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)

What to do when the taxman comes?

With the tax filing season for individuals now closed, taxpayers may find themselves with tax debt that is due. This may be due to administrative penalties as a result of the non-submission of tax returns, the submission of a return without payment, only partial payment or debt arising from an audit assessment.

The South African Revenue Service (“SARS”) provides assistance to taxpayers in managing their tax debt. As an initial phase, SARS will remind taxpayers of the amount of tax due before the due date. This is done by way of an assessment with the relevant due date indicated thereon as well as courtesy notifications from SARS which acts as reminders to pay the outstanding amount. Paying the full outstanding tax debt at this point will ensure that no interest and penalties are levied against the taxpayer.

Once the due date has past and the debt remains outstanding, the taxpayer’s tax compliance status will change to ‘non-compliant’. SARS will, however, continue to send reminder notifications to the taxpayer to settle the debt.

At this point, it is important to note that the taxpayer may at any point request for remedial actions which could include a request to defer payment, the suspension of payment with the intention to lodge a dispute or to request a compromise.

Should taxpayers fail to settle the debt without requesting any of the remedial mechanisms, a notice of final demand will be issued. SARS may now appoint a third party who holds money on the taxpayer’s behalf to deduct the tax debt and to pay it over to SARS. For example, an employer or bank may be requested to deduct the debt from the taxpayer’s salary. Such a third party is legally obliged to act on behalf of SARS.

SARS also have other collection tools available to ensure all tax debts are paid. These include issuing a judgement against the taxpayer and having the taxpayer blacklisted as well as attaching and selling the taxpayer’s assets.

The take away is that taxpayers should ensure that all relevant tax debts are paid timeously to avoid interest and penalties being levied. Also, taxpayers should regularly update their contact details with SARS to ensure that they receive all relevant tax correspondence.

However, should taxpayers not be able to pay their tax debts in time or need assistance in managing their tax debts, they should contact SARS to request any of the remedial mechanisms. SARS’ website lists a number of contact details for taxpayers to engage with SARS on these matters depending on their location. Taxpayers could also contact their tax advisors or tax practitioners to assist them in making contact with SARS in order to settle all outstanding tax debts.

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) 

Is there tax on gift cards?

The Cape Town Tax Court delivered a judgement on 17 April 2019 on the timing of income tax in relation to gift cards issued by a retailer.[1]

Here, the taxpayer “sold” gift cards to its customers to be redeemed at any of the taxpayer’s stores. The question under consideration was whether the revenue from the “sale” of the gift cards constituted “gross income” for purposes of the Income Tax Act[2] as soon as it was received by the taxpayer, or only when the gift card was redeemed or has expired.

In terms of section 1 of the Income Tax Act,[3] a taxpayer must include in “gross income” all amounts “received by or accrued to or in favour of” that taxpayer. Initially, the taxpayer included all amounts received in respect of the gift cards in the year in which the cards were issued and paid for.

However, the Consumer Protection Act (“CPA”)[4] came into effect with specific provisions on the treatment of gift cards. It stated that any consideration paid by a customer to a supplier for a gift card is the property of the bearer of the card until the supplier redeems it. Also, a supplier may not treat any prepayments in its possession as the property of the supplier.[5]

As from 2013, the taxpayer, therefore, transferred the revenue from the gift cards to a separate bank account until such time as the cards were redeemed or become expired and accounted for these amounts in its financial records as an unredeemed gift card liability.  The taxpayer also did not include these amounts in its “gross income” at the time of the “sale” based on the argument (and irrespective of the CPA provisions) that the money was not received by the taxpayer for its own benefit, but was held for the benefit of the card bearer. Secondly, the effect of the CPA provisions rendered it inconsistent with being “gross income” for income tax purposes.

The Court found that the mere segregation of monies in a separate bank account did not by itself mean that the funds were somehow held “in trust” for the benefit of the cardholders as opposed to the taxpayer. However, the result of the CPA and the treatment of these amounts in order to comply with its requirements was that the taxpayer did not receive such monies for its own benefit until the cards were redeemed. The Court held that these receipts therefore only constituted “gross income” when it was redeemed or had expired.

