A taxpayer has a credit loan in a company (company owes individual). There are 2 loans, one is from a shareholder and one from a director. The loans were to fund deductible expenditure. The taxpayer now wants to convert the loans to equity. Please advise
Author: Peter Surtees
Important:
This answer is based on tax law year ending 28 February 2021.
Answer:
The starting point in section 19 of the Income Tax Act, where the definition of “concession or compromise” includes “(b) a debt owed by a company is settled, directly or indirectly- (i) by being converted to or exchanged for shares in that company…” Then the definition of “debt benefit” comes into play. In the matter in question, one creditor is a person who did not hold an interest in the company before the conversion (referred to in paragraph (c) of the definition), and the other is a person who held an interest before the conversion (paragraph (d) of the definition), that interest being that of a shareholder. In both instances the same condition applies, namely that the debt benefit comprises the amount by which the face value of the claim exceeds the market value of the shares acquired by reason of the conversion. The reason for this provision is clear: if the creditor is getting full value, or more, in return for the loan, there has been no concession or compromise. Bear in mind that SARS is likely to look hard at the arrangement in so far as the value of the shares is concerned. The taxpayer should be able to show that the market value of the shares does exceed the face value of the loan. It’s not just a question of the company stating that it has issued 100 shares of R1 each on conversion of a loan of R100. The market value of the shares must genuinely be R100.