By Pranith Mehta

Front-end fees are not defined in the Income Tax Act 58 of 1962 (the Act), however, it is ordinarily construed as a fee payable to the lender or arranger of a loan, in consideration for work done in providing or arranging the loan. At the inception of a loan or other agreement front-end fees are often deducted from the loan amount. Front-end fees are commonly paid by borrowers in connection with the raising of loans, however, it is unclear whether – if used for the purpose of carrying on a trade – it would be deductible in terms of s 11(a) of the Act.

In order for front-end fees to qualify for deduction as interest, it should be evaluated whether such amounts constitute ‘interest’ as envisaged in s 24J of the Act, which reads:

‘interest’ includes the –

‘(a) gross amount of any interest or similar finance charges, discount or premium payable or receivable in terms of or in respect of a financial arrangement’.

The Act does not define the term ‘similar finance charges’, however, prior to the Taxation Laws Amendment Act 15 of 2016, which was promulgated on 19 January 2017, the provision read ‘interest or related finance charges’. The change was effected in an effort to clarify the policy position and arguably to narrow the application of this provision to finance charges of the same kind. Prior to the amendment, the term ‘related finance charges’ was quite widely interpreted. In the case of Commissioner, South African Revenue Service v South African Custodial Services (Pty) Ltd 2012 (1) SA 522 (SCA) the taxpayer entered into various loan agreements in respect of which it was required to pay several fees incurred in connection with these agreements, including –

• guarantee fees;
• introduction fees;
• financial advisory and margin fees; and
• commitment, administration and legal fees.

In this regard, Plasket AJA concluded that ‘the various fees are deductible in terms of s 11(bA): because of their close connection to the obtaining of the loans and the furtherance of SACS’s project, they qualify as “related finance charges” for purposes of the section.’ Section 11(bA) of the Act has since been repealed, however, the court’s findings provide an indication of how front-end fees would be treated.

While South African courts have yet to consider the issue in full, the findings of foreign tax authorities may serve as a point of reference. In the Singaporean case of GBG v The Comptroller of Income Tax [2016] SGITBR 2 the taxpayer entered into three facility agreements, all of which were conditional on the payment of front-end or facility fees. The taxpayer then claimed deductions for these fees against their income in terms of s 14(1) of the Singaporean Income Tax Act 1967, which is comparable to s 11(a) of the Act. The relevant section reads as follows:

‘Deductions allowed

14(1) For the purpose of ascertaining the income of any person for any period from any source chargeable with tax under this Act (referred to in this Part as the income), there shall be deducted all outgoings and expenses wholly and exclusively incurred during that period by that person in the production of the income, including –

(a) except as provided in this section –

(i) any sum payable by way of interest; and

(ii) any sum payable in lieu of interest or for the reduction thereof …, upon any money borrowed by that person where the Comptroller is satisfied that such sum is payable on capital employed in acquiring the income’.

As the taxpayer in this case did not draw down from the facilities, either for capital or revenue purposes, the Income Tax Board of Review (the Board) concluded that as borrowing did not occur the front-end fees payable on the facility were not a substitute for interest expenditure and were thus not deductible. The Board, however, also came to the following conclusion regarding instances in which such fees will be deductible:

‘“Any amount payable to the lender … at the beginning … of the term of borrowing, which is equivalent to the interest which the borrower would otherwise be required to pay to the lender under the loan agreement”, so if the loan is subsequently drawn down within the same year (thereby meeting the requirement under section 14(1)(a) that the expense is payable “upon any money borrowed”), a deduction should be allowed.’

On the other hand, the Australian tax authorities, under Interpretative Decision ATO [Australian Tax Office] ID 2010/133, have held that upfront commitment fees, or front-end fees, are not interest nor of a similar nature as interest, as these are ‘not payable for the actual use of any sum of money or conversely for keeping another person out of the use of any sum of money’ and could, therefore, not be deducted in terms of their income tax legislation.

It remains to be seen whether, in light of the above decisions, the South African Revenue Service, or a court, would permit the deduction of front-end fees under s 11(a) of the Act. A further consideration to be taken into account is that of s 8FA of the Act, which provides that any amount incurred by a company in respect of ‘hybrid interest’ will be deemed to be a dividend in specie and not deductible. The definition of ‘hybrid interest’ includes any amount of interest that is not determined with reference to a specified rate of interest or with reference to the time value of money. It stands to reason that, if front-end fees are structured specifically as being related to interest as contemplated in s 24J of the Act and the front-end fee is not determined with reference to either a specified rate of interest or to the time value of money, then those fees may be taxable as dividends and will in any event not be deductible in terms of s 8FA(2)(a) of the Act.

It is, therefore, imperative that these considerations are taken into account when advising a client on structuring a loan or financing arrangement that includes a front-end fee.

Pranith Mehta BCom (UKZN) BCom Hons (Unisa) LLB (Unisa) is an attorney at Allen & Overy in Johannesburg.

This article was first published in De Rebus in 2018 (Nov) DR 19.