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)

SARS interest on provisional tax

As with various other business transactions, taxes in their various forms also attract interest, either payable by the taxpayer to SARS, or due to the taxpayer from SARS. Apart from knowing which of the various SARS interest rates are applicable (which is often a challenge in itself), knowing in which circumstances interest is applicable and the relevant income tax treatment of that interest, is increasingly important. This article explores one such a scenario: provisional tax.

Overpayment of provisional tax

If a taxpayer has any tax credit (amount by which taxes already paid exceeds the calculated tax liability) and that credit exceeds R10 000 or the taxpayer has a tax credit and the taxable income exceeds a certain amount (R50 000 for individuals and trusts and R20 000 for companies), the taxpayer earns interest at the prescribed rate, namely 6% (compared to the 10% when interest is payable to SARS – see in more detail below).

Subsequent income tax treatment

Interest earned from SARS will be included in the gross income of a taxpayer and accordingly, is fully taxable (subject to any annual interest exemptions for natural persons). Although income tax generally works on the principles of receipt and accrual, section 7E of the Act determines specifically that any interest due to a taxpayer from SARS will only be deemed to have accrued on the date on which it is paid to (received by) a taxpayer. Although less material for individuals, this could lead to some differences in treatment for companies and potentially give rise to deferred tax.

Underpayment of provisional tax

If a taxpayer’s normal tax obligation exceeds any tax credit and the taxable income exceeds a certain amount (R50 000 for individuals and trusts and R20 000 for companies), interest will be levied by SARS at the prescribed rate – currently 10%. Interest is also payable at the 10% prescribed rate on late payments in respect of first, second and third provisional tax periods.

Subsequent income tax treatment

Section 23(d) prohibits the deduction from taxable income of any interest paid under any act that is administered by SARS. Therefore, any interest paid to SARS will not be deductible for income tax. Presumably, this is since this interest will not be considered to be in the production of income or expended for the purposes of a trade.

Given the widely publicised delays on refunds for various types of taxes, taxpayers should carefully scrutinise their statements of account from SARS to ensure that interest they are entitled to in terms of the various tax acts has been paid to them. Taxpayers should also carefully take note of due dates for provisional tax payments, to ensure that interest is not incurred on late payments or any underpayments.

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)

Deductibility of interest for non-trading individuals

SARS Practice Note 31.2 (PN31.2) provides for a person to be able to deduct interest paid, even where that person is not a moneylender or doesn’t carry on any other trade, where that interest expense is incurred in the production of other interest earned to the extent that it does not exceed the interest income. Strictly, in terms of prevailing income tax legislation, this practice (which favours taxpayers) is not supported by the Income Tax Act, 58 of 1962.

Reliance on this practice by a taxpayer was recently considered in the Western Cape High Court.[1] Due to the unique structure of the taxpayer’s employment contract as a partner at a law firm, a portion of his profit share was withheld as an obligatory interest-bearing loan to the employer, to fund ongoing working capital requirements (‘director’s loan’). While periodic distributions of interest that accrued on the director’s loan was paid to him and treated as taxable income, he was not allowed to claim repayment of the capital for as long as he was in employment. At the same time, the taxpayer would incur interest on a bank loan used to purchase an immovable property (‘bank loan’).

The court had to consider whether there is a sufficiently close link between the interest incurred by the taxpayer on the bank loan, and the interest earned by him on the outstanding balance of the director’s loan. In other words, whether the bank interest can be said to have been incurred in the production of the interest income on the director’s loan.

The taxpayer contended that it did since he would have used the proceeds of the director’s loan to repay the bank loan had it not been for the strict repayment terms, and in the process reducing the capital and interest incurred on the bank loan. He considered the portion of the bank loan equal to the director’s loan as a loan payable on which an interest deduction should be allowed. This was supported by evidence of deposits into the bank loan from distributions of profit share which could also be matched.

