Page 86 - SAIT Compendium 2016 Volume2

PN 43/1996 Income Tax acT: PracTIce noTes PN 2/1996
PRACTICE NOTE 43 OF 1996 – TREATMENT OF CERTAIN TYPES OF POLICY LOANS
General Notice 245 published in Government Gazette 17017 of 8 March 1996
Withdrawn on 18 August 2015: Section 29 was repealed by Revenue Laws Amendment Act 20 of 2006
PRACTICE NOTE 1 OF 1996 – PROVISION FOR SHIP REPAIRS IN TERMS OF SECTION 14(1)(c) OF THE INCOME TAX ACT
General Notice 470 published in Government Gazette 17090 of 12 April 1996
Withdrawn on 18 August 2015: Section 14(1)(c) was repealed by Taxation Laws Amendment Act 31 of 2013
PRACTICE NOTE 2 OF 1996 – DETERMINATION OF TAXABLE INCOME WHERE FINANCIAL ASSISTANCE HAS BEEN GRANTED BY A NON-RESIDENT OF THE REPUBLIC TO A RESIDENT OF THE REPUBLIC
issued by
OFFICE OF THE COMMISSIONER FOR INLAND REVENUE
General Notice 584 published in Government Gazette 17194 of 24 May 1996, as corrected by General Notice 1117 in Government Gazette 17362 of 16 August 1996
1. Introduction
1.1 In anticipation of a possible relaxation in exchange controls, the Commission of Inquiry into certain aspects of the Tax Structure of South Africa (under the chairmanship of Prof M M Katz) recommended in its rst and second interim reports that transfer pricing provisions be introduced into the Income Tax Act, 1962 (the Act), inter alia to counter thin capitalization practices which may have adverse tax implications for the South African scus.
Transfer pricing provisions are normally applied to adjust the prices of goods and services in terms of certain transactions concluded between related parties to re ect an arm’s length price which would have applied had the transactions been concluded on normal commercial grounds between unrelated parties. The effect of the application of transfer pricing provisions is to neutralise the tax bene t arising from such transactions. On the other hand, thin capitalization provisions are applied to limit the deductibility of interest where there is a disproportionate ration between the loan capital and equity employed in, for example, a company.
In order to counter such practices, section 23 of the Income Tax Act, 1995 (Act 21 of 1995), substituted section 31 of the Act. Such section consists of a combination of transfer pricing and thin capitalization provisions which may, for instance, be applied where nancial assistance is granted in respect of international transactions.
1.2 Measures to counter transfer pricing schemes are in essence contained in section 31 (1) and (2). Although these provisions may also, in certain circumstances, be applied to combat thin capitalization, the provisions of subsection (3) are more speci cally aimed at countering thin capitalization schemes.
Once the excessive portion of nancial assistance has been determined in accordance with the guidelines as set out in paragraph 4 of this Practice Note, the provisions of section 31 (2) must be applied to determine whether the interest calculated on that portion of the nancial assistance falling within the 3:1 guideline provided in the aforementioned paragraph, is based on an arm’s length price (interest rate). In this regard consideration should be given to the guidelines provided in paragraph 2.2.
On a literal interpretation of section 31 the concept of nancial assistance would include not only interest-bearing nancial assistance, but also interest-free nancial assistance. As the purpose of subsection (3) is in essence to enable the Commissioner for Inland Revenue to determine an acceptable debt/equity ratio in order to disallow a deduction in respect of interest relating to the excessive portion of loan capital, the application of subsection (3) will be limited to interest-bearing nancial assistance. This will, however, not have the effect that nancial assistance which is not interest- bearing, will be regarded as permanent owner’s capital.
On the same basis only, interest-bearing nancial assistance will be taken into account in the application of the transfer pricing provisions of subsection (2) in cases where it is applied in conjunction with the provisions of subsection (3) in order to determine whether the interest calculated on that portion of the nancial assistance falling within the 3:1 guideline, is based on an arm’s length price (interest rate). However, where the application of the thin capitalization provisions are not necessary because the nancial assistance granted falls within the prescribed guidelines, nancial assistance may include nancial assistance which is not interest-bearing in the application of the provisions of subsection (2).
1.3 EXAMPLE:
A pro table South African Company, TPS (Pty) Ltd, was capitalised in rand by its shareholder who is a non-resident. The company’s nancial year ends on 31 August. The RSA prime rate was 18,5% throughout the 1995/6 year of assessment. The following further information is relevant for the application of section 31:
Fixed capital Shareholder
Loans
Shareholder granted loan # 1 on 1/9/95 @ 24% p.a. Shareholder granted loan # 2 on 26/1/96 @ 0% p.a.
R1 000 000 R4 000 000 R2 000 000 R2 000 000
Interest
Loan # 1: R2 000 000 at 24%
78
R480 000 SAIT CompendIum oF TAx LegISLATIon VoLume 2