Demand loans, prescription and tax

If a person advances money or credit to another person without a fixed date for repayment, unless the parties agree otherwise, the debt becomes due on the date of the conclusion of the agreement.  However, what is the position in the case of a so-called “demand loan”, that is, a loan agreement in terms of which the creditor has the power – by making demand – to unilaterally determine when the debtor must perform?

That question was at issue in the Constitutional Court case of Trinity Asset Management (Pty) Ltd v Grindstone Investments 132 (Pty) Ltd 2018 (1) SA 94 (CC).

In that case, the creditor advanced an amount of money to the debtor in terms of a simple written loan agreement. The salient term of the agreement was the following:

The Loan Capital shall be due and repayable within 30 days from the date of delivery of the Lender’s written demand.

The debtor argued that prescription began running when the loan amount was advanced. The creditor argued that prescription only began running when the creditor made a written demand for payment.

The majority of the judges in the Constitutional Court held that, unless the parties agree otherwise, a loan repayable on demand is due from the moment the advance is made, and that no specific demand for repayment needs to be made for the loan to be immediately due and repayable. Accordingly, prescription begins to run when the advance is made, unless there is a clear indication to the contrary.

However, the Court added the following (at paragraph [125]):

Ultimately, it is a question of fact whether the parties intended demand to be a condition precedent for the debt to be “due”. Loubser [an academic in a leading textbook] postulates the vivid example of a family trust. Say you make a loan to a close relative, your daughter, or your father. The daughter is studying. Or the parent is hard up. The circumstances show that the loan is on the never-never. The debt won’t be due, in any sense, legal, technical or practical, until you say, “Please won’t you pay back”. In that case, it is clear that the parties intend demand to be a condition precedent to repayment. The parties do not intend the debt to be “due” until demand is made.

Now, the prescription of a debt may give rise to tax consequences. For example: if a taxpayer bought trading stock from a supplier; and if the taxpayer deducted the price of the stock for income tax purposes. If the supplier forgets to claim payment for the stock from the taxpayer and the claim accordingly prescribes – then the taxpayer may conceivably realise a taxable recoupment or recovery in his hands, in terms of s8(4)(a) of the Income Tax Act, No 58 of 1962 (Act) (compare Omnia Fertilizer Limited v C:SARS 2003 (4) SA 513 (SCA)).

Conceptually, also, if a creditor purposefully allows a debt to prescribe (for example, in the case of a father who has made a loan to his daughter), the creditor may become liable for donations tax if the action of the taxpayer could be said to constitute “the gratuitous waiver or renunciation of a right” (see definition of “donation” in s55 of the Act).

The judgment in the Trinity Asset Management case appears to have created some confusion for taxpayers, especially in the case where the parties are in a special relationship, for example where a founder of a trust has made a demand loan to a trust, or a holding company has made a demand loan to its subsidiary.

However, it appears from the Trinity Asset Management case that, unless a creditor and a debtor who are in a special relationship agree otherwise, it is likely that a debt between them cannot prescribe, unless the creditor makes demand.

For example: A holding company has sold stock to its wholly-owned subsidiary, a start-up. The price of the stock is left owing on interest-free loan account with no fixed terms of repayment. The subsidiary deducted the price of the stock for income tax purposes. The loan account has been owing for a period of five years. Due to cash flow constraints, the subsidiary has not been in a position to repay the loan amount. The holding company has also not demanded repayment of the loan account.

It could be argued that in this scenario, it was not the intention that the debt (the price of the stock) would become due when the loan account arose. It could be argued that the holding company provided credit to the subsidiary on the “never never”. In other words, the parties likely intended that demand would be a condition precedent to repayment, that is, that the debt would be “due” the moment demand is made. Accordingly, the loan account would not have prescribed within three years of the date that the stock was supplied; the loan account would only prescribe within three years from the date that the holding company demands repayment of the loan account. And, accordingly, the subsidiary would only suffer a taxable recoupment or recovery if and when the loan were to prescribe in that manner, and not before.

It is apparent that each demand loan should be considered separately in the light of its terms and all the relevant facts – notably the relationship between the creditor and debtor – to determine whether it has prescribed and, accordingly, whether tax consequences have arisen.