Draft tax law legislation, released 16 July 2018 for public comment, appears to reflect an understanding that a rule introduced in 2017 to address the income tax implications of debt reductions may have an unanticipated consequence when a company enters into certain debt subordination agreements—and that could result in taxable income in the company.
The new rule introduced in the Income Tax Act in 2017 concerned the income tax implications of debt reductions. An unanticipated consequence was that it could be triggered when a company entered into a debt subordination agreement, for example, with a shareholder who had given a loan to the company could then result in taxable income in the company because it was seen as having received a “debt benefit.”
The reason for this anomaly was that the rule provided that any change in the terms or condition of a debt would be regarded as a “concession or compromise.” Thus, if the initial loan agreement provided for annual, monthly or quarterly repayments of the loan, and a debt subordination agreement was subsequently entered into that provided that payments only needed to be made once the company was in a position to do so, that would be deemed to be a change to the terms of the loan. Thus, the debt subordination agreement would fall into the definition of a “concession or compromise.”
Once there was a “concession or compromise,” the next step would be to assess whether there was now a “debt benefit”—and again, because of the language of the section, it could be asserted that the market value of the loan was less than its face value.
The draft Taxation Laws Amendment Bill was released on 16 July 2017 for public comment. National Treasury officials have recognised that the rule was (to use their own words) “a blunt instrument aimed at targeting a narrow group of taxpayers.” The definition of a “concession or compromise” would be completely replaced, and any reference to a change in the terms or conditions of a loan would be removed.
This change would be effective retroactively(retrospectively) from the same date when the rule initially became effective—that is, 1 January 2018—and would apply in respect of tax years beginning on or after that date. Thus, any risk attendant on having entered into a debt subordination agreement in 2018 would be removed.
Read a July 2018 report [PDF 121 KB] prepared by the KPMG member firm in South Africa
<p>© 2018 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.</p>
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.