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PN 2/1996 Income Tax acT: PracTIce noTes
PN 2/1996
Calculation of excessive interest in respect of shareholder X in terms of section 31 (2)
Interest falling within the 3:1 guideline
=
Effective interest rate of acceptable nancial assistance
Excessive interest relating to the 1995/6 year of assessment
6. Commissioner’s discretion
= R8 277 049 – R1 376 365 R6 900 684 = R6 900 684 ÷ R30 000 000 = 23% = R6 900 684 x (23 – 20,5) ÷ 23 = R750 074
6.1 Notwithstanding the guideline of the 3:1 ratio and the interest rates referred to in paragraph 2.2, with regard to the application of section 31, it is acknowledged that a higher level of nancial assistance in contrast with the guideline ratio of nancial assistance to xed capital or a higher rate of interest may be applicable as a result of transactions and agreements entered into for commercial or economic reasons rather than to obtain tax advantages.
6.2 Where a taxpayer, therefore, can justify a higher level of nancial assistance in contrast with the guideline ratio of nancial assistance to xed capital or a higher rate under particular or special circumstances, he may approach the Commissioner, to exercise his discretion in terms of section 31. This will, generally be of a temporary
nature and a period may be speci ed within which the 3:1 ratio should be restored or the interest rate be reduced.
6.3 Taxpayers falling within the 3:1 ratio will not be required to justify their ratio. They must, however, submit the information requested in the annual income tax return.
7. Financial assistance in currency other than rand
Where nancial assistance is denominated in a currency other than the currency of the Republic, the equivalent currency value of the Republic must be determined by applying the spot or relevant forward rate, as the case may be, on the date the amount of nancial assistance is to be determined. However, where there is an increase in the rand value of the nancial assistance as a result of a weakening of the rand against the relevant foreign currency, the rand value of the nancial assistance may be determined with reference to the spot or relevant forward date, as the case may be, on the following dates: In the case of a loan owing by a person, the date on which the amount payable in respect of the loan was received by such person and in the case of a debt owing by a person, the date on which the debt was actually incurred.
8. Back-to-back arrangements
In the application of section 31 (3), the term ‘ nancial assistance granted indirectly’ includes back-to-back arrangements through independent parties or co-investors. Where a foreign parent company, therefore, makes a loan to a South African bank, a foreign bank or any other person on condition that the bank or other person on-lends the funds to the South African subsidiary of the parent company, the loan will be treated as nancial assistance. Where the foreign parent company provides a guarantee to a foreign bank or any other non-resident as security for a loan to the local subsidiary, the bank debt will be treated as nancial assistance. Where, however, the foreign parent company provides a guarantee to a South African bank a security for a loan to the local subsidiary, the bank loan will not be treated as nancial assistance as the foreign company will not receive any interest and the recipient of the interest will be taxed thereon.
9. Excessive (see para 2.2) and disallowable (see para 4) interest subject to secondary tax on companies (STC)
In the case of companies the total amount of the excessive and disallowable interest will be deemed to be a dividend
declared in terms of section 64C (3) (e) of the Act and STC will be payable on the excessive and disallowable interest. As the determination of the excessive and disallowable portions of interest and the exercising of the Commissioner’s discretion are to be made at the time the relevent assessment is raised, the dividend cycle in respect of such deemed dividend will, for purposes of the de nition of ‘dividend cycle’ in section 64B (1), be regarded to end on the date of assessment in respect of the year of assessment to which the excessive and disallowable interest relates. Where, however, the taxpayer has been noti ed in writing by the Commissioner of the amount of the excessive and disallowable interest prior to such date of assessment, the dividend cycle will be regarded to end one month after the date of such noti cation.
10. Application
The provisions of section 31 shall inter alia only apply to any services supplied on or after 19 July 1995. As already mentioned, the supply of services includes the granting of nancial assistance. Interest incurred after that date on a loan or advance received or debt incurred before that date will, therefore, not be subject to the provisions of section 31.
ADDENDUM TO PRACTICE NOTE 2 OF 1996: ‘INCOME TAX: DETERMINATION OF TAXABLE INCOME WHERE FINANCIAL ASSISTANCE HAS BEEN GRANTED BY A NON-RESIDENT OF THE REPUBLIC TO A RESIDENT OF THE REPUBLIC’
1. Paragraph 2.2 of Practice Note No. 2, dated 14 May 1996 has been replaced with the following paragraph: ‘Where in terms of section 31 (2) a service, speci cally the granting of nancial assistance, is provided by a non-resident to a resident who is a connected person in relation to the non-resident and the consideration relating to the nancial assistance is excessive in the sense that the consideration does of re ect an arm’s length price, the Commissioner may, in the determination of the taxable income of the resident, adjust the consideration in the hands of the resident to re ect an arm’s length consideration in relation to the nancial assistance granted. Consideration, in the context of nancial
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