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South Africa: Proposal to limit interest deductions on cross-border debt

South Africa: Proposal to limit interest deductions

A discussion paper—“Reviewing the Tax Treatment of Excessive Debt Financing, Interest Deductions and Other Financial Payments”—was released in February 2020, with comments originally due in April 2020.

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However, because of the implications of the coronavirus (COVID-19) pandemic, the comments due date has been extended to 30 September 2020.

In general, the discussion paper is the government’s attempt to limit base erosion and profit shifting (BEPS) in South Africa. Much of the discussion paper is based on an OECD report relating to the limitation of base erosion involving interest deductions, but the South African discussion paper also reveals that studies from the Davis Tax Committee and the African Tax Administration Forum have been considered.

One recommendation is to limit the deduction of the net interest expense in terms of a fixed ratio of between 10% and 30% of earnings before interest, tax, depreciation and amortisation (“tax EBITDA”). It appears that the term “net interest expense” would mean the balance of interest expense after having combined and set off any interest income against the gross interest expense (local and cross-border—however, this has not been clarified). Furthermore, the OECD recommended applying the rule to all entities of a multinational group.

South African tax law already has interest limitation and tax avoidance provisions (such as those relating to hybrid debt instruments, section 23M of the Income Tax Act, transfer pricing rules and withholding taxes)—provisions that are viewed as being onerous and very specific.

The discussion paper therefore indicates that government is proposing to restrict net interest expense deductions to 30% of “tax EBITDA” and to apply the proposed rules to all entities operating in South Africa that form part of a foreign, or South African multinational group. Furthermore, the discussion paper proposes to repeal section 23M of the Income Tax Act. While the paper notes the OECD recommendation to focus on multinational groups as being rational in terms of which taxpayers the proposed rule would apply, it nevertheless provides that:

Net interest expense in respect of debt from both external and connected persons is included so that any attempts to circumvent the rules with back-to-back loans, for example, are ruled out and there is no need for complex anti-avoidance rules.

To some tax professionals, this would be counterintuitive and contrary to the rest of the discussion paper.

A five-year carry-forward period in relation to excess non-deductible net interest expense is also proposed, albeit on a “first in, first out” (FIFO) basis. Furthermore, government tentatively proposes that a de minimis rule be included (of between R2 million and R5 million) in relation to the net interest expense, subject to the proposed legislation.

Read a May 2020 report [PDF 365 KB] prepared by the KPMG member firm in South Africa 

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