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Treasury to consider impact of repealing beneficial interest deduction

National Treasury is currently gathering information about the structures and taxpayers who rely on a practice note that covers interest deductions and the impact once this practice note is withdrawn.

The recent announcement by the South African Revenue Service (Sars) that it intends to withdraw Practice Note 31 by March next year has been met with outcries in corporate tax circles.

Read: Repeal of beneficial interest deduction practice note worries corporates

The practice has been in place since 1994 and essentially ensures that although interest must in theory be incurred in the course of trade to be deductible, Sars has allowed the deduction of interest in non-trade situations.

During a recent workshop the treasury asked affected parties to submit comments and examples of current structures to it.

It undertook to consider the structures and taxpayers that have been supported by the practice to see what can be codified into law and the rationale for doing so.

Any further announcements in this regard will only be made in the February budget.

Read: Potential window of opportunity for non-compliant taxpayers

Legislative solution?

The note established the practice that where money was borrowed and then on-lent, Sars had been happy to concede that the taxpayer was “trading” – even though the company may do nothing other than borrow to on-lend.

Kyle Mandy, partner and head of tax technical at PwC, says he appreciates that National Treasury will be looking at the issue with the potential introduction of legislation to regulate the deduction of expenditure against interest income in a non-trade scenario.

There is a wide reliance on the practice in non-trade situations, particularly in back-to-back financing.

“The announcement that it is to be withdrawn has introduced a huge amount of uncertainty into the equation.”

Mandy says in the absence of any statutory provisions that will allow for the interest deductions some finance vehicles will become insolvent and illiquid with the “strike of a pen” [sic] when Sars withdraws the practice note.

He also foresees audit issues around the going concern of some of these vehicles because of the uncertainty about the future of the practice note. This is already a reality as it has been raised in relation to some of the transactions PwC is working on.

“I think it would be a potentially extremely irresponsible decision to withdraw the practice note in the absence of a statutory regime being in place.”

Mandy has implored Sars and National Treasury to only withdraw the note once there is a legal framework in place.

Keith Engel, CEO of the South African Institute of Taxation (Sait), noted that the proposed removal is particularly problematic for back-to-back group loans in the absence of South African group relief rules.

“It is also problematic for small business owners who borrow funds from a bank to finance their small business companies and for holders of real estate investment units who acquired those units with borrowed funds.”

Small companies with “real and day-to-day benign transactions” rely on the practice note.

Sait believes the practice note currently achieves the right practical outcome, but realises that it lacks a firm legal foundation given the absence of a “trade” normally required for business deductions.

Significant fall-out

It proposes that the practice note is not withdrawn, and that Treasury – at the very least – considers doing an investigation to see what will transpire in its absence of. Sait foresees a “potentially significant” fall-out.

The banking industry has also expressed concerns about the withdrawal and has requested that the South African Reserve Bank be given the opportunity to comment and provide input.

Craig Miller, director at law firm Webber Wentzel, previously noted that the proposed withdrawal is to curb perceived abuse of the concession, although Sars does not articulate what the abuse is.

He suggested that Sars use its general anti-avoidance rules in the Income Tax Act, which is already available to it. “This may very well be an isolated case,” he added.

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