I have a client who is a related party to a company that loaned the company a sum of money (this money loaned was access from his personal bond. The interest charged for the loan company is 24% and the interest charged on his bond is 9,5%. Please confirm
Important:
This answer is based on tax law year ending 28 February 2017.
Answer:
The fact that the parties are connected persons in relation to each other is not relevant in this instance.
The interest is not exempt – because there is a receipt (or an accrual) it will be gross income – see section 24J(3).
The principle, with regard to any interest-bearing debt (we leave instruments out for the moment) is that an amount of interest incurred during a year of assessment, must be deducted from the income of that person 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.
We submit that what is relevant here is “the income of that person derived from carrying on any trade” requirement. In order for the taxpayer to make a deduction it is necessary that the taxpayer must be able to meet the burden of proof that a trade was being carried on, and then that the amount of the expense was incurred in the production of the income (the interest) derived from that trade.
Judge Heher of the Supreme Court of Appeal, in the Scribante case (similar to your scenario), that:
“In addition, borrowing money and re-lending it at a higher rate of interest, thereby making a profit, constitutes the carrying on of a trade...” The Judge used the Burgess case as authority for this.
That requires an inquiry to determine the purpose of obtaining the funding.
The original purpose, of the funding obtained was private (section 23(a) will then prohibit the deduction). The taxpayer will have to prove that the amount taken from the bond was transferred (or advanced) to the company.