Practice Note 31 – what’s the big deal?

A lot of South African underpants have gotten in a twist recently over a recent announcement from the South African Revenue Services (“SARS”). On 15 November, SARS announced that it intends to withdraw Practice Note (“PN”) 31 and Practice Note 37 for years of assessment starting from 1 March 2023.

While PN37 isn’t a big deal, actually a clarification regarding the deductibility of tax compliance costs by “registered tax practitioners”, PN31 is worrying a lot of people, particularly those who’ve recently implemented financing or holding structures that rely on an intermediary holding company being able to claim an interest deduction where it on-lends funds.

So what is PN 31 anyway?

PN 31 covers interest deductions in certain instances and has been in existence since 1994.  It essentially says that, although interest must in theory be incurred in the course of trade to be deductible, in practice SARS would allow the deduction of interest incurred purely for the purpose of earning interest.

This has meant that if a company borrows and on-lends at a small margin, it could claim a deduction on the interest expense (although not strictly in the furtherance of its trade) and thus it only had to pay tax on the margin between the interest paid and the interest earned.

This helpful nugget is what SARS is now getting rid of, so going forward if a company borrows and on-lends, e.g. an intermediary holding company, it would have to pay tax on the full interest income with no deduction.  This, especially nowadays with high-interest rates, could scupper the economics of many a structure.  No wonder so many knickers were atwist.

Why would SARS do away with dear old PN 31?

SARS’ reasoning for the notice of withdrawal is that the concession as provided for in PN 31 has been abused by naughty structures and naughty taxpayers who created transactions with the intention of obtaining a deduction that would otherwise not be permitted.  We do not agree and think that this practice has been eminently sensible in facilitating normal commercial intra-group funding transactions, and we will certainly be lobbying SARS on this point.

For yes, at this stage, the withdrawal is merely a proposal and SARS called for comment by 15 December 2022.

What should we do?

Watch this space!  We don’t think PN 31 will be repealed completely and we do think some concessionary practice will still apply, as on-lending will always be a commercial transaction and it would be unfair to have punitive tax treatment.   However, claims of unfairness never stopped the tax man, so we will closely follow the discussions.