The court found that even assuming the funds standing in credit of the director’s loan are ‘capital’ or ‘surplus’ funds as required by PN31.2, any distributions he receives thereon are entirely in the discretion of his employer. As a result, he was not solely reliant on the distributions to maintain the bank loan and the fact that he made deposits into the bank loan from profit distributions does not distract from this fact. To have access to the bank loan, he had to maintain it from sources other than distributions on the director’s loan. Accordingly, the purpose of the bank loan was to provide him with a facility, and not to maintain the director’s loan. It cannot be said that interest paid on the bank loan brought about interest earned on the director’s loan. He would have received interest on the director’s loan, irrespective of the existence of the bank loan. Accordingly, the court disallowed the taxpayer’s appeal for deduction of the interest incurred.

An important takeaway from the judgment is the distinction the court made between the two scenarios dealt with in PN31. Firstly, PN31.1 deals with a scenario where an interest expense was incurred in the carrying on of a trade, while PN31.2 deals with a scenario where a taxpayer does not carry on a trade. The requirements of the two paragraphs should be considered separately and not treated as a single principle. It is therefore important for taxpayers that want to claim interest deductions and rely on PN31 to consider both scenarios, especially if they are not in the business of lending money.

[1] L Taxpayer vs The Commissioner for the South African Revenue Service (Case A124/2017, on appeal from the Tax Court).

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)

Changes to the dispute management process

The South African Revenue Service (SARS) recently introduced certain changes and improvements to its current dispute management process.

Any taxpayer who is aggrieved by any assessment may request SARS to provide those reasons for the assessment sufficient to enable the taxpayer to formulate an objection. For the first time, taxpayers will be able to make such a request for reasons for an assessment electronically via eFiling or at any SARS branch. This automated functionality will be available for personal income tax (PIT), corporate income tax (CIT) and value-added tax (VAT). Where a valid request for reasons has been identified by the SARS system, the period that an objection can be lodged will be automatically extended to the period permitted by the Dispute Resolution Rules issued by SARS in terms of section 103 of the Tax Administration Act.[1]

The new dispute management process will also introduce a separate condonation workflow whereby the taxpayer will be allowed to submit a Request for Reasons, Notice of Objection (NOO) or Notice of Appeal (NOA) after the periods prescribed by the Dispute Resolution Rules have lapsed. Previously, the condonation process was included in the actual dispute process. To the extent therefore that a dispute was treated by SARS as invalid (as opposed to not being allowed to proceed as a result of a late submission), taxpayers were confused as to the outcome of the dispute and what the next available step in the dispute process was. The new automated condonation process therefore allows SARS to attend to requests for condonation for the late submission of the relevant notices or requests before attending to the dispute itself. This will ensure that the late submission is aligned with the legislation as it will prevent situations where the dispute is simply classified as invalid merely because the relevant submission is late (quite often automatically).

Taxpayers will also now be able to request SARS to suspend certain payments of VAT pending the outcome of a VAT dispute via eFiling or at a SARS branch similar to the requests for suspension of payments that were already implemented for PIT and CIT in 2015.

eFiling will furthermore be made an entirely guided process to ensure that the dispute is submitted according to legislative requirements and to eliminate any invalid disputes from being submitted to SARS.

The take-away is that SARS regards these changes as part of its ongoing commitment to delivering a better service to taxpayers. The changes to the dispute management process are therefore aimed at aligning the process more closely with the relevant legislation, to remove uncertainties that existed with regards to the dispute process and to make the process easier to follow.

[1]28 of 2011

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)

Penalties on Underpayment of Provisional Tax

Under paragraph 20(1) of the Fourth Schedule to the Income Tax Act 58 of 1962, amended (“the Act”), if the actual taxable income of a provisional taxpayer, as finally determined under the Act, exceeds R1 000 000 and the estimate made in the return for the payment of provisional tax, that is the so-called second provisional tax payment, is less than 80% of the amount of the actual taxable income, the Commissioner is obliged to levy a penalty, which is regarded as a percentage based penalty imposed under chapter 15 of the Tax Administration Act 28 of 2011 (“TAA”).

