The Taxation Laws Amendment Act 17 of 2023, which was promulgated on 22 December 2023, contains two almost identical amendments to s 19 of the Income Tax Act 58 of 1962 (Act) and paragraph 12A of the Eighth Schedule to the Act, which deal with the concession or compromise of a debt. These amendments modify exclusions from the exemptions in s 19(8)(d) and para 12A(6)(d) when the group-funded asset is disposed of under s 42, 44, 45 or 47. For the sake of simplicity and avoiding duplication I shall deal only with para 12A(6)(d) in this article.
Background
Paragraph 12A deals with the concession or compromise of a debt and replaced the problematic para 12(5) which applied to years of assessment commencing before 1 January 2013. Paragraph 12A was not without its problems and underwent substantial amendment for years of assessment commencing on or after 1 January 2018. Paragraph 12A in its present guise provides that when a creditor waives a debt, the debtor is required to reduce the base cost of the asset funded by that debt under para 12A(3) if the asset has not been disposed of in a year of assessment prior to that in which the debt is waived. If the debt is waived and the debtor disposed of the asset in an earlier year of assessment, para 12A(4) requires the capital gain or loss originally determined to be redetermined assuming the debt had been waived in that year. The absolute difference between the capital gain or loss originally determined and the redetermined capital gain or loss is then brought to account as a capital gain in the year in which the debt is waived.
For example, assume a capital asset with a base cost of ZAR 100 was funded by a loan of ZAR 100 in tax year 1. The asset is sold in tax year 3 for ZAR 120. If the debt of ZAR 100 is waived in tax year 3 (before or after the sale, the base cost of the asset will be reduced to nil under para 12A(3) and the capital gain will be ZAR 120 (ZAR 120 proceeds less nil base cost). Note: The base cost must be reduced even if the debt benefit arises after the sale but before the end of the year of assessment, since a capital gain or loss is determined for a year of assessment under para 3(a) or 4(b) and not only up to the date of sale. If the debt is waived in tax year 5, the original capital gain would have been ZAR 20 (ZAR 120 proceeds less ZAR 100 base cost). The redetermined capital gain would be ZAR1 20 (ZAR1 20 proceeds less nil base cost). The absolute difference between ZAR 120 (capital gain after applying para 12A(3)) and ZAR 20 (capital gain originally determined) is ZAR 100, which must be recognised as a capital gain in tax year 5.
Exemptions
Paragraph 12A(6) contains a number of exemptions from para 12A, and most of these exemptions contain exceptions. Paragraph 12A(6)(d) provides that para 12A must not apply to a debt benefit in respect of any debt owed by a person
'(d) to another person where the person that owes that debt is a company, if—
(i) that company owes that debt to a company that forms part of the same group of companies as that company; and
(ii) that company has not carried on any trade,
during the year of assessment during which that debt benefit arises and the immediately preceding year of assessment: Provided that this subitem must not apply in respect of any debt—
(aa) incurred, directly or indirectly by that company to fund expenditure incurred in respect of any asset that is disposed of by that company, before or after that debt benefit arises, by way of an asset-for-share, intra-group or amalgamation transaction or a liquidation distribution in respect of which the provisions of section 42, 44, 45 or 47, as the case may be, applied: Provided further that, for purposes of this paragraph, where a debt benefit arises prior to the disposal of an asset, that debt benefit must be treated as a debt benefit that arose immediately before that disposal; or …'.
Thus, generally, intra group debts funding assets will not have base cost reduction consequences for the debtor under para 12A(3) or capital gains tax consequences under para 12A(4) as long as the debtor company has not traded in the current and immediately preceding years of assessment.
But para 12A will apply if the group funded asset is disposed of under s 42, 44, 45 or 47 and the group debt is waived before or after that disposal.
The words 'before or after that debt benefit arises' were substituted for the words 'was subsequently' by s 41(1)(a) of the Taxation Laws Amendment Act 17 of 2023 and came into effect on 1 January 2024 and apply in respect of any disposal of an asset on or after that date. The further proviso was added by s 41(1)(b) of the same amending act with the same effective date.
