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Thesis by: Dave Deetlefs

During the 2012 United States presidential contest between then Democratic Party nominee Barack Obama and his Republican challenger, Mitt Romney, much was made by both sides of Mr Romney’s experience at Bain Capital, the fabled private equity firm which Mr Romney founded and ran before moving into politics. Whilst Mr Romney’s supporters contended that such experience was the prescribed tonic for the financial woes America faced after the onset of the global financial crisis and would help to solve the deepening unemployment faced by America, Democratic Party supporters and Mr Romney’s detractors argued that private equity industry destroyed, not created, jobs, and served only as a vehicle to enrich its investors and managers to the detriment of the companies which it invested in.

At the core of the Democrats’ argument were, by layman’s standards, fairly complex debates surrounding the tax treatment of the income earned by private equity firms’ managers and investors and the effects on the companies which were targets of the leveraged buyout transactions which they conducted. Whilst a part of this debate circled the treatment of carried interest (being the interest of the private equity firms’ managers in the outcome of the transactions), much of the controversy centred around what was portrayed as an abuse of corporate interest deduction principles, which typically allow for the deductibility of interest on debt used by an acquirer to finance a leveraged acquisition. The application of this latter principle has arguably been the primary driver behind the growth of the private equity interest from its turbulent beginnings to its current status as a multi-trillion dollar global industry and asset class in its own right. In recent years, however, this same principle has globally been the subject of much debate, and its application is often maligned for putting the interests of the acquirer ahead of the risks imposed on the target firm, its stakeholders and employees.

Although the United States’ presidential election may have brought corporate tax policy in respect of private equity and leveraged buyout (or LBO) transactions into the spotlight and the general principles governing the tax treatment of such transaction to the attention of the general public for the perhaps first time, the subject has increasingly come under scrutiny by tax authorities and practitioners.

Recent tax reforms have targeted the industry in the United States and Europe1 as well as more recently, closer to home in South Africa, where the private equity industry has mushroomed since its beginnings following a spate of privatisations in the late 1990s.2 It is clear that the private equity industry’s economic importance and high public profile has ensured that it will continue to attract greater scrutiny from tax authorities globally. In this respect, the South African revenue authorities:  the South African Revenue Service (SARS) and the Department  of the National Treasury (the Treasury) have indicated on several occasions both concerns about, and an interest in, various facets of the industry. In the last 3 years a slew of amendments to the Income Tax Act No 52 of 1968 (the Act), have firmed SARS’ stance on the matter, and provided fodder for comment by the private equity industry, whilst significantly altering the tax landscape for all participants in South African leveraged transactions.

The aims of this paper, then, are twofold: first, to provide an overview of the South African tax law principles governing the deductibility of interest expenditure incurred by taxpayers in respect of LBO transactions, as altered by the recent changes to the Act, and secondly, to critically consider and comment on the nature and perceived effect of such amendments….


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