SEPTEMBER 2016 – ISSUE 204

COMPANIES

2542. Crowdfunding

2543. Reinstating a deregistered company

2544. Amalgamation transactions

TAX ADMINISTRATION

2547. Compromise agreements

2548. Relevant material – lifestyle

questionnaire

GENERAL

2545. Trading stock in wine farming

industry

VALUE-ADDED TAX

2549. Interest-free credit

2550. Contra fiscum rule applied

INTERNATIONAL TAX

2546. Foreign business establishments

SARS NEWS

2551. Interpretation notes, media releases

and other documents

COMPANIES

2542. Crowdfunding

There has been a rapid expansion of the crowdfunding industry during the last couple of

years where businesses and entrepreneurs use crowdfunding platforms to promote their

business ideas and to obtain funding from the public to finance their ventures. Although

there are advantages and disadvantages to a crowdfunding arrangement in comparison to

traditional funding arrangements, one constant factor applicable to both alternatives is that

the transactions between the recipient and the provider of funding will, at all times, be

subject to the provisions of the Income Tax Act, 1962 (the Act).

2

In this article, we briefly consider some of the possible South African tax implications that

may arise pursuant to the utilisation of the various types of crowdfunding that have lately

been gaining traction in South Africa.

Rewards-based crowdfunding

In terms of rewards-based crowdfunding, investors (the Investors) generally make an

“investment” into a business with an undertaking by the business (the Recipient) that they

will receive goods or services in return for the funding once the business has been

launched successfully.

The tax consequences arising for Investors and Recipients depend, inter alia, on the legal

form of the transaction entered into between the parties. The contracts in place between

the Investors and the Recipient will therefore have to be analysed in order to test the

precise nature of the relationship between the parties. For example, it will have to be

tested whether the parties have concluded an agreement in respect of the sale of goods or

the provision of services, or if the parties have entered into a partnership.

We set out below certain tax aspects which require consideration in respect of a rewards-

based crowdfunding arrangement.

In terms of the Act, “gross income” is defined (in the case of any resident), as the total

amount, in cash or otherwise, received by or accrued to or in favour of such resident

during any year or period of assessment, excluding receipts or accruals of a capital nature.

Therefore, if the payment by an Investor constitutes an advance revenue receipt by the

Recipient in respect of the sale of its trading stock or the provision of a service (i.e. the

receipt is not of a capital nature), the Recipient will be required to include such amount in

its gross income in the year of assessment during which the amount is received by or

accrued to it, whichever is the earlier. This could mean that, although the goods or

services may only be supplied in following years of assessment, the Recipient will need to

account for income tax thereon in the year of assessment in which the amount is received

or accrues.

3

In determining this tax liability, it should be considered whether the Recipient would be

entitled to a deduction of expenditure incurred against such income.

In terms of the general deduction formula contained in the Act, for the purposes of

determining the taxable income derived by the Recipient from carrying on any trade,

certain amounts of expenditure and losses may be deducted from the income of the

Recipient where, inter alia, such amounts are actually incurred in the production of the

income. Whether or not the Recipient is carrying on a trade is a question of law that will

have to be decided on a case-by-case basis.

If the Recipient receives an amount from the Investor at a time that it has not commenced

carrying on a trade, the Recipient will not be permitted a deduction of expenditure

incurred from the abovementioned income in terms of the general deduction formula. The

Act, however, makes provision for the deduction of certain expenditure incurred prior to

the commencement of trade, but such deductions may only be permitted in years of

assessment when trading has commenced and may also be limited.

In addition, the Act also permits an allowance in respect of future expenditure to be

incurred by the Recipient in respect of certain contracts. Although limited in application,

the Recipient could be permitted a deduction of an allowance of certain expenditure in

terms of section 24C of the Act.

Debt-based crowdfunding

In terms of debt-based crowdfunding, the Investors provide funding to the Recipient by

means of loan funding, which is then repaid over time with interest.

