A South African parent company, Crookes Brothers Ltd, owned 99% of the shares in a subsidiary in Mozambique, MML.
Crookes Brothers and MML entred into a loan agreement.
According to the agreements MML would not be obliged to repay the loan in full within 30 years. Furthermore, repayment of the loan would not take place if the market value of the assets of MML were less than the market value of its liabilities as of the date of the payment, and no interest would accrue or be payable.
According to clause 7 of the loan agreement, in the event of liquidation or bankruptcy of MML, the loan would immediately become due and payable to Crookes Brothers.
At the time of submitting the 2015 income tax return, Crookes Brothers made an adjustment to its taxable income in terms of section 31(2) and (3) on the basis that an arms-length interest rate should apply.
Later, Crookes Brothers requested a reduced assessment on the basis that the loan met the requirements contained in section 31(7) and was excluded from normal arm’s length interest requirement.
The “arm’s length interest rate exclution” in section 31 of the Income Tax Act, No 58 of 1962 (Act) containing South Africa’s transfer pricing provision applies where a controlled foreign company is not obliged to redeem the debt in full within 30 years from the date it is incurred.
The tax authorities rejected the request on the basis that according to clause 7 of the agreement the loans would become immediately due and payable in the event of liquidation or bankruptcy of MML. Therefore the requirements of section 31(7) were not met.
This decision was appealed by Crookes Brothers to the South African High Court.
The Court agreed with the tax authorities,