Thin capitalisation : an analysis of the application of the amended section 31(3) of the Income Tax Act no. 58 of 1962

Abstract

The current Income Tax legislation, in relation to thin capitalisation, requires South African-based entities to transact at an arm’s length basis. This is in accordance with the Draft Interpretation Note issued by the South African Revenue Service in April 2012. The amendment of section 31 of the Income Tax Act No. 58 of 1962, seeks to combine the thin capitalisation rules with that of the transfer pricing provisions, in terms of the Draft Interpretation Note. The thin capitalisation guidelines contained in the Draft Interpretation Note has become a difficult concept for the South African entities to apply, for they are required to demonstrate to the tax authorities that transactions, arrangements, schemes and operations entered into between connected persons meet the arm’s length principle. Practice Note 7, Draft Interpretation Note, and the Organisation for Economic Co-operation and Development document, outlines guidelines that entities can use to apply the arm’s length principle. Uncertainty exists for these South African entities, on how they can measure the arm’s length basis of transaction entered between connected persons. This study aim to develop a measuring instrument that entities can apply to determine the arm’s length debt, in terms of section 31 of the Income Tax Act No. 58 of 1962.