[FAQ] Employee benefits in respect of interest on debt

[FAQ] Employee benefits in respect of interest on debt

• 07 December 2020
• Piet Nel

Background

A client owns a residential property worth R1million property. A husband and wife (non-related) run the client’s business (which is also a residential letting business). The client wants to put ownership of a property into their hands but retain a share in the property as security.

If he gives each of the two employees a loan of R400,000 to acquire 40% of the property during the tax year, can Paragraph 11(4)(c) of the 7th Schedule - Benefits in respect of interest on debt, assist us to allow no fringe benefit in their hands if the loan is interest free to them?

The client still has a bond on the property, will he still be able to deduct the interest on the bond in his business, as the benefit now shifts towards retaining key employees?

Answer

You are reminded that SAIT's technical query system policy prescribes that only guidance should be provided in relation to requests submitted. To do otherwise would cause SAIT to compete with its own members. Guidance implies that sources or references relevant to the request are provided, but that ultimately the tax practitioner’s own professional judgment is required to be applied to the specific circumstances.

The Income Tax Act

Where a loan was granted to the employee for the acquisition of a fixed property, such loan will have no value in terms of paragraph 11(4)(c) of the Seventh Schedule to the Income Tax Act if all the below requirements are met:

(4)(c) a debt owed to his or her employer in consequence of a loan by that employer to that employee as does not exceed the amount of R450 000 if—

(i) the debt was assumed for the purposes of acquiring immovable property by the employee;

(ii) the market value of the immovable property acquired does not exceed R450 000 in relation to the year of assessment during which the property is acquired;

(iii) the remuneration proxy of the employee does not exceed R250 000 in relation to the year of assessment during which the loan is granted; and

(iv) the employee is not a connected person in relation to the employer.

Although the market value is one of the requirements, the market value cannot be divided according to the percentage of each ownership.

The law relevant to your request is found in section 24J(2) – see section 24J(12), and section 23(g), of the Income Tax Act.

You must consider the following when you take a tax position or in giving the opinion to the client:

In terms of section 24J(2) a person (the taxpayer) will be entitled to make a deduction of the interest incurred “from the income of that person derived from carrying on any trade, if that amount is incurred in the production of the income.”

From the facts provided, the taxpayer is carrying on a trade – in terms of the definition of trade, in section 1(1) of the Act, it specifically includes “… the letting of any property …” We accept that the property was used in ‘residential letting business’.

Judge Nicholas, in CIR v Giuseppe Brollo Properties (Pty) Ltd (1993), said that in “a case concerning the deductibility or otherwise of interest payable on money borrowed, the enquiry relates primarily to the purpose for which the money was borrowed. Where a taxpayer's purpose in borrowing money upon which it pays interest is to obtain the means of earning income, the interest paid on the money so borrowed is prima facie an expenditure incurred in the production of income.” This was in respect of section 11(a), but we submit that the same principle applies as far as section 24J(2) is concerned.

Judge Heher, in CSARS v Scribante Construction (Pty) Ltd 2002, linked the interest paid to the income – the judge said, in that instance that there was a “sufficiently close link between the expenditure and the income earning operations having regard to the purpose of the expenditure and what it actually effects …”

Application of the principles

We submit that for purposes of section 23(g), that requires the “moneys, claimed as a deduction from income derived from trade” to have been “laid out or expended for the purposes of trade”, the purpose of the interest paid is relevant.

The taxpayer, in our view, need then only to prove (or your opinion) that the amount withdrawn from the bond were used to acquire the property and that the property produced the rental income.

We submit that the original intention is relevant here. You ask whether “he will still be able to deduct the interest on the bond in his business, as the benefit now shifts towards retaining key employees”. The interest incurred on the bond, related to the acquisition of the property, was not incurred to provide the loans to the employees.

Judge Ndita, with judge Sher agreeing, in SARS and Spur Group (Pty) Ltd, explained the ‘in production of income requirement’ as follows:

“Accordingly, for the expenditure to meet the “in the production of income” test and satisfy the requirements of section 11(a) of the Act, there must be a sufficiently close connection or link between it and the income earning operations of the taxpayer. The degree of closeness required for the expenditure to be deductible is determined on the particular facts and circumstances of each taxpayer. It does not need to be shown that expenditure produced any part of the income in a particular year of assessment for it to be deductible for tax purposes. The critical enquiry is whether the expenditure was incurred for the purpose of earning income as defined in section 1 of the ITA, whether in the current or future year of assessment.”

We submit that it will also apply with respect to section 24J(2), or that is what you will consider in arriving at the tax position you will take.

Webinar Commentary

Further webinar commentary on 2020 Webinar Interest – To charge or not to charge can be accessed here.

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