South Africa: Proposal to expand application of the interest limitation rules

If enacted, there would be limits imposed on tax deductible interest incurred by taxpayers.

If enacted, there would be limits imposed on tax deductible interest incurred by taxpayers

The Draft Taxation Laws Amendment Bill 2021 (released on 28 July 2021) proposes amendments to the current interest limitation rules for years of assessment beginning on or after 1 April 2022.

If enacted, there would be limits imposed on tax deductible interest incurred by taxpayers—interest deductions that currently are not subject to the interest limitation rules.


The draft legislation includes proposed amendments to section 23M of the Income Tax Act No 58 of 1962.

Section 23M currently restricts the deductibility of interest payable to a creditor that is in a “controlling relationship” with the debtor, when that creditor is not subject to tax in South Africa in respect of such interest or when a creditor, not subject to tax, sources the funding from a person who is in a controlling relationship with the debtor. Typically, this would be the case when there is an income tax treaty between South Africa and the country of residence of the foreign creditor that has an article reducing any withholding tax to zero.

In general, section 23M limits the amount of interest that can be deducted to the sum of:

  • Interest received by or accrued to the debtor plus
  • A formula driven percentage of “adjusted taxable income” less
  • Interest incurred by the debtor in respect of debts, other than debts subject to section 23M, which has not been disallowed under the provisions of section 23N of the Income Tax Act (section 23N limits the deductibility of interest incurred on loans used to fund “reorganization” or “acquisition” transactions)

Interest that is disallowed in a particular year of assessment can be carried forward indefinitely and reconsidered for deductibility in subsequent years. 

Proposed changes

The draft legislation proposes the following changes to section 23M.

Broader definition of “interest”—The definition of interest for purposes of section 23M would be expanded to include:

  • Amounts incurred or accruing under interest-rate swap agreements (as defined in section 24K of the Income Tax Act)
  • The finance cost element of lease arrangements, included in or deducted from income and recognised as finance leases under IFRS 16
  • Taxable foreign exchange gains or losses arising in respect of such debt

The definition of interest for purposes of withholding tax would be unchanged, with the result that the above amounts (such as the finance cost element of a finance lease) may not be subject to tax in the hands of the creditor.

Interest on back-to-back loans—In its current form, section 23M considers whether the creditor is subject to tax, either in the form of normal tax or withholding tax. It does not look beyond the creditor. Currently, section 23M will only apply when the creditor is tax exempt or, as noted above, is a non-resident who is not subject and liable for withholding tax as result of income tax treaty relief. Under the proposed amendment, section 23M would apply even if the funds which are lent out by a taxable person are sourced from a person who is not subject to tax.

This proposed amendment is best explained by a simple example:


Company A (the South African taxpayer) has an ultimate parent company (Company B) that is tax resident in the United Kingdom.

The income tax treaty between South Africa and the United Kingdom grants taxing rights on interest to the United Kingdom—meaning no withholding tax applies on any interest payments made to Company B. If Company B were to advance funds directly to Company A, section 23M would apply to limit the deduction of interest in the hands of Company A.

When, however, the funds are advanced by Company B to a South African resident intermediate holding company (HoldCo) that, in turn, on-lends the funds to Company A, the position currently, under section 23M, is different.

The provisions of section 23M would not apply to Company A because the interest accrues to a person who is subject to tax. Company A would thus be entitled to claim a deduction of interest paid to HoldCo in full.

The provisions of section 23M would technically be applicable to the interest paid by HoldCo to Company B.

However, as a result of “interest received” being a factor in the calculation of the interest limitation, HoldCo would be able to claim a deduction, at a minimum up, to the amount of interest received from Company A.

The legislative proposal would apply section 23M to interest incurred by a debtor (Company A in the example) in circumstances when the creditor (HoldCo) sources the funds from another person (Company B) that is in a controlling relationship with the creditor and that person (being Company B) is not subject to tax on interest received from the creditor. This significantly would broaden the application of section 23M.

Interest deemed to be “not subject to tax”—When an applicable income tax treaty reduces the rate of withholding tax but does not entirely remove South Africa’s taxing rights, the interest is currently regarded as being subject to tax, and the provisions of section 23M would not limit the deduction of such interest in the hands of the South African taxpayer. The proposed legislation would deem all or a portion of the interest to be “not subject to tax” when the interest is not included in the income (i.e., gross income less exempt income) of the recipient. In determining the portion that is “not subject to tax,” a formula would be applied. The lower the withholding tax rate applicable to the interest, the higher the portion of the interest that would be deemed to be not subject to tax. The inclusion of the deeming provision would result in interest, which attracts withholding tax, falling into the section 23M net.

Percentage of adjusted taxable income to included—Currently, the percentage of adjusted taxable income that is included in the determination of the deductible interest is calculated based on a formula which is driven largely by the average repo rate. It is proposed that this formula be replaced by a flat rate of 30% of adjusted taxable income.

Adjusted taxable income for REITs—The taxation of listed real estate investment trusts (REITs) is governed by section 25BB of the Income Tax Act. REITs are able to claim a tax deduction in relation to qualifying distributions made to investors. These amounts would under the proposal be added back in the adjusted taxable income calculation.

Carrying forward of disallowed interest—The proposals retain the current rules around the indefinite carrying forward of disallowed amounts.  National Treasury has, however, indicated that the rules would be revised in five years. 

KPMG observation

As noted above, the proposed amendments could significantly increase the number of taxpayers affected by the interest limitation rules under section 23M and would thus result in a higher proportion of interest being disallowed. Based on announcements made by the Minister of Finance in the 2021 Budget Speech, implementation of the new interest limitation rules would likely be accompanied by a reduction in the corporate income rate from 28% to 27%.

Read a July 2021 report [PDF 223 KB] prepared by the KPMG member firm in South Africa


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