The “corporate rules” contained in South Africa’s Income Tax Act currently allow for the transfer of assets between companies within a larger group of companies on a tax-neutral basis, thereby, hopefully, promoting corporate activity and economic growth. The rules apply, for example, to amalgamation (section 44) and intra-group (section 45) transactions, as well as liquidation distributions (section 47).

Essentially, the corporate rules provide for a deferral of income tax or capital gains tax where companies within a group of companies undertake any of the transactions mentioned above. SARS says, however, that “it has become evident that, while some taxpayers used the corporate rules for its intended purpose, others utilized these provisions in structures to obtain interest deductions otherwise not available.”

The government has been concerned about the use of the rules as a tax-free mechanism to obtain interest deductions linked to excessive debt (and other hybrid instruments masquerading as debt) in facilitating, for example, leveraged buyouts and other restructuring. As SARS adds: “Some taxpayers went even further with complex structures to achieve a more beneficial tax position, for example, attempting to engineer mismatches between interest deductions on one hand and exempt income on the other.”

As the revenue loss resulting from transactions involving the corporate rules, debt and tax-exempt counterparties has been estimated to be in the order of ZAR3bn (USD417.6m) to ZAR5bn a year, the National Treasury had previously proposed a two phase approach to these issues.

The first phase involved temporarily suspending the operation of section 45 for an 18-month period to enable an in-depth investigation, with a second phase involving the implementation of longer-term solutions. However, following consultations, the Minister of Finance recently announced the lifting of the proposed suspension of section 45 to allow transactions that are commercially-driven to continue, as long as these transactions do not result in “an unacceptable revenue loss”.

The revised interim approach proposes that a section will be introduced in the Income Tax Act to control interest deductions associated with debt used to fund the acquisition of assets in terms of sections 44, 45 and 47.

The new section will be effective from June 3, 2011 to December 31, 2013, in respect of section 45 transactions; and from August 3, 2011 to December 31, 2013 in respect of section 44 and 47 transactions. As initially intended, during the term of the revised interim approach, the National Treasury and SARS will have time to investigate a longer term solution.

The draft guide has therefore been issued by SARS with the aim of providing general guidance regarding the new section and the obtaining of approval for deducting interest associated with debts used to fund the acquisition of assets in terms of sections 44, 45 and 47.

The new section will disallow interest deductions if a taxpayer procured interest-bearing debt directly or indirectly to fund the acquisition of an asset or assets in terms of a reorganization transaction. It will however not be applicable where the taxpayer has obtained approval from the SARS Commissioner, who may direct that the deduction of the interest is allowed provided the amount will not lead to a significant erosion of the tax base.

In that regard, the Commissioner will also be able to exercise his discretion to allow an interest deduction, after consultation with the Minister of Finance, taking cognizance of the information that the taxpayer presented and the guidelines prescribed by regulation. In certain instances, the Minister may also prescribe circumstances under which interest will not be disallowed.

A reporting requirement will also be activated, and the circumstances will be prescribed under which a person entering into any transaction must furnish a return of the transaction.

Comments regarding the guide should be forwarded to SARS on or before August 31, 2011.