There should be no tax implications arising for the Recipient or the Investor upon the

issue of the loan by the Recipient.

If the loan funding takes the form of an interest bearing loan, the provisions of section 24J

of the Act may apply to such a loan. This section, inter alia, regulates the incurral and

4

accrual of interest in respect of financial instruments. In terms of section 24J, interest

income and expenditure will effectively be spread over the term of the loan for tax

purposes. Upon settlement of the loan, certain adverse tax implications may arise for the

Investor and/or the Recipient in instances where total consideration paid by the Recipient

to the Investor over the term of the loan and at settlement thereof differs from the amounts

taken into account for tax purposes.

Furthermore, if the debt owed by the Recipient is written off by the Investor or reduced

for no consideration, then the provisions of section 19 of the Act or paragraph 12A of the

Eighth Schedule to the Act may apply, which could give rise to income tax or capital

gains tax (CGT) implications for the Recipient.

It should also be noted that specific anti-tax avoidance provisions may apply in instances

where the terms of the loan or the interest payable on the loan contain certain equity-like

features (for example where the interest payable in respect of the loan is not determined

with reference to an interest rate, but rather with reference to the profits of the Recipient).

In such cases, the provisions of the Act deem interest payments to be dividends paid by

the Recipient to the Investor and they are taxed accordingly. In such instances, the

Recipient would not be allowed a tax deduction of such interest and the interest payments

would be subject to the dividends tax.

Equity-based crowdfunding

In terms of equity-based crowdfunding, Investors provide funding to a start-up company

by subscribing for shares in the Recipient company. The Investors will then receive

dividends when the Recipient becomes profitable.

With regard to dividends declared and paid by the Recipient to an Investor, such

dividends will generally not be subject to income tax in the hands of an Investor, unless

certain anti-avoidance provisions apply in terms of which dividends are deemed to be

income in the hands of the Investor.

5

Dividends tax is levied at the rate of 15% on the amount of any dividend paid by any

company, subject to certain exemptions. Certain documentary requirements must be met

in order to rely on certain exemptions from the dividends tax. There is no exemption

available where the beneficial owner of the dividend is a natural person.

Any gains in respect of a disposal of the shares by an Investor may give rise to income tax

or CGT implications in the hands of such an Investor, depending on whether the Investor

trades in the shares or not.

A transfer of the shares may further be subject to securities transfer tax, payable by the

Recipient, which may recover the tax so payable by it from the transferee.

In light of the above, we recommend that the tax implications arising out of crowdfunding

be considered before providing substantial funding or utilising such platforms to obtain

funding.

ENSafrica

ITA: Sections 1 ‘gross income’ definition, 11 read with 23(g), 11A 19, 24C, 24J, 64E,

64F and paragraph 12A of the Eighth Schedule

2543. Reinstating a deregistered company

The common incidence of companies being deregistered when their CIPC returns are in

arrears has resulted in immovable properties registered in the names of these companies

becoming bona vacantia and reverting to state ownership.

This requires court applications to reinstate the companies and restore their ownership of

the properties involved. In Binding Private Ruling 237, published on 7 June 2016, SARS

has addressed the income tax consequences of this deregistration and re-registration. The

ruling does not accord with the law, but it does offer some no doubt welcome relief for the

taxpayer.

6

Two companies entered into an amalgamation transaction conducted under section 44 of

the Income Tax Act (the Act). The effect of a section 44 transaction is that the assets of a

company, the amalgamating company (A), are transferred to another company in return

for shares in the recipient company, known as the resultant company (R). A then

distributes its shares in R as a dividend in specie to its holding company, after which its

existence must be terminated within 36 months.

According to section 44(13), if the termination does not happen within the stipulated

period, or if steps are taken to withdraw or invalidate the termination, the benefits of

section 44 do not apply. These benefits are:

rollover relief: the assets pass from A to R at base cost in the case of capital assets

and at carrying value in the case of trading stock, while the base cost and

allowances of allowance assets are transferred to R. In other words, there is no

immediate tax consequence;

there is no transfer duty on the transfer of immovable property; and

VAT is not payable on the supply of the assets in question.

