Page 177 - SAIT Compendium 2016 Volume2

IN 2 (3) Income Tax acT: InTeRPReTaTIon noTes IN 2 (3)
If and to the extent the exemption for foreign dividends and foreign-sourced interest is used under section 10 (1) (i) (xv) (aa), the above amounts must be correspondingly reduced. Thus, for the 2009 year of assessment a person who is at least 65 years of age who has, say R2 500 in foreign dividends will have an amount of R25 000 (R27 500 — R2 500) available as an exemption for any South African-sourced interest and taxable local dividends.
4.3 Determining taxable income derived from foreign dividends
4.3.1 The deductibility of interest expenditure in general
Any dividend income received by a passive investor in foreign shares does not represent trading income. As a result any interest expenditure incurred on money borrowed to purchase foreign shares will not be deductible under the general deduction formula in section 11 (a) read with section 23 (g). This is because these sections require expenditure to be incurred in the course of carrying on a trade.
A special dispensation has been created for foreign dividends under section 11C, which allows for the deduction of interest when the interest does not qualify for a deduction under any other provision of the Act. Section 11C provides for a deduction of interest incurred in the production of income derived from foreign dividends. In order to qualify as a deduction under section 11C, the interest expense must relate directly to the relevant foreign dividends. In other words, the relevant borrowings must have been used speci cally to purchase the foreign shares from which the foreign dividends have been or will be earned.
It is irrelevant whether the interest expense relates either to exempt foreign dividends or taxable foreign dividends. Should the foreign dividends consist of both a taxable and an exempt part, it is not required that the interest expense be dissected between the two parts. This will also be the case if the full amount is exempt from tax. The full amount of the interest expense will be deductible in the year of assessment in which it is incurred or in a subsequent year of assessment.
The term ‘income in the form of foreign dividends’, as used in section 11C (1), must be interpreted to mean the gross amount of the foreign dividends; in other words, ‘gross income in the form of dividends’ and not ‘income’ as de ned in section 1. Under section 11C (2) the interest deduction for a year of assessment is limited to the amount of foreign dividends included in income during that year. In this context the term ‘income’ means ‘income’ as de ned in section 1.
If for a particular year of assessment, say year 1, the sum of the qualifying interest expense exceeds the income derived from foreign dividends, the excess portion of the interest may qualify as a deduction in year 2 against income derived from foreign dividends during year 2 (see Example 7). However, the excess amount of interest must rst be reduced by the amount of foreign dividends that are exempt from tax during that year of assessment.
The balance of excess interest remaining after the deduction of the exempt foreign dividends, is carried forward to the immediately succeeding year of assessment and regarded as interest actually incurred in the production of foreign dividend income derived during that year (section 11C (3)). If the amount carried forward to the following year is not used in that year (year 2) it may be carried forward to year 3 and will qualify as a deduction in year 3.
Although the wording of section 11C (1) seems ambiguous in this respect SARS will not seek to disallow the carry-forward of interest when no foreign dividends are received during a year of assessment, provided the relevant shares were not sold. It is not always possible to determine when a dividend will be declared, and if so, whether or not it will be exempt from income tax.
When the underlying shares are sold the application of capital gains tax must be considered (see 4.3.2).
Example 4 — Carry-forward of unused interest expense to succeeding years of assessment
Facts:
In year 1 Mr A borrows money at interest in order to invest in foreign shares.
The following results were achieved:
Income derived from foreign dividends Interest expense
Result:
Application of section 11C (3):
Income derived from foreign dividends
Less: Amount deducted under section 11 C (1) limited
to income derived from foreign dividends Taxable income derived from foreign dividends Interest expense
Balance of interest expense brought forward from
the previous year
Total interest available for deduction
Less: Amount deducted under section 11C (1) limited
to income derived from foreign dividends Balance of interest carried forward to the next year
Year 1 Year 2 Year 3 RRR Nil Nil 4 500 1 000 1 500 2 000
RRR
Nil
(Nil) Nil 1 000
Nil 1 000
(Nil) 1 000
Nil
(Nil) Nil 1 500
1 000 2 500
(Nil) 2 500
4 500
(4 500) Nil 2 000
2 500 4 500
(4 500) Nil
4.3.2 Interaction between section 11C and the Eighth Schedule to the Act
The capital gains tax consequences resulting from the disposal of shares in a foreign company by a person having a balance of excess interest available for purposes of section 11C (3) must be considered.
Under paragraph 20 (1) (g) (iii) of the Eighth Schedule one-third of any interest expenditure, as contemplated in section 24J, actually incurred on money borrowed to directly nance any expenditure—
• actually incurred for the cost of acquisition or creation of a share listed on a recognised stock exchange or a
participatory interest in a portfolio of a collective investment scheme; or
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