A ruling has been issued that may help taxpayers to determine the tax position in a situation where a loan has been cancelled. On 13 August 2013, the South African Revenue Service (SARS) issued a binding private ruling dealing with the question as to whether the cancellation and extinguishment of a right to claim interest on a shareholder loan will trigger a capital gains tax liability under the 8th Schedule to the Income Tax Act No. 58 of 1962 (the Act). Details of the ruling are summarized below.
(a) Facts. A listed public company sold its majority shareholding of 74% in a private company (the Co-Applicant) to another public company (the Applicant). The Co-Applicant and the Applicant, which are both incorporated and tax resident in South Africa, were not connected parties prior to this equity acquisition transaction.
As part of the equity acquisition, the Applicant acquired a loan claim to the value of ZAR 4,161 billion owed by the Co-Applicant to a financing company. The Applicant paid ZAR 1.1 billion for the loan claim. The Co-Applicant, however, continues to owe the Applicant the total ZAR 4,161 billion amount. Interest is charged at the Johannesburg Interbank Agreed Rate (JIBAR) plus 4.9% per annum. The Co-Applicant is not in a position to service all the interest on the loan claim due to the Applicant.
The Applicant proposes splitting the loan claim into two parts. Interest will continue being charged on the ZAR 1,11.1 billion, while interest on ZAR 3,061 billion, reflecting the discounted portion of the loan claim, will be cancelled. The ZAR 3,061 billion amount will subsequently become an “interest free portion”.
In addition, the loan claim will be subordinated in order to restore the solvency of the Co-Applicant and to allow the Co-Applicant to be in a position to negotiate better credit terms with other financial institutions.
(b) Ruling. SARS ruled that:
– since the Co-Applicant and the Applicant were not connected parties prior to the equity acquisition, the ZAR 1,11.1 billion paid for the loan claim will represent an arm’s length price; and
– the cancellation and extinguishment of the Applicant’s right to interest based on the interest free portion of the loan claim will not trigger any capital gains tax liability for the Applicant under the provisions of the 8th Schedule to the Act.
(c) Validity period. The binding private ruling is valid for a period of 5 years from 30 April 2013.