This is what happened in the present matter and A was duly deregistered as required by

section 44. R then discovered that the parties had omitted to transfer an immovable

property from A to R. The property was still registered in the Deeds Office in the name of

A. So R was faced with having to procure the re-registration of A in order to get the

immovable property transferred to R.

However, in addition to the administrative difficulties and costs involved in applying to

court for re-registration and retrieving the immovable property from its bona vacantia

status, the fiscal implications of the omission were serious. Firstly, the transaction no

longer qualified under section 44, because a condition of a qualifying amalgamation

transaction is that all the assets of A must be transferred, in terms of the definition of

“amalgamation transaction” in section 44(1). And secondly, the relief from income tax,

transfer duty and VAT no longer applied, in terms of section 44(13).

7

So R applied for a ruling enabling it to apply for re-registration of A so as to effect the

transfer without losing the benefits of section 44. The ruling makes no mention of the fact

that the transaction was disqualified from section 44 altogether because of the failure to

transfer all A’s assets to R. It seems that SARS must have condoned this breach without

stating as much in BPR 237.

SARS issued a ruling favourable to R: the rollover relief would still apply; the

reinstatement and subsequent deregistration would not trigger section 44(13);

section 8(25) of the VAT Act would continue to apply to exempt the transaction from

VAT; and the Transfer Duty Act section 9(1)(l)(iB) exemption would apply to the

transfer.

SARS imposed certain conditions to the ruling: R would have to approach National

Treasury and Public Works to ensure that they had no objection to the re-registration, in

view of the fact that, as bona vacantia; the property now belonged to the State; and R

would have to advertise the application in a local newspaper. Finally, R would have to

make the necessary re-registration application in terms of CIPC Practice Note 6 of 2012.

Whilst one can sympathise with R, the fact is that SARS overruled the law in making this

ruling, and one wonders whether this is a healthy precedent. BPR 237 does have the merit

of indicating what needs to be done in these bona vacantia instances.

Professor Peter Surtees

ITA: Section 44

VAT Act: Section 8

Transfer Duty Act: Section 9

BPR 237

CIPC Practice Note 6 of 2012

Editorial Comment: Published SARS rulings are necessarily redacted summaries of the

facts and circumstances. Consequently, they and articles discussing them should be

treated with care and not simply relied on as they appear.

8

2544. Amalgamation transactions

The South African Revenue Service (SARS) has traditionally adopted a conservative

approach in issuing rulings which approve a tenuous interpretation of provisions of the

Income Tax Act, 1962 (the Act), in favour of the taxpayer. However, in Binding Private

Ruling 231 (BPR 231), which was issued by SARS on 10 May 2016, SARS adopted an

interesting interpretation of the corporate roll-over relief provisions in section 44 of the

Act, which raises a number of questions. The BPR 231 is quite long and therefore we will

only discuss the manner in which SARS applied the provisions of section 44, relating to

corporate roll-over relief in the case of so-called amalgamation transactions (section 44

transaction).

Facts

The Applicant in this case is a South African resident company that is held 74% by a

foreign company (ForeignCo) and 26% by black economic empowerment (BEE)

shareholders. ForeignCo is a wholly owned subsidiary of another foreign company

(HoldCo). There are also a number of Co-Applicants, including three companies that are

majority-owned by BEE shareholders (BeeCo1, BeeCo2 and BeeCo3). BeeCo2 is a

wholly owned subsidiary of BeeCo1. BeeCo2 and BeeCo3 also each participate in two

separate unincorporated joint ventures (UJVs).

The relevant legal framework

In terms of section 44(2) of the Act, a company will qualify for certain corporate roll-over

relief, in that the transfer of capital assets or trading stock will not trigger the inherent tax

gain, if the transaction constitutes a section 44 transaction in terms of section 44(1)(a) or

(b).

