IN THE SUPREME COURT OF APPEAL
OF SOUTH AFRICA
REPORTABLE
Case No: 443/97
In the matter of:
TICKTIN TIMBERS CC
Appellant
and
THE COMMISSIONER FOR INLAND REVENUE
Respondent
Coram:
Hefer, Grosskopf, Marais, Zulman JJA et
Madlanga AJA
Date of hearing:
16 August 1999
Date of delivery:
10 September 1999
Income tax - sec 11(a) and 23(g) of Income Tax Act 58 of 1962 - close
corporation - distribution of profits to sole owner - amount distributed
simultaneously lent by owner to corporation - whether interest on loan paid
to owner by corporation deductible.
J U D G M E N T
Hefer JA

[1]    This appeal is against the judgment in Commissioner for Inland
Revenue v Ticktin Timbers CC 1997(3) SA 625 (C) in which the full
court of the Cape Provincial Division upheld the Commissioner’s
refusal to allow the appellant, a close corporation, to deduct  interest on
capital borrowed from its only member from its income for the purpose
of determining its taxable income during the 1985 to 1989 years of
assessment.   What has to be decided is whether the full court’s finding
that the interest did not constitute expenditure incurred in the
production of the corporation’s income as envisaged in s 11(a) of the
Income Tax Act 58 of 1962, as amended, is correct.
[2]      The general deduction formula of the Act and its precursors has
received the attention of the courts on many occasions and, although
problems arising from its application in particular cases still present
themselves, its ambit is well-defined.   For present purposes it suffices
to record the following:
(a)
S 11(a) which allows the deduction of non-capital
“expenditure ... actually incurred ... in the production of the
income” is subject to s  23(g) which (before its amendment
during 1992) prohibited the deduction of moneys “not
wholly or exclusively laid out or expended for the purposes

of trade”.
The combined effect of the two sections is that
“[i]f expenditure is incurred ‘in the production of
income’ and ‘wholly and exclusively for the purpose of
trade’ it is deductible, otherwise not.”
(Per Watermeyer AJP in Port Elizabeth Electric Tramway
Co v Commissioner for Inland Revenue 1936 CPD 241 at
245.)   The enquiry must accordingly proceed by
examining, on the facts of each case, firstly, whether the
expenditure in question can be classified as expenditure
actually incurred in the production of income and, secondly,
whether its deduction is prohibited by s 23(g)
(Commissioner for Inland Revenue v Nemojim 1983(4) SA
936 (A) at 947A).
(b)
The purpose for which the expenditure was incurred is the
decisive consideration in the application of s 23(g).   As far
as s 11(a) is concerned, Corbett JA said in Commissioner
for Inland Revenue v Standard Bank of SA Ltd 1985(4) SA
485 (A) at 500H-J:
“Generally, in deciding whether money outlayed by a
taxpayer constitutes expenditure incurred in the
production of income (in terms of the general
deduction
formula)
important
and
sometimes
overriding factors are the purpose of the expenditure

and what the expenditure actually effects;  and in this
regard the closeness of the connection between the
expenditure and the income-earning operations must
be assessed.”
(c)
There can be no objection in principle to the deduction of
interest on loans in suitable cases.   Loan capital is the life
blood of many businesses but the mere frequency of its
occurrence does not bring about that this type of
expenditure requires different treatment.   (Cf the Standard
Bank case and Natal Laeveld Boerdery (Edms) Bpk v
Kommissaris van Binnelandse Inkomste 1989(1) SA 639
(A).)
[3]      The interest which concerns us in the present case was credited
annually on the accumulated balance in the loan account of the
corporation’s member, Dr David Ticktin.   The sole issue is the purpose
for which the loan was made.   In order to decide it, it  is necessary to
deal briefly with the facts.
[4]      The appellant came into being during 1985 when Dr Ticktin
acquired the shares in a private company and converted the company
into a close corporation.   Among the company’s assets was a
substantial amount of distributable reserves which, in terms of s 40A of
the Act (as it then read), were deemed to have been distributed to the

corporation.   In the first entry in the loan account the balance of the
reserves after tax was credited to Dr Ticktin.  Thereafter the
corporation’s net income until 30 June 1985 was also credited to him;
and so was its net trading income for every ensuing year until 1989. Dr
Ticktin’s explanation is to the effect that, as sole member of the
corporation, he was entitled to whatever dividends he wished to
declare; and that all the credits were passed in respect of dividends
which he had declared but retained in the business as an interest
bearing loan in order to finance its day to day operations.
[5]      It is quite clear that it was of Dr Ticktin’s own doing that the
appellant was in effect compelled to exist on borrowed capital.   There
was no obvious need for the diversion of money which had accrued to
it and could have been used to finance its trade.   The question is:
Why did Dr Ticktin deprive the corporation of the benefit of using its
own money and instead saddle it with the apparently unnecessary
burden of paying interest?
[6]      We have the answer from his own lips.   His evidence is that it
was agreed when he purchased the shares in the erstwhile company
that the purchase price would not be payable immediately because the
transaction was structured as a “loan”.   Asked about the way in which

