By Jean-Louis Nel – Tax Director
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Taxpayers often engage in financial arrangements when obtaining or granting loan or debt funding. Under these arrangements, the lender normally advances an amount to the borrower who is obliged to repay the amount advanced together with interest thereon. The definition of interest as provided for in section 24J of the Income Tax Act 58 of 1962 (“ITA”) is a contentious aspect, which includes the following charges:
- gross amount of any interest;
- similar finance charges; or
- discount or premium payable or receivable in terms of or in respect of a financial arrangement.
The effect is that certain amounts that are chargeable by a lender, which does not constitute interest in the natural sense, can be categorised as ‘finance charges’ – whether appropriately or not. The recently released draft interpretation note of ‘financing charges’ notes that the following charges may constitute finance charges:
- loan application fees;
- monthly service fees and administration fees; or
- structure fees and raising fees.
Caution should however be exercised when claiming such finance charges under section 24J as the term is not defined in the ITA. The view formulated by SARS in determining whether finance charges fall within the ambit of section 24J can be summated as follow:
- The finance charges resembling interest, without being identical to interest, are regarded as similar finance charges; and
- For an amount to constitute interest under paragraph (a), the finance charges must have analogous or matching characteristics to that of ‘interest’. Stated differently, there must be minimal distinction in character between the finance charges and the interest incurred.
Following the reasoning of SARS, the phrase ‘similar finance charges’ shall in all probability be interpreted by SARS to mean charges similar to ‘interest’ and must be part of the financial arrangement itself. It does not include all forms of costs associated with a financial arrangement. For example, SARS indicated in the draft interpretation note that a monthly service fee may constitute a finance charge, however, remarks later that a monthly service fee levied for administering a loan account does not form part of the cost of borrowing. This is premised on the reasoning that the administration of the loan account is very different to and distinguishable from the use of the funds loaned for which interest is charged. In order to deduct finance charges under section 24J, a nexus should be drawn between the finance charges incurred and the charges levied [interest in this instance] for the deferral of the repayment of the loans, such costs should be identical in nature.
If finance charges related to a financial arrangement do not qualify for a deduction under section 24J(2), such finance charges may still be deductible under section 11(a) read with section 23(g) if the taxpayer can demonstrate, on a balance of probabilities, that the charges were expended in the year of assessment as part of the taxpayer’s trade and are connected to the production of income.