Taxing Below Market Interest Loans in the U.S. and South Africa: A Case Study in Comparative Taxation (appearing under the title: Does Brummeria Sweep Clean?: A U.S. Tax Law Perspective)

Abstract:     
In Commissioner for the South African Revenue Service v. Brummeria Renaissance Ltd., South Africa’s Supreme Court of Appeal held that an interest-free loan produces taxable income for the borrower equal to the interest that would have been charged at market rates. Within South Africa, the Brummeria decision was widely criticized as an ‘economic disaster’ imposing ‘double taxation.’ Ignoring the benefit to a borrower of an interest-free loan, however, undermines the fundamental object of the income tax, which is to apportion taxes according to economic well being. The Brummeria judgment, nevertheless, fails to consider other critical aspects of the interest-free loan transaction. The proper tax treatment implicates multiple taxpayers and requires an appropriate balance between preventing tax avoidance and limiting the complexity of the income tax. This article compares Brummeria with U.S. tax law, which recharacterizes an interest-free loan as a loan bearing interest at the market rate, coupled with a non loan payment from the lender to the borrower that funds the payment of market rate interest by the borrower.

Keywords: South Africa, income tax, tax law

JEL Classification: H24, K34, F14, F33

working papers series