Section 44(1)(a) defines an amalgamation transaction as a transaction where:

1. any resident company (amalgamated company);

2. disposes of all of its assets (other than assets it elects to use to settle any debts by it

incurred in the ordinary course of its trade, and other than assets required to satisfy

9

any reasonably anticipated liabilities to any sphere of government of any country

and costs of administration relating to the liquidation or winding-up); or

3. to another resident company, which is a SA resident (resultant company) in terms of

an amalgamation, conversion or merger.

Section 44(1)(b) contains the exact same wording, the only difference being that the

amalgamated company is a foreign company and that the shares in the amalgamated

company are held as capital assets. Section 44(2)(a) contains a further requirement for the

corporate roll-over relief in that the shares must be acquired by the resultant company as

capital assets or as trading stock, as the case may be.

Description and purpose of the transaction

The Applicant and the relevant subsidiary Co-Applicants intend to rationalise and

simplify their South African group structure by entering into four separate transactions

which will eliminate the UJVs and unnecessary companies in its structure. Transactions 1,

2 and 4 entail section 44 transactions, whereas Transaction 3 constitutes an asset-for-share

transaction in terms of section 42 of the Act.

We will only discuss SARS’s ruling with respect to Transactions 1 and 2.

In Transaction 1, the group wishes to eliminate the intermediate holding of the

Applicant’s shares by ForeignCo. To do this, ForeignCo will dispose of its shares in the

Applicant for a new issue of shares in the Applicant in terms of a section 44 transaction.

The new shares in the Applicant will be distributed by ForeignCo to its sole shareholder,

HoldCo, in terms of the relevant amalgamation agreement. ForeignCo will then be

liquidated in terms of that amalgamation agreement.

In Transaction 2, a similar approach will be followed. BeeCo1 will dispose of its shares in

BeeCo2 for a new issue of shares in BeeCo2 in terms of a section 44 transaction. The new

shares in BeeCo2 will be distributed by BeeCo1 to its shareholders in terms of the

relevant amalgamation agreement and BeeCo1 will then be liquidated in terms of that

amalgamation agreement.

10

SARS’s ruling

With respect to Transaction 1, SARS ruled that the transfer by ForeignCo of its shares to

the Applicant under the amalgamation agreement will constitute a section 44 transaction

in terms of section 44(1)(b) of the Act and will qualify for the corporate roll-over relief

and that the repurchased shares of the Applicant will also be cancelled upon repurchase.

There will also be no dividends tax payable on the distribution of the newly-acquired

shares of the Applicant to HoldCo.

With respect to Transaction 2, SARS ruled that the transfer of assets by BeeCo1 to

BeeCo2 under the amalgamation agreement between them, will constitute a section 44

transaction terms of section 44(1)(a) of the Act and will qualify for the corporate roll-over

relief. The repurchased shares of BeeCo2 will also be cancelled upon repurchase. No

dividends tax will be payable on the distribution of the newly-acquired BeeCo2 shares by

BeeCo1 to its shareholders.

Comments

Although SARS rulings often do not include all the facts provided to it by the applicants,

it is possible that ForeignCo and HoldCo might be liable to pay capital gains tax (CGT) in

terms of paragraph 2(1)(b)(i) of the Eighth Schedule to the Act, if they disposed of their

shares outside of the ambit of the corporate roll-over relief provisions in the Act.

Paragraph 2 of the Eighth Schedule states that a non-resident company will be liable for

CGT in South Africa if on disposal, it holds more than 20% of the shares in a South

Africa resident company and 80% of the market value of the South Africa resident

company’s shares are directly or indirectly attributable to immovable property. This might

explain why the parties wish to make use of the roll-over relief in section 44. Upon closer

scrutiny, it appears that some of the requirements of section 44 might not have been met.

