Raising fees as similar finance charges

The issue before the Supreme Court of Appeal in the Cornucopia case was whether raising fees incurred by the Cornucopia Trust (“Cornucopia”) constituted similar finance charges (to interest) and were thus deductible in terms section 24J of the Income Tax Act, 1962. 

Background

Cornucopia conducts a property investment and leasing business.

It purchased from the George Nicholas Trust the following immovable properties:

• a property leased to Absa Bank Limited (Absa precinct); and
• a property leased to Life Healthcare Limited (Life Precinct).

Financing agreements were concluded as follows:

Absa precinct

• on 22 December 2021 a three-year facility agreement between Cornucopia, as borrower, and Sanlam Life Insurance, Sanlam Credit Division and Sanlam Capital Markets (“SCM”), as lenders, was concluded in an amount of R115 million. A floating interest rate with a fixed margin applied;
• in 2015, in anticipation of the termination of the above facility, a refinancing agreement was concluded which increased the total facility to R170 million;
• in 2018 two further refinancing agreements were concluded. One was a Mezzanine Refinance Facility for R16 million and the other was for an amount of R170 million to settle the capital amount in respect of the 2015 refinancing agreement;

Life precinct

• on 22 December 2021, an 11-year loan facility of R295 million was concluded. A fixed interest rate of 10.62 per cent per annum applied;
• in 2019 an addendum was concluded for an additional amount of R150 million (to acquire a property to be used as a dialysis centre, to fund works on various buildings, and to repay loans of R92 million owing to the George Nicholas Trust).

Raising fees

A fee letter, dated 22 December 2011, recorded that, for both the Absa precinct facility and Life precinct facility, in consideration for arranging the facilities, SCM would be paid a fee equal to two per cent of the respective facilities. Half was to be paid on signature, and the remaining half was to be paid on the earlier of 31 March 2012 and the date on which the mortgage bond was registered.

The other agreements made provision for raising fees as follows:

• the 2015 agreement made provision for a raising fee on the terms and conditions set out in the fee letter (which oral evidence suggested was two per cent as no fee letter was provided);
• the 2018 Mezzanine Refinancing Facility agreement recorded the raising fee as two per cent of the total commitment as set out in the fee letter. The fee letter recorded that the raising fee:
  • is payable on demand from SCM; and
  • is an ‘advance condition’ to be fulfilled prior to the use of the Mezzanine Refinancing Facility;
• the fee letter, in respect of the other 2018 Refinancing Facility, was worded on a similar basis;
• the 2019 addendum made provision for a raising fee of R3 million payable on signature against receipt of an invoice. The addendum recorded that the raising fee was an ‘advance condition’ to be fulfilled prior to the use of the facility.
• The court summarised the position as follows:

“In sum, each facility agreement referred to a raising fee payable as a precondition for drawing down on the facility. The raising fee was regulated under the terms of a fee letter. The fee was two per cent of the capital and was payable to SCM upfront as the facility agent, irrespective of whether SCM or a different Sanlam entity was the lender.”

Cornucopia’s managing trustee testified as follows:

• he dealt with financial institutions over the years and the raising fee they charged was generallytwo per cent of the total loan amount;
• he suggested that the interest rate and the raising fees were determined according to how Sanlam structured their financing facility and how they assessed their cost of funding;
• the raising fee may decrease if the loan is for a shorter period.    

Dispute

Cornucopia spread its raising fee deductions over the duration of the loan facility to which it related i.e. it claimed portions of the raising fees as deductions of interest under the yield to maturity method set out in section 24J.

SARS disallowed the raising fee 24J deductions on the basis that they did not constitute similar finance charges (to interest).

The tax court upheld Cornucopia’s appeal and held that raising fees were similar finance charges as envisaged.

Interest definition

Section 24J(1) defines ‘interest’ as follows:

“includes the –

1. gross amount of any interest or similar finance charges, …, payable or received in terms of or in respect of a financial arrangement …

irrespective of whether such amount is –

1. calculated with reference to a fixed rate of interest or a variable rate of interest; or
2. payable or receivable as a lump sum or in unequal instalments during the term of the financial arrangement;”

(underlining reflects emphasis)

Note that before 19 January 2017, the definition of interest referred to related finance charges instead of similar finance charges.

