Sections 11(a) and 23(g) of the Income Tax Act No. 58 of 1962 (“the Act”) are commonly referred to as the “general deduction formula”. As the name suggests, it is in terms of these sections of the Act that tax deductions in general are sought to be claimed by taxpayers. The Act does, however, contain provisions which are specially tailored for the deduction of specific expenditure. Section 24J of the Act (“section 24J”) is one such provision and allows taxpayers to claim a deduction specifically for interest expenditure.
A taxpayer who acquires credit will normally incur various costs in relation to such credit. However, before it can be considered whether such costs, or any portion thereof, can be claimed as a deduction in terms of section 24J, such costs must, as a prerequisite, be shown to constitute “interest” as defined in section 24J. The purpose of this article is to consider which of the said costs meet this prerequisite requirement, so that it stands to be considered whether they are deducible in terms of section 24J, as opposed to the general deduction formula. In this regard, the details of the rest of the requirements of section 24J are not discussed in this article.
Section 24J’s definition of “interest”
In everyday language, one can correctly state that interest is not the only cost of credit, and that instead, the cost of credit further includes other types of finance charges, such as commitment fees and arrangement fees. However in the context of section 24J, the accuracy of such a statement, which assumes that there is a clear distinction between “interest” and such other finance charges as commitment fees and arrangement fees, depends on how wide the parameters of the notion of “interest” are. If wide enough, commitment fees and similar charges may be seen to constitute “interest”, so that they may be claimed as a specific deduction in terms of section 24J, provided, of course, that all other requirements of this section are met. On the other hand, if “interest” is narrowly defined, such amounts will be seen as being different to “interest” and thus not deductible in terms of section 24J. In such a case, the question would be whether such amounts nevertheless qualify for a deduction in terms of the general deduction formula.
Section 24J defines “interest” to include, inter alia, the following:
“(a) gross amount of any interest or related finance charges, discount or premium payable or receivable in terms of or in respect of a financial arrangement;
irrespective of whether such amount is—
- calculated with reference to a fixed rate of interest or a variable rate of interest; or
- payable or receivable as a lump sum or in unequal instalments during the term of the financial arrangement.”
From the above, it can be deduced that for an amount to constitute “interest” in the context of section 24J, it must constitute, inter alia, one of the following:
- related finance charges; or
- a discount or premium payable or receivable in terms of a financial arrangement.
For purposes of this article, only the words “interest” and “related finance charges” as used in section 24J’s definition of “interest” will be discussed in more detail.
The word “interest” as used in section 24J’s definition of “interest”
It can be noted that the definition of “interest” in section 24J circularly includes the word “interest”, and therefore does not ascribe a meaning to this word. As if this doesn’t make the definition appear elusive enough, the position turns out to be that the word “interest” is not defined in any other part of the Act. Such a scenario calls for the general principle of statutory interpretation commonly referred to as the “literal approach”. Accordingly, where no specific meaning is given to a term contained in a piece of legislation, that term must be given its ordinary meaning, provided that such ordinary meaning does not lead to an absurdity so glaring that it could not have been intended by the Legislature.
In determining the ordinary meaning of a word, a court will normally have recourse to dictionaries. In this regard, the Shorter Oxford English Dictionary (Sixth Edition) defines the word “interest” as “money paid for the use of money or for the forbearance of a debt”. This definition is consistent with the meaning that our courts have generally given to the notion of interest in terms of common law, that is “compensation for the use of money lent” (See Commissioner for Inland Revenue v Cactus Investments (Pty) Ltd 59 SATC 1).
For an amount to be seen as compensation for the use of money lent, it follows that the amount must be paid for the benefit of the lender. That is to say, if the amount is not paid for the lender’s benefit, one cannot say that such an amount serves to compensate the lender for allowing the borrower to use the lender’s money. As such, the element of compensation requires that the payment of the relevant amount establishes a link (whether direct or indirect) between the borrower and the lender.
A direct link which clearly establishes the element of compensation can be said to exit where:
- the borrower pays the amount directly into the lender’s hands; and
- the lender can put the amount to any lawful use as he pleases.
On the other hand, it can be said that an indirect link which nevertheless establishes the element of compensation exists where:
- the borrower pays the amount directly into the hands of a third party;
- who receives the amount on behalf of the lender;
- so that it is the lender, and not the third party, who acquires the right to put the amount to any lawful use as he pleases.
It is not unusual to find cases where a borrower’s payment of certain fees relating to its acquisition of credit is not for the lender’s benefit, but for the benefit of, for instance, an independent third party who is an arranger or agent in relation to the lender. Normally, whether or not one is dealing with such a case can be determined with reference to the terms of the relevant credit agreement and related documentation. What is important to note, however, is that whereas such fees do not constitute “interest” within its ordinary meaning (i.e. because the element of compensation for the use of money lent is absent), there is still the possibility that they fall within section 24J’s definition of “interest” by virtue of being “related finance charges”. As such, due consideration must be given to what is meant by the words “related finance charges”.
“Related finance charges”
The term “related finance charges” is not defined in the Act, nor is there any case law bearing particularly on this term in the context of section 24J. Therefore, as per the “literal approach” to statutory interpretation explained above, the term must be given its ordinary dictionary meaning.
The Dictionary of Banking Terms (Sixth Edition) defines the term “related finance charge” as:
“the borrower’s total cost of credit, including loan interest, commitment fees, and prepaid interest, in a consumer loan” (emphasis added)
The description of a “related finance charge” as a cost of credit entails that at the very least, there must be a factual causal link between the borrower’s obligation to pay the amount in question and the lender’s extension of credit to the borrower. This means that one must be able to say that as a matter of fact, the borrower would not have incurred the obligation to pay the relevant amount but for the lender’s extension of credit to the borrower. However, arguably, such a causal link is only a minimum requirement. In this regard typical charges include arrangement fees and commitment fees. An arrangement fee is generally payable upfront, i.e. on entering into the loan agreement. Such fee is generally not paid unless the loan is advanced. A commitment fee is generally charged on the undrawn portion of a facility and is charged for the relevant financial institution committing its funds to the borrower even if they are undrawn. In both these cases the causa for the fees relates to the commitment of funds/the provision of credit to the borrower. These amounts are generally not paid for, for example, services provided by the lender to the borrower.
From the discussions above, it is evident that the question of whether the costs incurred by a taxpayer in relation to its acquisition of credit can be seen as “interest” for purposes of section 24J is, for the most part, one which must be determined through a rigorous factual analysis. Although this means that taxpayers (or their legal advisors) do not have the luxury of simply applying a set of hard and fast rules to determine this question, it is noted that because the deductibility requirements of section 24J(2) are fewer and easier to meet than those of the general deduction formula, undertaking such a factual analysis is worth the taxpayer’s while. Taxpayers are therefore advised not to simply conclude that certain costs they incur in relation to their acquisition of credit, such as arrangement fees or agency fees which are paid to and for the benefit of an independent third party, are not “interest” and are therefore not deductible in terms of section 24J. Instead, it is prudent for taxpayers to consult their legal advisors on the position in this regard.