The Income Tax Act contains specific provisions relating to the timing of the accrual or incurral of interest for tax purposes. BPR272 deals with an arrangement that contains deferred payment terms and amounts determined with reference to an interest rate. The ruling however confirms that this arrangement is not an instrument within the scope of section 24J. Determining whether an arrangement is interest-bearing requires a detailed analysis of its overall terms and yield.
The Income Tax Act contains a specific provision, section 24J, that deals with the tax consequences of interest. Interest is deemed to accrue to the recipient or be incurred by the payer on a day-to-day basis. Amounts that are not interest follow the normal tax principle of accrual when the recipient becomes unconditional entitled to it or incurral when the payer has an unconditional obligation to pay the amount. This article considers the distinction between interest and other amounts based on a recent ruling by SARS (Binding Private Ruling 272 (BPR272)).
Facts that the ruling relate to
A listed company (applicant) wishes to develop land for purposes of selling residential sectional title units. The land is owned by a company whose shareholders cannot sell it due to religious reasons. The applicant will therefore acquire the right of use of the land for 99 years. This right of use will eventually be transferred to the purchaser of each unit. An option will exist for the right of use to be extended for a further 99 year period.
The company that owns the land will grant the right to develop it to another group company (Subco A). Subco A will in turn cede the development rights to the applicant. The applicant will develop and market the units for its own risk and account. In exchange for the cession of this right, the applicant will pay Subco A an amount upon signature and further instalments as units are sold. It appears from the information in the ruling that the consideration is linked to the unit selling price, subject to certain minimum and maximum amounts. It furthermore appears as if the timing of the payment of these amounts depend on the timing of the sale of units by specified annual dates.
The applicant may redeem its obligation in respect of the development rights at an earlier date, in which case it is entitled to pay a reduced amount for these rights. If early redemption takes place after the specified date, the reduced amount is calculated with reference to an interest rate.
Legislation and ruling
Section 24J applies to interest incurred or accrued in terms of an instrument. The term instrument is defined widely, amongst others, as "any interest-bearing arrangement or debt".
The ruling confirms that the payments made by the applicant to Subco A are deductible (it appears when the payments are made). These payments do not constitute pre-payments for future benefits or services (s 23H). If the applicant were to redeem its obligations early, a recoupment may arise in respect of the discount received. The ruling confirms that the arrangement is not an instrument, as defined above, and section 24J does not apply.
Analysis and practical considerations
Despite the fact that the arrangement between the applicant and Subco A constitute a deferred payment arrangement and certain amounts are calculated with reference to an interest rate, this is not sufficient for the arrangement to be interest-bearing. It is submitted that the yield or cost structure of the arrangement as a whole must be analysed to make the determination as to whether the arrangement bears interest or not. BPR272 does not provide sufficient details to consider the reason for the SARS view in more detail. Planners and taxpayers should however bear the possibility of arrangements containing an interest-element in mind, as this affects the timing of the tax implications of the arrangement.
Pieter van der Zwan, the author of this article,
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.