.

While we agree with the fact that changes are necessary, it seems that the consequences may again be ‘unintended’.

The proposed changes to the definitions in section 19 and paragraph 12A will be implemented retrospectively. Therefore, if the definitions are implemented as they currently read in the draft bill, these changes will be effective for years of assessment commencing on or after from 1 January 2018.

Elizabeth Lombaard (CA)SA, a National Tax Committee member and an associate director, International Corporate Tax, KPMG, and Nishtha Bhoola, Consultant, International Corporate Tax, KPMG

This article was originally published in the October 2018 issue of ASA.