South Africa: Practice Note 31 – still of interest… for now

Interest expenditure incurred by a South African resident taxpayer may only be deducted in terms of section 24J(2) of the Income Tax Act, No. 58 of 1962 (‘ITA’) –

• from the income which is derived from carrying on any trade;
• and only if such interest expenditure was incurred in the production of the income.

Failure to meet the above requirements will result in the inability to deduct interest expenditure for tax purposes. Given that passive holding companies arguably do not carry on a trade, no interest expenditure may be deducted by such companies in terms of the letter of the law.

The South African Revenue Service (‘SARS’) has, however, granted a long-standing concession to taxpayers that accrue interest income (without carrying on a trade) by enabling them to claim a deduction in respect of expenditure incurred in production of the interest income, to the extent that it does not exceed such interest income (i.e. a loss may not be created). This concession is contained in Practice Note 31 (‘PN 31’).

On 16 November 2022, SARS issued a notice of its intention to withdraw PN31 with effect from 1 March 2023, with such withdrawal applying in respect of tax years commencing on or after that date. The purpose of the proposed withdrawal, according to SARS, is to prevent certain alleged abuses, to prevent instances where debt funding is ultimately used to fund non-income producing assets, and to protect the fiscus by prohibiting the deduction of expenditure by a taxpayer that does not carry on a trade.

In light of the proposed withdrawal of PN31, National Treasury proposed in the Draft Taxation Law Amendment Bill of 31 July 2023 that a new provision, section 11G, be inserted in the ITA. The initial iteration of section 11G that National Treasury proposed would have significantly limited the scope of interest deductions outside the ambit of section 24J and, hence, the draft provision was strongly criticised by stakeholders at large.

Following consultation between National Treasury and stakeholders, the provisions of section 11G were (in our view favourably) revised to allow as a deduction from the income of any person, interest incurred by that person to the extent that the interest –

• is incurred in the production of interest income that is included in the income of that person;
• and is not incurred in carrying on a trade.

Section 11G comes into effect on 1 January 2025 in respect of years of assessments commencing on or after that date. In the interim, PN 31 will remain in effect until this newly proposed effective date.

Taxpayers relying on PN31 to secure interest deductions are urged to consider the impact of the withdrawal thereof and the introduction of section 11G on their funding arrangements so as to ready themselves for this new regime.

If you wish to discuss these topics, please contact:

WTS Renmere