By: Dr Charl du Toit
Number Two – cross-border loans (2)
Loans are very common in business. It is unsurprising, therefore, that various tax rules in respect of them have been introduced over the years. These include rules pertaining to cross-border loans or loans between related parties.
Whereas some of the rules are universal, present in the legislation of many countries, some are specific to South Africa where loans are also subject to exchange control rules.
In this article, the second in a series of three, we outline further rules, including those relating to cross-border loans. All references to ‘section’ are in respect of the South African Income Tax Act (‘the Act’). Tax legislation is subject to constant changes. The rules as per this article are generally those that apply in the 2020/21 tax year.
Deductibility of interest expenses
As with other expenses, interest is deductible provided it has been incurred to produce taxable income. Interest incurred on the acquisition of shares, therefore, is normally not deductible. Interest is deductible, though, in funding shares acquired in an ‘operating company’ as defined in section 24O and provided all other requirements of that section are met.
During his annual Budget speech in February 2020, the South African Minister of Finance announced that legislation will be introduced to restrict net interest expense deductions to 30 percent of earnings. Whereas existing restrictions apply only to related-party debt, the new rules would apply to all interest. The Government has since announced that the introduction of this legislation will be postponed as a result of the Coronavirus pandemic.
Taxability of interest in the hands of non-residents
Non-residents are normally only taxed on income from a source in South Africa. In this regard, interest earned from South Africa is a South African source, subject to certain exceptions (section 9(2)). However, provided the non-resident was present in South Africa for a period not exceeding 183 days in a year (in the case of a natural person) and/or the debt is not connected to a permanent establishment in South Africa, an exemption from normal income tax applies —although withholding tax must still be considered.
Withholding tax
A withholding tax at a rate of 15%, which is a final tax, normally applies on interest received by or accrued to non-residents from a source in South Africa. Various exemptions apply, including interest paid from a South African bank. The rate of 15% can be reduced by double tax treaties, mostly to 10%. In the case of a number of double tax treaties the rate is reduced to zero.
Interest free loans to trusts
Section 7C was introduced into the Act a few years ago and applies to interest-free or low-interest loans to a trust or a company underneath a trust. It results in the difference between interest calculated at the ‘official rate of interest’ as defined and the actual interest charged being deemed to be a donation subject to donations tax. In addition, in terms of various subsections of section 7, interest-free or low-interest loans to trusts (or other persons) can result in the income earned by the trust or the beneficiary, being taxed in the hands of the ‘donor’. In the case of cross-border loans from South Africa it is also often difficult to determine which of sections 7C or the subsections of section 7 (especially section 7(8)) or transfer pricing rules apply to loans, including determining the interest rate to charge in order to fall outside the ambit of these provisions.
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