n Business Tax and Company Law Quarterly - Interest is deductible, except when SARS says no - the impact of the new section 23K

Volume 3, Issue 3
  • ISSN : 2219-1585


The quantity and values attributable to leveraged buy-outs, particularly in the private equity industry, over the last five years have created concern in government and the South African Revenue Service ('SARS'), particularly in relation to the large amounts of gearing and the attendant interest costs forming part of these transactions.

As an interim measure, to manage the impact of these large levels of gearing and resulting tax deductions in respect of interest costs, section 23K of the Income Tax Act 58 of 1962 was promulgated. This provision seeks to disallow any interest deduction without SARS approval in respect of a debt instrument issued or used directly or indirectly to acquire assets qualifying for tax roll-over relief in terms of section 45 (inter-company sale of assets) or section 47 (transfer of assets intra-group in anticipation of the liquidation of the transferring company).
The new section provides for an application to be made to SARS by an 'acquiring company' for a directive that the non-deductibility provision does not apply. The application must seek to motivate why undue tax benefits are not created by virtue of the section 45 or section 47 transaction. Criteria to be applied by SARS in assessing the validity of the application will include aspects such as debt-to-equity ratios of the acquiring company, the total amount of the interest incurred in relation to the taxable income of the acquiring company after the reorganisation transaction, the terms and economic effect of the debt instrument, and whether the holder of the debt instrument (the lender) is a direct or indirect shareholder in the acquiring company.
Specific instances are prescribed by ministerial regulation issued pursuant to section 23K(9), in which directives are not required in respect of the interest deduction, namely where the funding transaction does not bear interest, and where the funding emanates from a company within the group of companies involved in the section 45 or section 47 transaction.

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