THE DEDUCTIBILITY OF INTEREST -
A PROBLEM UNRESOLVED?
Professor, Rand Afrikaans University
Continued from 1997
2 4 5
Borrowing in respect of members' loan accounts
When a company borrows money with the purpose of declaring a
dividend, the interest paid on such loan cannot be deductible as the loan
is not incurred in the production of income.
If a company declares a dividend without actually paying the dividend
to the shareholder, but instead credits the member's loan account with
the amount of the dividend, a contentious issue arises as to whether
interest payable on such loan account is deductible. The reason for not
paying the dividend is because the company does not have the necessary
COT v Avenue Buildings (Pvt) Ltd
the interest expenditure was
held to be non-deductible as it was not incurred in the production of
income. In one of the two judgments of the High Court of Southern
Rhodesia, Beadle CJ held that the creation of the loan account and the
payment of the dividend were both part of the same integral transaction.
As the money was borrowed from the shareholders in order to pay the
dividend, the purpose of the loan was not to produce income. In the other
judgment, Young J held that the loan was incurred with a dual purpose,
that is to keep the money in the business and to distribute the profits, but
because the taxpayer had failed to discharge the onus of establishing its
dominant purpose, the interest could not be deductible.
Guiseppe Brollo Properties (Pty) Ltd
the deduction was also
"[t]he taxpayer's capacity to produce income was not increased by the transaction. On the
contrary, the only result of the transaction was to burden the taxpayer with a liability to pay
interest with a consequent reduction in its net income."
16 SATC 348.
From a lawyer's point of view it might be difficult to understand how the above problem can ever
arise as dividends may not be declared out of capital
(cf S v De Jager
Cohen v Segal
does not have the necessary cash, no dividend declaration is possible. However, dividends may be
declared out of divisible profits (Cilliers, Benade, Henning, du Plessis & Delport
(1992) 347-352). These profits may not be in the form of available cash, for example where the
company has several creditors, where the money is tied up in trading stock or where a revaluation of
fixed assets took place. Although the dividend may thus be legally declared, it is not physically
possible to do so.
1963 4 SA 954 (SR), 25 SATC 366.
© Juta and Company (Pty) Ltd