What is relevant in a record of review?

In a judgment delivered on 17 February 2020, the Gauteng High Court dealt with a matter regarding a “record of review”, and its relevance relating to a review application brought by the Applicant in the matter, Medtronic International (“Medtronic”), on the refusal by the South African Revenue Service’s (“SARS”) refusal to reduce certain interests and penalties imposed on its Value-Added Tax (“VAT”) statement of account.

Medtronic was the victim of large-scale fraud to the value of approximately R460 million and as a result, fell behind with its tax obligations (the payment of VAT in particular). To correct the situation, it approached SARS through a Voluntary Disclosure Programme (“VDP”) application and entered into an agreement with SARS. Generally, the VDP programme does not allow for the reduction in interest due to non-payment of taxes. Medtronic, therefore, applied for the remission of interest in terms of section 39 of the Value-Added Tax Act, No 89 of 1991 (“the VAT Act”). SARS refused this application on the basis that the VDP agreement entered into between the parties was already in effect and, presumably, did not deal with interest.

Medtronic proceeded with review proceedings to overturn that decision, based on various points of law (including the principle of legality). Consequent to the launching of the review application, SARS delivered the record of proceedings (as it is required to do) to enable Medtronic to formulate its review arguments. After considering the record, Medtronic concluded that it does not comply with the requirements of a “record of review”. This was based upon the fact that various documents, such as the main application, internal memoranda, directives, policy documents, records of deliberations, and minutes of meetings, on which SARS based its decision, were not included. SARS claimed legal professional privilege on various documents relating to advice from legal advisors and claimed it was confidential information. Medtronic proceeded with a further legal notice, requiring SARS to dispatch the necessary documents. SARS failed to respond to this notice, as it contended it has complied with the necessary rules and that there was no further need for compliance.

The question arising from this dispute is: What is relevant in the “record of review”?

The court held that where a party requires evidence as to the interpretation of statutory provisions for those responsible for administering the provision, the courts may invoke the so-called Bosch-principle to tip the scales in the favour of those responsible for the administration of the legislation. The principle entails that evidence of a prior and consistent interpretation of a statutory provision by those responsible for the administration of legislation is admissible. In this instance, SARS had decided not to invoke this principle. The court considered the additional records requested by Medtronic and it sided with SARS in that the Bosch-principle was not applicable. Furthermore, the documentation sought would not further the interpretation of the statutory provision on which Medtronic intends to rely in a manner opposed to that which SARS has done. The court considered the documents that SARS had not provided as part of the “record of review” to be irrelevant. Ultimately, the court’s premise was that relevance is not dependent upon the pleaded issues in the initial review application. Relevance remains to be determined by the decision sought to be reviewed.

The take-away from the judgment is that an applicant will not always have full access to all SARS’s internal records as part of a review application. It is, therefore, important to ensure that when review proceedings are lodged, applicants appreciate what constitutes a proper “record of review”.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).

SARS eases burden on taxpayers, but there’s a catch

The tax season is swiftly approaching. For many people, it’s a time of the year that they dread. When it comes down to it, tax can become complicated mess that involves a lot of maths and calculations that just doesn’t come naturally to most. For those of us who don’t have PhDs in accounting or mathematics, crunching the numbers and factoring in a variety of different income sources can be tough.

In 2020, the tax season looks quite a bit different from previous years where taxpayers could start filing electronically in July. One of the main reasons for the delayed tax season is the emergence of COVID-19 and the desire to keep as many people as possible from having to submit a tax-return in person, which means that SARS has taken measures to increase electronic means of filing tax-returns. This year, the tax filing season starts on the 1st of September and ends on the 31st of October (for those filing manually in-branch) or the 16th of November (for those using e-filing).

Because of the often-complicated nature of tax, there are a few measures that SARS takes to ease the burden on tax-payers, although some of these measures are not necessarily accurate or act in the best interest of the taxpayer.

This year, for instance, SARS is sending out a large number of auto-assessments, where they assess your tax-data for you and give you the simple option of accepting their assessment or going ahead and filing your tax-return as usual. Notifications of auto-assessments will be sent via SMS, and individuals can then use eFiling or SARS MobiApp to view, edit, or accept the proposed assessment.

For these auto-assessments, SARS only base their evaluation on the data that they have received. This means that if there are outstanding tax certificates or third-party data related to your taxable income, you need to make sure to get all your documents in order as incorrectly reported or undeclared income could make you liable to penalties and interest on outstanding tax amounts. If this is the case you will need to submit your tax-return as per usual.

