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  • Taxing Debt Restructuring and Recapitalisation

Taxing Debt Restructuring and Recapitalisation

26 October 2016

By Moses Sadiki, Corporate Consulting Manager for Tax at BDO South Africa

Tax is usually a key business issue, but during financial distress becomes even more important. Many companies seek financial relief by restructuring their debt when in financial distress.

SARS’ position on the tax treatment of the debt restructure and recapitalisation is not entirely clear. The following comment in SARS’ recently issued interpretation note on debt reduction seems to keep the water muddied:

The above comments [regarding the issue of shares and the reduction of debt] must not be construed as sanctioning a situation in which the issue of shares, whether for cash or by set-off, is simply a sham transaction intended to disguise a waiver of debt. The facts and circumstances of each case will therefore have to be considered before it can be determined whether the issue of shares gives rise to a reduction amount.

SARS’ latest ruling on this issue is Binding Private Ruling 246 (BPR246). BPR246 considers the invocation of the debt reduction provisions of the Income Tax Act, where debentures are redeemed at full value. A partnership advanced funding to the applicant in which the partnership held 64,69% of the ordinary shares. The funding was done by way of unsecured, fixed rate debentures. The precarious financial position of the group of which the applicant formed part necessitated a debt restructuring, which agreed the following steps:

  1. Applicant to obtain bridging funding from the bank for the amount due under the debentures.
  2. Applicant to redeem the debentures for the full value, including all accrued paid interest and all other amounts that may be payable by the Applicant in accordance with the terms of the debentures (redemption proceeds), by way of electronic funds transfer into a banking account designated by the Partnership.
  3. The Partnership to subscribe for preference shares and direct the designated bank to pay, by way of electronic funds transfer, an amount equal to the redemption proceeds into a banking account designated by the Applicant.
  4. The Applicant to allot and issue the preference shares to the Partnership as fully paid-up and deliver the share certificates to the Partnership.
  5. The Applicant to repay the external bridging funding, using the proceeds from the issue of the preference shares.

BPR246 confirmed that the redemption of the debentures at full value will not be subject to the debt reduction provisions to the extent that the amount outstanding on the debentures includes interest for which a deduction or allowance was permitted. In the absence of the debt reduction provisions, recoupment will also not apply to redemption for accrued unpaid interest, since there will be no amount recouped by the applicant.

In sum: The debt reduction provisions only apply in case of a reduction of a debt. The term “debt reduction” is not defined, although the term “reduction amount” is defined in relation to debt owed, as any amount by which the debt owed by a person is reduced, less any amount applied by that person as consideration for that reduction. Although not addressed by BPR246, it is possible, given the precarious financial position of the applicant that the market value of the preference shares will fall short of the amount owing in terms of the debentures. BPR246 specifically does not cover the possible application of any general anti-avoidance provisions of the Act. Therefore, SARS did not express a view on whether or not the transaction could give rise to impermissible tax avoidance under any general anti-avoidance provisions. One must bear in mind that binding private rulings only apply to the specific applicant and facts contained in the ruling.

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