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February 24, 2023

Supreme Court of Mauritius rules on timing of deduction for passage benefits and application of deemed interest income on interest free loans

  • On 21 February 2023, the Supreme Court (SC) of Mauritius issued its judgment in the tax case of Innodis Ltd (the appellant). This was a long-awaited judgment following a ruling issued by the Assessment Review Committee (ARC) on 26 May 2016.

  • The ARC ruled in favor of the Mauritius Revenue Authority (MRA) on: (a) whether passage benefits (cost of air travel for employees) is deductible for corporate tax purposes even if the employees have not yet travelled; and (b) the application of a deemed interest income on the interest free loans (IFL) made by the appellant company to five wholly owned subsidiaries.

  • The SC upheld the decision of the ARC.

Executive summary

The SC upheld the decision of the ARC and therefore agreed that: (i) passage benefits are not deductible for tax purposes on an accrual basis; and (ii) interest should be recognized by the appellant for tax purposes, irrespective of the fact that from a commercial perspective no interest income was recognized by the parties.

Overall, the SC judgment may result in increasing the gap between the taxable profit and the economic profit and under the worst scenario, tax may well be paid on fictitious profits.

It appears that the SC did not consider the IFL from the standpoint of the subsidiaries in its analysis and the interpretation of the SC may give rise to double or treble taxation in the case of multi-tier structures in Mauritius.

It is not known at this time if the appellant will appeal the SC judgment to the Privy Council. There are a number of pending cases on IFL at the ARC level and the facts and circumstances of each case should be independently considered to determine the appropriate course of action.

Companies should assess the implications of this judgment regarding the manner that time passage benefits and IFL are treated for tax purposes. In our view, section 75 of the Income Tax Act (the Act) cannot be applied in isolation and the deductibility test for interest expense and the other anti-avoidance provisions on interest expense should be considered to determine the appropriate tax treatment. If the MRA applies this ruling without considering the tax treatment of the interest expense, there may be cases of economic double taxation.

It is important to note that section 75 of the Act does not have any corresponding adjustment for the borrower so that it is applicable on a stand-alone basis. At the same time, the application of section 75 of the Act does not necessarily imply that an adjustment must be made to the gross taxable income of the company. An adjustment to the allowable expense of the company is possible under section 75 of the Act.

Detailed discussion

Interaction of section 75 of the Act with the deductibility test

Section 19 of the Act is the legal basis pursuant to which a company is allowed to treat interest as a deductible expense in the computation of its tax results. Interest is deductible if it is in respect of the capital employed by the company in the production of the gross taxable income of the company.

Hence, if a company has an interest-bearing loan, the proceeds of which are exclusively used to advance an interest free loan to a related company, the interest expense is not deductible in full. Applying deemed interest income will give rise to economic double taxation. In the case of the appellant, it appears from the ruling of the ARC that the IFL were not financed by any interest-bearing debts. It also appears that this was not investigated further by the MRA at the time the appellants’ affairs were examined so that the MRA did not consider the possibility to restrict the interest expense.

The SC does not appear to have considered the interplay of section 19 of the Act with section 75 of the Act in its judgment.

Interaction of section 75 of the Act with the anti-avoidance clauses on interest expense

Irrespective of the fact that the proceeds from an interest-bearing debt may have been deployed to activities that give rise to taxable income, interest expenditure is treated as non-deductible in the following cases:

  • If the interest is paid to a nonresident that is not subject to income tax on such interest. This is effectively an anti-base erosion and profit shifting measure that seeks to protect the tax base of Mauritius.

  • Where the interest is not paid in cash within a reasonable period. This is irrespective of the fact that the lender may be fully taxed on the interest income under the accrual basis pursuant to section 5(2) of the Act.

  • Interest expense is also treated as non-allowable where such interest relates to debentures issued by reference to shares. This is irrespective of the fact that the terms and conditions of the debentures are comparable to third party arrangements and the requirements of section 19(1) of the Act are complied with. The interest that is re-characterized as a dividend under section 84 of the Act is not treated as a dividend for the purposes of the Act, considering the amendment made by section 11(a) (i) of Finance Act 2004.

