TAX ALERT…Deemed Interest Income by Shah N Kadall CFE, CFA, IFC
‘Deemed Interest Income’ charged by MRA
The ARC ruling on 26 th May 2016 in the case of Innodis v MRA has created uncertainty regarding the tax implications of interest-free loan advanced to Subsidiary/Related company in Mauritius.
The Question
Whether as per Section 75 of the ITA ‘arm’s length principle’, the MRA may charge a Domestic Company ‘ Deemed Interest Income’ on loan given to a Subsidiary/Related Company who received the ‘benefit’ of an interest-free loan?
In the majority of cases where interest-free loan are received, no ‘consideration’ is provided in return for the use of the capital on interest-free loan. Most of the Subsidiary/Related company in Mauritius have the ‘benefit’ of not paying any interest on loan it received as an interest-free loan.
1. What is Interest?
There are two types of interest. One is legal and the other one is conventional. Interest is a compensation fixed by the parties for the use of money which is referred to as ‘monetary interest’. Interest may also be imposed by the MRA under Section 122D of the Income Tax Act or by the courts as penalty damages which is referred to as ‘compensatory interest’. The right to interest arises only by contract for delay to pay the principal loan on which interest is demanded as per the Mauritius Civil Code.
2. What is ‘deemed interest?
The taxation of interest income is made on a receipt basis and not on an accrual basis. There is a difference between ‘direct interest’ and ‘deemed interest’ since direct interest is interest received and deemed interest is just adjusted for tax purposes. Therefore, any deemed interest charged by the MRA may not give rise to additional tax collection until the interest income has been received and there is a contract in the first place.
3. What is arm’s length principle?
The arm’s length principle came into force in Mauritius in the year 2003. Arm’s length principle commonly applied to ‘commercial and financial transaction’ between related companies, i.e. transaction should be valued as if they had been carried out between unrelated parties, each acting in his best own interest. However, the arm’s length test apply to see whether companies that contractually charged interest abide to the market condition, bank rate and repo rate. For example if a company has contractually charged interest at say 8% and according to the prevailing market condition the rate of interest is 12%, then the nature of that transaction would not be at arm’s length.
What does the provision of law say on interest?
A loan is an advance of a sum of money with deferred repayment terms. Interest is not essential and there is no Local Legislation governing that any lender is required by law to charge interest on a loan. It is purely a bilateral contract agreement between two parties that interest be charged on that loan. The charging of interest is at the discretion of the parties.
The general purpose of obtaining a loan by a subsidiary company is to obtain financing from the parent company in order to fund a need in the business or for business operational purposes and once fulfilled, to repay that loan advanced. Interest is not payable unless it has been agreed upon in terms of an agreement between the parties that is a (contract done as per the provision made under the Article 1134 of the Mauritius Civil Code).
The Mauritius Civil Code
Mauritius has inherited two systems of law namely the Common Law from UK and the Civil Law from France.
Common Law is the law that has evolved from UK courts going back to the Norman Conquest in 1066. These earlier decisions set “precedent” which are used in future cases of a similar nature.
Civil Law is the law that evolved from the Roman law, based on written “civil code”. This was adopted in France after the French Revolution in 1789 called the Code de Napoleon which covered only matter of private law. The civil code sets out the organizing, concepts, principles, rules and ideals of law. It does not rely on precedents as with the British Common Law. Civil Law is used in many European Countries as well as Mauritius.
Inspired by the 1804 Code Napoleon, the French Civil Code was extended to Mauritius since 200 years ago by decree of Decaen, Capitaine-General, on 21 April 1808. When the French left Mauritius in 1810 both the French and the British executed the “Acte de Capitulation” on the 3 Dec 1810 at 1 a.m at the British Head Quarters and where under the Code Farquhar at Article 8, it is stipulated that ‘the inhabitants shall preserve their religion, laws and customs ‘. The 1808 decree was further enacted in 1974 called the “Code Civil Mauricien”. In the Privy Council case of Shophold (Mauritius) Ltd v ARC Mauritius [2016] UKPC 12, Lord Hodge stated at paragraph 21 that ‘Mauritian law of contract is derived from the French Civil Code.’
Our law in Mauritius as per the French Civil Code only provides for capitalisation of interest by banks under Article 1154 and 2202-6. The parent company is not a bank and does not hold a money lending licence and the law does not require them to charge interest. Even religious communities such as the ‘Muslim Law’ per the ‘Coran’ in which there is ‘no shades of grey’, require that no interest be charged on loans provided.
The Banking Act 2004
Furthermore, up until December 2013, the activity of money lending in Mauritius by entities licensed as Mauritian Banks under the Banking Act 2004 (BA) was governed by the Money Lenders Act 1960 (MLA). The MLA was repealed on 21 Dec 2013 and licensing requirements for money lenders were moved under the BA. The Finance Act 2015 adopted in May 2015 brought amendments to the BA clarifying the scope of the money lender’s licence. In a new schedule 4, the BA provides a list of persons exempted from money lender’s licence. However, these new provisions open the debate regarding the need for a licence for intra-group lending between domestic holding companies and their subsidiaries.
Conclusion
I am of the opinion:
Ø that collection of any ‘Interest’ without any stipulation in writing is in breach of the civil code;
Ø that any ‘Interest’ is not payable unless it has been agreed by the parties;
Ø that if as per the contract no specific ‘Interest’ is charged, no right accrues to the company to earn ‘Deemed interest income’; and
Ø that any alleged tax on ‘Deemed Interest Income’ is unfair and may be null and void.
An appeal in this regard has been sent to the Ministry of Finance as this may disrupt the business and entrepreneurial atmosphere of many domestic companies in Mauritius. The rest I leave it for the ‘Grand Argentier’ wisdom and fine sense of judgment.
My sentiments to all negativism is just this ‘muddai lack bura chahe to kya hota hai, wahi hota hai jo majure khuda hota hai’. This couplet in urdu simply means that even if people speak ill of you and wish for bad things to happen to you, only that will happen which God has in store for you.
Regards
Shah N Kadall, CFE, ICFA, IFC, MQA
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