Conversely, if the assessment does not take into account outstanding documents or other factors that preclude some of your income from being taxable, you should not accept the auto-assessment as you will be losing out. The bottom line here is that before you accept SARS’s auto-assessment you need to make sure the assessment reflects any and all of the aspects that have an impact on your taxable income.

Another measure comes in the form of Pay-As-You-Earn (PAYE), which is the monthly amount that your employer pays as a tax deduction on your behalf, based on your income-tax bracket. It’s nice because it means that you as an individual are covered for the most common tax that comes from earning a salary. The not-so-nice thing about PAYE is that it is a crude calculation and does not factor in the parts of your income that are not taxable, or the different parts of your income that are subject to different tax-levels.

For this reason, some young employed people, earning from only one stream of monthly income are exempt from submitting a tax return, but are losing out in actuality. Most of the time this option will not work in their best interest as they will be freely giving tax on non-taxable income to SARS.

For other taxpaying individuals, they will need to take into account a variety of income streams (including taxable interest, rental income, capital gains, medical aid schemes, retirement annuities, allowances, tax-deductible donations, to name but a few). If you are subject to many of these tax-variables, doing your own tax-return becomes a hassle.

While you could go ahead and piece together the puzzle of your annual individual tax-return on your own, it is advisable to make use of a registered tax practitioner. A tax practitioner will be able to do the complex calculations on your behalf so that you come out of the tax season with your sanity intact. This means you’ll likely have more money in your pocket than if you had blindly accepted an auto-assessment or neglected certain aspects of your tax-calculations.

Reference

https://www.sars.gov.za/TaxTypes/PIT/Tax-Season/Pages/default.aspx

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).

Deemed Disposals and Tax Residency

Section 9H of the Income Tax Act deals with matters relating to the cessation of residency in South Africa.

This section essentially states that where a person that is a resident ceases to be a resident during any year of assessment, that person must be treated as having disposed of his assets on the date immediately prior to ceasing his residency, and re-acquiring the same assets on a date immediately thereafter. This is referred to as a “deemed disposal”. Similarly, the year of assessment will be deemed to have ended immediately prior to the cessation and to have started on the next day.

Such a “deemed disposal” does not relate to the immovable property that such a person may hold in South Africa.

As a result of his ceasing to be a South African tax resident (an event simply declared by ticking a box on the annual income tax return when submitted), a so-called “deemed disposal” (also sometimes referred to as an “exit charge”) will be activated in terms whereof all the individual’s assets will be deemed to have been disposed of, at market value, on the day before he ceased to be a South African tax resident.

This event, therefore, potentially gives rise to capital gains tax incurred on the deemed disposal. Excluded from this regime, as stated above, is South African immovable property, cash and (although not explicitly stated, though included on a very technical basis) accumulated retirement-related funds. Apart from these assets, all remaining South African and other worldwide assets are included in the “deemed disposal” regime.

Before a taxpayer decides on cessation of tax residency, an investigation should be done into possible tax treaty relief the individual may qualify for. SARS has stated that “an individual who is deemed to be exclusively a resident of another country for purposes of a tax treaty is excluded from the definition of “resident”. It follows that while an individual may qualify as a resident under the ordinarily resident or physical presence tests, that individual will not be regarded as a resident for South African tax purposes if that person is a resident of another country when applying for a tax treaty.”

Based on this, it is clear that section 9H of the Income Tax Act immediately becomes applicable to a taxpayer in the case of financial emigration or the cessation of tax residency, for whatever reason, and may increase tax liability in the current year of assessment in which the cessation of residency occurs. One must, however, always remember the exemptions described above, and in the event that emigration and/or ceasing to be a tax resident is considered, pre-emigration planning is of utmost importance to ensure that a smooth and fluid transition plan is formulated.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).

Cryptocurrencies: The new generation’s cash

1.1 Background to Bitcoin

Bitcoin, Ether and Litecoin. These are some of the most prominent cryptocurrencies on the market today. Bitcoin is by far the best-known cryptocurrency due to the substantial increase in the price that was experienced in the past couple of years.

Bitcoin is a cryptocurrency – a digital asset designed to work as a medium of exchange that uses cryptography to control its creation and management, rather than relying on central authorities. Bitcoin was developed by an anonymous creator – Satoshi Nakamoto – to enable society to operate with a digital cash system, without the need for third-party intermediaries which are traditionally required for digital monetary transfers.

