The South African Revenue Service (SARS) has provided taxpayers with a long-awaited new years gift in the form of the final version of Interpretation Note 127 (IN 127): Determination of the taxable income of certain persons from international transactions: intra-group loans.

The IN provides long overdue guidance as to how SARS will apply the amended provisions of section 31 of the Income Tax Act, 58 of 1962 (ITA) to intra-group loans. This has been highly anticipated as, since the withdrawal of Practice Note 2, there has only been a draft interpretation note in place since 2013. This has resulted in uncertainty for taxpayers as to how SARS would interpret some aspects of section 31 of the ITA.

The finalised IN 127 provides guidance on the application of the arm’s length principle in the context of the pricing of intra-group loans and covers several aspects, including transactions that qualify as affected transactions, who qualifies as connected persons and associated enterprises as well as the factors which SARS will consider to determine whether the arm’s length principle has been complied with.

SARS emphasises in IN 127 that it will act sternly to protect fiscus if the parties are found to have acted at variance with the arm’s length principle.

Some of the key issues covered in IN 127 are briefly summarised as follows:

Arm’s length

Paragraph 5 of IN 127 states that SARS will consider a taxpayer’s debt to be non-arm’s length if, amongst other factors, some or all of the following circumstances exist:

  • The taxpayer is carrying a greater quantity of debt than it could sustain on its own (that is, it is thinly capitalised).

  • The duration of the lending is greater than would be the case at arm’s length.

  • The repayment, interest rate, or other terms are not what would have been entered into or agreed to at arm’s length.

No “safe harbour” rules have, however, been introduced.

IN 127 indicates that both direct and indirect funding is included in the ambit of section 31 of the ITA and includes guarantees provided by a party to support a borrower’s credit.

Thin capitalisation

In applying the arm’s length principle, SARS requires taxpayers to consider a transaction from the perspective of the borrower and the lender.

Accordingly, an arm’s length amount of debt for a borrower with a healthy balance sheet and excess cash reserves may be nil and such a loan will fall within section 31 of the ITA if the borrower cannot show a business need or reason or commercial benefit for obtaining the relevant loan.

Advanced Pricing Agreement

Per IN 127, although no advanced pricing agreement process is in place as yet, SARS is considering the introduction of an APA process.

We are hopeful that this newly released IN will provide taxpayers with some comfort and certainty as they head into the new year.

If you would like to discuss the implications of IN 127 in more detail or would like to understand the impact it could have on your business, please do not hesitate to contact us.

Remote working

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.