The penalty, in the case of a company, amounts to 20% of the difference between the amount of normal tax calculated using the corporate tax rate of 28% in respect of the taxable income amounting to 80% of the actual taxable income and the amount of provisional tax in respect of that year of assessment  paid by the end of the year of assessment.

Paragraph 20(2) of the Fourth Schedule to the Act confers a discretion on the Commissioner to remit the penalty or a part thereof where he is satisfied that the estimate of taxable income was seriously calculated with due regard to the factors as having a bearing thereon and was not deliberately or negligently understated.

The Port Elizabeth Tax Court was recently required to adjudicate a matter relating to the imposition of a penalty on the underpayment of provisional tax in Case No. IT14027, as yet unreported, where judgment was delivered on 7 December 2016.

The Tax Court had to consider whether the company could lawfully amend its grounds of objection even though the matter was already on appeal ©iStock.com/ “Alert Judge
-by junial

ABC (Pty) Ltd was a provisional taxpayer which delivered its return for payment of provisional tax for the 2010 year of assessment on 30 June 2011. In its return of provisional tax it estimated the taxable income for the year of assessment and made payment in accordance with its estimate. Sometime later it appeared that the actual income received exceeded the estimate made by the company substantially. As a result the South African Revenue Service (“SARS”) imposed an underestimation penalty in terms of paragraph 20 of the Fourth Schedule to the Act.

The company lodged an objection which was rejected by SARS and resulted in an appeal which was decided in its favour by the Tax Board. SARS subsequently appealed the decision of the Tax Board to the Tax Court for a hearing de novo and subsequently filed a statement of grounds of assessment and opposing the appeal.

In reply, ABC (Pty) Ltd filed its statement of grounds of appeal according to the Tax Court rules. In its grounds of appeal the company abandoned all of the grounds raised in its original objection and in its notice of appeal and sought to rely only on the procedural ground raised for the first time by the chairperson of the Tax Board upon which he had found in favour of the company.

SARS subsequently filed a notice of exception arguing that the company could not rely on a new ground of objection not previously contained in its grounds of objection.

The company originally estimated its income for the 2011 year of assessment in an amount of R431 638,00 and made payment of provisional tax amounting to R64 905,54. Later, on 30 September 2011 the company made a further payment of R1 377 466,22. Subsequently, the company filed its income tax return reflecting a taxable income for the year of assessment amounting to R5 050 076,00.

By virtue of the large difference between the tax actually due per the final taxable income and the provisional tax paid, SARS imposed the underestimation penalty under the provisions of the Act. SARS considered the objection lodged by the company on the basis that the company did not seriously calculate its tax income as required.

The TAA had not yet come into force by the time that the company’s objection had been disallowed and its notice of appeal lodged. The Tax Board decided that the Commissioner was correct in rejecting the company’s objection and that the appeal should be dismissed on its merits.

However, the chairperson of the Tax Board mero motu raised a procedural issue under the TAA which had since come into force and decided in favour of the company. The chairperson of the Tax Board reached the view that the manner in which SARS had dealt with the imposition of the penalty was in conflict with chapter 15 of the TAA, especially sections 214 and 215 thereof.

The Tax Court had to consider whether the company could lawfully amend its grounds of objection even though the matter was already on appeal. Tax Court Rules do not provide for an amendment to the taxpayers’ grounds of objection and the Court therefor referred to the rules of the High Court.

The Tax Court considered the various provisions of the TAA and made the decision that SARS’s exception to the company’s application should be upheld and that the application for the amendment of the company’s grounds of objection should be dismissed. The Court therefore dismissed the company’s appeal and confirmed the penalty imposed on the understatement of provisional tax.

Based on the judgment it is concluded that taxpayers need to exercise extreme caution in calculating taxable income for purposes of provisional tax, failing which they will become liable to the 20% underpayment penalty.

Furthermore, when a taxpayer disputes the imposition of a penalty, or in fact any assessment, it is important that the grounds of objection are properly formulated as it is not possible to subsequently amend the grounds of objection.

Source:
Dr Beric Croome is a Tax Executive  at ENSafrica. This article first appeared in Business Day, Business Law and Tax Review, February 2017.

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)