Brummeria: Finally Put To Rest ?
01 November 2010
Posted by: Author: Heather Pretorius
Brummeria: Finally Put To Rest ?
The following extract appeared on a blog earlier this year
"In Commissioner for the South African Revenue Service v Brummeria Renaissance Ltd, South Africa’s Supreme Court of Appeal held that an interest-free loan produces taxable income for the borrower equal to the interest that would have been charged at market rates.Within South Africa, the Brummeria decision was widely criticised as an economic disaster imposing double taxation.Ignoring the benefit to a borrower of an interest free loan, however, undermines the fundamental object of the income tax, which is to apportion taxes according to economic well-being.The Brummeria judgment,nevertheless, fails to consider other critical aspects of the interest free loan transaction.The proper tax treatment implicates multiple taxpayers and requires an appropriate balance between preventing tax avoidance and limiting the complexity of the income tax.This article compares Brummeria with US tax law, which re-characterises an interest-free loan as a loan-bearing interest at the market rate, coupled with a non-loan payment from the lender to the borrower that funds the payment of market rate interest by the borrower.”The extract relates to an article published in The South African Law Journal entitled Does Brummeria Sweep Clean A US Tax Law Perspective.The writer, Professor Stephen B.Cohen concludes that the Brummeria judgment goes a long way to sweeping clean, but does not do so in its entirety.This article serves to evaluate the above comments made by Prof. Cohen against the backdrop of the Brummeria judgement, read together with the Final Interpretation Note issued by SARS in respect of said judgment and to establish whether there is any merit in the statements contained in the above.
2.How does the US tax law treat interest free loans?
Prof. Cohen states that US tax law refers to an interest-free loan as being "a below-market interest loan” and then goes on to re-characterise such a loan as implicitly involving two separate payments between the lender and the borrower, on the following basis:
Firstly, an implicit non-loan payment from the lender to the borrower of an amount equalling the foregone interest, being the excess of market-rate interest over the interest actually charged, if any. Prof. Cohen said that it is this implicit payment, representing an economic benefit to the borrower, which was correctly identified and dealt with as such by the Court in the Brummeria judgment. Secondly, a reciprocal implicit payment of interest at the market rate by the borrower to the lender. Prof. Cohen argues that it this second implicit payment which the Court in Brummeria failed to take into account.
3.The specific context of brummeria : Quid Pro Quo
It is not the purpose of this article to repeat all the facts and controversies that have surrounded the Brummeria judgment, as much has, since the delivery of the judgment by the Supreme Court of Appeal in September 2007, been published in this regard.What does, however, serve to be emphasised, is that the important distinguishing feature of the Brummeria case pertains to the fact that the matter dealt with a quid pro quo transaction.In other words, the interest-free loan was granted by the occupants (the lenders in the transaction) to the taxpayers, being the developers, (the borrowers in the transaction) in exchange for the occupants being granted the right of life-long occupation of the units for no rental consideration.
The Supreme Court of Appeal held that a right to retain and make use of loan capital, free of interest, and over a period of time, is a valuable right and is one which has money’s worth.It further held that the test to be applied when ascertaining the value of the right in question is an objective one.In other words, can the right, objectively speaking, be converted into money’s worth? It is common cause that the Supreme Court of Appeal answered this question in the affirmative.
4.The final SARS interpretation note on the brummeria judgement (The interpretation note)
When dealing with the Interpretation Note, perhaps the best place to start is at the end.The Interpretation Note concludes as follows:Conclusion The Brummeria case is clearly not authority for the general conclusion that the value of the right to use an interest-free loan should in each and every case be included in the borrower’s gross income.The value of the receipt or accrual in a form other than money would usually not have to be included in gross income if the receipt or accrual did not take place in exchange for goods supplied or services rendered.The reason for this is that such a receipt or accrual would probably be of a capital nature.However, each and every transaction will have to be evaluated on its own merits and against the background of its own facts and the intentions of the parties.”Paragraph 4 of the Interpretation Note summarises the principles enunciated by the Supreme Court of Appeal and states that the judgement can be viewed as authority for the following principles:
•A wide interpretation is to be given to the word‘amount’ in the definition of ‘gross income’.
