Corporate income tax: A bittersweet reduction

The reasons outlined by the minister for proceeding with this reduction, against many expectations, are as follows:

• Corporate income and profits have been more resilient than anticipated with tax collection recently buoyed by strong increases in the prices of exports relative to imports.
• South Africa’s corporate income tax rate exceeds the Organisation for Economic Co-operation and Development’s average of 23%.
• The CIT rates of countries with strong investment and trading ties to South Africa have significantly lower rates of CIT, which provides a strong incentive for tax avoidance.
• The reduction in CIT is part of a broader restructuring of the corporate income tax system in South Africa.
• While the reduced CIT rate will result in a revenue loss, it will be offset by the additional revenue earned from protecting and broadening the tax base.

And now the bitter

With the reduction in the CIT rate now confirmed, the following key proposals aimed at protecting and broadening the tax base also come into play (i.e. for years of assessment ending on or after 23 March 2023):

• the limitation on the use of assessed losses; and
• further restricting the deductibility of interest paid to tax exempt persons.

We deal with these proposals in more detail below.

Limitation on use of assessed losses

Some exceptions aside, South African corporate taxpayers are currently permitted to use the full balance of an assessed loss to shield taxable income in a year. However, under the revised rules, which now become effective for years of assessment ending on or after 31 March 2023, a company can only offset a balance of an assessed loss against the higher of R1 million or 80% of taxable income arising in a year. The impact of this revised rule is illustrated in the following example:

Company A has an assessed loss brought forward of R2 million and makes taxable income of R1,100,000 for its tax year ending 30 June 2023. In determining its taxable income for this year, Company A can only offset the higher of R1 million or R880,000 (80% of R1,100,000) by the assessed loss brought forward. Company A will thus pay tax on R100,000 and will carry forward an assessed loss of R1 million to the following tax year.

While the overall aim of this proposal is generally appreciated by the taxpaying public, the timing of it is still unfortunate and may burden businesses trying to recover from the effects of the COVID-19 pandemic. It also negates the effect of accelerated allowances as an incentive, which is particularly concerning and may adversely impact the level of investment into critical energy and gas related projects going forward.

Further restricting the deductibility of interest paid to tax exempt persons

The existing rules that limit the tax deductibility of interest paid to tax exempt persons are encapsulated in section 23M of the Income Tax Act 58 of 1962 and first became effective for interest incurred on or after 1 January 2015. In order to strengthen the application of these rules (i.e. to increase the amount of “interest” that does not qualify for a tax deduction) the 2021 legislative cycle included changes to section 23M as follows:

• broadening the definition of interest to include payments made under interest rate swap agreements, the finance cost element of finance leases, and foreign exchange differences;
• curbing the circumvention of the rules by using back-to-back loans; and
• ensuring that the rules apply even if the interest is subject to interest withholding tax in South Africa.

We draw attention to the last change outlined above as section 23M currently does not apply where the interest has been subject to any level of withholding tax in South Africa. This is a critical change and will result in significantly more cross border interest-bearing loans being subject to section 23M.

Corporate taxpayers are thus advised to revisit the application of section 23M to interest paid once the revised rules become effective.