The ‘Debt Reduction’ - Lifeline

Although, companies should be cautious when issuing shares in lieu of payment. Notice should be had to section 19 (the “debt reduction rules”) of the Income Tax Act, 58 of 1962 (“ITA”) and the Binding Private Ruling 246 (“BPR”) issued by SARS. The relevant facts of the BPR are summarised as follows:

1. A Partnership holding ordinary shares in a private company provided funding to the company via unsecured, fixed rate debentures. The Partnership subsequently agreed to assist the company in restructuring its debt as follows:
   1. The company, by way of bridging finance, would redeem the debentures at full value (including accrued and unpaid interest), and make transfer of the amount owing to the Partnership;
   2. The Partnership would then subscribe for preference shares in the company by utilising the redemption proceeds;
   3. The Company would repay the bridging finance by utilising the preference shares subscription price proceeds.

The question at hand was whether the redemption of the debentures at full value would be subject to the provisions of section 19 of the ITA. SARS ruled that these provisions would not apply, as the amount so reduced would not be an amount ‘received’ or ‘recouped’ by the company. The debt reduction rules must therefore be applied with a great degree of consideration and only after obtaining professional advice.