Should you wish to read the original paper used to introduce bitcoin to the word, please follow this link:  https://bitcoin.org/bitcoin.pdf.

1.2 Tax consequences of cryptocurrencies

For the most part, South Africans have only been able to enter the crypto market locally for a short while, which has drawn the attention of the South African Revenue Service (SARS) to cryptocurrencies.

SARS released a statement on the 6th of April 2018, declaring its stance regarding the taxation of cryptocurrencies. The following is an extract from the statement:

The South African Revenue Service (SARS) will continue to apply normal income tax rules to cryptocurrencies and will expect affected taxpayers to declare cryptocurrency gains or losses as part of their taxable income.”

The statement further indicates that for purposes of the Income Tax Act, SARS does not deem cryptocurrencies to be a currency (due to the fact that wide adoption has not been reached in South Africa and crypto can’t be used on a daily basis to transact), but rather defines cryptocurrencies as assets of an intangible nature.

The definition has the effect that cryptocurrencies will be treated as any other investment for tax purposes. The onus lies on the taxpayer to declare all cryptocurrency-related taxable income in the tax year which the taxpayer received or accrued.

Should a taxpayer thus trade in bitcoin, the trades will be deemed to be income in nature and the profit and loss on the trades should be included in the taxpayer’s taxable income. However, if the taxpayer holds the bitcoin as a long-term investment (the same way some investors hold a share portfolio for long-term investing), the income derived from the disposal of the bitcoin will be deemed to be capital in nature, resulting in capital gains tax needing to be declared on the disposal.

1.3 Conclusion

Whether you are for or against cryptocurrencies, it is evident that cryptocurrencies have formed a part of the modern era and will likely remain relevant. This new form of currency/investment has caused quite a stir at SARS and taxpayers are advised to familiarise themselves with the tax treatment of these currencies to prevent any unexpected tax consequences.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).

2020 Tax filing season and important changes

The 2020 filing season covers the period 1 March 2019 to 29 February 2020.

In support of the President’s call to the Covid-19 pandemic, that Social Distancing be observed at all times and that we should at most stay indoors and limit movement, SARS is responding by rapidly enhancing its efforts to enhance filing requirements for individual taxpayers and removing the need to travel in 2020. Through the increased use of third-party data, SARS will obtain more information regarding your tax affairs more accurately than ever.

Due to the pandemic, tax filing season has been delayed and will only open on the 1st of September 2020. SARS have advised that they will however commence a new process of issuing auto-assessments for non-provisional taxpayers during the course of 1 August 2020 and 31 August 2020.

We strongly suggest that you supply us with your tax documents during the course of August as we will also need to dispute or confirm and accept any auto-assessments issued by SARS. The correctness of the auto-assessment can only be verified against your own financial data. We accordingly need you to provide us with your tax   information as soon as possible.

Individual income tax return filing dates for the 2020 filing season have been revised as follows:

  • 1 August to 31 August 2020: Auto assessments for Non-Provisional taxpayers.
  • 1 September to 16 November 2020: 
  • 1 September to 22 October 2020: Taxpayers who cannot file electronically can do so at a SARS branch.
  • 1 September 2020 to 29 January 2021: Provisional taxpayers who file electronically.

The delayed filing dates will not effect the interest charged by SARS on tax due for the 2020 tax period. Such interest will accrue from 1 October 2020.

If there is a possible shortfall on tax payments for the 2020 fiscal year on provisional tax, we will still be able to calculate your top-up payment in order to provide you with the option of settling your income tax liability “interest-free” on or before 30 September 20. We therefore need your information as soon as possible.

Due to the time limits we kindly request that you forward the following documentation (where applicable) to our office as soon as it has been received:

  • Income – IRP5 or IT3(a) certificate
  • Income from investments/Interest on loan accounts – IT3(b) certificate
  • Local/foreign Capital Gain/Loss – IT3(c) certificate (including sale of property, shares in private companies, etc.)
  • Any other income – please provide details (e.g. inheritance received, etc.)
  • Business income – full details of income and expenditure
  • Lump sum income – IRP5 certificate
  • Rental income – full details of property, income and expenditure including period let
  • Medical contributions certificate and expenses – medical aid certificate and proof of “other expenses”
  • Donations – S18A certificate reflecting proof of donation made
  • Pension Fund or Retirement Annuity Fund contribution certificates – certificate reflecting proof of contribution paid
  • Travelling allowance – make/model of motor vehicle, registration number, cost thereof and opening and closing km’s (kindly provide us with your compulsory logbook detailing split between business/ private mileage, destination, reason for travel).  Please detail any change in motor vehicles.
  • Subsistence allowance – detail number of days spent away from home on business (local and international) and kindly include destination/i> 
  • Changes to Assets and Liabilities including sale and purchase of fixed property.

