Interest free loans cross border

A consideration of the tax consequences of interest free loans will be incomplete if not also considered in the context of interest free debt funding being provided cross-border. Typically, when “cheap debt” is encountered it is in the form of low interest or interest free loans being provided to related parties (or “connected persons” as defined) due to the non-commercial nature of such an arrangement. This is especially the case for the lender, who could typically receive far greater returns on investment if utilising excess cash in another manner. However, due to group efficiencies, it may be preferable for one group company to provide low interest or interest free financing to a fellow group company, especially if this also has the potential to unlock certain tax benefits.

One such manner in which a corporate group may save on its ultimate tax bill is to ensure that funding is provided by a company situated in a low tax jurisdiction, such as Mauritius for example (which levies a corporate tax rate of effectively 3%). Were the Mauritius company to lend cash to a South African group company, the group would prefer it to do so at a very high rate. This would ensure that the South African company is able to deduct interest in a corporate tax environment where it would create a deduction of effectively 28%, whereas the tax cost would only be 3% in Mauritius.

Where the South African company however is in the position that it sits on the group’s cash resources, it would want to lend money to the Mauritius company at as low rate as possible. Interest, to the extent charged, will now only be deductible at an effective 3% in Mauritius (where the borrower is situated), whereas interest received will be taxed at 28% in South Africa. Such a loan would therefore be most tax efficiently structured as an interest free loan.

The transfer pricing regime, contained in section 31 of the Income Tax Act,[1] seeks to legislate against this tax avoidance behaviour. The provision, which covers all cross border transactions entered into by connected persons, but specifically also cross border debt financing, determines that in such instances “… the taxable income or tax payable by any person contemplated … that derives a tax benefit … must be calculated as if that transaction, operation, scheme, agreement or understanding had been entered into on the terms and conditions that would have existed had those persons been independent persons dealing at arm’s length.”

In other words, the tax consequences of cross border debt funding with connected persons will be calculated as though arm’s length interest rates would have been attached thereto. Therefore, even though the loan extended by the South African company above to the Mauritian company would have been interest free in terms of the financing agreement, the South African company will still be taxed in South Africa as though it has received interest on arm’s length terms. The same is true for the exaggerated rates that may have been charged had the South African company been the lender: SARS would adjust these rates downward to ensure that the South African company does not claim inflated interest costs.

Using interest free or low interest loans as a tool to increase tax efficiency, especially in a cross border context, much be approached with circumspection. It may very often amount to a blunt and clumsy tax planning tool at best.

[1] 58 of 1962

This article is a general information sheet and should not be used or relied upon as 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 financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)




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IC Marais

Professional experience:

IC Marais is a certified CA (SA) with public sector and private sector technical knowledge based on 5 years’ Public Sector accounting, auditing and financial management experience and 5 years audit, tax and accounting experience. Detailed knowledge of private and public sector accounting and auditing standards (GRAP, IPSAS, IFRS, IAS, ISA) and public sector financial legislation (MFMA, etc.)

He enjoys the outdoors, hunting and fishing.


Professional experience:

In 1995, Schalk started as a trainee at Warner and Newton (which became Moores Rowland in 1997 and then Mazars Moores Rowland in 2007) in Bloemfontein. In 1998, Schalk was appointed as manager at Moores Rowland, where he became a partner in 2003. Schalk received his Postgraduate Certificate in Advanced Taxation in 2006 and in 2009 he received his Certificate in the Administration of Estates.


Professional experience:

Cedric started as a trainee at Warner and Newton (which became Moores Rowland in 1997 and Mazars Moores Rowland in 2007), Bloemfontein, in 1986. After completion of his articles, he joined the Special Investigations Division of the Department of Finance (SA Revenue Services) as a senior inspector from 1990 to 1991.


Professional experience:

Lucha started her career as a tax inspector at the Inland Revenue Department of New Zealand. After this she worked in commerce in Canada, Mexico and the United States.

On her return to South Africa, she completed her CA training contract with us and has been with Newtons ever since. She became a Partner in 2012.

Apart from her CA(SA) qualification she also holds a postgraduate certificate in Advanced Taxation (2005) and has the overall responsibility for training as our Training Officer.