The increase of the “official rate of interest”

The “official rate of interest” is the present repurchase rate plus 100 basis points (7.75%) and is used to quantify the fringe benefit of low interest rate loans provided by employers, as well as the amount of a donation for low interest loans to trusts by connected persons.

The effect of low interest loans made by employers

In terms of the s1 of the Income Tax Act, No 58 of 1962 (Act), any amount received or accrued to an employee who is a resident, in cash or otherwise, must be included in the income of the employee. Paragraph (i) of the definition of “gross income” in the Act specifically includes as an amount subject to income tax “the cash equivalent, as determined under the provisions of the Seventh Schedule, of the value during the year of assessment of any benefit … granted in respect of employment or to the holder of any office…”

In terms of paragraph 2(f) of the Seventh Schedule, a taxable benefit is said to exist where a debt which has been incurred by the employee, which includes a director as per the definition of “employee” in paragraph 1 of the Seventh Schedule, whether in favour of the employer, or any other person by an arrangement with the employer or any associated institution in relation to the employer, and either of the two requirements are met:

• no interest is payable by the employee in respect of the debt; or
• interest is payable by the employee in respect of the debt at a lower rate than the official rate of interest.

Paragraph 11 in turn seeks to quantify the amount of the taxable fringe benefit to be included in the gross income of the employee. Essentially, the taxable fringe benefit would be equal to the amount of interest that would have been payable on the amount owing in respect of the debt in the year of assessment if the employee had been obliged to pay interest on the debt amount at the official rate of interest, less the amount of interest actually incurred by the employee.

It must further be kept in mind that although the definition of the “official rate of interest” was deleted by s67 of the Taxation Laws Amendment Act, 2017, in the event that a new repurchase rate or equivalent rate is determined, the new rate of interest applies from the first day of the month following the date on which that new repurchase rate or equivalent came into operation. 

Therefore, should the proposed official rate of interest be increased to a level closer to the prime rate of interest, which is currently 10.25%, a significantly larger taxable benefit will be included in the income of the employee from the first day following the date on which the new rate comes into operation. 

The effect on loans made to trust by connected persons

In the event that a connected person makes a donation to a trust, and the trust incurs no interest in respect of the loan, alternatively interest at a rate lower than the “official rate of interest”, the interest foregone is considered a donation in terms of s7C(3) of the Act. 

In this regard, an amount equal to the difference between the amount incurred by that trust during a year of assessment as interest in respect of that loan that would have been incurred by that trust at the “official rate of interest”, must be treated as a donation made to that trust on the last day of that year of assessment of that trust.

Therefore, the proposal that the “official rate of interest” is increased to a level closer to the prime rate of interest could have far reaching tax consequences wherein loans made by connected persons to trusts will be seen as a donation and taxed at rate of 20%.