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South Africa: Proposed legislation on tax treatment, debt subordination agreements

South Africa: Debt subordination agreements

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.


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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.

Draft legislation

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

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