Loan Capitalisation Agreement

In other words, the parties wanted to capitalize on the loan. The uncertainty as to whether the activation of a loan triggers the debt authorization provisions stems from C:SARS V Labat 2011 ZASCA 157, where it was found that the issuance of shares would not reduce the assets of a company and therefore would not constitute an expense. If a company issues shares to settle its credit obligations, then the question arises as to whether the company has actually fulfilled its credit obligations. This judgment is important in that it indicates that the capitalization of a loan would not necessarily constitute a reduction of the debt disguised as the issuance of shares in the context of the repayment of a loan. It was proposed that the majority shareholder subscribe for new shares of the applicant and that the proceeds of the subscription be used by the applicant to repay the outstanding loan to the majority shareholder. For example, the terms of a loan agreement may contain provisions that provide that interest is not paid in cash in the event of the borrower`s insolvency, but that such interest is capitalized. Where the capitalisation mechanism is formulated in the loan agreement in such a way that the borrower`s interest payment obligation is fulfilled by the capitalisation in the event of the borrower`s insolvency situation, there may be no `deferral` of such an obligation and the requirements of point (b) of the definition of a hybrid debt instrument may not be met. In Labat, the General Court pointed out that it might be possible to structure the transaction differently so that the set-off would be applicable. However, since there is no indication that the contracts are simulated, the court must take the transaction at face value. The General Court has therefore never ruled on the question whether compensation can take place in the context of the capitalisation of the loans. However, the application of point (b) of the definition of a hybrid debt instrument is not necessarily limited to subordination agreements. A non-subordinated loan agreement that contains provisions on interest capitalization may result in the loan being a hybrid debt instrument.

Capitalized interest is an accounting practice that is required on an accrual basis. Capitalized interest is interest added to the total cost of a long-term asset or loan. As a result, interest for the current year is not recognised as an interest expense. Instead, capitalized interest is treated as part of the fixed assets or loan balance and included in the amortization of the long-term asset or the repayment of the loan. Capitalized interest is shown on the balance sheet and not in the income statement. However, it is important to note that SARS made the decision conditional on the assumption that the payment of the subscription price, as well as the repayment of the loan, will be paid in cash and not by compensation. It appears that the applicant`s main concern was that the subscription of new shares and the subsequent repayment of the loan as debt reduction within the meaning of section 19 of income tax law no. 19. Article 58 of 1962 (Act) and this reimbursement would be made in the hands of the applicant. This is mainly because the loan was used for deductible expenses. Furthermore, the concern appears to have been that the transaction would constitute a reduction in debt within the meaning of section 12A of the Eighth Schedule to the Act and that this would result in a reduction in eligible expenditures for capital gains tax purposes. The above provision has been incorporated into the law to regulate subordination agreements.

It is clear that, in cases where a subordination agreement is concluded for a loan, its effects must be taken into account in the light of the tax provisions of Article 8F and any exemptions from applicability. This is more common for deferred student loans. While a student is still in school, interest accrues on the balance of the student loan and the total amount of interest due is added to the loan principle, effectively increasing the monthly interest. Accrued interest is the amount of interest a business owes on a long-term loan or asset, based on the effective annual interest rate and the time that has elapsed since the last payment of the company`s loan or debt. It is possible for a business to calculate accrued interest by dividing its reported annual interest rate by 365 and multiplying it by the total balance of the loan and the number of days since the business last payment. From a practical point of view, the majority shareholder would subscribe for common shares of the applicant at par value because the applicant had enough approved but unspent shares to cover the loan amount. The majority shareholder would pay the subscription price in cash and the applicant would issue the corresponding share certificates. Thereafter, the applicant would pay the loan from the cash proceeds of the issue. SARS did not make a decision on the deductibility of the operating expenses for which the loan was used or on the application of transfer pricing rules to the facts.

The majority shareholder had previously granted the applicant a loan to cover operating expenses, which were still outstanding. When a corporation capitalizes accrued interest, it adds the total amount of interest due since the last debt payment and adds the amount to the cost of the long-term asset or loan balance. However, where the capitalization mechanism does not result in the fulfilment of the borrower`s interest payment obligation, but in a suspension or deferral of the borrower, the loan agreement may raise concerns about hybrid debt instruments. If the parties do not acknowledge that this requirement is met once the capitalization provisions of the loan agreement are triggered, this could have negative effects on income tax and dividend tax in relation to the loan agreement. The provisions of Section 8F that must be taken into account in the above circumstances include the provisions of point (b) of the definition of a hybrid debt instrument. For the purposes of the foregoing, an interest-bearing debt issued by a corporation may constitute a hybrid debt instrument in which the obligation to pay an amount due is deferred because that obligation is subject to the condition that the market value of the borrower`s assets is not less than the amount of that borrower`s liabilities. To find out how Lexology can drive your content marketing strategy, please send an email enquiries@lexology.com. .

SARS ruled that section 19 of the Act and section 12A of the eighth Schedule to the Act would not apply to the proposed transaction…..


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