There is tax relief available to companies in the instance where money is owed to them, however debt forgiveness can have severe tax consequences in South Africa in terms of the Income Tax Act ( Section 19 and par 12A-12D of Eighth Schedule) for the debtor. When debt is reduced, cancelled or settled for less than what was initially owed, the benefit received by the debtor may be treated as income or a reduction of base cost for tax purposes. This is dependent on the nature of the original debt.
The original nature of the transaction of what the debt was used for is a key factor to be considered in determining whether the ‘benefit’ is income or a reduction of base cost.
Debt used to acquire Trading Stock
When the debt was used to acquire trading stock which was subsequently sold in a tax period prior to the tax period in which the debt is reduced, the amount forgiven must be included in income.
Where trading stock has been acquired and not disposed of at the time of reducing the debt, the amount forgiven must reduce any deductions which was previously claimed in respect of trading stock.
Debt used to fund Operating Expenses
In the event that debt was used to fund operating expenditures for which an expense was claimed, the amount forgiven is deemed a recoupment for income tax purposes and therefore included in income.
Debt used to fund Capital Assets
Debt previously used to finance capital assets which are not disposed at the time of reducing the debt, the amount forgiven may reduce the base cost of the asset and potentially increase the taxable capital gains when disposed at some future point.
In the event of a capital allowance asset, the debt reduction, may also trigger a recoupment to the extent an allowance was claimed on the asset.
In summary, the following income tax provisions can be applied for determining the debt ‘benefit’:
Debt used for (purpose): |
Section of Income Tax Act: |
Tax impact: |
| Operating expenditure | Section 19 | Deemed Recoupment and Added back to income (to form part of taxable income) |
| Trading Stock disposed | Section 19 | Recoupment and added to income |
| Trading Stock on hand | Section 19 | Reduce any deductions claimed in respect of trading stock |
| Capital asset | Section 19, read with Paragraph 12A of the Eighth Schedule |
Reduces base cost, potentially affecting capital gains tax. May also trigger a recoupment for income tax purposes on allowance assets. |
| Personal loan(non-deductible) | No tax implications | No tax implications |
There are some exclusions when no recoupment or a capital gain adjustment will apply:
- Debt owed to a deceased estate
- Debt reduced by way of donation
- Debt reductions that could be taxable fringe benefits
- Debt between resident companies in the same group under specific conditions.
Although there might be relief in terms of debt reductions, taxpayers are cautioned as one may be caught with unnecessary tax debt to SARS. This is a complex matter and each set of facts will give rise to a different approach and that accordingly, it is advised that you obtain a formal tax opinion in terms of section 223 of the Tax Administration Act from your local PKF office and the correct tax treatment of the debt reduction. The opinion will contain all the necessary information to be able to deal with a SARS audit and in the event that there is still a dispute over the treatment there is protection from the penalties.
