An analysis of Section 23M in light of the OECD best practice approach to interest limitation

Abstract

The ability of multinational companies to reduce their tax burden on their worldwide profits has generated public interest in recent years. Excessive interest deductions can be used to shift profits from one country to another to avoid or reduce the tax burden of a group of companies. Base erosion through excessive interest deduction was identified as a risk in South Africa. To address this risk, the South African legislation introduced Section 23M to limit interest deductions for persons exempt from tax, effective from 1 January 2015. However, the Organisation for Economic Co-operation and Development (OECD) report with recommendations on limiting base erosion through interest deductions was only released in October 2015. The objective of this study is to determine whether the provisions of Section 23M are in line with the OECD recommended best practice approach on interest limitation, as outlined in the OECD Action 4 report. The study found that Section 23M bears some similarities to the OECD best practice approach recommendation; but there are also differences. The OECD best practice recommendation and Section 23M both follow the general approach of basing the interest limitation on a fixed percentage of the profits of an entity. Section 23M, however, focuses on the interest deduction risk relating to intra-group debt utilised to fund exempt income whereas the OECD is concerned with interest deduction relating to both intra-group and third party debt. It was found that Section 23M seems to be a more lenient approach than recommended by the OECD