Question
A company operates commercial lodges not only on land that it owns but also on land owned by it's 100 % owned subsidiary.The sudsidiary owns land and buildings and it's only debt are shareholder loan owing to the holding company. The loan of the holding company is interest free and no rent is charged by the subsidiary company. All expenses associated with the property as well as related to the maintenance of the property is paid by the holding company. All income earned by the holding company from third parties are retained by the holding company. The subsidiary is essentially dormant. There is no lease agreement in place.

Are there any tax consequences in terms of tax law ?

My concern is that SARS may want to impose deemed rental and interest as essentially no rent is charged in lieu of no interest being charged and all expenses being borne by the holding company. Or is it acceptable to arrange one's affairs in the manner described.


Your View
It is acceptable to treat the subsidiary as dormant as described.


 Answer
The answer to this question can probably only be given comprehensively after a full consultation and this is outside the scope of this service. The answer below will give some guidance.

The answer below assumes that the two companies are both RSA tax resident companies. If one of them is not a RSA tax resident, the transactions between them will have to be accounted for, from a RSA tax perspective, at market value – both the loan and the use of the land.

Apart form the connected persons provisions, which mainly deal with the disposal and acquisition of assets between connected persons, the RSA income tax legislation does not have a similar provision (section 31) for transactions between two RSA resident taxpayers. The only provision in terms of which the above treatment is at risk from a tax perspective is section 23(g). A recent example of where section 23(g) was argued can be found in Tax case 12262 (reported on 7 December 2010). At issue were excessive management fees.

In your case it could well be that SARS could argue that the holding company has an asset (the loan) which does not produce any income and in terms thereof they may then disallow the deduction of some expenses (such as interest) of the holding company.
It is not clear why the subsidiary must be kept dormant. The Supreme court of appeal has, a recent as 1 December 2010 (in the SARS v NWK case), confirmed that “There is, in principle, nothing wrong with arrangements that are tax effective.” It went further to state “there must be some substance – commercial reason – in the arrangement, not just an intention to achieve a tax benefit or to avoid the application of a law.” If the reason for not accounting for the transactions is because of losses in the subsidiary, SARS may well be in a position to disallow expenses in the holding company.
A further concern is the possible application of section 64C in respect of the interest-free loan granted to a connected persons of a shareholder.

 Source : SAICA