Following a period of uncertainty, the Supreme Court of Appeal (SCA), in a majority judgment, has found that raising fees can be deducted for tax purposes. Tax specialists believe this decision is a significant win for taxpayers because it has the potential to reduce the after-tax cost of funding.
The uncertainty stemmed from the different interpretations of what constitute “interest or similar finance charges” between the South African Revenue Service and a finding of the Tax Court in the Cornucopia Trust matter. This uncertainty has now been cleared up, with the higher court finding that raising fees are similar to interest.
Itumeleng Moeletsi, the founder of BIM Legal Advisory, says that for many businesses, debt is fundamental to growth. Property acquisitions are financed, so is infrastructure, working capital, expansion, energy and mining projects.
“Every one of those facilities can carry costs beyond the headline interest rate. If a company raises R500 million and pays a 2% fee, the fee alone is R10m. Its legal and tax character matters,” she says in her analysis if the SCA’s judgment.
The Income Tax Act was amended in 2016 to change section 24J to read “interest or similar financial charges” rather than “interest or related financial charges”. The aim was to narrow the scope of deductible financing costs.
However, the Tax Court and now the SCA have found that SARS’s interpretation of the amendment is too narrow.
What happened
Cornucopia Trust obtained substantial funding from entities. As part of these transactions, the trust paid upfront raising fees of approximately 2% of the value of the loan facilities to gain access to the debt.
In its 2019 and 2020 tax returns, Cornucopia claimed deductions for the raising fees. SARS disallowed the deductions, arguing they did not constitute finance charges “similar” to interest.
Doelie Lessing, the head of tax at Werksmans Attorneys and senior associate Luke Magerman, referred to the Tax Court’s decision, which found that the fees bore a sufficiently relevant resemblance to interest to be regarded as “similar”. The SCA majority (four judges to one) agreed with the Tax Court’s findings.
“The majority accepted, correctly in our view, that finance charges which are similar to ‘interest’ must be something other than interest, but with the necessary degree of similarity,” they wrote in their analysis.
“The majority identified the essential character of interest paid in respect of a loan for consumption as not merely compensation for the time value of money, but more broadly as the functional cost of credit, including compensation to the lender for the risks involved,” they added.
Why it is important
Jean-Paul Fraser, the head of cross-border taxation at Tax Consulting SA, says the judgment extends beyond the technical interpretation of section 24J. Deductibility directly affects the after-tax cost of borrowing and the economics of debt-funded transactions.
“Sectors that rely heavily on external funding will find that this judgment provides important authority for taxpayers seeking to deduct financing charges that share relevant functional characteristics with interest and form part of the lender’s compensation for the provision of credit,” says Fraser.
The judgment should not, however, be interpreted as a blanket approval of all costs incurred in connection with funding transactions. The SCA distinguished raising fees from more peripheral expenses such as legal fees, advisory costs, and administrative charges.
Nonetheless the importance of Cornucopia is heightened by the fact that SARS relied heavily on the 2016 legislative amendment. “The Supreme Court concluded that SARS’s interpretation was overly restrictive and failed to reflect the commercial reality of the financing arrangements before it,” Fraser adds.
Moeletsi believes the dissenting judgment should not be ignored. The dissent exposes precisely why future disputes may remain difficult.
For the dissenting judge, the fact that the raising fee was payable upfront, remained payable in full irrespective of early settlement, and was payable to a facility agent even where the agent had not advanced the loan capital pointed strongly towards a fee for procuring access to capital, rather than a return for providing capital over time.
Going forward
Moeletsi says the timing of the SCA judgment makes it particularly interesting.
At the end of last year SARS issued an Interpretation Note (IN 142) dealing specifically with the meaning of similar finance charges. SARS’s view is that a conventional raising fee paid for arranging finance would generally not constitute a “similar” finance charge.
Nico Theron, founder of Unicus Tax Specialists, says the firm has had concerns about the Interpretation Note. “SARS accepted linguistically that ‘similar’ does not mean ‘identical’, but its substantive test appeared to leave remarkably little room for anything other than interest itself to qualify.”
Theron says the SCA judgment was not unanimous, and it will remain important to see whether SARS seeks leave to appeal. “If the SCA judgment stands, SARS will have to consider what it does with its Interpretation Note.”
Although these notes are important, they are not legislation, he says. SARS remains one of the parties to a tax dispute. Its interpretation of legislation does not become correct merely because it has been published in an Interpretation Note.
The question is whether the note can continue to state an interpretation which the SCA has materially rejected. “At the very least, it would seem difficult for IN 142 simply to remain untouched as though the judgment had never happened,” Theron adds.
Click here to download the judgment.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies.