We wish to stress that we cannot take any responsibility for incorrect or incomplete information furnished to us. Furthermore, we cannot be held responsible for any penalty charges for late submission of your return should you fail to provide us with the required information timeously.

Please advise us if any of your personal details have changed (e.g. physical address, telephone numbers or e-mail address).  SARS require details of your banking account irrespective of whether you are entitled to a refund or not.  Should you have provided us with this information, please confirm that the details remain the same.

Kindly note that we cannot request documentation on your behalf from third parties (i.e. previous employers, insurance companies, banks, etc.) for confidentiality reasons.  It is therefore of the utmost importance that you provide us with all the necessary documentation and information to enable us to submit your tax return correctly and timeously.

We wish to point out that SARS are confirming investment income information received from Financial Institutions with details recorded in the tax returns submitted.  Please ensure all investment income is supplied to us.

Please do not hesitate to contact us should you require any further information.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

Can a third party collect my taxes?

In SIP Project Managers (Pty) Ltd v CSARS (29 April 2020), the Gauteng Division of the High Court ruled against SARS on the appointment of a third-party (Standard Bank, in this case) to collect tax debts from taxpayers’ accounts. The matter was an application for declaratory relief against SARS for such an appointment to be set aside and declared null and void, and that SARS repays an amount of R1,261,007 which was paid over by Standard Bank as the third-party agent to SARS.

In its application, SIP contended that no letter of demand was received from SARS as is required in section 179 of the Tax Administration Act. SIP also submitted that if the Court found that the letters were delivered, then these were premature, and that no debt was yet due or payable at that time, and that the 10 business days (as is required in the Admin Act) had not expired before the delivery of the third-party notice.

The Tax Administration Act stipulates that a notice to a third party may only be issued after delivery of final demand for payment, which must be delivered at least 10 business days before the issue of the notice, as well as recovery steps that SARS may take and also further relief mechanisms available to the taxpayer. This is a peremptory step required to be taken before issuing a third-party notice for recovery of outstanding tax debt.

The Court stressed that it was not enough for the existence of final demand. However, that final demand should have actually been delivered in accordance with the Rules for Electronic Communication prescribed in terms of the Tax Administration Act, and if an acknowledgement is not received the communication is not regarded as having been delivered except for via eFiling.

As SARS had not furnished proof of the letter being sent via eFiling, and the there was no other proof of delivery, the Court held that SARS had not delivered a final demand to SIP before appointing Standard Bank as the third-party agent.

The notice issued is therefore unlawful and declared null and void by the Court, and SARS was required to repay the full amount, with costs, to SIP.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

Transferring assets from persons to companies

Many business transactions are concluded in terms of section 42 of the Income Tax Act. This section essentially allows a transfer of an asset by a person to a company, in exchange for equity shares in that company, allowing for a tax neutral transaction.The South African Revenue Service has recently issued Binding Private Ruling 339, relating to a transaction in which listed shares are transferred to a collective investment scheme (CIS) in exchange for participatory interests in a collective investment scheme. The parties to the transaction are a resident discretionary investment family trust (herein referred to as the Applicant) and a resident CIS as defined in the Collective Investment Schemes Control Act (herein referred to as the Fund).

The facts

The Applicant holds assets which comprise fixed properties and listed shares (amongst other things) that are held as long term investments. In this instance, the current market value of the shares exceeds the base cost. Some shares have been held by the Applicant for more than three years, and some for less than three years. The settlor (also a trustee of the Applicant) of the trust has been managing the investments of the trust, while the administration and stockbroking have been attended to by a separate wealth management company. It has been decided by the trustees to transfer the share portfolio to a CIS to be professionally managed and administered. For this to happen, the Applicant will enter into an agreement to transfer shares to the CIS fund in exchange for a participatory interest in this fund.

