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Welcome to the March 2011 edition of Juta's Tax Law Review. We thank you for your constructive suggestions and comments about this electronic review.
SOME POINTS ABOUT THE CASE NOTES:
The case notes, classified by subject, are not intended as comprehensive summaries of the various judgments referred to. Rather, their focus is to identify those aspects most likely to be of interest to tax practitioners, and to provide a concise evaluative commentary.
Following each case note is a link to the full text of the judgment on Juta Law's website. The successive reviews and judgments are incorporated in your Juta's Tax Library, providing a comprehensive record of tax case law.
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Amnesty only safeguards a taxpayer from criminal prosecution for the specific tax for which it was granted, CSARS v Saira Essa Productions CC unreported judgment of the Supreme Court of Appeal delivered on 30 November 2010.
Ms Essa and Mr Collett, husband and wife and members of the close corporation Saira Essa Productions CC, were investigated by SARS for the non-payment of PAYE, underpayment of VAT and non-filing of tax returns for the 2003/2004 tax year. SARS had raised a VAT assessment that was subsequently paid with an admission of guilt fine. In addition, SARS proceeded with criminal charges under the VAT Act.
When SARS proceeded with the criminal charges in the regional court, the taxpayers asked for a postponement of the proceedings on the basis that they applied for amnesty under the Small Business Tax Amnesty Act 9 of 2006, which, they held, would have safeguarded them from prosecution if granted.
The Court scrutinised SARS' response to the taxpayers' amnesty application and concluded that amnesty was not granted for the VAT but only for the Income Tax transgressions. As a result the taxpayer's were not safeguarded from prosecution under the VAT Act.
A Rule 26 application does not entitle the taxpayer to dispute the merits of the reasons provided by SARS, it is merely a procedure to force SARS to provide reasons for its assessments, Sprigg Investment 117 CC t/a Global Investment unreported judgment of the Supreme Court of Appeal delivered on 1 December 2010.
On the facts of the case, the taxpayer was not satisfied with the reasons provided by SARS for the issuing of an assessment and brought a Rule 26 application to force SARS to provide adequate reasons. The Court applied Minister of Environmental Affairs & Tourism v Phambili Fisheries (Pty) Ltd 2003(6) SA 407 (SCA) in which it held (at par 40) that reasons were "adequate" when a taxpayer is placed in the position to know why a particular decision was taken, regardless of whether the taxpayer agrees with SARS' decision or not.
Depending on the wording of a trust deed, a distribution to a trust created for the benefit of a beneficiary, instead of to the beneficiary itself, may be valid, The Abraham Krok Trust v CSARS, unreported decision of the Supreme Court of Appeal delivered on 29 November 2010.
The simplified facts of the case were that trustees distributed assets to trusts created for the benefit of trust beneficiaries instead of to beneficiaries themselves. The question which the Court had to adjudicate was whether these distributions were exempt from donations tax under s 56(1)(l). This section provides for an exemption of donations tax for property disposed of under and in pursuance of a trust.
As the individuals and not their trusts were trust beneficiaries, SARS argued that the assets were not distributed under and in purchase of the trust.
The Supreme Court of Appeal scrutinized the trust deed. It provides that the trustees have to apply the trust capital for the benefit of the beneficiaries. As distributions to trusts created for the benefit of the beneficiaries still constitute a distribution for their benefit, the Court held that the exemption was applicable.
A new test was formulated by the Supreme Court of Appeal to determine whether the substance of an agreement correlates with its legal form, CSARS v NWK Ltd, unreported decision by the Supreme Court of Appeal delivered on 1 December 2010.
NWK, a maize trading company, needed financing. It entered into an agreement with a subsidiary of First National Bank ("FNB") in terms of which it borrowed R96m, repayable by the delivery of a specified quantity of maize five years after the contract was concluded. The difference between the R96m and R50m represented the interest. In its tax return NWK claimed the R96m as expenditure in the production of income.
SARS denied the deduction on the basis that the contract was a simulation as NWK never intended to borrow R96m. SARS in addition imposed a 200% penalty on NWK for furnishing false statements in its tax return.
The Johannesburg Tax Court found in the taxpayer's favour on the basis that the parties intended to give effect to their contracts. It took into account the performance, five years later, by the parties of their respective obligations under the various contracts, including the constructive delivery of maize (by exchange of silo certificates in front of a notary) by NWK to FNB and the immediate delivery of the same quantity of maize by FNB to NWK.
