[FAQ] Connected persons and the waiver of loans

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[FAQ] Connected persons and the waiver of loans

• 28 April 2021
• Corporate Tax
• The Tax Faculty Tax Specialist

This article is based on tax law for the year ending 28 February 2021.

Background

Two companies with loan accounts between them are connected persons. The one company liquidated during the tax year. Subsequently the loan accounts between them were written off resulting in an acquittal of loans. The company (which is still operating) thus realised a capital gain on this acquittal of loan. Will this company be able to disregard the capital gain as per paragraph 12A?

Answer

The Income Tax Act

Step 1: s 12A(6)(e) of the Income Tax Act No.58 of 1962 (“ITA”).

Other resources: SARS comprehensive guide on CGT May 2020 at page 129.

The above guidance should lead you to the correct action.

The loan between the two companies is a ‘debt’ as envisaged by paragraph 12A. When the loan owing by the one company to the other is waived/written off/ forgiven by mutual agreement, it will constitute a ‘concession or compromise’ as envisaged in paragraph (a)(i) above and there will be a ‘debt benefit’.

Paragraph 12A of the Eighth Schedule applies where—

(a) a debt benefit in respect of a debt owed by a person arises in respect of a year of assessment by reason or as a result of a concession or compromise in respect of that debt during that year of assessment; and

(b) the amount of that debt is owed by that person in respect of or was used by that person to fund, directly or indirectly, any expenditure, other than expenditure in respect of trading stock in respect of which a deduction or allowance was granted in terms of this Act.

The application of paragraph 12A is subject to paragraph 12A(6) – it provides for three instances, relevant to these facts, where paragraph 12A will not apply. They are:

• Paragraph 12A will not apply to a debt benefit to the extent that the debt is reduced by way of donation. The mutual agreement between the parties to waive the loan is not done gratuitously, but even if it was and there was a donation, the donation will not be subject to donations tax because it is a donation between companies forming part of the same group of companies.
• Paragraph 12A must not apply to a debt benefit in respect of any debt owed by a person if that company owes that debt to a company that forms part of the same group of companies as that company. This however will only apply where that company has not carried on any trade, during the year of assessment during which that debt benefit arises and the immediately preceding year of assessment.
• Paragraph 12A will also not apply in respect of any debt owed by a person that is a company, where that debt is reduced in the course, or in anticipation, of the liquidation, winding up, deregistration or final termination of the existence of that company; and the person to whom the debt is owed is a connected person in relation to that company. This however will only apply to the extent that debt benefit in respect of that debt does not, at the time that the debt benefit arises, exceed the amount of expenditure contemplated in paragraph 20 incurred in respect of that debt by the connected person.

We accept that none of the above mentioned exclusions apply. Paragraph 12A will therefore apply to the debt benefit that arises when the companies mutually agree that the loan between them will be waived or written off.

The two companies are connected persons in relation to each other. If the two companies are connected persons in relation to each other (as defined in section 1(1) of the Income Tax Act), or in the same of group of companies (as assumed in the first response), the one company would then potentially have to disregard the loss that arises when the loan is disposed of. This is in terms of paragraph 56. However, and despite paragraph 39, paragraph 56(1) does not apply in respect of any capital loss determined in consequence of the disposal by a creditor of a debt owed by a debtor, to the extent that the amount of that debt so disposed of represents an amount which is applied to reduce the expenditure in respect of an asset of the debtor in terms of paragraph 12A(3). This is in terms of 56(2)(a)(i) of the Eighth Schedule.

Paragraph 12A does indeed have a substantial similar provision to the one contained in section 19(8) when the existence of the company is terminated. It is found in paragraph 12A(6)(e) and reads as follows:

This paragraph must not apply to a debt benefit in respect of any debt owed by a person … that is a company, where—      

1. that debt is reduced in the course, or in anticipation, of the liquidation, winding up, deregistration or final termination of the existence of that company; and
2. the person to whom the debt is owed is a connected person in relation to that company,

to the extent that debt benefit in respect of that debt does not, at the time that the debt benefit arises, exceed the amount of expenditure contemplated in paragraph 20 incurred in respect of that debt by the connected person: Provided that this subitem must not apply—

(a) if—

(i) the debt was reduced as part of any transaction, operation or scheme entered into to avoid any tax imposed by this Act; and

(ii) that company became a connected person in relation to the person to whom the debt is owed after the debt (or any debt issued in substitution of that debt) arose; or

(b) if that company—

(i) has not, within 36 months of the date on which the debt is reduced or such further period as the Commissioner may allow, taken the steps contemplated in section 41(4) to liquidate, wind up, deregister or finally terminate its existence;

(ii) has at any stage withdrawn any step taken to liquidate, wind up, deregister or finally terminate its corporate existence; or

(iii) does anything to invalidate any step contemplated in subparagraph (A), with the result that the company is or will not be liquidated, wound up, deregistered or finally terminate its existence; …

But, as was said earlier, this however will only apply to the extent that debt benefit in respect of that debt does not, at the time that the debt benefit arises, exceed the amount of expenditure contemplated in paragraph 20 incurred in respect of that debt by the connected person.

Webinar Commentary

For more commentary, refer to webinar commentary on our Monthly Tax Update for April 2021.

FAQs

1. What does SARS mean by a “connected person”?

A “connected person” is defined in the Income Tax Act as someone who has a close relationship with the taxpayer, such as a relative, trust beneficiary, or company shareholder. SARS applies special rules to transactions involving connected persons to prevent tax avoidance.

2. What is considered a loan waiver in South African tax law?

A loan waiver occurs when a creditor forgives, cancels, or reduces a debt owed by a connected person. This may have income tax, capital gains tax, or donations tax consequences, depending on the nature of the transaction.

3. How does the waiver of a loan affect taxable income?

If a loan is waived, the amount may be treated as income in the hands of the debtor or reduce the tax base of an asset. SARS looks at whether the loan was related to trade, capital, or personal expenditure when determining tax treatment.

4. Are there tax consequences if a company waives a shareholder loan?

Yes. When a company waives a loan owed by a shareholder or connected person, SARS may treat it as a deemed dividend, donation, or taxable income, depending on the circumstances.

5. Can the waiver of a loan trigger donations tax in South Africa?

Yes. If a loan is waived without consideration (no repayment or benefit to the creditor), SARS may view it as a gratuitous benefit, making it subject to donations tax at 20% or 25%, depending on the value.

6. Does the waiver of a loan have VAT implications?

It can. If the loan waiver relates to a taxable supply between connected persons, VAT consequences may arise. However, in many cases, a pure loan waiver without goods or services supplied will not attract VAT.

7. What happens when a trust waives a loan to a beneficiary?

If a trust forgives a beneficiary’s loan, SARS may treat it as a distribution or donation. The tax implications depend on whether the trust is discretionary or vested, and whether the waiver was part of an estate or family arrangement.

8. Are there capital gains tax (CGT) consequences on loan waivers?

Yes. When a loan linked to a capital asset is waived, it may result in a capital gain or base cost reduction under the debt relief provisions of the Income Tax Act.

9. Does SARS allow exemptions on loan waivers between connected persons?

Certain exemptions apply, such as intra-group transactions, estate duty settlements, or specific restructuring arrangements. Each case must be reviewed against the Income Tax Act debt reduction rules.

10. How should businesses and individuals handle loan waivers for tax purposes?

It’s important to document the transaction properly, assess whether it triggers income tax, CGT, or donations tax, and ensure compliance with SARS rules. Consulting a tax professional is strongly recommended to avoid penalties.

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