TAX TALK
Beware Of Limitation of Foreign Currency Loss Deductions with New Income Tax Law
Tax reform over the years has had two broad purposes – lower tax on income and broadening of the tax base to protect against tax avoidance and loss to the fiscus. Section 23M of the Income Tax Act was introduced with effect from 1 January 2015 with the objective of limiting excessive interest deductions in respect of debts owed to persons not subject to tax in South Africa. Typically, for example, this could be the case where, in a controlling relationship, a foreign holding company provides funding to its South African subsidiary. Section 23M limits the deductibility of interest incurred on such debt in terms of a complicated formula.
Should, however, the foreign company be subject to South African interest withholding tax in respect of interest paid or payable by a South African company, the limitations rules provided in Section 23M would not apply as the foreign company would be regarded as being subject to South African tax in respect of that interest, subject to the application of any Double Tax Agreement concluded between South Africa and the foreign jurisdiction concerned.
The income tax law amendments to section23M came into effect for years ending on or after 31 March 2023 and will have far-reaching implications.
One of the significant amendments that may affect smaller companies is the definition of “interest” has been expanded to include, amongst others, taxable foreign gains and losses arising from such debt.
A trade receivable or trade payable balance that is receivable from or owed to a foreign company that is in a controlling relationship with the South African company constitutes an exchange item. For purposes of the amendments to section 23M, any foreign exchange difference arising on such a trade balance and which is taken into account in the determination of taxable income would be regarded as “interest”. This implies that any foreign exchange loss that arises on a trade payable balance should be subject to the interest limitation in terms of section 23M. This position complicates matters for taxpayers, as it results in the application of the interest limitation rules even in instances where the taxpayer has not incurred any “interest” or any finance cost.
The issue of foreign exchange gains and losses that arise on trade balances becomes even more complex when one considers a scenario where the taxpayer has a trade receivable balance that has given rise to a foreign exchange loss. The new amendments to section 23M give rise to this foreign exchange loss being subjected to the interest limitation rules.
On the basis of the complexities involved in the application of section 23M, it is advisable for taxpayers to seek advice from their BAN accountant regarding its application in respect of loans from foreign holding companies and foreign losses incurred on transactions.
Article by: Monique Sharland
ACCOUNTNG 101
Correctly classifying assets and liabilities as current or long-term in financial reporting (management accounts or annual financial statements) is crucial for assessing a company’s liquidity, operational efficiency and its overall financial health. Current assets and liabilities are those due within 12 months from the financial reporting date, while long-term assets and liabilities have obligations due beyond that period. The financial reporting date typically marks the end of the 12-month period from the start of the company’s financial year.
DID YOU KNOW?
Often confused with “cash flow”, working capital has no similarity to cash flow and is a far more significant financial indicator than cash flow. Working capital, or net working capital, is a key financial metric that measures a company’s ability to meet its short-term obligations. It is calculated by subtracting current liabilities (e.g., creditors, taxes, overdrafts) from current assets (e.g., cash, accounts receivable, inventory). A positive working capital, meaning current assets exceed current liabilities, indicates financial health and operational efficiency especially when inventory from current assets is excluded.
In contrast, cash flow refers to the timing difference between when a business spends money (on suppliers or employees) and when it receives payments from customers. While cash flow issues are often blamed for delays in payments to suppliers, VAT and other taxes, the real problem may lie in negative liquidity conditions, where a company is struggling with adverse working capital.
Though related, working capital focuses on the company’s capacity to meet immediate obligations, while cashflow addresses the timing and availability of cash. Both need careful management for a company’s financial stability and long-term success.
Ask your BAN accountant to measure your company’s net working capital and its cash-flow-cycle to ascertain the health of your business and to pinpoint your real cash issues, if any.
Article by: Monique Sharland
TOP TIP
Starting a business for the first time? Do NOT form a company before receiving expert advice on the right business structure for you and your business. Choosing the wrong structure to start off with, could cost you more in compliance than you could ever have bargained for.
Contribution by: Monique Sharland