Section 44(2)(a)(i) states that where an amalgamated company disposes of a capital asset,

the resultant company will only qualify for the roll over relief if the resultant company

11

“…acquires it as a capital asset…” In Transaction 1, ForeignCo concludes a section 44

transaction in exchange for the Applicant issuing new shares to it. It is the subsequent

cancellation of these repurchased shares which raises issues. The cancellation is an

unavoidable outcome and therefore, regardless of the intention of the Applicant, it could

never have held the shares as capital assets.

Should section 44(2) or (3) of the Act not apply, the repurchase might constitute a

‘dividend’ and potentially trigger a dividend withholding tax charge. A further

consequence of section 44(2) or (3) not applying is that the distribution of shares by the

amalgamated company will not be income tax and dividends tax neutral.

Section 41 of the Act defines a capital asset as any asset as defined in the Eighth

Schedule, except an asset that constitutes trading stock. The Eighth Schedule defines an

asset essentially as any property or any right in such property. The definitions of trading

stock in section 1 and section 41 of the Act essentially state that trading stock is anything

acquired by the taxpayer for the purposes of sale or the proceeds of which would form

part of the taxpayer’s gross income upon disposal. The shares of the Applicant and the

shares of BeeCo2 that are bought back in terms of Transactions 1 and 2 are therefore not

acquired as capital assets or as trading stock in terms of the repurchase transactions.

In terms of section 44(6)(c) of the Act, the transfer of capital assets or trading stock to the

shareholders of the amalgamated company will only qualify for the roll-over relief, if the

requirements of section 44(2)(a) are met. As it appears that these requirements have not

been met, a capital gain will potentially be triggered when ForeignCo disposes of the

newly issued shares of the Applicant to HoldCo.

This argument is supported by the fact that a company cannot acquire rights against itself

and by section 35(5) of the Companies Act, 2008, which states that once shares have been

repurchased by a company, they no longer have the status of issued shares, but have the

same status as authorised unissued shares. In commercial terms, these shares are thus not

reflected on the balance sheet of a company as assets.

12

The same comments apply to Transaction 2, in terms of which BeeCo1, the amalgamated

company, disposes of its shares in BeeCo2, the resultant company, in exchange for the

issue of new shares in BeeCo2.

Cliffe Dekker Hofmeyr

Companies Act: section 35(5)

ITA: Sections 1 ‘trading stock’ definition, 41, 42, 44 and paragraph 2(1)(b)(i) of the

Eighth Schedule

BPR 231

Editorial Comment: Published SARS rulings are necessarily redacted summaries of the

facts and circumstances. Consequently, they and articles discussing them should be

treated with care and not simply relied on as they appear.

GENERAL

2545. Trading stock in wine farming industry

The South African wine industry is internationally renowned for the quality of wine it

produces. From a tax perspective, a specific tax dispensation applies to income derived by

a person from “pastoral, agricultural or other farming operations” as contemplated in

section 26(1) of the Income Tax Act, 1962 (the Act). To the extent that a person’s taxable

income is derived from such operations, the First Schedule to the Act will apply.

On 1 June 2016, the Supreme Court of Appeal (SCA) handed down judgment in Avenant

v The Commissioner for the South African Revenue Service (367/2015) [2016] ZASCA 90

(1 June 2016), where it had to interpret section 26(1) and certain paragraphs of the First

Schedule. This case forms the subject matter of this article.

Facts

Avenant, the taxpayer, carried on “pastoral, agricultural or other farming operations” in

terms of section 26(1) of the Act and filed tax returns which showed that a portion of his

overall taxable income was derived from his farming operations. The farming income

consisted of payments that the taxpayer received from a co-operative (Co-op), of which he

13

was a member, for grapes that he delivered to the Co-op for the purpose of being made

into wine.

On delivery, the taxpayer’s grapes were pressed into a pulp and mixed with the pulp from

pressing grapes of the same cultivar and class, such as Sauvignon Blanc and Chenin

Blanc, delivered by other farmers, who were also members of the Co-op. These common

pools of individual cultivars and classes of grapes were managed by the Co-op.

