n Business Tax and Company Law Quarterly - The reduction of debt and taxation : some takeaways

Abstract

As most tax-orientated people will be aware, a new income-tax and capital gains tax (CGT) regime has been introduced that deals specifically with debt reduction, by whatever legal means the debt is reduced. Where any debt owed by a person is reduced and that debt was used to fund, whether directly or indirectly, expenditure in respect of which a deduction or allowance was granted in terms of the Income Tax Act 58 of 1962 (the IT Act), and the amount of that reduction exceeds any consideration given by the debtor for such reduction, the provisions of section 19 of the IT Act apply. Depending on the nature of the expenditure, certain income-tax implications are triggered. Should such debt have funded expenditure incurred in respect of assets, paragraph 12A applies and certain CGT implications are triggered. This article briefly discusses the ambit of these two fairly new provisions.

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A number of issues arise in relation to the new provisions, as well as other issues relating to debt reduction in general, and these issues (takeaways) are discussed in more detail.

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The first issue is: in what circumstances will a debt be regarded as having been 'reduced'? The author notes that a debt is nothing other than a contractual obligation to discharge an amount owing at some point in time, and in a manner agreed upon. The debt may be discharged in many ways, such as, for example, payment, merger, set-off, prescription or release. These different methods of discharge and their requirements are considered in this article. The most contentious issue in this regard seems to be the issue of shares as a means of discharging the liability. This aspect is considered and the conclusion reached that this is an acceptable method of consideration, but it is important to ensure that the subscription price for the shares equal the market value of the shares issued.

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The appropriation of the debt reduction is also canvassed. An issue may arise where the creditor forgives all or part of a debt owing and the debtor has utilised the funds to acquire various goods or services. Given that the provisions of section 19 and paragraph 12A rely on a connection between the nature of the expenditure incurred and the funds provided by the creditor, the question arises as to how one is to appropriate the waiver of the debt. Clearly the debtor would benefit enormously if it was able to apportion the amount of the debt waived, apportioning the amount of debt waived first to those expenditures/assets that will trigger the least amount of tax, such as capital goods. Both ENSafrica and SARS suggest that a proportional allocation would be fair and reasonable, while the article questions whether one should not apply the contractual and common-law rules that apply when payments of debts are appropriated - which would in effect allow the debtor and creditor to choose.

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The article finally considers the various VAT implications that arise when debt is forgiven. Section 23C(1) of the IT Act provides that where the cost to a taxpayer or the market value of any asset acquired by a taxpayer must be taken into account under the IT Act, the cost or market value of the asset must be reduced by the amount of any input tax deducted in respect of such cost or market value. It follows that in determining the liability for any tax under section 19 or paragraph 12A the 'expenditure incurred' must be reduced if the taxpayer has been able to deduct any input tax in respect of such expenditure. Examples are provided of the working of this section.

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While the forgiveness of debt constitutes a supply of services by the creditor for VAT purposes, the article argues that such supply is a non-enterprise supply and as such does not trigger any VAT implications under the general provisions of the VAT Act.

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However, the forgiveness of debt in respect of the consideration payable by a vendor for the supply of goods or services by the creditor vendor may trigger VAT implications under section 22(3) of the VAT Act. If the recipient vendor has claimed an input tax deduction in respect of the supply of the goods or services by the creditor vendor and the full consideration (the debt) is not paid within a period of 12 months from the date the input tax was deducted, the input tax previously claimed is in effect recouped - by the debtor vendor having to account for output tax equal to the input tax previously deducted.