On appeal the decision was overturned and the Court held that the transaction was a simulation. In the particular it was held that the substance over form principle does not merely mean that the parties must intend to give effect to their agreements. The Court per Lewis AJ explains:
" In my view the test to determine simulation cannot simply be whether there is an intention to give effect to a contract in accordance with its terms. Invariably where parties structure a transaction to achieve an objective other than the one ostensibly achieved they will intend to give effect to their transaction on the terms agreed. This test should go further, and require an examination of the commercial sense of the transaction: of its real substance and purpose. If the purpose of the transaction is only to achieve an object that allows the evasion of tax, or of a peremptory law, then it will be regarded as simulated. And the mere fact that the parties do perform in terms of the contract does not show that it is not simulated: the charade of performance is generally meant to give credence to their simulation." (par 54).
On the facts it was found that NWK did not intend to borrow R96m, but merely R50m. A factor that played a significant role in the Court coming to this decision was that the contract had no commercial substance or made any business sense.
SARS does not have an unlimited discretion to make use of the "certificate procedure", Sepataka v CSARS, unreported decision of the South Gauteng High Court delivered on 31 August 2010.
The facts of the Sepataka judgment are that SARS was of the opinion that the taxpayer did not disclose his full income in the 2001 year of assessment. As a result, it issued on 22 April 2004 additional assessments under s 79 of the Act. Despite the taxpayer's lodgement of an objection against the additional assessments on 27 June 2005, SARS decided to make use of the certificate procedure and the certificate was issued on 1 December 2005.
On 29 August 2007, the Commissioner allowed the objection on the basis that the additional assessments were based on a duplication of certain amounts. This lead the Court to believe that the additional assessments were not issued by suitably qualified or experienced persons (par 13).
The High Court was of the opinion that SARS' collection powers and, in particular, the right to issue an estimated or additional assessment as well as the certificate procedure, were "draconian and should be exercised with care by properly experienced and suitably qualified personnel since it may otherwise be reduced to an arbitrary guesstimate with grave consequences to the taxpayer." (par 10).
As SARS' collection powers may be to the prejudice of taxpayers, certain checks and balances have to be in place to safeguard the rights of taxpayers. The Court found these checks and balances in requiring that before the certificate procedure is lodged, a responsible person ensures that no objection against the assessment is pending (par 19).
As the certificate did not provide adequate safeguards for the taxpayer, it was set aside.
The Tax Court was once again confronted with the question whether contingent liabilities accrue at the end of the year of assessment, Case 12262, unreported decision delivered by the Johannesburg Tax Court on 7 December 2010.
The facts of the case were briefly that the taxpayer, a fluorspar mining company in the North West province, exports its product mainly to the United States. The product is exported FOB through Durban accompanied by a provisional invoice showing the amount payable by the client. The invoice reflects the price as well as the product's compliance with the agreed specifications. The agreement between the parties is that upon receipt of the product by the client in the export country, the client must undertake its own tests to determine whether the product meets the specifications agreed to in terms of its weight and moisture content. After the tests are concluded, the client pays the taxpayer in accordance with the results of the tests. The degree of non-compliance with the specifications affects the final amount payable i.e. the greater the degree of non-compliance the lesser the price payable. Such price, in the event of the product not meeting the exact requirements (weight & purity), being subject to negotiation between the parties. As at the end of the respective years of assessment some of the product had been exported but the tests had not been finalised by the client on that particular batch.
The Commissioner included the amounts of these provisional invoices issued by the taxpayer in the taxpayer's gross income for the tax years. The taxpayer objected to the inclusion on the basis that, before the specifications tests are finalised, such amounts had not accrued to the taxpayer at year end because the amount payable or receivable was unknown and therefore accrual has not taken place.
SARS's alternative argument was that if an accrual did not take place, the amounts were nonetheless taxable as they were recouped under s 24F(2).
In addition, a dispute also arose regarding the deductibility of marketing and management fees claimed by the taxpayer. SARS' view was that this expenditure was excessive.
The Tax Court analysed the facts and came to the conclusion that the amounts did not accrue to the taxpayer at the end of the year of assessment, Accrual only took place after the goods were inspected and analysed in the country of destination. Until such time the purchase price was uncertain.
However, despite no accrual taking place, the purchase price was recouped under s 24F(2) which provides for the recoupment of expenditure incurred on the acquisition of trading stock for which payment was not received yet.
As far as the deductibility of the marketing fees were concerned, the Tax Court confirmed the principle that excessive expenditure is not deductible on the basis that it was not incurred in the production of income. However, it is not for the Court or for SARS to say, with the benefit of hindsight that the expenditure was not necessary incurred, or that it was as effective as it could have been. Accordingly, the marketing fees were allowed as a deduction.
The taxpayer was also successful as far as the deductibility of the marketing fees was concerned. The Court rejected SARS' argument that as the marketing fee was incurred with the purpose of making use on an assessed loss, it was non-deductible - taking advance of an assessed loss is not inherently wrong. Many subsidiaries are dependent on their holding companies for effective functioning.
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