Abstract
Debt reduction in business is recognised for the economic relief afforded to the debtor involved. The new debt reduction regime was introduced in the Income Tax Act (section 19 and paragraph 12A of the Eighth Schedule) with the aim of minimising the tax impact so as not to negate the economic benefit. The new regime introduced an exclusion for debt reduced by way of a donation and uncertainty exists on instances where this exclusion would apply. This article considered four broad categories of factors indicative in the classification of a debt reduction as a donation (inadequate consideration; gratuitous waiver; intent and motive; classification as connected persons) and concluded with the formulation of such factors. The classification as connected persons is regarded as the most indicative of a debt reduction being classified as a donation, which could result in tax arbitrage if the creditor and debtor are taxed at different rates on the taxable income result of the debt reduction.
Highlights
Amendments were made to provisions in the Income Tax Act 58 of 1962 (‘the Income Tax Act of 1962 (the Act)’) in respect of a debt reduction during 2013 because Government sought a uniform system for the taxation treatment of debt reduction or relief to assist in local economic recovery
It is conceivable that in circumstances where a debt reduction takes place in respect of a debt owed by a South African resident to a non-resident, donations tax will not be payable since the donation is made by a non-resident and not subjected to the provisions of the new debt reduction regime (PwC, 2013:28)
Not classifying the debt reduction as a donation would result in the application of the new debt reduction regime, which in effect reduces the deductible expenditure for the debtor in respect of an asset funded by such debt and still on hand
Summary
Amendments were made to provisions in the Income Tax Act 58 of 1962 (‘the Act’) in respect of a debt reduction during 2013 because Government sought a uniform system for the taxation treatment of debt reduction or relief to assist in local economic recovery. Under the new debt reduction regime the extent to which the debt is reduced by way of a donation as defined in section 55(1) or a deemed donation in terms of section 58 it would be excluded from normal tax and potentially subjected to donations tax This exclusion rests on the proposition to avoid double taxation as such a reduction would fall within the ambit of donations tax. There would not be an immediate recoupment of expenditure as the case may be under the new debt reduction regime if debt funded the acquisition of trading stock already sold, or deductible trade expenditure Based on this argument it might even be more beneficial for the debtor to regard the debt reduction as a donation which may promote the intent to provide the best possible economic relief in respect of the debt reduction. In an attempt to provide guidance and certainty in the donations’ exclusion this study investigated the effect of classification as connected persons for which no existing literature could be identified
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