CASE SUMMARY: UNITRANS HOLDINGS LIMITED V COMMISSIONER FOR THE SOUTH AFRICAN REVENUE SERVICE

In this case the definition and requirements of the section 24J(2) – which regulates the deductibility of interest expenses – was highlighted. The court ultimately found that to qualify under section 24J(2), the interest expenditure must be intended to generate income for the taxpayer and must be closely connected to the income earning activities of the taxpayer.

This matter was heard by the Gauteng Division of the High Court following an appeal by the taxpayer from the Tax Court.

The taxpayer in casu engaged in both investment holding and loan funding activities. The taxpayer initially alleged that its primary venture involved the investing of funds in subsidiaries to generate dividends. It would borrow funds and then lend these funds to subsidiaries at a rate less than the borrowing cost – in doing so the taxpayer incurred interest expenses which they contend is deductible under section 24J(2) of the Income Tax Act. SARS however disagrees with this position.

SARS conducted an audit on the taxpayer and notified the taxpayer of their intention to raise additional assessments and impose an understatement penalty alleging that the interest expenditure deducted by the taxpayer was impermissible under section 24J(2) of the Income Tax Act. SARS argued it was not incurred in the conduct of any trade or in the production of income. SARS asserted that the taxpayer did not trade as a money lender and that the purpose of the interest expenditure was to further the interest of the subsidiary and not to generate income.

It was argued on behalf of the taxpayer – abandoning previous arguments that the interest expenditure was incurred in their trade as a money lender – that the interest expense was incurred in their trade as an investment holding company and that this did not preclude them from deducting the interest expense in terms of section 24J(2). In support of this the taxpayer argued that part of its trade as an investment holding company was to lend funds to its subsidiaries and that in this way, furthering the interests of the subsidiaries, they furthered their own interests.

The court however noted that, as per the financial statements of the taxpayer, the taxpayer earned ‘unproductive interest’ (interest paid for private or non- business activities), which produced exempt income. This in turn means that the interest expense cannot be allowed as a deduction. The court further supported this finding by stating that there was insufficient evidence to prove that the taxpayer was intimately involved in the management of its subsidiaries. The court highlighted, noting previous legal precedent, that an ‘active step’ is required in carrying on a trade – mere oversight in a passive manner does not suffice.

The court reaffirmed that the most important factors in enquiries as to tax deductibility of expenditure are: the purpose of the expenditure in question, and how closely this expenditure is linked to the income-earning operations of the taxpayer.

With regard to the interest expense the court ultimately found that the taxpayer had specifically structured its affairs in such a way that it intended to improve the financial-earning capabilities of the subsidiaries. In doing so, the court found that the taxpayer never intended to earn any income from the expenditure in question, all it intended was to increase the profitmaking potential of the subsidiaries.

The taxpayer alleged, with regard to the understatement penalty imposed by SARS, that there had been an ‘inadvertent error’. The court however highlighted the absence of evidence supporting the alleged ‘inadvertent error’ and was unwilling to accept such argument.

The court ultimately dismissed the appeal and costs were awarded to SARS. The decision by the Tax Court dated February 9, 2022, was affirmed.

Intellectual property disclaimer:
The contents of any article published by Pieterse Sellner Erasmus should not be construed as professional legal advice.