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Over the past several years, the South African (SA) revenue authorities have become increasingly concerned about various corporate tax arrangements. One such arrangement used excessive deductions, where income was effectively shifted to a no-tax or low-tax jurisdiction or converted to a different type of income in another jurisdiction. These deductions are typically characterized as interest, royalties, service fees, or insurance premiums. The authorities were most concerned with excessive interest deductions.
In response, the SA government introduced, effective January 1, 2015, domestic legislation that implements some of the expected recommendations of the OECD base erosion and profit shifting (BEPS) Action Plan, Action 4 ("Limit base erosion via interest deductions and other financial payments"). The legislation provides deductible interest limitations on debts owed to persons not subject to SA tax.
Background. SA taxpayers often enter into transactions in which deductible interest that SA residents pay to nonresidents and other exempt persons is not taxed in the hands of the recipient.
These are mainly debts between entities of the same economic group. Usually, because the entities are connected, an instrument's actual terms do not determine its substance because the parties will change the instrument's terms as the need arises. Therefore, even if an instrument has no equity features, excessive debt between these entities remains a concern to the fisc, especially if the creditor falls outside the SA tax net.
Application of the interest deduction limitation. To address this...