Relief for small businesses corporations and social-impact firms
Reforms to the tax regime applicable to small business corporations are proposed. The reforms are aimed at broadening the regime for qualifying entities by increasing the turnover limit from R14 million to R20 million. It is proposed to provide additional tax relief for qualifying companies in the form of an increase in the tax threshold and a reduction in tax payable on the first R550 000 of taxable income.
The extension of the favourable tax regime for small business corporations to public benefit organisations (“PBOs”) and other social impact businesses with mixed profit and social objectives is being explored.
Although the proposed changes are to be welcomed, one still questions the limited application of the small business corporation tax regime. It is hoped that the provisions will be expanded to include a greater variety of businesses within these beneficial regimes, such as small service organisations, thereby encouraging the growth of all types of small to medium enterprises.
Restrictions on the deductibility of debt
In response to National Treasury’s concerns over a reduction of the tax base flowing from the use of debt financing, amendments are proposed which include the following:
- Additional measures to curb the use of debt instruments which contain equity-like features: Such instruments will be re-characterised as shares and interest deductions disallowed. The main focus will be on debt instruments that do not have a realistic possibility of being repaid in 30 years and debt that is convertible into shares at the instance of the issuer. Banks and insurers which commonly use such instruments for a variety of commercial reasons will be excluded from the re-characterisation
- A cap on the interest deduction on connected person debt: It is proposed that a cap of 40% of earnings after interest paid on 3rd party debts will be introduced, with the excess interest deductions being allowed to be carried forward for up to five years. It is unclear whether this restriction will apply in general or will only be limited to circumstances where a party is not taxable on the interest
- The deductibility of interest on borrowings including, it appears, third party borrowings, used to finance new acquisitions in corporate transactions will be limited, with excess interest deductions being allowed to be carried forward for up to five years. This new regime will replace the existing discretionary system for interest deductions. No indication is given on the extent of the limitation.
General interest cap on connected party debt
The restrictions on the interest deductibility of connected person debt are concerning and may have significant implications for a number of corporate taxpayers.
Firstly, the use of net income in isolation for the purposes of determining a cap on interest deductions is, in our view, too restrictive. It is hoped that a balance sheet “thin capitalisation” test will first be applied before a cap on interest deductions with reference to earnings becomes effective.
Secondly, it is hoped that exemptions are provided for in the legislation for entities such as group treasury companies.
Thirdly, the five year period for carrying forward interest deductions also does not cater for long-term capital intensive projects which may have a payback period in excess of five years.
Finally, the restrictions could also have unintended consequences especially in the case of small businesses where owners often raise finance in their personal capacity and use the borrowings in the financing of their business.
Interest cap on corporate acquisitions and restructures
The statements in the Budget Review regarding interest limitations on corporate acquisitions and restructures lack detail as to the exact extent of their intended ambit.
The existing provisions to counter perceived abuse are extremely complex and difficult to interpret, as well as being subject to frequent change. It appears that these proposals will add to the complexity and will complicate financing of business.
Share cross-issues to be revised
The anti-avoidance rules around share cross-issues, which currently provide that the acquirer has no base cost in the shares acquired, will be revised to take account for the fact that they are commonly used in a commercial context in South Africa, particularly for black economic empowerment transactions. As a result the “zero base cost rule” for shares issued will either be eliminated or narrowed. The Budget Review notes that cross-issues can currently be used to migrate offshore without incurring an exit charge. It is proposed that the rules will be revised to immediately trigger tax when value is shifted into tax-exempt hands.
It is hoped that the rules are amended with a view of facilitating commercial transactions.
Proposals applicable to financial institutions
The following proposals applicable to financial institutions are contained in the Budget Review:
- The risk business of long-term insurers will be separated from its policyholder funds and included with the results of the corporate fund, with the effect that risk business will be taxed on a similar basis as that of short-term insurers.
- he real estate investment trust (REIT) regime applicable to listed property companies and property unit trusts will be extended to unlisted entities once they are subject to similar regulation to listed REITs.
- Hedge funds will fall under collective investment scheme legislation and will be regulated and taxed on a similar basis. Unit holders will, however, be required to treat the proceeds on disposal of units as ordinary revenue when realised.
- The mark-to-market taxation applicable to the financial instruments of banks, which will come into effect in 2014, will be refined to:
- include most companies in a banking group in addition to the “bank”;
- prevent “artificial” losses flowing from dividend transactions;
- align the type of instruments subject to the rules with those recognied under IFRS; and
- potentially provide for differing tax and accounting treatment of impaired financial assets (bad and doubtful debts).
The proposed changes are welcomed as the trend appears to be an alignment of the tax laws to economic reality. Some implications of the proposed changes to consider are the following:
- Difficulties in classifying and taxing long-term insurance products which have both a risk and savings element. In addition, the proposal is likely to have the effect of increasing the tax payable in the policyholder funds of a long-term insurer.
- There is likely to be a delay of the extension of the REIT regime to unlisted entities owing to a delay in the establishment of the required regulatory framework.
- Clarification is urgently required on the treatment of doubtful debts by banks and similar financial institutions as there is uncertainty in the market following a directive recently issued by SARS.
Other proposed changes
The following is a list of other proposed business tax changes and items under consideration as announced in the 2013 Budget Review:
- Donations to PBOs in excess of the current allowable limit of 10% of taxable income will be carried forward and allowed as a deduction in subsequent years.
- he cost price of trading stock will automatically comport to IFRS without the need for SARS approval.
- The rules around the deductibility of insurance premiums paid to short-term insurers will be amended to consider whether there has been a significant transfer of risk from the perspective of the policyholder rather than the insurer. Long-term insurers will also be subject to similar anti-avoidance rules relating to the deductibility of premiums in respect of re-insurance arrangements which similarly lack a significant element of risk.
- Anti-avoidance rules applicable to captive insurers will be revised with a view of addressing the concern that dividends paid from the captive insurers are out of deductible reserves rather than taxable profits.
- The mining royalty regime is currently under investigation to determine if it is sufficiently robust and appropriate to the South African environment.
- onsideration is being given to extending the exemption provided for mining rehabilitation entities to a mining dewatering association which is responsible for restoring water levels adversely impacted by mining.
- Exemption from securities transfer tax (STT) for brokers transacting on the JSE will be extended to provide STT relief for other intermediaries such as banks.
In addition, it is proposed that further research be carried out on:
- Company restructurings, with attention to urgent matters and anomalies
- ividend cessions and manufactured dividends: A single unified treatment for both forms of transfers is contemplated and anti-avoidance rules to eliminate shifting of income from taxable parties to exempt parties.