In 2010 a director and 100% shareholder provides finance to his private company to fund its operations. Loan agreement was entered with the company that the loan will be repayable in equal instalments over ten year period. No interest was charged by the d
Important:
This answer is based on tax law for the year ending 28 February 2018.
Answer:
The decision to, or not to, charge interest in respect of debt is not a tax related issue. In this instance it is clear that the agreement between the directors, the company in essence, and the person providing the finance, didn’t provide for interest to be levied on the amount outstanding from time to time.
The Income Tax Act doesn’t ‘force the parties to charge interest’. Your last comment, ‘post 1 March 2017’, relates to section 7C of the Income Tax Act. The Act was amended and deals with interest free loans to companies. It also doesn’t ‘force’ the parties to ‘charge’ interest’. We copied the amended section 7C(1) below:
“This section applies in respect of any loan, advance or credit that—
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a natural person; or
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at the instance of that person, a company in relation to which that person is a connected person in terms of paragraph (d) (iv) of the definition of connected person,
directly or indirectly provides to—
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a trust in relation to which—
(aa) that person or company, or
(bb) any person that is a connected person in relation to the person or company referred to in item (aa),
is a connected person; or
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a company if at least 20 per cent of—
(aa) the equity shares in that company are held, directly or indirectly; or
(bb) the voting rights in that company can be exercised,
by the trust referred to in subparagraph (i) or by a beneficiary of that trust.”
It was amended by section 5(1)(a) of Act No. 17 of 2017 and the amendment is deemed to have come into operation on 19 July, 2017 and applicable in respect of any amount owed by a trust or a company in respect of a loan, advance or credit provided to that trust or that company before, on or after that date. The relevant principle is that the individual must be a connected person – as a beneficiary that requirement is met with regard to the trust. It is not based on the fact that it was provided indirectly. You must therefore determine the relationship, from a connected person point of view, to the company.
Note that the mere granting of a loan interest free, does not give rise to a donation, as no right to earn interest is waived (definition of donation in section 55(1)). If a loan agreement grants the lender a right to charge interest, then the waiving of that right is a “donation” as defined in section 55 of the Income Tax Act and subject to donations tax.
Refer to Interpretation Note 58 (issue 2) dated 4 October 2012: The Brummeria case and the right to use loan capital interest free. This interpretation note discusses in which instance an interest free loan can result in an inclusion in gross income, being the interest “saved” by the borrower.
It is true that Judge Froneman, in CSARS v RM Woulidge said, “as long as the capital remains unpaid the failure to charge interest represents a continuing donation…” At issue before the court then was section 7 of the Income Tax Act. We have already referred to section 7C - it deems a donation to arise when an interest free loan is made to a trust or a company by a person connected to the trust (under certain circumstances).
Where the agreement between the parties provides for interest to be incurred by the company, the principle is that the amount of interest incurred during a year of assessment, must be deducted from the income of that person (the company) derived from carrying on any trade, if that amount is incurred in the production of the income. See section 24J(2) of the income Tax Act in this regard.
The interest will accrue to the holder of the instrument - see section 24J(2) of the income Tax Act in this regard.