the transaction was financed, he replied:
“The purchase price was about R1.8 million.   They gave me a loan
in my personal capacity for which I was going to service it via
Ticktin Timbers.”
Elsewhere he said:
“When I purchased the business and obtained a loan basically from
the family represented by the trusts, it was agreed that I would pay
them interest at 3 per cent below prime.
MR EMSLIE:  So, the interest on the loan account was pegged at
a similar figure, similar rate.   Would you agree with the statement
then that from your point of view, you wanted to be able to charge
interest on the amounts standing to your credit in your loan
account, so as to be able to pay interest to your brothers and
sisters? ... Certainly, yes.”
Equally instructive is the answer to a question which the Commissioner
posed in a letter to the appellant’s accountants after the appeal to the
Special Court had been noted.   The Commissioner wanted to know
what the purpose of the loan by the sellers of the shares was.   The
answer was as follows:
“1.   The purpose of the loans was to enable Dr Ticktin to acquire
his interest in the companies which in terms of the agreement were
to be converted into Close Corporations.   The agreement obliged
Dr Ticktin to structure his interest in the form of loan capital
(debt rather than equity) to the extent that this was done, thereby
ensuring that he would earn interest income.
2.   The agreement in terms of which Dr Ticktin was and is
liable to pay interest to the trusts also obliged him [to] advance
funds by way of loan capital.   The link between the interest
paid/incurred and the interest earned is thus clear.   The payment
of interest to the trusts was the sine qua non of the interest
earned by Dr Ticktin.”
These extracts from the record, particularly the portions  which I have

emphasized, reveal all that we need to know.   It is plain that the whole
scheme of diverting the corporation’s funds and making them available
again in the form of an interest bearing loan was devised and agreed
upon when Dr Ticktin bought the shares.   Its obvious aim was to
ensure that he would be able to pay the interest on the purchase price
(and possibly even the purchase price itself).
[7]      Appellant’s counsel argued that all this is irrelevant.   The motive
for Dr Ticktin’s actions, he submitted, does not concern us;  what has
to be determined is the corporation’s purpose in taking up the loan  and
on this we have Dr Ticktin’s evidence which is confirmed by the fact
that the money was used to finance the corporation’s trading. I do not
agree. When the corporation started trading it had already been agreed
that a loan account would be opened.   Qua member Dr Ticktin was
aware of his personal contractual obligation and there is no reason to
suspect, nor did he suggest in his evidence,  that he did not intend to
carry it out. As Nicholas AJA aptly remarked in Commissioner for Inland
Revenue v Pick `n Pay Wholesalers (Pty) Ltd 1987(3) SA 453 (A) at
470J in dealing with a comparable situation, “a man does not change
his mind when he changes his hat.”   I agree with the court a quo that
the loan was not needed for the appellant’s income producing activities

and that the intention was to increase Dr Ticktin’s income, not that of
the appellant.   The liability for the interest was accordingly not incurred
in the production of the latter’s income.   But, even if it was, the loan
plainly served a dual purpose, one of which had no bearing on the
appellant’s trade.   The deduction of the interest was thus prohibited by
s 23(g) and the Commissioner rightly refused to allow it.
[8]      There is another way of looking at the matter which leads to the
same result.  It is trite that interest paid on a loan which was raised in
order to enable a dividend to be paid is not expenditure incurred in the
production of income and is therefore not deductible.   A company or
corporation is not obliged to pay a dividend or make a distribution
respectively irrespective of the financial circumstances in which it finds
itself.   If, after doing so, it will have the resources to enable it to
continue its income earning activities without having to borrow
simultaneously an equivalent amount no problem arises.   When it will
not, but none the less pays a dividend or makes a distribution and
simultaneously raises a loan in exactly the same amount, it becomes
a question whether or not the purpose of the loan was to enable a
dividend to be paid or the distribution to be made or to provide the
entity with liquid funds required to enable it to pursue its income earning

