The Deductibility of Interest— Partnership Replacement Loans

• Jurisdiction: South Africa
• Pages: 224-233
• Published date: 03 September 2019
• Citation: (2000) 12 SA Merc LJ 224
• Author: BA van der Merwe
• Date: 03 September 2019

The Deductibility of Interest—

Partnership Replacement Loans

BA VAN DER MERWE

University of South Africa

1 Introduction

Generally an interest expense is deductible from a taxpayer's gross

income in terms of the Income Tax Act 58 of 1961 if it complies with the

elements of the general deduction formula (s 11 and 23

(g))

and with

s 24J, when applicable. However, the issue to consider when dealing

with the deductibility of interest mostly revolves around whether or not

the interest expenditure was incurred in the production of the taxpayer's

income.

It seems to be accepted that interest on money borrowed on a partner's

mortgage loan in order to fulfil a partnership's initial need for working

capital and the partner's contribution requirement, is deductible for being

in the production of the partner's income (see

ITC 1603

(1995) 58 SATC

212; Lynette Olivier 'The Deductibility of Interest — A Problem

Unresolved?' (1997) 8

Stellenbosch LR

296 and (1998) 9

Stellenbosch

LR

44 at 50). However, there is no clarity as to whether the same can be

said about the interest on later replacement loans where a taxpayer, after

initially having committed his own private capital to the partnership

to fund the contribution requirement, withdraws the capital in order to

replace it with borrowed funds.

Two very similar cases were heard by the Special Court for Hearing

Income Tax Appeals regarding the deductibility of interest expenditure

resulting from the conclusion of 'replacement loans'. The one taxpayer

was successful, the other not.

In

ITC 1583

((1993) 57 SATC 58), the taxpayer, an attorney in a

partnership, had a credit balance standing to his capital account with his

firm while money was owed on a mortgage to fund the matrimonial

home. The taxpayer withdrew his credit balance by agreement with his

partners to extinguish the bond debt. As the firm needed its partners' loan

accounts as working capital, it was by agreement immediately replaced

with an equivalent sum funded by a re-advance of a loan by the bank.

The taxpayer was not allowed to deduct the interest paid. Conradie J

indicated that the replacement of 'old capital' with 'new capital' did not

in any way impact upon the partnership's income earning capacity, as

the partnership (the income producer according to the Court) had all the

capital it needed. The partnership could not afford to repay the portion

of the capital contributed by the taxpayer. His Lordship found that the

taxpayer's purpose in re-arranging his affairs was to obtain a fiscal

advantage, and not to maintain the flow of income from his practice. The

224

(2000) 12 SA Merc LJ 224

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