In other words, before the 2023 amendment, the exclusion applied only when the debt benefit arose and then the asset was disposed of under s 42, 44, 45 or 47. Now it will also apply when the group-funded asset is disposed of under s 42, 44, 45 or 47 and then the debt benefit arises.
Debt benefit arising before the disposal under s 42, 44, 45 or 47?
Neither the
Comprehensive Guide to Capital Gains Tax(Issue 9) nor Interpretation Note 91 (Issue 2) contain any examples on the application of the subsequent disposal of the asset following the debt benefit. This seems hardly surprising as the previous wording made little sense. How is a debtor expected to apply a provision that is dependent on a future event? The debtor does not have a crystal ball and applying the rule retrospectively would offend against the principle that there should be finality in the raising of assessments. Botha JA in
Caltex Oil (SA) Ltd v SIR summed up the position as follows:[1]
'What is clear, I think, is that events which may have an effect upon a taxpayer's liability to normal tax are relevant only in determining his tax liability in respect of the fiscal year in which they occur, and cannot be relied upon to redetermine such liability in respect of a fiscal year in the past.'
This problem has now been addressed by the introduction of the further proviso to para 12A(6)(d).
Its effect is to change the time when the debt benefit arises from the time when the actual debt benefit arose and when the exemption applied, to immediately before the disposal of the group-funded asset. Thus, para 12A(3) will be triggered, with the result that the debtor company must reduce the base cost of the asset before the s 42, 44, 45 or 47 transaction. The effect on the transferee under that transaction will be that it will acquire the asset at its reduced base cost. Unfortunately, the creditor, which would have been denied a capital loss under para 56(1)[2] when the actual debt benefit arose,[3] will not be entitled to a capital loss immediately before the disposal of the asset because the further proviso applies 'for the purposes of this paragraph', which restricts its application to para 12A.
Example 1 – Debt benefit arising before disposal of group-funded asset under s 42, 44, 45 or 47
Facts: Holdco owns all the shares in Subco 1 and Subco 2. All these companies are residents with years of assessment ending on the last day of February. Subco 1 acquired an asset from Holdco at a cost of ZAR 1 million on loan account on 28 February of year 1 after which it immediately ceased trading. On 28 February of year 3, Holdco waived the debt of ZAR 1 million owed by Subco 1. On 28 February of year 4, Subco 1 disposed of the asset to Subco 2 under s 45. Result: On 28 February of year 3 there was a concession or compromise of the debt of R1 million but it was excluded from para 12A under para 12A(6)(d) as Subco 1 had not traded in the current or immediately preceding year of assessment. Holdco was precluded from claiming a capital loss under para 56(1) because Subco 1 did not suffer any of the consequences listed in para 56(2), for example, a base cost reduction under para 12A(3). However, as a result of Subco 1 subsequently disposing of the asset to Subco 2 under s 45, Subco 1 is treated for purposes of para 12A under the further proviso to para 12A(6)(d) as having a debt benefit immediately before the s 45 transaction. Subco 1 must therefore reduce the base cost of the asset by ZAR 1 million. The effect will be that Subco 2 will acquire the asset at the reduced base cost of nil. Holdco is, however, unable to claim a capital loss despite the base cost reduction imposed on Subco 1, since the time of the disposal of the debt by Holdco under para 56(1) is not carried forward by the further proviso.
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Debt benefit arising after the disposal under s 42, 44, 45 or 47?
Strangely, the effect of the debt benefit arising after the disposal seems to be the same under both para 12A(3) and (4).
Paragraph 12A(3)
If the asset is disposed of in the earlier part of a year of assessment under, say, s 45, and the debt that funded that asset is later waived in the same year of assessment, the base cost of the asset will need to be reduced when determining the capital gain or loss for the year of assessment. However, for purposes of s 45, the base cost of the asset which will equal the proceeds for the transferor and base cost for the transferee, must be determined on the date of the s 45 transaction (that is, before the debt benefit). The effect will be to trigger a capital gain for the transferor. The creditor should be able to claim a capital loss under para 56(2).
