Thin capitalisation and financial rules in South Africa

Abstract

It is no wonder that in a globalised environment financial assistance transactions between related parties are examined more closely. Financial transactions should be reviewed when the capital of a company is made up of a much greater contribution of debt than equity, which is said to be ?thinly capitalized?. The tax consequences that flow from these arrangements can affect a taxpayer‘s taxable income in relation to determining the debt versus equity funding structure of that arrangement. The ripple effect of these financial arrangements is that they will impact the way in which a company is capitalised and therefore affect the level of profit the company would be taxable for. In essence, the higher the level of debt in a company, and thus the correlating amount of interest expense the company is liable to pay, the lower the tax base will be and thus its taxable profit. There is still uncertainty regarding the practical application and interpretation of the guidelines in relation to thin capitalisation rules in South Africa. This study aims to review whether sufficient guidance in respect to thin capitalisation legislation in South Africa is provided, taking into consideration the legislation that has been amended, as contained in the revised section 31 of the Income Tax Act 58 of 1962 (?section 31 of the Act‘) and the guidance provided in the form of the Draft Interpretation Note on 22 March 2013 (?the Draft IN‘). The guidance provided is still in draft and refers to the old provisions of section 31 of the Act relating to the general ?safe harbour‘ ratio and the deemed loan provisions. The provisions do not provide any guidance relating to the new provisions of the legislation regarding deemed dividends and the treatment and application thereof. There are challenges that many multinational companies face in relation to transfer pricing legislation, and specifically thin capitalisation rules for companies‘ resident in South Africa that receive inbound financial assistance from their related parties. It has also become a major concern for tax authorities to reduce the amount of tax leakage in their country‘s tax base as many multinationals fall short of adhering to the regulations that govern these financial arrangements.