As at midnight on 28 February 2009, (the end of taxpayer’s 2009 year of assessment) all

of the taxpayer’s harvested grapes had been delivered to the Co-op and pressed into pulp

to begin the process of wine making. The Co-op thereafter bottled or packaged the wine,

marketed and sold it. The members of the Co-op did not sell their produce, or transfer

ownership to the Co-op, meaning it did not become the owner of the produce.

Judgment

The SCA had to decide the following four questions:

Whether the income received by the taxpayer, which is generated by the sale of wine,

constitutes income derived from “carrying on pastoral, agricultural or other farming

operations” in terms of section 26(1) of the Act?

The court held that the transformation of grapes into wine does not result in the income

earned from the sale of wine being removed from the ambit of income derived from the

taxpayer’s agricultural operation. The income earned from the sale of wine is therefore

also taxable in terms of the First Schedule.

Whether the pressing of the grapes delivered by the taxpayer to the Co-op results in

the pulp no longer constituting ‘produce’ as contemplated in paragraph 2 of the

First Schedule?

The taxpayer argued that after the grapes were pressed they no longer existed at midnight

on 28 February 2009 and once the resultant pulp was mixed with the pulp from other

14

farmers’ grapes, the mixture was a work-in-progress in a process of manufacture, namely

the manufacture of wine by the Co-op and therefore not the taxpayer’s produce at all.

The taxpayer further argued that the process whereby the mixed pulp was treated with

chemicals to aid the fermentation process constituted a process of manufacture which

substantially changed the character of the materials out of which the wine was made,

meaning it no longer constituted ‘produce’ of the farming operation.

The court rejected this argument and agreed with SARS that the pulp was essentially

‘wine in process’, which fell within the concept of the ‘produce’ of a wine grape farmer as

envisaged by the First Schedule. The principle laid down by the court was that:

The extent to which the identity of a natural product may be transformed by some form of

treatment until it no longer exists as produce, must depend upon the product as well as the

nature and extent of the processing, or treatment, to which it is subjected. Each case must

be decided upon its own facts.

The extent to which the raw product loses its identity by confusion and survives only as an

inseparable portion of a factory product due to the manufacturing process, is an important

consideration to take into account to answer this question, but did not apply in this

instance.

The court further held that a contextual and purposive interpretation of the word ‘produce’

had to be adopted. Produce, as in the case of ‘trading stock’ dealt with in section 22 of the

Act, includes work-in-progress, and therefore the pulp produced by pressing the grapes

falls within the definition of ‘produce’. The SCA held that the principle underlying the

inclusion of closing stock in the income tax calculation, being the balancing of the

person’s tax calculation for that tax year and which also underlies paragraph 2 of the First

Schedule, had to be applied by taking into account the existence of the pulp in that tax

year.

15

Whether the pressing into a pulp of the taxpayer’s grapes and its subsequent mixing

with the pulp of other members of the Co-op, results in what was delivered by the

taxpayer no longer being “produce held and not disposed of by him”, in terms of

paragraph 2 of the First Schedule?

The court stated that just as trading stock is ‘held and not disposed of’ if the taxpayer has

ownership in it, the same principle applied to ‘produce’. Here, the taxpayer retained

ownership even though the grapes were delivered to the Co-op, meaning they were still

‘held’ in terms of paragraph 2 of the First Schedule. The SCA held that the taxpayer

retained joint ownership, in an undivided share of the pooled pulp and at a later stage the

pooled wine, pro rata to his contribution of grapes to the pool.

As the taxpayer retained ownership of the pulp, the Co-op could never have held it for the

purpose of sale by itself. The pulp remained the taxpayer’s “own produce derived from his

or her farming operations” in terms of paragraph 2 and he therefore had to have accounted

for his produce. If this were not the case, farmers could mix their produce together before

the year end to avoid having to account for closing stock. Such an interpretation gives

effect to the purpose of the legislation, is in accordance with its language, and achieves

sensible and business-like results.