SARS’ submissions

SARS’ submissions were as follows:

• the raising fees in question lacked the fundamental characteristics of interest;
• the raising fees were upfront and once off payments incurred before the loan agreements became effective;
• the raising fees were conditional to drawdowns;
• the raising fees were paid for arrangement of the loans - not for the use of borrowed money;
• the raising fees were not linked to the time value of money;
• the raising fees were not compensation linked to the outstanding capital balance;
• the raising fees were not compensation linked to the loan duration;
• similar meant of the same nature with the same characteristics;
• the raising fees were not similar to interest.

SARS accepted the following:

• raising fees form part of the cost of credit;
• raising fees qualify as finance charges;
• the loans in question constituted loans for consumption (under South African law).

Cornucopia’s submissions

Cornucopia’s submissions were as follows:

• the narrowing of the definition from related finance charges to similar finance charges was not intended to excise raising fees from the interest definition;
• raising fees are an economic reality of modern finance;
• raising fees are an inevitable requirement when acquiring a loan;
• a raising fee is the key that unlocks funds i.e. without a raising fee there would be no access to, and no receipt of, the loan funds;
• the raising fee is inextricably linked with obtaining the loan and constitutes a payment for the credit advanced;
• similar denotes a relevant resemblance rather than an identical resemblance;
• a raising fee is a finance charge similar to interest as both constitute a cost of credit;
• the raising fees in question fell squarely within the concept of similar finance charge.

Majority decision 

To determine whether the raising fees are similar to interest the court had to determine the following:

• the nature of interest;
• the nature of finance charges;
• whether the raising fees were similar to interest.

Nature of interest

In the majority’s view, interest:

• is a payment which becomes due because the creditor has not had his money at the due date. It represents the profit the creditor might have made if it had use of the money, or the loss it suffered because it did not have that use (a creditor is entitled to compensation for the deprivation);
• is consideration for the benefits (credit or rights to obtain credit) the lender allows the borrower;
• may accrue immediately to the lender upon advancing the loan (although the right to claim payment is delayed by a time clause – consistent with the notion that interest is consideration for the supply of money);
• reflects the time value of money plus a quid pro quo for the lender’s forbearance in awaiting repayment and compensation for the risk involved;
• is the functional cost of credit (cost of credit plus a margin).

Nature of finance charges

The majority referenced the following:

• finance charges are defined as the total cost, including interest, that one must pay for borrowing money in the form of a loan or with a credit card;
• a finance charge is a fee charged for a service, or the provision of a facility (making credit available);
• a raising fee constitutes consideration for a service which is the provision of credit.

Similarity

In assessing similarity, the majority’s reasoning was underpinned by the following reasoning:

