Many South African businesses are funded by foreign holding /group companies or other connected non-tax resident persons (including individuals). These loans vary from interest free to interest-bearing, both of which may have accounting and tax implications, which are generally not considered in sufficient detail.
This simple example is provided to highlight the potential tax risks that may arise.
Facts: SA Co borrows $7 million at the beginning of the 2025 financial year (FY 2025) from Foreign Co B for a period of 10 years at an interest rate of prime less 2%. The loan is to be repaid in bi-annual installments commencing from year 3 of inception. The company year-end is December. In the FY 2025 accounting records and resulting annual financial statements (AFS) of SA Co, this transaction was treated as follows:
- The interest is calculated on the $7 million loan and capitalized to the loan balance.
- The loan was converted into rands for the purposes of determining the rand balance owing at 31 December 2025.
Tax risks and questions that arise from this loan transaction:
- Due the loan being cross border from a connected person it is likely to fall within the ambit of an “affected transaction” for transfer pricing purposes. Hence one must ascertain whether the transaction is being carried out at “arm’s length” to ensure compliance with section 31 of the Income Tax Act (ITA).
- Effectively the question is would an unconnected person grant a similar quantum of loan value at the same rate of interest?
- Has any Withholding Tax on Interest (WHTI) been accounted for and paid over to SARS timeously? Has the DTA between SA and the relevant foreign country been considered to determine the correct WHTI rate? When is this WHTI triggered (time of accrual or payment)? The terms of the agreement must be properly analysed to determine when the interest becomes due and payable to the loan holder as this may not simply occur at the time of accrual of such interest.
- Similar to Dividends Tax, which requires a Dividends Tax return to be submitted even where the dividend paid is exempt or subject to a low withholding tax rate, this step is often overlooked when it comes to WHTI.
- WHTI has a rate of 15% however where a lower/nil rate is applicable, a WHTI return must be submitted and the relevant declarations and undertakings obtained by the company from the Foreign Co.
- Is the interest deduction capped when determining the taxable income of the SA Co?
- Where interest paid to the Foreign Co is not subject to WHTI or is subject to a WHTI rate of less than 15%, the anti-avoidance provisions contained in section 23M of the ITA may apply and need to be considered.
- Has the realized and unrealized foreign exchange gain/loss been accounted for and does the unrealized portion qualify for any deferral in terms of section 24I(10A) which generally applies where the loan is classified as long term for IFRS purposes, is not hedged and is extended within the context of a “group of companies” as defined.
- Other compliance considerations:
- If the “affected transaction” or cumulative affected transactions exceed R100 million in the FY 2025, SA Co must submit a compliant transfer pricing policy (local file) to SARS with the submission of it’s annual income tax return
- If the Multinational Entity Group turnover exceeds R10 billion the SA Co may be liable to submit a Country-by-Country-Report (CbCR return) as well.
Based on the above, it is apparent that a simple loan transaction can have far reaching tax consequences. Whilst this list is not exhaustive, it certainly highlights the need to obtain proper tax advice when entering into these types of transactions to avoid any unintended and potentially dire consequences.
