Corporate Tax

In order to survive the economic restrictions imposed due to COVID-19, many companies might have restructured their debt either through debt subordination or debt concessions. Debt restructuring can have serious tax consequences. Below we highlight on a high level the potential tax implications that organisations should take into consideration prior to concluding these restructuring arrangements.

Subordinated loans & changes to connected party loans

Subordinated debt might result in the debt meeting the requirements of a hybrid instrument for tax purposes. Generally, interest incurred on hybrid instruments is not deductible for tax purposes.  Connected party loans can also be impacted by similar rules where the term of the loan is longer than 30 years.

Debt Concession

Some entities might consider cancelling, waiving converting debt to equity or using proceeds from a sale of shares to clear any debt in order to improve the balance sheet position during this period. If your organisation is considering any of these you might also need to consider tax implications that will follow. In terms of section 19 of the Income Tax Act, No.58 of 1962(“the Act”) or paragraph 12A of the Eighth Schedule to the Act the transaction could potentially trigger the determination of a debt benefit.

The entity entering to debt concession will also need to consider recoupment of interest, foreign losses, and other expenses previously claimed.

Where the transaction includes a foreign debt holder one might need to consider some international tax requirements and Transfer Pricing requirements

VAT Considerations
Bad Debts

A vendor who writes off bad debt is entitled to claim a deduction equal to the VAT portion of the consideration written off as an input tax deduction according to section 22(1) of the VAT Act. If the debt originated from a zero-rated supply, an input tax deduction of nil arises.

Recovery of bad debts

If a debt is wholly or partly recovered for which an input tax deduction was claimed in terms of section 22(1), output tax must be accounted for on the amount recovered during the tax period when it is recovered as per section 22(2) of the VAT Act.

Long outstanding creditors

When a vendor (who account for VAT on an invoice basis) has made a deduction of input tax and has not paid the full consideration within 12 months after the expiry of the tax period when input tax deduction was made, he must, in terms of section 22(3) of the VAT Act, account for output tax in the next tax period, equal to the tax fraction of the consideration not paid. This rule does not apply if the agreed payment terms are greater than 12 months.

If the input tax credit has been claimed and the vendor, within 12 months sequestrated, liquidated or enters into a section 155 compromise with its creditors, the VAT claimed must be reversed on the date of sequestration, liquidation or section 155 compromise.

If the vendor subsequently settles the creditor, then he may claim an input tax deduction equal to the tax fraction of the amount paid as per section 22(4) of the VAT Act.

Group of companies outstanding debt

If there is any outstanding debt between group companies that is irrecoverable, the debtor company will not be entitled to an input tax deduction on the irrecoverable debt. The input tax deduction will only be allowed at such a time where the companies are no longer part of the same companies as per section 22(3A) and (6) of the VAT Act.

The general rule in section 22(3) that applies if a debt is outstanding for a period of 12 months, the vendor has to account for output tax on the debt, will not be applicable to taxable supplies between group companies.

The obligation to account for output tax will only apply to the debt of a vendor that was part of the same group of companies, once the vendor and his creditor are no longer part of the same group of companies.

Transfer of debts

In terms of a recourse basis, debt that cannot be recovered by the new holder reverts back to the original holder. In terms of the non-recourse basis, the recipient of the debt assumes full risk of bad debts

  • No deduction on discount for transfer of debt
  • If transferred on a non-recourse basis:
  • No adjustment on transfer
  • If the debt is returned and written off by the transferor, deduction on face value of debt.
  • If the recipient of debt acquired on the non-recourse basis:
  • If the debt is written off, the new owner of the debt may make an irrecoverable debt deduction.
  • Deduction limited to the price paid for debt (face value less discount)
  • Deduction deemed to be input tax.