Taxpayers intending to claim expenses or losses from carrying on trade as an investment holding company or a moneylender should ensure they meet the relevant tests and have sufficient evidence to back up their claims.
Unitrans was sent packing by the Tax Court and the High Court when it objected to and appealed a decision by the South African Revenue Service (SARS) to disallow interest expenditure of about R33 million it incurred during the 2011 tax year.
Joon Chong, tax partner at law firm Webber Wentzel, says it appears from the judgment by the High Court in Johannesburg that there are no sound prospects of success for an appeal to the Supreme Court of Appeal.
The case
At the time, Unitrans traded as an investment and holding company, performing a treasury function for the Unitrans group of companies. It provided loan funding and cash management functions to the group’s subsidiaries.
In its 2011 tax returns, it declared interest income derived from its subsidiaries of about R35m. It claimed interest expenditure of R68m paid to its shareholder, Steinhoff Africa.
Following an audit in 2015, SARS disallowed the part of the interest expenditure that exceeded the interest income. The basis for disallowing the interest deduction was that the interest claimed by Unitrans was not an expenditure incurred in the conduct of any trade and was not in the production of income.
The issue was whether the interest expense claimed by Unitrans met the requirements of section 24(J)(2) of the Income Tax Act. The section provides that interest can be deducted from income derived from “carrying on a trade” only if that amount is incurred in the “production of income”.
Unitrans objected to the additional assessment that disallowed the R33m. When the objection was disallowed, the company took the matter on appeal to the Tax Court. The court dismissed the appeal, and Unitrans approached the High Court, which dismissed its appeal in January this year.
Sufficient evidence
Christine Fourie, senior tax manager and colleagues Louis du Plessis and Gizelle Ridgway at PwC, wrote in the firm’s February synopsis that the judgment underscores the importance of sufficient evidence to confirm the trade status of the holding company.
“It will not be sufficient for a taxpayer to merely assert that it is carrying on a trade as an investment holding company. It remains a question of fact that will need to be supported by sufficient objective evidence indicating that the holding company is intimately involved in the management of its subsidiaries or conducting treasury operations for the group.”
The Tax Court rejected the contention that Unitrans carried on a trade as a moneylender, but the High Court found that a holding company providing loan funding to its subsidiaries does not necessarily have to be seen as a moneylender to be carrying on a trade.
However, when the High Court considered whether Unitrans had any “profit-making motives” through its trade activities, it found no evidence to support that Unitrans had the purpose of making profits in the medium term.
Chong noted that the interest charged to the subsidiaries was always lower than the rate of interest it paid on the money borrowed from Steinhoff.
“It was clear from the financial statements that Unitrans earned unproductive interest. Expenses incurred in earning unproductive interest were not tax-deductible,” she added.
The High Court found no evidence to suggest that the company performed a treasury function on behalf of the group companies or that it was intimately involved in managing its subsidiaries. There was no evidence that Unitrans provided any administrative, financial, or secretarial services to its subsidiaries.
“Holding companies are therefore encouraged to assess whether they can be seen to be carrying on a trade, and what evidence is available to support this, based on the facts and circumstances of its activities,” the PwC tax experts advised.
Getting it right
Companies involved in moneylending or investment trading should ensure that a robust lending and credit policy is in place, says Chong.
Lending activities should be done primarily to generate a profit for the investment company itself.
Loans advanced should be documented in writing with commercial terms such as security or repayment terms in place as far as possible.
Interest on the funds it on-lends should exceed interest on the loans the treasury company borrows.
She advises taxpayers who are carrying on trade as an investment holding company to ensure they can demonstrate a high degree of involvement in the operations of the subsidiaries.
The evidence could include minutes and resolutions of the subsidiaries, or emails exchanged between personnel in the holding company and the subsidiaries on key decisions. The company should show that its staff interacted with financial institutions on behalf of the subsidiaries, and that it has dedicated employees tasked with performing the administrative or secretarial services for the group’s companies.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute financial planning, legal or tax advice that is appropriate to every individual’s needs and circumstances.