•The right to use the loan capital, interest free,has a monetary value.
•The test to be applied when determining whetherthe receipt or accrual has a monetary value is an objective and not subjective test.Here the Supreme Court of Appeal overturned the part of the judgment in Stander v CIRwhich held that the test was a subjective one.
•The value of a receipt or accrual in a form otherthan money constitutes an amount that accrues to a taxpayer and should be included in his gross income for the year of assessment in which the right is received by or accrues to the taxpayer.In this regard, the Court confirmed the principles in the following line of cases: Lategan v CIR, CIR v People’s Stores(Walvis Bay) (Pty) Ltd and Cactus Investments (Pty) Ltd v CIR18
•For a benefit of this nature to be taxable, it is not necessary for the amount to fall within paragraph (i) of the definition of gross income in section 1 which relates to taxable benefits as dealt with in the Seventh Schedule to the Income Tax Act. Paragraph 6 of the Interpretation Note deals with the application of the principles enunciated by the Brummeria case.It is stated, inter alia, that: "As a result the principles from the judgment may be applied in all cases in which benefits in a form other than money (such as the right to use an interest-free loan) are granted in exchange for goods supplied, services rendered or any other benefit given.”
It is also important to note that the Interpretation Note serves as a binding general ruling (BGR) issued under section 76P of the Income Tax Act on the meaning of the term ‘amount’ as used in the definition of ‘gross income’ in section 1 of the Act.
It is submitted that upon a proper evaluation of the Brummeria judgement, read together with the final Interpretation Note issued by SARS in respect of said judgment, Prof. Cohen is attempting, with respect, to extend the meaning of what constitutes gross income or, put differently, what should constitute gross income, under South African tax law, too far.
The tax implications of the specific transaction in the Brummeria matter are adequately covered by virtue of the very nature thereof: being a quid pro quo/barter transaction.The right to use the loan capital, free of interest, was exchanged/bartered for a lifelong right of occupation of the unit. It was the borrower and the right to use the loan capital, interest-free, which fell under the scrutiny of the Supreme Court of Appeal.The lenders were not before the Court and their lifelong rights of occupation, which have a value, were not issues before the Court in this instance.It is not desirable, nor is it necessary, to complicate the matter further by, in addition to the aforegoing, imputing reciprocal payments and receipts of the foregone interest between the lender and the borrower as suggested by Prof. Cohen. To adopt this approach would, it is submitted, result in double-taxation: of the actual quid pro quo transaction, on the one hand, and of an imputed quid pro quo transaction with regard to the interestfree loan itself if the re-chracterisation model of the US tax law were to be applied.
Whilst US tax law appears to re-characterise all below-market interest loans, it is clear from the Interpretation Note of SARS, that this approach is not adopted in our tax law.It is only where the right to use the loan capital interest-free is in exchange for goods supplied, services rendered or any other benefit given that this right will have a value for purposes of including same in the taxpayer’s gross income. Where there is no quid pro quo, the right to use loan capital interest-free will not be included in the taxpayer’s gross income because the receipt or accrual will, in all likelihood, be of a capital nature and as such, be excluded.The Court in the Brummeria matter was not given the opportunity to comment on the potential capital nature of the transaction because the taxpayers had not raised this in their statement of grounds of objection or appeal.In conclusion, it is therefore submitted that the Interpretation Note has indeed put to rest much of the controversy and unanswered questions which were stirred up by the Brummeria judgment initially.
In future, the Courts may very well be called upon, by the facts and circumstances of a particular matter or matters, to make pronouncements with regard to the issues which were not decided by the Supreme Court of Appeal in the Brummeria judgement and, in so doing, the Courts will contribute to the ever-evolving pool of emerging principles surrounding these issues.Time will tell as: "... each and every transaction will have to be evaluated on its own merits and against the background of its own facts and the intentions of the parties.”
Source: By Heather Pretorius (TaxTALK)