All small business owners will say that cash-flow is one of their biggest challenges as they grow their businesses and create jobs. In many cases, SMEs will often have to take u
p expensive loans or overdraft facilities to assist them with meeting their month-end financial obligations like salaries, rent etc. As such, government is attempting to improve the chances of success for BEE businesses through the Enterprise & Supplier Development section of the BEE Scorecard. Any support offered by other businesses that may do this, secures that company enterprise development points.
The purpose of this section of the BEE Scorecard is to encourage the establishment and growth of BEE businesses. The high business failure rates around the world indicate that running a business is one of life’s greatest challenges. That said, there are a number of ways a business can implement their Enterprise Development programs, and one of the strategic ways is to provide an interest-free or interest-bearing loan to their beneficiaries. The intention is to encourage companies to provide credit to SMEs which have difficulty securing reasonable financing that promotes growth through the traditional channels, while preserving working capital. Additionally, the enterprise development loans are intended to directly serve the needs of disadvantaged SMEs that quite often lack the resources to obtain credit through conventional means. The EDL Program’s primary goal is to secure the retention and creation of jobs by providing subordinated, long-term financing at attractive rates.
In such instances, these loan accounts often arise either through funding being provided by one company to another or in circumstances where, for example, a company provides services or sells goods to another company and the consideration remains outstanding on loan account. Often such loan accounts are written off, particularly in circumstances where the Enterprise Development beneficiary is not able to repay the loan.
This article focuses on certain tax consequences arising from the writing off or waiving of debt. Whilst the purpose of the loan may have good intentions in the bigger scheme, the consequences may be significant for the beneficiary company.
Section 24J of the Income Tax Act
Where on the basis that the loans are interest-bearing, the provisions of section 24J of the Income Tax Act should be considered.
A gain on redemption of the loan will arise for the Enterprise Development beneficiary upon the waiver of the loan. This gain will be deemed to accrue to Enterprise Development for tax purposes in terms of section 24J(4). However, section 24J(4) only deems such gain or loss to accrue to, or be incurred by, the taxpayer. It must still be determined whether such gain or loss is to be of a capital or a revenue nature.
Debt reduction provisions
According to the Explanatory Memorandum on the Draft Taxation Laws Amendment Bill No. 22 of 2012, the amendments were prompted in response to the global financial crisis and the unusually large number of companies facing financial anguish or in worse cases complete closure as a result. The intention was therefore to establish a mechanism which facilitated debt reductions without creating an additional obligation to pay further tax.
The “debt reduction provisions” contained in section 19 and paragraph 12A of the 8th Schedule should firstly be superseded by establishing the purpose of the debt then the ordering rules will apply in determining the tax treatment in the context of any proposed waiver of loans. Essentially, Section 19 deals with the income tax consequences of a loan waiver whilst 12A deals with the capital gains tax (“CGT”) implications thereof.
Broadly speaking, section 19 applies where:
- a debt that is owed by an Enterprise Development beneficiary is reduced;
- the amount of the debt that was used to fund deductible expenditure; and
- the difference between the amount advanced under the loan and the amount repaid in terms of the loan (“Reduction Amount”).
This essentially deems any deduction or allowance granted in terms of the Act in respect of the expenditure, to be an amount that has been recovered or recouped by that person for the year of assessment in which the debt is reduced.
Paragraph 12A of the 8th Schedule represents the capital gains tax equivalent of section 19. It essentially applies where the Enterprise Development Contributor applied the loanto acquire an asset which is held on capital account and there is a Reduction Amount.
Once again to stress the importance of a clear picture for the purpose for which the debt was incurred, as this is an advantage in the easier application of the above-mentioned rules.
Income tax implications for the borrower: Section 19
In order to determine the tax implications in respect of section 19, it must be determined how the Enterprise Development Contributor applied the debt proceeds and, in particular, whether such proceeds were used to fund:
- expenditure incurred in the acquisition of goods and/or services; or
- expenditure incurred in the acquisition, creation or improvement of an allowance asset; or
- deductible expenditure other than set out above.
A donation is defined as any gratuitous disposal of property including the gratuitous waiver or renunciation of a right. A waiver of a loan may constitute a donation.
Please do note however that according to SARS A donation will be exempt if the total value of donations for a year of assessment does not exceed:
- Casual gifts by companies and trusts: R10 000.
- Donations by individuals: R100 000 (2008 to 2013 years of assessment) (section 56(2) (a) and (b)).
The person making the donation (donor) is liable for the tax but if the donor fails to pay the tax within the set period the donor and donee are jointly and severally liable for the tax (section 59). It is therefore incumbent on the beneficiary to ensure that these timelines are explicitly agreed upon and adhered to in order to circumvent the succeeding liability herein.
In respect of the example set out above, it is unlikely that Enterprise Development contributor will make a tax-deductible loss on redemption or Enterprise Development will make a taxable gain on redemption in terms of section 24J of the Act. This is because both parties will likely hold the loans on capital account and potentially also because section 24J does not apply since the loan is repayable on demand. It can be seen from the above very high level analysis, that a multitude of tax issues must be considered before writing off a loan.
For further information, contact:
Thato Malebane, Marketing & Communications Manager
Tel: (+27) 011 259 4018