In a 2007 case before the Supreme Court of Appeal, the question arose whether or not the value of interest which accrues by reason of having received an interest free loan, constitutes taxable income.
In short the lender and borrower were engaged in a scheme in terms of which interest free loans were received in exchange for certain life rights. The Borrower contended that the interest free loans did not result in any amount being received by it which could be included in its gross income.
In short the court ruled that the word “amount” in the definition of “gross income” (as defined by the Income Tax Act 58 of 1962), includes not only an amount actually received, but also rights of a noncapital nature.
The ruling of the court created wide spread uncertainty regarding the tax implications associated with interest free loans. SARS subsequently released an explanatory note in order to create clarity on this matter. The note sets out certain principles as follows:
- The word “amount” in the definition of “gross income” is to be interpreted widely.
- The “right” to use the loan capital interest free has a monetary value.
- The test to be applied in order to determine whether the receipt or accrual has a monetary value is an objective rather than subjective one.
As a result, the principles 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) is granted in exchange for goods supplied, services rendered or any other benefit given.
A receipt or accrual in a form other than money could constitute an “amount”, unless the amount is of a capital nature which is not specifically included in the definition of “gross income”. As such the receipt or accrual could be valued and included in the gross income of a taxpayer in the year of assessment in which it is received or accrued.
With reference to an interest free loan, the valuation would in all probability take into account normal rates of interest. Hence, the amount of interest that would ordinarily accrue to a loan could be deemed as income in the hands of a borrower who is not obliged to pay same.