Corporate tax rate change: encouraging or discouraging

As industry, we were all delighted when the Minister of Finance announced the reduction in Corporate Income Tax rate from 28% to 27% for years of assessments commencing on or after 1 April 2022. This seems to suggest that Treasury is encouraging growth in the private sector. This would hopefully assist with providing much-needed relief to South Africa’s massive unemployment, not to mention the effects that COVID 19 has had on job losses.

Although this rate change is encouraging for South African business there is a sting in the tail with the announcement. The Minister used the following specific wording in conjunction with the announcement: “This will be done alongside a broadening of the corporate income tax base by limiting interest deductions and assessed losses.”

These limitations were announced by the Minister in the 2020 budget speech and were supposed to be introduced from 1 January 2021. However, due to COVID 19, the implementation was postponed until at least 1 January 2022.

What do these proposals mean for companies?

For assessed losses, Treasury is proposing that when a previously loss-making company starts making a profit, it can only use its balance of assessed losses to shield 80% of its taxable profits. If the assessed losses exceed this amount these can be carried forward to future years. Thus, a newly profitable company must start paying tax (on 20% of its profits in the year) even if it still has unutilised assessed losses.

As a practical example, a company has an assessed loss carried forward of R1 000. In year 1 its taxable income is R300. Under the current rules it would pay no tax, and the assessed loss is reduced to R700.

Under the proposed rule, the company must pay tax on R60 (at 27% this would amount to a tax liability of R16.20), and it can carry forward assessed losses of R740.

This effectively means that Treasury will be collecting revenue irrespective of a company being in an assessed loss position. Ultimately, this would be most pronounced on start-up companies or new investments into South Africa, as they generally only turn profitable within two to three years of commencement of business.

To compound this, Treasury has proposed to tighten the interest limitation rules. In the original discussion paper on the interest limitation rule, Treasury indicated the possibility of limiting the deduction of all interest – whether paid to related or third parties. Fortunately, they have retracted somewhat from this position. However, the proposed interest limitation would appear to apply to any related party loan, whether the lender is situated in South Africa or not.

If our company has support from a related party in its start-up phase, it may be in a situation where it must pay tax before recouping all of its losses and is possibly denied a deduction of some or all of its interest which it incurred on the loan utilised to fund its operations.

So, while the proposal to reduce corporate tax rates, but expand the tax base through the interest and loss limitation rules are revenue neutral for the country, taxpayers in the new investment sector may face greater cash flow constraints through these measures.

Would these terms be favourable for foreign, or even local, investment into our economy?