South Africa: Unravelling Tax Deductibility - The Transition from PN31 to Section 11G

In terms of either section 11(a) or section 24J of the Income Tax Act 58 of 1962 (‘ITA’), interest expenditure is deductible only where a taxpayer derived income from carrying on a trade and such expenditure is incurred in the production of income. Practice Note 31 of 1994 (‘PN31’), however, permits a deduction of expenditure where a taxpayer incurs such expenditure in the production of interest income but not in the carrying on of a trade, limited to the amount of interest income.

The South African Revenue Service will soon replace PN31 with section 11G of the ITA, governing deductions for expenses incurred in producing interest income. This will apply to years of assessment starting after 1 January 2025. The final wording of section 11G in the Taxation Laws Amendment Act 17 of 2023 reads as follows:

• For purposes of this section ‘interest’ means interest as defined in section 24J.
   
• For purposes of determining the taxable income derived by any person, there shall be allowed as a deduction from the income of that person, interest incurred by that person to the extent that the interest –
  • is incurred in the production of interest that is included in the income of that person; and
  • is not incurred in carrying on a trade.
     
• The amount allowed to be deducted under this section shall not exceed the amount of interest income referred to in subsection (2)(a), that is received by or accrued to a person, during the year of assessment.

There are similarities between PN31 and section 11G. Both apply to all persons, including individuals and trusts, and limit deductible expenditure to related interest income. Both require interest expenditure to be directly linked to interest income for deduction.

Section 11G codifies PN31, allowing deductions even if the trade requirement is not met. It limits deductible interest to the equivalent interest income received, while other expenditures are redirected to section 11(a).

A key difference is that section 11G only allows deduction of 'interest' as defined in section 24J, unlike PN31, which allowed any expenditure incurred in producing interest income. This restricts deductible expenses, affecting taxpayers like holding or treasury companies and private equity firms, who previously deducted administrative fees and other charges not covered under section 24J. For instance, trusts borrowing money to lend to beneficiaries can deduct interest on borrowed funds under section 11G, but cannot deduct other related expenses like accounting fees, which was allowed under PN31.

While both PN31 and section 11G offer concessions to taxpayers not fulfilling trade requirements under sections 11(a) or 24J, their nuances lead to significant tax differences of which taxpayers must be aware. Understanding section 11G's details and limitations can help optimise tax positions within the new framework.

If you wish to discuss these topics, please contact:

WTS Renmere