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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.
FAQs
1. What is considered a loan between group companies in South Africa?
A loan between group companies occurs when one company advances funds to another company within the same group, including subsidiaries, holding companies, or entities under common control.
2. Are loans between group companies subject to tax?
The loan itself is not taxed, but interest income, interest deductions, and certain waivers can create tax consequences for both the lending and borrowing entities.
3. What happens if a loan is interest-free or below market rate?
An interest-free or low-interest loan may trigger deemed interest, donations tax, or transfer pricing adjustments, especially between connected companies.
4. Can interest paid on a group company loan be deducted for tax purposes?
Yes, interest may be deductible if it is incurred to earn taxable income and the loan is structured on commercially acceptable terms.
5. Do transfer pricing rules apply to loans between group companies?
Yes. Cross-border group loans must comply with transfer pricing rules, ensuring interest rates and loan terms reflect arm’s length conditions.
6. What are the risks of thin capitalisation for group company loans?
If a company is excessively debt-funded, SARS may limit or disallow interest deductions, treating some debt as equity under thin capitalisation rules.
7. What are the tax implications if a group company loan is waived?
Loan waivers can trigger income tax, capital gains tax, or donations tax, depending on the relationship between companies and the waiver circumstances.
8. Why does SARS closely monitor loans between connected companies?
SARS monitors these loans to prevent profit shifting, tax avoidance, or disguised distributions of value, ensuring proper taxation.
9. Is documentation required for loans between group companies?
Yes. Proper loan agreements, repayment terms, and interest calculations are essential to demonstrate commercial substance and compliance with tax laws.
10. Why is professional tax advice important for group company loans?
Professional advice is essential to navigate transfer pricing, interest deduction limitations, and deemed income risks, ensuring compliance and tax efficiency.