Interest And Financial Instruments

Question 1

S24J (exclude lease agreement)

Answer 1

• Amount of interest will be deducted if requirements of s 24J(2) of the Income Tax Act are met
• Amount of interest that accrues will form part of gross income
• s24J will not apply if not holder/issuer of an income instrument/instrument
• The definition of trade should be given a wide interpretation
• Borrowing money and re-lending it at a higher interest makes it profit making and it constitutes carrying on a trade
• Interest should be closely connected to trade
• In order to be able to deduct the interest expense, s102 of the Tax Administration Act requires that the onus of proof is on the taxpayer, to prove that the amount is deductible
• Section 24J(2) is applicable to the interest expense as Co is the issuer of an instrument, an amount of interest is incurred in terms of an interest bearing arrangement or debt on the loan of R5 440 000 million to the HBC bank.
• In terms of s23B(3), no deduction may be allowed under s11(a) where a deduction or allowance may be granted under a specific provision. Therefore s11(a) must not be considered.
• The interest deduction in terms of s 24J(2) will not be deductible as the income from shares are dividends and it is exempt in terms of s 10(1)(k) so the deduction is prohibited in terms of s 23(f) as no ‘income’ is received.
• Mention that debentures is an interest bearing arrangement and regarded as an instrument
• Mention who is an issuer (instrument) or holder (income instrument) (definition of instrument or income instrument)
• Lease agreement is not an instrument
• Debt is an instrument even if it doesn’t have interest
• From date issued to Y/E /365
• YTM means interest accrues on day to day basis
• Mention who are CP
• The interest paid on the loan to acquire the shares is prohibited as a deduction (1) in terms of s 24J(2) by s 23(f) because the income of shares is dividends and dividends are fully exempt (1) in terms of s 10(1)(k) of the Income Tax Act.
• The base cost of the shares will include one third of any interest incurred in funding the purchase of listed shares (par 20(1)(g) of the Eighth Schedule).

Issuer - s24J (2)
- Trade and in production of income

Holder - s24J (3)

• Interest incurred by her in production of income and can be deducted under s24J

VAT

• Issue of shares is a financial service therefore exempt
• Issue of an instrument is capital in nature

CGT
- 1/3 if used to buy shares included in BC if in production of income. If not, include full interest without apportionment

Question 2

General notes: Interest and financial instruments

Answer 2

• Interest received is linked to Visser case law ( fruit is the interest of long term investment of money)
• s12T full exemption of interest received
• NR - s9(2)(b)- s10(1)(h) not applicable if in country for more than 183 days so go to 10(1)(i) or if PE, WHT s50A-H if 10(1)(h) applies

Interest deduction:
- Practise Note 31 (interest earned on the capital invested does not constitute carrying on a trade. It allows expenditure incurred in the production of interest to the extent that interest expense does not exceed income

• s7E (Time of accrual of interest payable by SARS) It deemed interest to accrue to taxpayer on date paid by taxpayer
• s7F (Deduction of interest repaid to SARS)
• WHT (Separate and final tax so no refund)

Individuals:

• X will include the interest earned in its gross income as not capital in nature
• The settlement of the loan is a disposal of an asset (par 11 of the Eighth Schedule) (1) for X and there will be a capital gains tax in terms of the Eighth Schedule as X is not a money lender

Question 3

Interest paid

Answer 3

• Consider purpose of the loan/debt/asset
• Prove trade and in production of income if not met go to practice note 31
• Trade given a wide interpretation or meaning (apply and conclude)
• Production of income _ what action gave rise to expenditure and what is the purpose of an action?) consider if closely connected to the production of income. Only expenditure incurred in generating income will be allowed if income and exempt income (apply and conclude)

Question 4

s24O

Answer 4

• The incurral of interest will be deductible if the provisions of s 24O is met. The provisions needs to be tested at the end of each year or when a change of shareholding take place
• It is incurred interest on a loan with HBC Bank in order to fund the acquisition of the shares.
• Acquired the shares in 20xx from a person that was not part of the same group of companies as Co - the company acquired the shares from an unconnected person.
• Because all the requirements of s 24O was met till x April 2020 the interest was regarded to be incurred in the production of income and for trade purposes
• Only the (Interest amount) (P) will be deductible in terms of s 24J(2)
• S24O and s24J(2) always work together
• Since no longer being controlling group company and resulted in X and Y no longer being part of the same group of companies - the (49 201 test 3) (P) interest will be prohibited by s 23(f) of the Income Tax Act.
• Comes in if you cannot prove that it is in production of income eg if income is exempt
• It applies if interest is payable by the taxpayer
• Therefore s24J and s11(a) does not apply
• Acquire loan to acquire shares, s23f prohibits you
• Companies become part of group of companies after a share acquisition not before
• Test if s24O applies annually
• Look at income after applying exemptions (operating company)

1. Start with s24J first then s24J(2)
2. CGT
   - Reduce BC with amount already included for income tax purposes
   - 1/3 added to base cost for listed and investment in collective schemes in securities and s24J not allowed as deduction
3. VAT
   - Financial services is an exempt supply
   - Services fees provided by banks eg bank charges (15%)

General:

• Generally interest incurred to acquire shares will not be deductible s23(f)
• As it is not for purposes of trade/ not incurred in production of income s23(g)

Question 5

Types of tax free investments

Answer 5

1. Interest bearing investment
   - Interest income fully exempt
2. Share investments
   - Growth on value of shares not subject to CGT
   - No dividend tax at 20% on dividends declared

• A natural person does have interest exemption s10(i)(vx) in any event 23 800
• Go for interest products as capital is guaranteed
• If young or willing to take risk, go for shares capital not guaranteed but value of shares can go down

Question 6

Planning to acquire 100% of another company

Answer 6

• Issue is if interest expense will remain in the provisions of s24O
• > 80% must come from selling goods or services
• Receiving dividend is passive income
• Income from rentals is not from selling goods or services
• Buying shares you’re buying hidden income tax implications

-This section does not determine interest amount deductible