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Appeal Court Rules On The Taxability Of Interest-Free Loans

01 July 2007   (0 Comments)
Posted by: Author: Daniel Erasmus
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Appeal Court Rules On The Taxability Of Interest-Free Loans

CSARS v Brummeria Renaissance:

The Supreme Court of Appeal (SCA) in September ruled that a development company granting life-use rights in retirement houses to elderly people, in exchange for an interest-free loan, should pay tax on the imputed value of what the interest-free amount is.Now some advisors are suggesting that this is the end of interest-free loans. Is this the case?

For many years, interest-free loans have been dealt with in section 7 of the Income Tax Act, and the 7th Schedule of the Tax Act, through specific provisions.Interest-free loans to trusts are included as deemed donations under section 7.Soft loans, or interest-free loans to employees are taxed under the 7th Schedule as a fringe benefit.This is the first time that the common law provides for an imputed interest amount to be taxed in the hands of a taxpayer as the taxpayer in the SCA case.But note: This is only the case where the facts are similar to the facts in the SCA case.

Taxable under donations

In practice, commercially-driven interest free loans between businesses have not been regarded as being taxable under donations.This is also supported by the prevailing practice of SARS.Now, after the SCA judgment, where a taxpayer receives an interest-free loan in exchange for some benefit, which is seen as a benefit of a revenue nature, the interest-free amount will be treated as being a taxable accrual in the hands of the interest-free recipient.

This does not mean that all interest-free loans will give rise to taxable amounts in the hands of recipients.If a Holdco grants a Subco an interest free loan in order to help grow the business in the Subco, thereby enhancing its assets, then the underlying purpose is a capital one, and Subco would argue that the "amount” imputed to it is of a capital nature, and not taxable.

Imputed interest

Another argument would be in relation to the valuation of the "imputed interest”. Who is to say that the prime-rate of interest is the correct measure between "connected persons”.The capital nature of the amount and the valuation of the amount was not argued before the SCA,nor was the possibility that the recipient of the interest-free loan, to whom the "imputed interest” accrues suffers some form of loss that is incurred in the production of income.Here a number of possibilities exist, depending upon the circumstances of the case.To overcome the problems that will unfold as a result of this SCA case, avoid the typical 7 Habitual Tax Mistakes:

1. Don’t be reactive and wait: Be proactive and determine as soon as possible whether or not the business is at risk on interest-free loans;

2. Don’t try and do it on your own; get a tax team to participate;

3. Don’t go forward blindly: Work out a tax strategy with the tax team;

4. Don’t sit in your insular ivory tower; Be transparent and share the concerns with senior management, getting their input on decisions and the way forward;

5. Don’t rely on assumptions and clever arguments.Get the facts and analyse them properly before thinking out arguments;

6. Don’t rely on your own facts; Get internal audit to assist in uncovering the truth and check again;

7. Don’t keep quite; Communicate with the board, the audit committee, the transactions, operations and financial accounting areas of the business. Spread the news.

Source: By Daniel Erasmus (TaxTALK)


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