Ruling

SARS has confirmed that the transaction in this instance would qualify as an asset-for-share transaction as per the definition in Section 42(1) of the Income Tax Act. It was further confirmed that:

  • Shares held for longer than three years would be regarded as capital assets, and that upon transfer, the participatory interests received in exchange for the shares would be deemed to have been acquired on the dates that the listed shares were acquired;
  • There would be no capital gains tax consequences from the disposal of the listed shares as the Applicant would be deemed to have disposed of the shares for proceeds equal to the base cost, and similarly, to have acquired the participatory interests in the CIS on the dates that the initial shares were acquired, for the same expenditure incurred that is allowable;
  • There would be an exemption on Share Transfer Tax for the proposed transaction.

Observation

If one ignores the potential application of the general anti-avoidance rules which apply to all arrangements, it is unclear why the participants to this arrangement approached SARS for a ruling, since the technical analysis is rather straightforward.

There has recently been an increase in such straightforward rulings issued by SARS. In general (and not suggesting that the parties in this ruling did so) one gets the sense that parties approach SARS for a ruling to avoid any attack on a transaction. SARS is however well within its rights to attack a transaction on anti-avoidance, despite a ruling having been obtained. Parties should, therefore, guard against applying for ruling on seemingly straightforward technical grounds, to avoid any attack on anti-avoidance. Such a strategy may end up being unsuccessful.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

Intra-group transactions: how it works

The South African Revenue Service (“SARS”) issued a private binding ruling (BPR329) on 27 September 2019 on the tax implications of intra-group transactions and the subsequent sale of the relevant assets to a third party outside the group of companies.

The taxpayer in this regard wants to implement a Broad-Based Black Economic Empowerment transaction in terms of which immovable properties owned by the taxpayer and its subsidiaries (all effectively managed in South Africa) will be transferred to a newly established black-owned third party. The latter will not form part of the taxpayer’s group of companies.

In order for the proposed transaction to achieve its objectives as an asset-based transaction1 the taxpayer’s group is required to undertake an internal restructuring as all the properties owned by the subsidiaries have to be transferred from the taxpayer to the third party.

In this regard, the following steps will be implemented. Firstly, the subsidiaries will sell all their properties to the taxpayer in terms of an intra-group transaction as contemplated in section 45 of the Income Tax Act with the purchase price left outstanding on loan account. The taxpayer will furthermore enter into lease agreements with two of the subsidiaries who in turn will sub-lease it to the relevant group company that occupies the property. This will ensure that the third party acquire existing income streams in addition to ownership of the properties. In the final step, the taxpayer will enter into a sale of property and rental enterprise agreement with the third party for a cash consideration and use the cash so acquired to pay off the loans with the subsidiaries in the transaction’s first step.

The question that arises in this regard is whether the subsequent sale of the assets to the third party will result in a capital gain for the taxpayer or in the alternative, whether the proceeds will constitute “gross income” as defined in section 1(1) of the Income Tax Act.

In terms of BPR329, SARS confirmed that the taxpayer will acquire the properties as capital assets from the subsidiaries who in turn held the properties as capital assets (pursuant to paragraph (a)(i)(aa) of the definition of an intra-group transaction in section 45(1)). Secondly, the sale of the properties by the taxpayer will result in a capital gain for the taxpayer, a portion of which will be ring-fenced in terms of section 45(5). The proceeds from the sale will therefore not constitute gross income as defined in section 1(1).

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

Personal benefit or occupational requirement?

In a recent Supreme Court of Appeal decision, the court had to determine whether the payment by an employer to tax consultants for providing assistance to the employer’s expatriate employees constituted a taxable benefit, as contemplated in the definition of “gross income” in section 1 of the Income Tax Act[1] read with section 2(e) or (h) of the Seventh Schedule.[2]

The taxpayer (in South Africa) belongs to a group of companies that conducts worldwide operations and, as a result, requires their employees to work for short to medium term periods in locations other than in their home countries. The group furthermore operates on a ‘tax equalisation’ basis which is standard practice within the group. This means that the group ensures that the net income of their employees, in whichever countries they are placed, is not less than in their home countries. As part of this arrangement, the taxpayer agreed to take responsibility for the payment of the tax due by expatriate employees of South Africa.

Due to the complex nature of tax legislation relating to expatriates, the taxpayer engaged the services of consulting firms to assist the expatriate employees. This included assistance with registering and deregistering them as taxpayers, the completion of tax returns and dealing with queries and objections to assessments. The taxpayer paid for these services.

