n Business Tax and Company Law Quarterly - The deductibility of interest incurred on loan funding used to acquire shares in corporate reorganisations : the interaction of sections 24J(2), 23N and 240 of The Income Tax Act

Volume 6, Issue 3
  • ISSN : 2219-1585


The article focuses on a corporate group restructure involving the acquisition by one operating subsidiary company of another. This would occur, for instance, where a consolidation or merger of business activities is desirable, and it is necessary for the acquiring company to acquire the shares in the acquired company from the holding company of the group, using interest-bearing loan funding from a bank in order to do so, with the acquired company thereafter distributing all of its assets to the acquiring company at book-value in anticipation of the former's liquidation in terms of the rollover relief provisions of section 47 of the ITA.

The article considers first whether the interest incurred by the acquiring company on the bank loan will be deductible for income tax purposes pursuant to section 24J(2), which requires the acquirerâ??borrower (a) to be carrying on a trade and (b) to have incurred the interest expense in the production of its income.
While the first requirement will be satisfied, the article explores whether the second requirement is met, having regard to the fact that the immediate purpose of the loan funding is the acquisition of shares which will produce non-taxable income. The ultimate purpose of the borrowing, however, is to expand its business by acquiring the assets distributed by the acquired company in terms of section 47. The author concludes, with reference to the relevant South African tax law, including the case of , that there would be a sufficiently close connection between the expenditure incurred in the payment of the interest and the production of the taxpayer's income, given the purpose of the acquisition which is aimed at enhancing and increasing the acquiringcompany's income. Consequently the interest incurred on the loan would be deductible under section 24J(2).
The article further considers the impact of section 23N of the ITA which, with effect from 1 April 2014, provides for the limitation of interest deductions allowed in respect of so-called 'reorganisation' and 'acquisition' transactions in accordance with a prescribed formula. Section 23N also limits to the same extent interest that may be deducted under section 24O. The latter provision deems interest incurred on debts used by an acquiring company to finance the acquisition of equity shares in another company giving the acquirer control thereof, to have been incurred in the production of its income.The author concludes that the proposed recourse to the rollover provisions of section 47 of the ITA and the ensuing 'liquidation' distribution by the acquired company will qualify as a 'reorganisation transaction' under section 23N, and that the loan debt will have been directly or indirectly used or applied in the manner contemplated in the section. The interest deductible in respect of the bank loan will accordingly be limited in accordance with the formula provided for in section 23N.
The article further concludes that, if the liquidation distribution occurs on a later date than the acquisition of the equity shares in the acquired company, there would be an 'acquisition transaction' as contemplated in section 24O of the ITA, for the period that it continues to exist as an operating company. The interest incurred on the loan debt will, in the circumstances, be deemed to have been incurred for the purpose of trade and in the production of the acquiring company's income and be deductible to the limited extent permitted. If, however, the acquired company ceases its operations as from the date of the acquisition of its shares then section 24O should not find application. If, on the other hand, there is a period during which the acquired company remains an operating company, as indicated, section 24O could well apply until its operations cease.

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