Company borrowings and the payment of dividends : deductibility of interest under section 24J(2)

• Author: Milton Seligson
• Record Number: btclq_v8_n3_a4
• Date: 12 October 2017
• Pages: 20-25
• DOI: 10.10520/EJC-a069cb714
• Published date: 12 October 2017

20 © SIBER INK

Company Borrowings and the

Payment of Dividends:

DEDUCTIBILITY OF INTEREST UNDER SECTION 24J(2)

MILTON SELIGSON SC*

ABSTRACT

This article deals with the problem frequently encountered by South African

companies which declare and pay dividends to shareholders at a time when

they are in receipt of interest-bearing loan funding, as to whether the interest

incurred on the borrowing is deductible for income tax purposes. Such

taxpayers may face an argument by SARS that the interest incurred on the

loan is not incurred for the purpose of producing income, but in order to

pay tax-exempt dividends to shareholders, thereby not satisfying the require-

ments for the deductibility of interest pursuant to section 24J(2) of the Income

Tax Act. This provision has governed the deduction of interest for income tax

purposes since 2005.

There is no case law dealing specif‌ically with the requirements of section

24J(2) of the Act, but the principles adopted by the Courts in relation to the

deductibility of expenditure under the general deduction formula in section

11(a) of the Act (which previously regulated the deductibility of interest),

and in particular those pertaining to the deduction of interest on moneys

borrowed to pay dividends, are relevant inasmuch as the requirements of

sections 11(a) and 24J are substantially the same.

The article discusses the requirements for deductibility and analyses the

leading decisions under section 11(a) in relation to the deductibility of interest

on borrowed funds where the company is also involved in the payment of

dividends to shareholders contemporaneously with the loan.

The author concludes that the principle which emerges from the case law is

that where a company does not have the resources available to continue with

its income-earning activities and cannot pay the dividend without borrowing

an equivalent amount, the loan interest will not qualify for deduction. For the

purpose of the loan will clearly be to fund the dividend in question and not

qualify as an expense in the production of income.

But where the purpose of the borrowing is to promote the company’s

income-earning activities by providing liquid funds and it has suff‌icient

surplus resources to carry on those activities even without the loan, i e the

borrowed funds are not essential to its ability to pay the dividend, the interest

on monies borrowed for sound commercial reasons is likely to be held to be

deductible as meeting the requirement of being in the production of the

taxpayer’s income. Introduction

A frequent problem confronting companies in South Africa which declare

and pay dividends to their shareholders at a time when they are in receipt

of interest-bearing loan funding, is whether they are entitled to deduct for

*

Senior Counsel, Cape Bar.