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Q1 2024 - (released May 2024)

SA's quarterly Private Equity & Venture Capital magazine


Budget introduces important tax changes for private equity

by Michael Rudnicki and Wally Horak


Two significant tax proposals impacting private equity (PE) funds were tabled in the 2024 budget review.


One relates to the unintended impact of the “connected person” rule, as defined in the Income Tax Act, 1962 (the Act), on limited partners of an en commandite partnership; and the other, the potential prejudice to tax exempt entities, such as South African pension funds, who lend monies to related parties, such as portfolio companies of an en commandite partnership.

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The ‘connected person’ definition

In terms of paragraph (c) of the definition of “connected person” in section 1 of the Act, members of a partnership are ‘connected persons’ in relation to each other and to any connected person in relation to such a partner. Treasury acknowledges that the wide definition has an unintended impact on limited partners in an en commandite partnership.

For example, the transfer pricing rules apply in respect of cross border transactions between connected persons. If a non-resident limited partner (or a connected person in relation to such a partner) should enter into a transaction with one of the underlying South African resident investee companies of the PE fund, that transaction could be subject to the transfer pricing rules if the PE fund held 20% of the shares in that company.

Furthermore, if the PE fund should make a foreign investment and holds more than 50% of the shares or voting rights in the foreign company, the tax resident limited partners will be exposed to the controlled foreign company (CFC) attribution rules, even if each of the limited partners held an interest of less than 10% of the shares (which would otherwise be an excluded interest in the CFC). These implications were not envisaged by the legislature. 


Treasury proposes that where the limited partner is a ’qualifying investor’ (a defined term in the Act, which essentially refers to the limited partners), the definition of ‘connected person’ will be reviewed to temper the impact.

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Interest deduction limitation rules applied to pension funds

Section 23M of the Act limits the deduction of interest incurred on loans, principally from creditors in a ‘controlling relationship’ with a debtor, where such interest is not subject to tax in the hands of the creditor. Creditors, such as pension funds, are exempt from tax on their income1.


A ‘controlling relationship’ arises where:

“a person, whether alone or together with any one or more persons that are connected persons in relation to that person… directly or indirectly hold at least 50 per cent of the equity shares or can exercise at least 50 per cent of the voting rights or participation rights in a company”.

In terms of the ‘controlling relationship’ definition, should a pension fund be a limited partner in a PE fund and the PE fund holds 50% of the equity shares in a portfolio company within the private equity fund, the pension fund could not lend money to that portfolio company since it would, together with the other partners of the PE fund, hold 50% of the shares and would thus be in the aforesaid relationship. 


The effect of an arrangement as described above is that interest incurred by the portfolio company on debt advanced by the pension fund will be limited, in terms of its deductibility, to 30% of ‘adjusted taxable income’ of the portfolio company, commonly referred to as Tax EBITDA.


Chapter 4 of the Revenue Trends and Tax Proposals for 2024 acknowledges an unintended consequence of the provisions of section 23M for pension funds in relation to loans to related parties. Government proposes to consider this matter further, with the possibility of including amendments in the 2024 Taxation Law Amendment Bill.


Rudnicki and Horak are tax executives | Bowmans.

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