Viewpoints: Debt relief – Tax inconvenience for companies already in financial distress

Muneer Hassan CA(SA) Tax Consultant, Senior Lecturer in Taxation at UJ and Lecturer on the Gauteng Board Course

When a debt which was previously owed by a debtor is written off by a creditor, section 19 and paragraph 12A of the Eighth Schedule are triggered. These sections consider the income tax implications in the hands of the debtor. Section 19 considers the income tax implications where the debt previously funded tax-deductible expenditure, trading stock or an allowance asset. Paragraph 12A considers the income tax implications where the debt previously funded an asset (ie, allowance and non-allowance assets). The following policy principles are written into section 19 and paragraph 12A:

• The debt benefit is applied to reduce the base cost (cost less allowances) of the asset that is still on hand in terms of section 19(3) (trading stock) and paragraph 12A(3) (allowance and non-allowance assets). The policy reasoning for firstly reducing the base cost is to ensure that there are no immediate tax implications in the hands of the debtor.
• Any previous tax benefit (ie, deduction or allowance) is recouped and taxed in terms of section 19(4)–(6) and paragraph 12A(6A), but only to the extent that the base cost is not able to absorb the debt benefit. The policy reasoning to trigger a recoupment of previous deductions or allowances is to ensure that immediate tax only arises as a last resort.
• The exclusions from the application of section 19 and paragraph 12A are aimed at ensuring that a reduction of debt is subject to only one of the following taxes that is, estate duty, donations tax, income tax on a fringe benefit received by an employee, income tax on income or capital gains tax.

Both section 19 and paragraph 12A do not apply to inter-group debt. South Africa does not have group taxation, and therefore inter-group tax relief is written into various sections of the Income Tax Act. Further, section 19 is also not applicable to non-interest-bearing loan conversions and interest-bearing loan conversions, to the extent that the amount converted does not represent interest. In addition, paragraph 12A is also not applicable under a liquidation, winding up or deregistration unless further requirements are met, in which case the exclusion no longer applies.

The problem arises when already distressed debtors are placed in a tax-paying position because of the recoupment/capital gain triggered as a result of the debt waiver. This recoupment/capital gain is triggered in terms of section 19 and paragraph 12A. The recoupment/capital gain is necessary as it achieves tax symmetry. However, the crux of the issue is the tax inconvenience and hardship that is placed on distressed debtors. This might make tax debts difficult to collect and jeopardise future tax revenue, which is counterproductive.

SARS’ position

SARS confirms that the problem at hand can exist. Companies have been struggling to trade in tough economic conditions, and COVID-19 had further compounded the effect on companies. As a result, a number of companies have filed for business rescue or liquidation. The tax liability imposed on companies that are already in financial distress is a further impediment. The proposed solution is that National Treasury considers relief through deferral of inclusion in taxable income for the distressed debtor. More specifically, the problem will be addressed if the distressed debtor has two years from the end of the tax year in which the recoupment/capital gain is taxed to spread the inclusion in taxable income. A two-year period is reasonable and would not leave SARS out of pocket in comparison to liquidation.

This viewpoint is based on the article which Riaan Wessels (a senior lecturer for taxation on the tax honours programme at the University of Johannesburg) and I co-authored. The full article can be accessed at Journal of Economic and Financial Sciences.