Picture: ISTOCK
Picture: ISTOCK

Taxpayers benefiting from zero-interest or low-interest loans who think they can limit the tax paid on such loans by relying on the "in duplum" rule will have to think again.

Under the in duplum rule, interest on a debt stops accumulating once the total amount of interest is the same as the principal debt.

The South African Revenue Service has amended the Income Tax Act with effect from last month to make it clear that, in spite of the in duplum rule, specific anti-avoidance provisions will continue to apply.

According to an explanatory memorandum issued by the National Treasury, taxpayers sometimes enter loan arrangements at zero or low interest to favour a related party with interest-cost savings.

The use of these loans means that SARS loses out on collecting "pay as you earn", or the taxpayer avoids paying donations tax or possibly dividends tax.

To counter the tax benefit resulting from the use of zero- or low-interest loans, the Income Tax Act contains anti-avoidance rules that introduce tax on the difference between the amount of interest actually incurred and the amount of interest that would have been incurred at the official rate.

There are three types of anti-avoidance legislation that apply to low-interest or interest-free loans, says Tertius Troost, a tax consultant at Mazars.

First, where an employer provides an employee a low-interest or interest-free loan, a fringe benefit will be included in the employee's remuneration and it is subject to normal PAYE.

Second, where a beneficiary of a trust provides a low-interest or interest-free loan to a trust, for example, as part of an estate planning exercise, then donations tax applies to an amount equal to the difference between the interest that would arise as determined with reference to the official rate of interest and the actual interest rate of the loan made.

Third, if a company provides a low-interest or interest-free loan to a shareholder, dividends tax could apply to the interest forgone.

Repo rate

Providing some background to the latter, Anton Gouws, a director at accounting firm Immelman Ferreira, says rather than drawing remuneration or receiving dividends from an owner-managed company, directors of such companies may distribute some of the profit of the company by way of interest-free loans from the company to the directors.

Troost says the official rate of interest, which is the repurchase rate (repo rate) plus one percentage point, is used to calculate the amount of tax that has to be paid, whether it is donations tax, dividends tax or normal tax applicable to fringe benefits. The official interest rate is currently 7.75%.

If the loan bears interest at a rate lower than the official rate, the difference between the amount of interest that would have been payable if the loan was granted at the official rate and the interest actually paid is taxed.

For instance, if an employer provides its employee with a R10000 interest-free loan which remains outstanding for the entire tax year, then the employee will have received a fringe benefit of R775 which is added to the employee's remuneration and subject to PAYE.

Where an interest-free loan of R10-million is granted to a trust by a person connected to that trust, it will be deemed that the person has made a donation to the trust equal to R775000. However, the first R100000 donated each year is excluded from donations tax, therefore the taxpayer will pay donations tax of 20% on R675000, which comes to R135000, he says.

According to the explanatory memorandum, the in duplum rule has been applied to South African case law for more than 100 years. The main aim is to protect borrowers from exploitation by lenders. The rule states that interest charged on a debt stops accruing where the total amount of the unpaid interest equals the capital, or amount lent.

A statutory in duplum rule was introduced into South African law when the National Credit Act came into effect in June 2007.

This in duplum rule goes even further in that it not only limits interest that can accumulate on a loan but also the costs. These costs include initiation fees, credit insurance, default administration fees and collection costs.

So the interest plus the costs together may not be more than the unpaid principal debt at the time of default.

Troost says taxpayers were trying to interpret the anti-avoidance legislation to suit themselves, but SARS has now clarified its position with this amendment. Taxpayers would argue that if the interest and other costs equal the capital amount of the loan, no interest may be charged in terms of the in duplum rule and therefore the tax anti-avoidance provisions should not apply.

However, the amendment now makes it clear that interest will not stop accruing when the interest and the costs equal the capital amount of the loan. Therefore neither the common law or statutory in duplum law applies to circumvent the anti-avoidance provisions.

"In the case of the NCA, the in duplum rule is there to protect the consumer whereas in the tax act, the rule is excluded to protect the fiscus," Troost says.