The evolution of interest deduction rules

By Zandi Setai – Junior Consultant

Introduction

South African tax law has long grappled with the deductibility of interest expenditure. SARS Practice Note 31 (PN 31), introduced in 1994, provided tax relief to taxpayers claiming interest‑related deductions in circumstances where they were not regarded as carrying on a trade. However, legislative developments and concerns around abuse have prompted a decisive shift.

With the withdrawal of PN 31 and the introduction of section 11G of the Income Tax Act - applicable to years of assessment commencing on or after 1 January 2026, taxpayers are now subject to a narrower, codified framework governing interest deductions outside the carrying on of a trade. This article examines the evolution from PN 31 to section 11G and considers the practical implications for taxpayers.

Background to Practice Note 31

PN 31 was issued to address situations in which taxpayers earned interest income but did not meet the requirement of carrying on a trade for purposes of section 11(a) of the Income Tax Act. It acknowledged that expenditure could be incurred in the production of interest income even where the underlying activity did not constitute a trade.

Under PN 31, SARS accepted that such expenditure could be deducted, limited to the amount of interest received or accrued. Although this position lacked a strict legal basis, it developed as an administrative practice applied by SARS over time.

The relief prevented the automatic denial of deductions solely on the basis that the taxpayer was not carrying on a trade, while ensuring that no assessed losses were created. Importantly, PN 31 applied only in limited circumstances: it did not apply where section 11(a) was already available, nor did it establish a general principle applicable to all expenditure, whether incurred in the production of interest income or not.

In practice, PN 31 was particularly valuable to companies and individuals incurring business‑related expenditure without meeting the onerous threshold of carrying on a money‑lending trade.

Reasons for Withdrawal

Over time, National Treasury and SARS became concerned that the flexibility afforded by PN 31 had become susceptible to abuse. While PN 31 initially served a legitimate purpose, according to National Treasury, its broad interpretation increasingly enabled taxpayers to structure transactions to maximise interest deductions in ways not contemplated by the original legislative framework. This raised concerns regarding revenue leakage and erosion of the tax base.

Notwithstanding these concerns, many taxpayers had legitimately relied on PN 31 for certainty and relief where interest‑related expenditure was incurred outside the carrying on of a trade.

further noted that subsequent legislative developments, including the introduction of targeted anti‑avoidance provisions, reduced the need for the continued relief provided by PN 31. From this perspective, the progressive codification of interest‑deduction rules rendered PN 31 increasingly obsolete. The withdrawal thus reflected a balancing of revenue protection against taxpayer reliance.

Withdrawal Process and Legislative Replacement

SARS formally withdrew PN 31 by way of Public Notice dated 30 December 2025. For all years of assessment commencing on or after 1 January 2026, the relief previously afforded under PN 31 is now governed by section 11G of the Income Tax Act.

This followed SARS’s announcement on 16 November 2022 of its intention to withdraw PN 31, with stakeholders invited to make submissions as part of the Budget 2023 Annexure C process.

After considering these submissions, National Treasury proposed the introduction of section 11G, which was subsequently enacted through the Taxation Laws Amendment Act No. 17 of 2025.

The consultation process was criticised by many stakeholders as being of limited practical value, with concerns that substantive submissions were not fully reflected in the final legislation.

Overview of Section 11G

Section 11G introduces a statutory framework governing the deductibility of interest expenditure in circumstances where the taxpayer is not carrying on a trade. The provision significantly narrows the scope of relief previously available under PN 31. In broad terms, interest is deductible where it is incurred in the production of interest income but not in the course of carrying on a trade. The deduction of the interest may not exceed the interest income produced.

PN 31 Compared to Section 11G

Under PN 31, taxpayers were permitted to deduct a range of expenditure incurred in the production of interest income, including interest, administration costs, bank charges and professional fees, subject to a cap equal to the interest received. Under section 11G, however, only interest expenditure itself remains deductible, with other related costs expressly prohibited (under section 23(g)) and the limit remains whereby the amount of interest deducted may not exceed the interest income.

Section 11G therefore represents a substantially more restrictive regime. The transition reflects a shift from flexible administrative practice to prescriptive legislation, characterised by:

• Narrower scope, with deductions limited to interest only;
• Legislative codification, reducing reliance on SARS’ discretion.

Practical Implications

Taxpayers and their advisers must reassess financing arrangements in light of section 11G. Continued reliance on PN 31 principles is no longer sustainable. In particular, taxpayers should:

• Re‑evaluate the deductibility of interest expenditure against the specific requirements of section 11G;
• Review existing funding structures and documentation;
• Consider the impact on provisional tax and year‑end assessments; and
• Monitor further SARS guidance or legislative amendments.

Failure to adapt may result in disallowed deductions and increased tax exposure.

Conclusion

The withdrawal of Practice Note 31 and the introduction of section 11G mark a fundamental shift in the treatment of interest deductions in South Africa. While the new framework enhances certainty and addresses perceived abuse, it significantly restricts relief previously available to taxpayers not carrying on a trade in earning interest income.

Tax practitioners and taxpayers alike must navigate a more stringent and prescriptive regime, with increased emphasis on compliance and documentation. Proactive review of financing arrangements will be critical to managing risk under the new legislative landscape.