By: Dr Charl du Toit
Number One – cross-border loans
Loans are very common in business. It is unsurprising, therefore, that various tax rules in respect of them have been introduced over the years. These include rules pertaining to cross-border loans or loans between related parties.
Whereas some of the rules are universal, present in the legislation of many countries, some are specific to South Africa where loans are also subject to exchange control rules.
In this article, the first in a series of three, some of the rules relating to cross-border loans are discussed.
All references to ‘section’ are in respect of the South African Income Tax Act (‘the Act’). Tax legislation is subject to constant change. The rules as per this article are generally those that apply in the 2020/21 tax year.
Exchange control
Administered by the South African Reserve Bank, South Africa’s exchange control rules apply inter alia to loans in and out of South Africa. All inbound and outbound loans need to be approved and recorded. The application and recording processes are normally dealt with via the commercial banks (the so-called ‘authorised dealers’). Full details on matters such as the terms, parties involved and purpose are required. Restrictions apply on the interest rate payable on inbound loans, depending on factors such as whether the loan is from a related party and the currency of the loan.
Transfer pricing
In line with international practice and rules, the interest rate on cross-border loans between connected persons must be calculated at the rate that would have existed if the parties had been independent persons dealing at arm’s length. The rules and methods as per the Organisation for Economic Co-operation and Development (OECD) are applied in order to calculate such rate. Among other things, the currency of the loan will play a role in determining the rate.
Thin capitalisation
Funding of a South African company from offshore can be introduced either by way of share capital or by debt. Countries sometimes restrict the portion that can be introduced as loans in order to restrict the claim for a tax deduction on interest paid. This is commonly referred to as ‘thin capitalisation’ rules. It is debatable whether a specific thin capitalisation rule exists in respect of the ratio between share and loan capital introduced from offshore into a South African company. There is no specific reference to this term or concept in the tax legislation. It is also arguable that rules in respect of thin capitalisation are not needed because there is a specific section in the Act (section 23M) that restricts the deduction of cross-border interest based on a formula.
Tax on exchange differences
South African companies can be subject to tax on exchange gains (or benefit from the deduction of exchange losses) on debts payable or receivable in a currency other than Rand. South Africa has extensive controlled foreign company (CFC) legislation. Simply stated, a CFC is a foreign company of which more than 50 percent of the shares or voting rights are held by South African residents. Subject to exceptions, the income of the CFC is taxable in the hands of the South African shareholders. Loans (including deposits) in the books of CFCs are also subject to tax on exchange differences, unless the loans are in the functional currency of the CFC or with another CFC.
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