Interest: SARS’ View on the In Duplum Rule
The in duplum rule originated from the South African common law and has been applied through South African case law for over 100 years. The rule aims to protect borrowers from exploitation by lenders that allow and, in some cases, cause interest to accumulate unabated: leading borrowers into further indebtedness. In terms of the common law, the interest charged on a debt stops to accrue where the total amount of the unpaid interest equals the outstanding principal debt. The statutory rule goes further in its application. It provides for a limit on several costs, in addition to unpaid interest, which added together may not be more than the outstanding principal debt.
Taxpayers sometimes enter into loan arrangements with parties, where the lender that is advancing that loan to the borrower (who is in some manner related party to the lender) will advance the loan at a zero or low-interest rate for the loan arrangement to be favourable to the related party by saving on interest costs. The use of these zero or low-interest loans creates a loss to the fiscus as it often leads to for example:
- Less PAYE collection where an employer grants a zero or low-interest loan to an employee.
- Avoidance of donations tax where a person transfers an asset to a trust in exchange for a zero or low-interest loan.
- Possible avoidance of dividends tax where a company grants a shareholder a zero or low-interest loan.
To counter the tax benefit as a result of the use of zero or low-interest loans, the Income Tax Act contains various anti-avoidance rules that deal with the taxation of the difference created because of these loans. One example is section 7C of the Act, which applies in respect of zero or low interest-free loan advanced to a trust by a connected person of that trust. The official rate of interest is used under this provision to quantify a donation that arises from advancing a zero or low-interest loan to a trust.
Previously, some taxpayers were relying on the in duplum rules to circumvent anti-avoidance rules in the Income Tax Act. These taxpayers rely on the in duplum rules to distort the quantification of the tax benefit derived from a zero or low-interest loan between connected parties on the difference between the amount of interest actually incurred and the amount of interest that would have been incurred at the official rate. These taxpayers claim that if a zero or low-interest loan is advanced and the unpaid interest on that loan (and other costs, in the case of the statutory rule) reaches the amount of the unpaid principal debt, the in duplum rules apply to stop the interest. Consequently, if the in duplum rules apply, then the application of the anti-avoidance rules on the tax benefit on zero or low interest-free loans must also not be applied.
However, section 7D of the Income Tax Act determines that the anti-avoidance rules dealing with zero or low interest-free loans should apply despite the application of either the statutory in duplum rule or the common law in duplum rule. Taxpayers should therefore be cognisant of any interest provisions in agreements, and that anti-avoidance mechanism will receive preference.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).