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[FAQ] Tax consequences of loans between group companies
- 21 June 2021
- Corporate Tax
- The Tax Faculty Tax Specialist
This article is based on tax law for the year ending 28 February 2021.
Background
There is a loan between Company A and Company B. Company B owes Company A R200million plus R54million of interest. The likelihood of Company B being able to settle that loan in the foreseeable future is doubtful.
What are the tax consequences for both Company A and Company B if Company A either capitalizes the loan for equity (Company A owns 100% of Company B) or if the loan is waived/written off?
Answer
The Income Tax Act
Company A and Company B comprise a group of companies as defined in section 1(1) of the Income Tax Act: two or more companies in which one company, the controlling group company, holds at least 70% of another company, the controlled group company.
The importance of this lies in section 12(8)(e) of the Act, which provides that section 19 does not apply to a debt benefit in respect of any debt owed by a company that owes the debt to another company in the same group where the debtor reduces or settles the debt by means of a share issue. We find an identical provision in paragraph 12A(6)(f) of the Eighth Schedule to the Act. Loans financing both income and capital expenses are covered by this relief. This means that there would be no tax implication as contemplated in section 19 or paragraph 12A if company A were to subscribe for shares in company B, using the loan as the means of settlement.
The subscription for shares is a condition for the exemption; if company A simply writes off the debt, company B would enjoy a debt benefit taxable in full to the extent of the R54 million interest forgone by company A and any other deductible expenditure incurred for which the loan funds were used and claimed by the company.
Similarly, to the extent that company B used the loan to acquire capital assets, their base cost would be reduced to the extent of the loan; if the asset is no longer on hand, there is a capital gain for company B but company A’s loss is clogged in terms of paragraph 39 and may be used only against future gains made from disposals to company B, and then only if they are still connected persons in relation to each other.
Webinar Commentary
Refer to the following webinar: Monthly Tax Update - June 2021 here.