• related meant connected – a term broader than similar;
• the meaning of similar ranges from ‘having characteristics in common, strictly comparable, to looking or being almost the same but not exactly the same, and of the same kind in appearance, character or quantity without being identical’;
• importantly, cognisant that the amendment from related to similar was enacted to narrow the scope of 24J deductible finance charges, there had to be some finance charges that are similar to interest - otherwise the words or similar finance charges would be rendered superfluous;
• SARS’ examples of similar finance charges (being substitute margin/profit spread, and default interest) were not clear illustrations of recognisable finance charges similar to interest;
• the court had to consider where on the scale the required similarity or required relative resemblance had to be placed (having regard to the triad of language, context and purpose);
• the amendment’s purpose was not to confine deductibility to the most obscure forms of finance charges – instead it was to restrict the broader connectivity/related test applied by the Supreme Court (which pre-amendment included various service fees connected to obtaining loans - such as guarantee fees, advisory fees, margin fees, commitment fees, administration fees, and legal fees);
• the amendment was not intended to eliminate every fee – though it ensures that legal fees, financial advisory fees, and other fees be excised from section 24J if not strictly necessary for the loan;
• if the credit would not be granted absent the raising fee, then, together with interest, it constitutes consideration for the loan. In such circumstances it has the same function as interest in the provision of credit and creates a direct link between the raising fee and the use of capital;
• where the raising fee is directly proportionate to the amount of the loan it is not merely consideration for work done in providing, arranging or setting up the loan but an indivisible cost of the raising of credit payable by the borrower to the lender as compensation for using its money (which bears the same characteristics as interest);
• raising fees strictly linked to the procurement of the loan (in amount and objective) and which compensate the lender for the risk and cost of being deprived of its money qualifies as similar as they have the same functional characteristics as interest (relying on a statement by academics that similar finance charges are any kind of charge levied with the intention and having the effect of raising the effective interest burden on the transaction as a whole);
• on the facts one could not state that the interest was incurred for the use of capital while the raising fees were the costs of acquiring the capital for the following reasons:
  • the sum of the raising fee was directly linked to the interest rate charged, and also linked to the period of the facility based on the uncontested evidence of the managing trustee; 
  • where a raising fee is quoted as a percentage of the loan that is entered into for a relatively short period the raising fee is inextricably linked;
  • the raising fee was determined according to the time value of money in that the lender required initial early compensation for the use of the capital and the once off payment did not detract from the raising fee compensating the lender for the time value of money (supported by the interest definition which specifically includes amounts payable as a lump sum);
  • if interest is compensation for the time value of the money as well as the risk taken by the lender in providing the loan, the raising fee is similar in character;
  • the raising fees shared the same characteristics as interest in that they were payments to mitigate the risk of non-repayment of the loan and compensation for the deprivation of the use of the money;

The majority indicated that raising fees charged for efforts associated with obtaining a loan would not qualify as similar finance charges. It distinguished ancillary charges such as legal fees, financial advisory fees, and other charges incidental to the loan and charged as compensation for the labour associated with arranging the funds – as such fees are not a necessary part of the loan so as to permit the taking of the risk and bearing the potential loss or profit to the lender.

Minority judgment

The minority judgment referred to interest as being the price of the supply of credit or the return for the provision of credit. It held that defining incidents of interest is that it is a return payable to the lender measured by reference to both the amount advanced and to the period for which the advance remains outstanding. In support of its view it touched upon section 8F’s (an anti-avoidance provision’s) treatment as dividends amounts denominated as interest but not calculated with reference to a specified rate or to the time value of money. In other words, amounts untethered to time and the outstanding balance are not treated as interest by the statute. 

It also concluded that the Genn decision did not decide whether raising fees qualified as similar finance charges (holding that Genn decided that the raising commissions there together with interest formed consideration for the use of the money for the duration of the loan and was tax deductible under the more general deduction provision). 

The minority judgment rejected the contention that because the interest definition made reference to interest being paid as a lump sum, the definition jettisoned the pre-requisite enquiry of whether a lump sum resembles interest.  

The minority judgment referenced academic commentary indicating that raising fees are calculated at the commencement of the arrangement, are added to the cost of acquisition, and remains payable in full (even if the borrower accelerates payment).

The minority judgment distinguished the raising fees from interest on the following bases:

• it was a single charge;
• it was fixed at two per cent of the capital;
• it was a precondition to any drawdown;
• it was payable irrespective of whether Cornucopia used the whole facility;
• it bore no relation to the term of the loan;
• it was payable in full despite early settlement;
• it was payable to SCM as facility agent and was payable even in respect of facilities in which SCM advanced none of the money;
• in the words of the fee letters, it was consideration for SCM ‘arranging’ the facility.

For these reasons it concluded that the raising fees were not a return to the lender referable to the outstanding capital over time. It held that the raising fees were the cost of obtaining capital and resembled the price of a service rendered once at the outset in return for access to a loan (instead of the price for use of borrowed money over time).

Conclusion

The question of whether a particular amount is deductible on the basis of being a finance charge similar to interest is dependent on the extent and nature of its similarity to interest. 

The majority reasoned that, in the section 24J definition of interest, similarity requires functional similarity (in the sense of being a necessary cost of credit as explained above). The majority did not accept that similarity meant a price of credit calculated with reference to the outstanding loan balance and the actual passage of time (as espoused by the minority).