From 1 April 2014, interest incurred on subordinated debt is no longer tax deductible. Section 8F of the Income Tax Act 58 of 1962 (“the Act”) is an anti-avoidance provision which deems the interest to be a dividend in specie and effectively disallows the deduction of affected interest. Section 8F only applies in respect of amounts incurred on or after 1 April 2014.
Subordination Agreements are commonly used in group scenarios and typically contain the following clause:
“The Creditor hereby agrees that, until such time as the assets of the Company fairly valued exceed its liabilities, it shall not be entitled to demand or sue for or accept repayment of the whole of any part of the said amount owing to it by the company and set-off shall not operate in relation to the subordinated claim in respect of any debts owing by it now or in the future; provided that if the auditor of the Company shall report in writing that he has been furnished with evidence which reasonably satisfies him that the amount of the subordinated claim exceeds the amount by which the liabilities of the Company exceed its assets, such excess portion of the subordinated claim as is specified in the said certificate shall be released from the operation of this agreement”.
There is accordingly a significant risk to taxpayers who have entered into Subordination Agreements that section 8F will apply. A further hindrance is that by their nature, subordinated loans cannot be repayable on demand, which could otherwise potentially place them beyond the ambit of section 8F.
It’s important to bear in mind that section 8F only applies to interest bearing subordinated debt. Taxpayers with interest-free subordinated debt do not fall within the section 8F net. Furthermore SBC’s (Small Business Corporations) are exempted from the provisions of this paragraph.