The above is clear and unambiguous in the Act and it does not appear that these provisions were considered by the SC. The application of deemed interest income in cases where the corresponding interest expense is treated as non-allowable would also give rise to cases of economic double taxation.

Comments on the application of section 75 of the Act

We agree that section 75 of the Act is an anti-avoidance clause that applies to related party transactions. However, the starting point in the application of section 75 of the Act is a determination of whether a particular transaction is executed in the context of a “business” or an “income earning activity.” This does not appear to have been considered by the SC in its judgment. Taking an extreme example, we agree that in the case of a company that advances funds to a related party as part of an income earning activity is within the scope of section 75 of the Act.

It is also important to emphasize that the arm’s-length principle cannot be considered in isolation and the point of view of the related party benefiting from the funds should also be examined. In the case of the appellant, the subsidiaries would not have been able to contract with a third-party financier so that in an arm’s-length transaction, it would not have been able to execute a similar debt arrangement. The witness of the appellant explained that one of the subsidiaries did not own any assets and was therefore unable to arrange for any bank loan. Another subsidiary was facing financial difficulties and was subsequently wound up.

It is disappointing to note that the SC did not apply the doctrine of substance over form in its analysis and did not address the financial health of the subsidiaries in its interpretation.

Impact of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations

Article 9 of the Organisation for Economic Cc-operation and Development Model Tax Convention (OECD MTC) is supplemented by the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD TP Guidelines) and is relevant in the context of the present discussion. The latest version of the OECD Guidelines was issued in January 2022 and includes an additional Chapter on “Transfer Pricing Guidance on Financial Transactions.” Part B1 of the Chapter on financial transactions “Determination of whether a purported loan should be regarded as a loan” reproduces paragraph 3(b) of the Commentary on Article 9 of the OECD MTC, which is reproduced below for ease of reference:

The Article is relevant not only in determining whether the rate of interest provided for in a loan contract is an arm’s length rate, but also whether a prima facie loan can be regarded as a loan or should be regarded as some other kind of payment, in particular a contribution to equity capital.

The OECD TP Guidelines, therefore, recognizes the fact that certain funding arrangements are not loans for tax purposes; hence, their legal form should be ignored. In that respect, paragraph 10.12 provides the following:

In accurately delineating an advance of funds, the following economically relevant characteristics may be useful indicators, depending on the facts and circumstances: the presence or absence of a fixed repayment date; the obligation to pay interest; the right to enforce payment of principal and interest; the status of the funder in comparison to regular corporate creditors; the existence of financial covenants and security; the source of interest payments; the ability of the recipient of the funds to obtain loans from unrelated lending institutions; the extent to which the advance is used to acquire capital assets; and the failure of the purported debtor to repay on the due date or to seek a postponement.

To date, the regulations which may be prescribed on the application of section 75 of the Act have not been issued. We consider that the SC should have at least considered the OECD TP Guidelines, irrespective of the fact that it is in the context of cross-border transactions, in assessing whether it was appropriate to apply a deemed interest income on the IFL. It is also important to note that the OECD TP Guidelines are subject to a rigorous consultation process by various international stakeholders before they are released in the public domain.

Time passage benefits are tax deductible

The SC agrees with the conclusion of the ARC that overseas passage benefit cannot be deducted on an accrual basis and unless and until payment occurs such expenses are not deductible for tax purposes. This interpretation implies that the accrual basis is effectively being ignored by the MRA, despite foreign decided cases on the impact of accounting standards in the computation of the tax results.


For additional information with respect to this Alert, please contact the following:

Ernst & Young (Mauritius), Ebene

Ernst & Young Société d’Avocats, Pan African Tax – Transfer Pricing Desk, Paris

Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London

Ernst & Young LLP (United States), Pan African Tax Desk, New York


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