South Africa: Interest incurred by investment holding company held nondeductible (High Court decision)

The Johannesburg High Court held (case no A3094/2022) that the taxpayer’s interest expense was not incurred in the production of income derived from carrying on a trade and thus was not deductible under Section 24J(2) of the Income Tax Act 58 of 1962. 

Summary

The taxpayer, an investment holding company, initially claimed that it conducted a trade in money lending with the purpose of making a profit from on-lending borrowed funds to its subsidiaries. The South African Revenue Service (SARS) disputed that the taxpayer conducted a trade as a money lender and that the expenditure was incurred in the production of income. The taxpayer ultimately argued that it incurred interest on funds borrowed from group companies with a view to making loans to group companies in the course of its lending trade carried on by it and in the production of income in the form of interest to be earned from the loans to group companies. Apart from the lending trade, the taxpayer did not identify any other trade.

The Tax Court found that the taxpayer had produced no evidence to suggest continuity and no system or plan of laying out and collecting money, being features of a trade of money lending. Further, the Tax Court highlighted that the taxpayer had recorded in its tax return that it had not concluded any transaction in terms of Section 24J, which made it difficult for the court to agree with the taxpayer’s claims of carrying on a trade in money lending. Similarly, the Tax Court concluded that the taxpayer failed to demonstrate that the interest expense was incurred in the production of income. The interest expense was incurred to advance the business interests of its subsidiary companies through which it would earn dividend income. 

In the High Court, the taxpayer abandoned its argument that it traded as a money lender in favor of the argument that it traded as an investment holding company. While the High Court recognized that the taxpayer conducted an investment trade, it concluded that the taxpayer earned exempt income in the form of dividends (through investment in subsidiaries). Ultimately, the High Court held that the interest expenditure was not proven to have been incurred in the production of income from conducting trade as an investment holding company. It went further, stating that the intention was never to earn any income, but rather subjugating its profit-making potential to the interests of the group companies. This argument was bolstered by the fact that the taxpayer declared in its tax returns that it had not entered into any transactions as contemplated in Section 24J.

The High Court also found that SARS was entitled to impose an understatement penalty as the error was not that of a bona fide inadvertent error.
 

Read a January 2024 report [PDF 391 KB] prepared by the KPMG member firm in South Africa