In the South African Budget 2020 speech, the Minister of Finance announced that government would be restructuring the corporate income tax system by broadening the tax base in order to potentially reduce the rate in future.
To do that, government wants to restrict net interest expense deductions to 30% of earnings for any years of assessment that commence on or after 1 January 2021. While this seems like a good move because it aligns South Africa with the recommendation of the Organisation for Economic Co-operation and Development (OECD), MNEs must get clarity on how this proposal interacts with Section 23M and Section 31 of the Income Tax Act as well as consider rules of other jurisdictions in which the MNEs operate to avoid being double-taxed.
BEPS and recouping the tax base
The South African Government recognises, as the OECD does, that Base Erosion and Profit Shifting (BEPS) can unfairly shift tax revenue from one country to another, reducing the amount of tax a MNE is liable for.
During 2019, all EU Member States aligned their domestic legislation to the OECD’s recommendations, applying an interest cap that restricts a taxpayer’s deductible borrowing to around 30 percent of the taxpayer’s EBIDTA. Developing countries like Mexico also implemented this. Various other countries took their own steps to limit interest deductibility, but increasingly there is a universal alignment to the OECD’s recommendations. As such it seems reasonable to think that South African should align to this too.
Where we need more clarity
Treasury is asking for consultation in this matter and it is important that Treasury considers alleviating confusion by guiding businesses on how this proposal intersects with section 23M of the Income Tax Act, which already restricts interest deductions, and with section 31 of the Income Tax Act. Without clarity, there could be situations where a MNE in one country will be taxed on arm’s length interest income, with the borrower in South Africa unable to deduct interest because of a mechanical interest limit. We need a holistic approach to analyse how pricing and financing transactions are characterised so that companies can map-out how this affects their profitability. Also: this proposed limit on interest deductibility could negatively prejudice certain industries, which would only hamper their growth in South Africa. These industries need to be identified and considered. Importantly, this is not a safe harbour rule, which means that interest expenses below this threshold, that are not restricted, will still have to be arm’s length in line with our current transfer pricing rules.
Consultation on the design of this limitation begins immediately. A discussion document is available on the National Treasury website. The closing date for comments is 17 April 2020.