Section 24O of the ITA can in certain circumstances be utilised in acquisition transactions when a company obtains financing to acquire equity shares in another company. The operative provision of this section essentially permits the interest levied on the financing to be claimed as a tax deduction. This is a welcome relief considering that interest expense is generally only deductible in terms of section 11(a) of the ITA as an expenditure incurred in the production of income, which is otherwise known as the general deduction formula. The acquisition of shares does not often fall within the ambit of the general deduction formula and would generally not, on its own, qualify as a deduction.
Unfortunately, however, this provision does not apply to all acquisition transactions. Certain criteria need to be present to qualify for the deduction. The debt must be incurred by a company to finance the acquisition of equity shares in terms of an acquisition transaction.
Section 24O(1) of the ITA defines an acquisition transaction as any transaction where a company acquires equity shares in another company that is:
- an operating company with the acquiring company and become a controlling group company of that target operating company at the end of the transaction; or
- a controlling group company in relation to an operating company and that acquiring company controls the controlling group company at the end of the transaction.
After the acquisition, there must be a change in control in order to rely on section 24O of the ITA. In other words, the provision is not applicable to companies that already form part of the same group of companies.
To completely understand the implications of section 24O of the ITA, it is vital to understand the meaning of “equity shares” and “operating company”. An operating company refers to a company where a minimum of 80% of the aggregate amounts received or accrued in a year of assessment is classified as income in the hands of that company and this income must be derived from a business carried on continuously by the operating company and which is derived from goods or services provided or rendered by the operating company for consideration.
Once it has been established that the debt was incurred for a qualifying acquisition transaction, the interest incurred on such debt, to the extent that equity shares so acquired constitutes a qualifying interest, in an operating company, will be deemed to be incurred in the production of income and deductible for tax purposes.
As is the case with all tax benefits, limitations must be imposed in order to prevent misuse. Section 23N applies directly to section 24O in that the allowable deduction is limited to an amount calculated by applying the specific formula to the income tax of the acquirer.
Where large interest-bearing loans are taken to finance the purchase of equity shares, section 24O can be of great value to the taxpayer who can make use of this deduction. But it is important to ensure that the criteria for the applicability of this section are met. As is the case with all hidden gems in terms of the ITA, correct planning and implementation are key to the success of a notable tax deduction. Therefore, consulting with our Tax Advisory and Tax and Accounting teams can provide you with the expertise and guidance needed to maximise your benefits.
Disclaimer: This article is the personal opinion/view of the author(s) and is not necessarily that of the firm. The content is provided for information only and should not be seen as an exact or complete exposition of the law. Accordingly, no reliance should be placed on the content for any reason whatsoever and no action should be taken on the basis thereof unless its application and accuracy have been confirmed by a legal advisor. The firm and author(s) cannot be held liable for any prejudice or damage resulting from action taken on the basis of this content without further written confirmation by the author(s)
