Section 31 of the Income Tax Act (58/1962) concerns transfer pricing, one of the most contentious areas of tax law not only in South Africa, but also around the world. Historically, there has been no judicial precedent in South Africa regarding the application of Section 31 – in particular, the arm's-length principle. However, in Crookes Brothers Ltd v Commissioner for the South African Revenue Service (SARS), the High Court issued its findings regarding the application of certain provisions included in Section 31.(1)


The taxpayer in Crookes Brothers formed part of a group of companies operating in the commercial agriculture industry in Southern Africa. The taxpayer advanced (what was purported to be) an ordinary shareholder loan to one of its subsidiaries located in Mozambique (Mozco) to enable it to fund certain costs associated with the establishment of a macadamia nut farm.

In its income tax return for the 2015 assessment year, the taxpayer made a transfer pricing adjustment to its taxable income under Sub-section 31(2) of the Income Tax Act, as well as a secondary adjustment under Section 31(3), resulting in a deemed dividend in specie being declared and paid to Mozco.

Subsequent to the filing of its income tax return, the taxpayer realised that the transfer pricing adjustment had been made in error on the basis that the shareholder loan fell outside the application of the transfer pricing provisions of Section 31(7) of the act. In an abbreviated manner, Section 31(7) states that a debt will not be subject to the Section 31 transfer pricing provisions to the extent that:

  • the debt is between:
    • a resident company; and
    • a foreign company in which the resident holds at least 10% of the equity shares and voting rights;
  • the foreign company is not obliged to repay the loan within 30 years of the date on which the debt is incurred;
  • redemption of the debt is conditional on the value of the assets being greater than the liabilities; and
  • no interest accrued on the debt in the assessment year.

The explanatory memorandum on the Taxation Laws Amendment Bill 2013 provides the following context to the introduction of the carve-out contemplated in Section 31(7):

It is proposed that transfer pricing relief should be extended to outbound loans that clearly resemble equity. In effect, taxpayers should not be forced to pay tax on notional interest from a share loan that is in substance nothing more than share capital... A loan that meets the [relevant] criteria is in substance exposed to the same economic risk as equity and thus poses little or no risk to the South African tax base if interest is under-charged (because interest should not be charged at all as an economic matter).

SARS's contentions

SARS disputed the taxpayer's reliance on Section 31(7) of the act on the basis that Clause 7 of the loan agreement contravened the requirements of Sections 31(7)(b) and (c) of the act. The matter therefore turned on Clause 7 of the agreement, which in simple terms stated that in the event of Mozco being liquidated or going into business rescue or bankruptcy, the loan would be immediately due and payable. SARS believed that given that liquidation, business rescue or bankruptcy could occur within 30 years, such clause was indicative of an obligation on Mozco's part to redeem the debt within 30 years (Section 31(7)(b) of the act). Further, it held that the debt was payable, notwithstanding the fact that the market value of Mozco's assets may be less than its liabilities (Section 31(7)(c) of the act). Lastly, SARS held that a subordination agreement entered into between the parties did not override Clause 7 of the loan agreement; rather, it merely altered the taxpayer's ranking among Mozco's creditors. The conclusion was that the shareholder loan was more akin to debt than equity.


In respect of whether the shareholder loan fell within the carve-out provisions of Section 31(7) of the act, Justice Louw agreed with SARS and held as follows at Paragraph 17:

In terms of clause 7 of the loan agreements, the agreements terminate with immediate effect and the loan, or any balance then outstanding, becomes immediately due and payable to the applicant in the event of an application being made for the liquidation of Mozco, or Mozco going into bankruptcy or business rescue or similar type proceedings, or judgment having been taken against Mozco and remaining unsatisfied for a period of 14 days. A situation may therefore arise which obliges the foreign company to repay the loan before expiry of 30 years. It follows that the loan agreements therefore do not comply with the requirement of s31(7)(b) of the Act.

Louw further agreed with SARS that the subordination of the loan did not override Clause 7, but simply regulated the subordination of the taxpayer's claim against Mozco to those of other creditors for such time as the liabilities of Mozco exceeded its assets.

Observation in respect of court's findings

Clause 7 of the loan agreement appears to be a common clause inserted into most shareholder loan agreements. Notably, the court held that the happening of an uncertain event (ie, liquidation, business rescue or similar) amounted to an obligation on Mozco's part to redeem the debt within 30 years. In other words, even though one of the eventualities may never occur within 30 years from the date on which the debt was incurred, the court found that there was nonetheless an obligation to redeem the debt within the stipulated period. Given the ongoing debate on what constitutes an 'obligation to redeem', it will be interesting to monitor whether the taxpayer may appeal the judgment, particularly when having regard to the legislature's intention when it introduced the relevant provision.

Development of transfer pricing jurisprudence

Notwithstanding the initial relief that the judgment may have ended the long-standing drought of South African case law dealing with the contentious transfer pricing provisions in Section 31 of the act, the judgment unfortunately falls short of providing any in-depth analysis of the key arm's-length principle, which forms the crux of any transfer pricing analysis.

For further information on this topic please contact Jerome Brink at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email ( The Cliffe Dekker Hofmeyr website can be accessed at


(1) [2018] ZAGPHC 311, judgment delivered on 8 May 2018.

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