The deductibility of interest—a problem unresolved?

• Jurisdiction: South Africa
• Pages: 44-53
• Date: 27 May 2019
• Published date: 27 May 2019
• Author: Lynette Olivier
• Citation: (1998) 9 Stell LR 44

THE DEDUCTIBILITY OF INTEREST -

A PROBLEM UNRESOLVED?

Lynette Olivier

BA LLD

Professor, Rand Afrikaans University

Continued from 1997

Steil LR

296.

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.

73

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

cash.

74

In

COT v Avenue Buildings (Pvt) Ltd

75

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.

In

CIR v

Guiseppe Brollo Properties (Pty) Ltd

76

the deduction was also

denied as

"[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."

77

73

ITC 678

16 SATC 348.

74

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

1965 2 SA 616 (A) 624-625

and

Cohen v Segal

1970 3 SA 702 (W) 705-706) with the consequence that, when a company thus

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

Corporate Law

(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.

75

1963 4 SA 954 (SR), 25 SATC 366.

76

1994 2 SA 147 (A), 56 SATC 47.

77

54.

44

(1998) 9 Stell LR 44

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