The South African Revenue Service (“SARS”) issued additional assessments for the 2004 to 2009 tax years on the basis that the payments to the consulting firms were a taxable benefit in the hands of these employees.

The taxpayer objected to these findings and contended that no advantage had been gained by the expatriate employees by virtue of the use of the consultancy services and the payment by the taxpayer of their fees. The services were procured by the taxpayer in pursuit of the taxpayer’s own tax equalisation policy to ensure that it paid the correct amount of tax.

SARS disallowed the objection and both the Tax Court and High Court agreed with SARS. Upon further appeal, the Supreme Court of Appeal considered the engagement letter entered into between the taxpayer and one of the consulting firms. Although it appeared from the introductory paragraph that the services were rendered to the taxpayer, the description of services clearly indicated the assistance to be provided to the expatriate employees. These were services that the expatriate employees would otherwise have had to pay for personally. The court, therefore, agreed with the court below that these payments constituted a taxable benefit in the hands of these employees.

There are several other relevant considerations that were not dealt with as part of the judgment. It is unclear whether these matters were not in dispute between the parties:

  • Whether output VAT was paid in respect of the fringe benefit (the assumption is that it was not since BMW did not regard the payment as a fringe benefit from the outset) or whether BMW was denied the input tax deduction on the expenses; and
  • Whether the costs incurred were allowed as a deduction in the production of BMW’s income.

The takeaway from the judgement is that when employers incur costs that relate in any way to employees, careful consideration should be made of whether the cost potentially results in a benefit or advantage for the employee that was used for their private or domestic purposes. If this is indeed the case, there are a multitude of potential tax consequences which should be considered.

[1] No 58 of 1962

[2] BMW South Africa (Pty) Ltd v The Commissioner for the South African Revenue Service (1156/18) [2019] ZASCA 107 (6 September 2019)

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

Distinction between expenses of a capital and revenue nature

On 15 November 2019, the Cape Town Tax Court handed down judgement in ITC24614. It is yet another judgement concerned with the distinction between expenses of a capital nature or revenue nature – arguably the issue over which there has been the most litigation in South African tax history. The importance of the distinction lies in the deductibility of the amount for income tax purposes – while expenses which are revenue in nature are generally deductible, those of a capital nature, are not.

The expense (or loss, in this instance) which gave rise to the dispute, is a fellow subsidiary receivable amount (treated in the taxpayer’s books as a “loan”), which was written off by the taxpayer since it was clear that the fellow subsidiary was unable to repay the amount. SARS argued that the loss was of a capital (as opposed to revenue) nature, and along with denying the deduction, imposed a 50% understatement penalty on the taxpayer.

The origin of the loan was not from funds advanced by the taxpayer to the fellow subsidiary, but rather from trading activities between the parties (i.e. amounts which were included in the taxpayer’s income and the amount deducted therefrom).

The tax court argued as follows:

  • A loss suffered by a taxpayer as a result of writing off indebtedness of another party can be categorised as either capital or revenue in nature and there is no single definitive yardstick for distinguishing between capital and revenue expenditure;
  • Whether an amount lost or written off was advanced or treated as a loan is not in itself determinative of the capital or revenue nature of the loss or expenditure, since the accounting treatment applied by a party is not to be regarded as determinative of either the legal position or the correct tax position. The question is always one of substance rather than form, and is to be decided on all the facts of the case;
  • It is not the treatment of an amount as a “loan” which is determinative, but whether the loss was incurred in the conduct of the taxpayers’ own revenue-earning trade or not; and
  • This was not an investment concerned with supporting an extraneous business of the fellow subsidiary and the loss incurred did not amount to the deployment of the taxpayer’s fixed capital to equip its “income-earning machine”. It was rather an indebtedness that arose from its trading activities with the fellow subsidiary and as such is a clear example of the deployment of floating capital, insofar as it was not intended to remain outstanding but intended to be converted back into cash in the ordinary conduct of the taxpayer’s trade.

In the result, the tax court found in favour of the taxpayer and ordered that the additional assessment be set aside.

Respectfully, the tax court’s findings in this regard are sound, and it is unclear why the matter proceeded to litigation. Where the line between revenue and capital in nature is often blurred, this appeared on face value to be rather straightforward. The take-away from the judgement is that taxpayers should, especially where material amounts are involved, not merely accept additional assessments from SARS and should consult with experts where there are uncertainties.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)