What to consider when writing off loans to an African subsidiary

One of the many unfortunate impacts of Covid-19 is the increase in business failures and companies becoming loss-making, which in turn is resulting in many connected party loans being written off.  Here we take a look at some of the implications of writing off or capitalising a loan to an African subsidiary; key issues include whether the write-off could result in taxable income, deductibility of loss arising from the write-off, transfer pricing considerations, thin capitalisation rules for remaining loans, interest considerations, capital losses. and controlled foreign company issues.

When writing off loans to an African subsidiary

Where the lender decides to write-off or waives a loan owed by its non-resident subsidiary, the amount of the loan written off or discharged may (depending on what it was used to fund) be included in the gross income or as a capital gain for the borrower, resulting in a tax charge for no income. In the event that the non-resident subsidiary has sufficient tax losses which it is not expected to utilise in future or tax losses that would otherwise be lost, it may still be a viable option to write-off the loan. However, care should be taken to confirm that no losses would be ring-fenced or not allowed in practice, which is increasingly common in certain African countries.

Although the non-resident subsidiaries are not South African tax resident companies, they would be regarded as controlled foreign companies (“CFCs”) for a South African parent South African tax purposes, being companies in which South African residents hold more than 50% of the participation or voting rights. This means, that the South African parent could also be required to include its proportional share of the respective CFC’s notional taxable income in its own taxable income, should the write-off be considered as creating taxable income.

Further, in respect of such CFCs, where the loan is waived or otherwise discharged for no or inadequate consideration, (which could include the conversion of the loan to equity) the amount of debt written off could be subject to specific South African debt waiver rules. Where the CFCs are more than 70% held, whether directly or indirectly, they should form part of the same group of companies, as defined for South African tax purposes and may, qualify for certain exemptions from these rules as well.  In particular, an exemption applies where the debt is waived in the course of or in anticipation of the liquidation, winding up, deregistration or final winding up of the entity. Most other waiver situations would give rise to a taxable benefit as defined in the legislation. Whether the taxable benefit would give rise to SA tax would depend on whether the CFC income is required to be imputed and, if so, what the loan was used for by the borrower CFC.

An alternative would be to capitalise the loans. However, this is not always feasible commercially as it could result in a change to the shareholding and voting rights.

Clearly, the issues to be considered are extremely complex, and care needs to be taken before determining the best approach on a per-country basis.  Do contact us should you wish to discuss.

What to consider when writing off loans to an African subsidiary

How can we help?

How you structure your business is a critical question as you expand globally.  The right structure will protect your assets, improve your currency position, support your business operations, facilitate future business expansion and changes, and optimise your overall tax rate. Trying to unscramble a sub-optimal structure entered into in haste or without full consideration of relevant facts is complex and expensive, so it’s important to plan upfront.

Structuring an international business is both a science and an art – this is our specialist area of expertise. Regan van Rooy is an international tax and structuring advisory firm focussing on Africa. We have offices in South Africa, Mauritius and Ireland and we can help you with any international tax or structuring query.