Last year we drew attention to the proposed withdrawal of Practice Notice 31  (PN31) by SARS . We also predicted that the proposed withdrawal would not go ahead without concurrent amendments to the tax legislation to cater for commercial lending arrangements adversely impacted by the withdrawal of PN31.

These views were re-affirmed by the Minister of Finance in his 2023 budget speech and, as expected, the draft taxation laws amendment bill circulated for comment by the public on 31 July 2023 contains a new concession to mitigate against the adverse effect that he withdrawal of PN31 would have on valid commercial lending arrangements.

So what is the concession?

In so far as they apply to back-to-back lending arrangements by non-trading holding companies, the proposed concession will only allow such holding companies to claim a tax deduction for interest paid if it earns interest from another company that forms part of the same group of companies. This essentially requires a holding of at least 70% by the non-trading holding company in the investee company to which the funds have been on-lent.

Does that suffice?

In our opinion, the proposed concession is deficient in many respects and we believe that many legitimate commercial back-to-back lending arrangements will not qualify for the proposed concession. We are thus actively lobbying the SARS to widen the ambit of the proposed concession.

It is also noted that the proposed concession is actually quite punitive when read in conjunction with another albeit unrelated amendment to the existing rules that limits or restricts the tax deductibility of interest paid to tax exempt persons, such as non-tax resident lenders.

The punitive effect of these proposals is perhaps best demonstrated by way of an example

Illustrative Example

  • Foreign Company Ltd is tax resident and incorporated in a foreign country.
  • It is interested in developing, maintaining, and investing in a critical infrastructure project in South Africa.
  • Foreign Company Ltd is a major global player in this industry.
  • Foreign Company Ltd will only hold a 35% stake in the equity of the South African  “Project Company” that will own and operate the infrastructure project.
  • The remaining 65% of Project Company’s equity is held by various local unconnected shareholders, including empowerment partners and     community-based organisation/charities.
  • No single shareholder holds a majority stake in the shares of Project Company.
  • Funding of the infrastructure project is a mix of debt and equity, and this mix is essentially dictated by the funding requirements of the local shareholders who will have to assume debt to fund their investment.
  • The use of debt in the structure is thus not necessarily a term of how Foreign Company Ltd wants to structure the funding of the investment.
  • The overall tax efficiency of the funding structure, amongst others, is also critical to ensure that the price charged by Project Company is as low as possible. Tax efficiencies are thus not necessarily designed so that the shareholders can extract more profit from the critical infrastructure project.
  • Foreign Company Ltd holds similar interests in infrastructure projects in South Africa, thereby creating a need for it to have a South African holding company (“SA HoldCo”) that directly holds these various minority investments.
  • Foreign Company Ltd is thus required to invest R100 million as loan funding bearing interest at 10% per annum into Project Company via a back-to-back lending arrangement with SA HoldCo, as illustrated in the following diagram:

The overall effect of the proposed concession and other changes to legislation is that:

  • Although SA Hold Co will not make any profit (it earns interest of R10 million per annum and pays interest of R10 million per annum) it is precluded from claiming a tax deduction for the interest expense as it does not earn interest from a company that forms part of the same group of companies.
  • SA Hold Co is thus required to pay tax at 27% per annum on a taxable profit of R10 million despite the fact that it only breaks even commercially on the lending arrangement.
  • At the same time Project Company may not be permitted to claim a tax deduction for all interest paid to SA HoldCo which in turn increases Project Company’s tax charge and decreases its operating profit.
  • Local investors share equally in this burden and receive less dividend and loan repayments which adversely impacts their ability to pay off their debt more timeously.

So what now?

As can been seen, the proposed concession and other changes to legislation unnecessarily complicates the position for all investors by creating punitive tax outcomes, ultimately driving up the price charged by the Project Company to provide the critical infrastructure service. The whole project may no longer be viable and be abandoned.

The proposed concession and other changes to legislation also creates the need for alternative funding structures to be implemented, such as preference share funding structures, which invariably places the local investors in a less advantageous position.

Local investors may be required to source their funds via preference shares from local lenders, and in my experience preference shares are far more expensive and complex to implement, administer, and ultimately leave less cash in the pockets of the investors and more in the pockets of the relevant funders.

It is clear that the proposed amendments are problematic and if promulgated will require changes to be made by investors to avoid wholly tax efficient outcomes. We also need to ask some serious questions about whether and to what extent tax policy is driving investment into or out of the country…

Meet the Author


Today’s article was written by Lance Collop, our head of SA Corporate Tax and M&A, based in Cape Town. Contact Lance at