Example 2 – Debt benefit arising after disposal of group-funded asset under s 42, 44, 45 or 47 in the same year of assessment
Facts: Holdco owns all the shares in Subco 1 and Subco 2. All these companies are residents with years of assessment ending on the last day of February. Subco 1 acquired an asset from Holdco at a cost of R1 million on loan account on 28 February of year 1 after which it immediately ceased trading. On 1 March of year 3, Subco 1 disposed of the asset to Subco 2 under s 45. On 1 August of year 3, Holdco waived the debt of ZAR 1 million owed by Subco 1. Result: Subco 1 does not qualify for the exemption under para 12A(6)(d) for the debt benefit arising as a result of Holdco's waiver of the debt because it disposed of the group-funded asset under s 45 to Subco 2 on 1 March of year 3. Under s 45 Subco 1 is treated as having disposed of the asset to Subco 2 on 1 March of year 3 for proceeds of R1 million and Subco 2 is treated as having acquired the asset on the same date for the same amount. Under para 12A(3) Subco 1 must reduce the base cost of the asset to nil as a result of the debt benefit occurring in the same year of assessment. Subco 1 will therefore have a capital gain of ZAR 1 million. Holdco will have a capital loss of R1 million under para 56(2)(a)(i) because Subco 1 has had to reduce the base cost of its asset under para 12A(3). |
Paragraph 12A(4)
If the debt benefit occurs in a year subsequent to the disposal, para 12A(4) will apply and the debtor will have to redetermine the capital gain or loss and compare it with the previously determined capital gain or loss (likely to be nil because of s 42, 44, 45 or 47). The absolute difference must then be recognised as a capital gain in the year when the debt benefit arises.
The creditor should be able to secure a capital loss under para 56(2)(a)(ii) because the debtor has a corresponding capital gain under para 12A(4).
The transferee company will acquire the asset before any base cost reduction.
Example 3 – Debt benefit arising after disposal of group-funded asset under s 42, 44, 45 or 47 in a subsequent year of assessment
Facts: Holdco owns all the shares in Subco 1 and Subco 2. All these companies are residents with years of assessment ending on the last day of February. Subco 1 acquired an asset from Holdco at a cost of R1 million on loan account on 28 February of year 1 after which it immediately ceased trading. On 1 March of year 3, Subco 1 disposed of the asset to Subco 2 under s 45. On 1 March of year 4, Holdco waived the debt of R1 million owed by Subco 1. Result: Subco 1 does not qualify for the exemption under para 12A(6)(d) for the debt benefit arising as a result of Holdco's waiver of the debt on 1 March of year 4 because it disposed of the group-funded asset under s 45 to Subco 2 on 1 March of year 3. Under para 12A(4) Subco 1 must redetermine the capital gain or loss and account for the absolute difference between the redetermined gain or loss and any capital gain or loss arising at the time of disposal (in this instance there was neither a capital gain or loss at the time of disposal on 1 March of year 3 because of s 45). The redetermined base cost, after applying para 12A(3) is nil (ZAR 1 million – ZAR 1 million). Since the proceeds were ZAR 1 million under s 45, the redetermined capital gain is ZAR 1 million (ZAR 1 million proceeds less nil base cost), which Subco 1 must account for when the debt benefit arises on 1 March of year 4. Holdco will be entitled to a capital loss of ZAR 1 million under para 56(2)(a)(ii) because Subco 1 has had to account for a capital gain of ZAR 1 million under para 12A(4). Subco 2 has a base cost of ZAR 1 million under s 45 on 1 March of year 3. |
Conclusion
The results achieved by the provisos to para 12A(6)(d) are not consistent when the debt benefit arises before and after the disposal of the asset under s 42, 44, 45 or 47. I question whether the provisos serve any purpose besides inflicting unnecessary complexity on SARS and taxpayers. Surely, as long as the creditor is denied a capital loss, there is no need to inflict a base cost reduction or capital gain on the debtor even if it has disposed of the asset under one of the corporate rules.
This article was first published in
ASA April 2024