activities.
[9] What happened in this case?   Simply put it amounts to this.
Appellant had enough money in its coffers to finance its income earning
operations without borrowing and incurring an obligation to pay interest.
It was under no obligation to use that money to make a distribution and
its controlling mind (that of Dr Ticktin) was well aware that, if it was
used for that purpose, it would be necessary to borrow simultaneously
an equivalent amount and pay interest on the loan.   It is quite clear that
the relevant transactions, namely, the making of the distribution on the
one hand, and the making of the loan, on the other, were not intended
to be separate and unconnected transactions.   They were plainly
interdependent and neither was intended to exist without the other.  It
is this linkage which, to my mind, is fatal for appellant’s case for it
shows that the true reason why appellant had to borrow back at interest
from Dr Ticktin money which it had had in its own coffers and was
under no obligation to part with, was because it wanted to make a
distribution to Dr Ticktin.   The fact that he was the sole owner of the
corporation makes it clearer still.   On that view of the matter, Dr
Ticktin’s personal obligations to his siblings are of little moment.   What
is of moment, as counsel for appellant rightly emphasised, is why

appellant incurred the interest bearing debt.   As I have said, the
answer seems plain: because it wished to make a distribution to Dr
Ticktin.  The interest was therefore not deductible.
[10] The criticism in 1997 SALJ 645 by Associate Professor Dendy of
the decision of the Court a quo is, in my view, misplaced and stems
from a failure to appreciate the significance of the linkage to which I
have referred and from an analysis of the transactions as if they were
not interdependent.  They obviously were and the conclusion of the
court a quo did not (as is suggested in the article) rest upon a wrong
assumption that the money in question was borrowed in order to
finance the making of the distribution.  It rested upon a correct finding
of fact on the evidence before the court that that was indeed the
purpose for which the appellant undertook to incur a liability to pay
interest which would not otherwise have existed.
[11]    It is of course so that the answer to the question whether or not
a loan is “needed” is not by itself conclusive in deciding whether interest
paid is deductible but it is certainly a highly relevant factor to be
weighed in conjunction with other relevant factors when examining
transactions in order to ascertain the real purpose driving them.
The concluding remarks in the article in question are

symptomatic of what I consider to be the faulty analysis of the problem
by its author:
“If Inland Revenue is not prepared to countenance the
treatment of interest on borrowed money as tax-deductible
in any situation in which a dividend has been declared,
then Parliament must be asked to amend the Income Tax
Act.  For, having allowed taxpayers to claim deductions
from gross income in respect of interest on money
borrowed for the purpose of producing income, the fisc
cannot be heard to cry foul if taxpayers so arrange their
financial affairs as to run their businesses on borrowed
money, and withdraw the profits earned by those
businesses in order to meet their personal debts.  (That
principle, indeed, was recognized as sound by Brand J
(Friedman JP and Farlam J concurring) in Van
Blommestein v Kommissaris  van  Binnelandse  Inkomste
1997 (1) JTLR 13 (C) at 21-23E, in which judgment was
delivered on the same day as the decision in Ticktin
Timbers.  The Van Blommestein judgment on the point was
incompatible with the test applied in Ticktin Timbers (see
1997 (1) JTLR at 4C-D, 1997 (3) SA at 629A-B).  Farlam
J, who concurred in the judgments in both matters,
apparently failed to see the inconsistency.)” (At 651.)
[12] The court a quo did not suggest that interest on borrowed
money is not tax-deductible “in any situation in which a dividend has
been declared”.  The second sentence conflates the identity of two
separate and distinct taxpayers (the business on the one hand and its
owner on the other) and begs the question.  If the business borrows
money at interest in order to distribute profits without a commensurate
loss of liquidity and it does so only because its owner needs money to

settle a personal debt, then the business has not in truth borrowed
money for the production of income.
[13] There is a clear conceptual distinction between, on the one
hand, a case in which a company in good faith and on the strength of
inaccurate financial statements furnished by employees declares and
pays a dividend, but shortly thereafter learns the true financial position
of the company and realises that the dividend should not have been
paid and that an equivalent sum will have to be borrowed to finance the
company’s trading activities and, on the other, a case such as the
present.  In the present case the purpose of the loan was to enable a
distribution to be made to Dr Ticktin.  Without the loan there would
have been no distribution;  without the distribution there would have
been no loan.   In the former case the interest paid will be deductible for
the loan was not procured in order to pay the dividend.  The fact that
the payment of the dividend was the historical cause of the company
needing to borrow is irrelevant.  The purpose of the borrowing was to
finance the company’s trading operations after it had parted with its
own resources while under the misapprehension that it could afford to
do so. The Van Blommestein case is quite distinguishable and I see no
inconsistency in the approach of the court which decided it and the

approach of the court a quo.
The appeal is accordingly dismissed with costs.
________________
JJF HEFER  JA
CONCURRED:
Grosskopf JA
Marais JA
Zulman JA
Madlanga AJA