Did the pulp have a value at midnight on the last day of the 2009 year of assessment?

The court had to consider paragraph 9 of the First Schedule, which merely states that the

value to be placed on the ‘produce’, as referred to in paragraph 2, must be ‘fair and

reasonable’. SARS is not compelled to apply a market value, but may adopt another

method provided it is fair and reasonable. The taxpayer argued that the pulp had a

negative value as the production costs incurred by the Co-op prior to any grapes being

delivered to it exceeded the pulp’s intrinsic value. SARS argued that the value of the pulp

was greater than zero, when valued with reference to either the distilling wine price or the

pulp’s production cost.

16

The court held that the pulp was not valueless when one considered that the wine to be

produced was intended to be sold at a profit and that in each year the taxpayer had

received positive returns from the pool. The distilling wine price was an ascertainable

value, reflected in wine statistics and publications and was calculated by using a specific

formula. The court found that this method of calculation is practical, workable and

realises a positive value for the stock and therefore places a fair and reasonable value on

the stock. Regarding the production costs method, the court found that the taxpayer’s

costs in relation to his wine farming activities were objectively ascertainable based on the

evidence before it and this was therefore also an acceptable method of calculation.

Finding

The court dismissed the appeal with costs and upheld the decision of the Tax Court to

refer the matter back to SARS for re-assessment. SARS is entitled to re-assess the

taxpayer to tax in accordance with the principles set out in the judgment.

Comments

Although the facts of the case relate to the wine farming industry, the SCA’s judgment has

implications for the broader farming community as well. In essence, where a person

conducts operations that fall within the scope of section 26(1) of the Act, any produce

from these operations that such person has not disposed of at the end of their year of

assessment and over which they retain ownership will have to be included in their income

tax calculation for that year of assessment.

Furthermore, if the goods produced in terms of the section 26(1) operations went through

a manufacturing process before being sold as the final product, they will still constitute

‘produce’. For the natural product to no longer constitute ‘produce’, it will have to lose its

identity. Whether such loss of identity has occurred will depend upon the product as well

as the nature and extent of the processing, or treatment, to which it is subjected.

Based on this principle, a farmer of seeds or nuts who has delivered seeds or nuts to a co-

operative where they might go through a cleaning process before being packaged and sold

to the public, will most likely have to include any seeds or nuts not yet sold at the end of a

17

year of assessment. On the other hand, a farmer producing grain used in the production of

bread or producing mealies to be used in the production of mealie meal, might not have to

include the processed but unsold bread or mealie meal as ‘produce’ at the end of the year

of assessment, if it is found that the grain or mealie meal has lost its identity due to the

extent of the manufacturing process to which it has been subjected.

Cliffe Dekker Hofmeyr

ITA: Sections 22 and 26, paragraphs 2 and 9 of the First Schedule

INTERNATIONAL TAX

2546. Foreign business establishments

In terms of the South African controlled foreign company (CFC) legislation contained in

section 9D of the Income Tax Act, 1962 (the Act), where South African residents directly

or indirectly hold more than 50% of the total participation rights (essentially, the right to

participate in the benefits of the rights attaching to a share) in a foreign company, a

proportional amount of the “net income” of that foreign company (as a CFC) will be

included in the income of those residents.

In determining the “net income” of the CFC, section 9D(9)(b) of the Act exempts, inter

alia, any amount which is attributable to any foreign business establishment (FBE) of that

CFC.

In this context, it is relevant to note that the presence of a FBE is only the first

requirement in a two-step test, which must be met in order for a CFC to rely on the FBE

exemption. Secondly, it must be determined whether the specific amount is attributable to

the FBE of that CFC.

An FBE is defined in section 9D(1) of the Act, inter alia, as:

“a fixed place of business located in a country other than the Republic [of South

Africa] that is used or will continue to be used for the carrying on of the business of

that controlled foreign company for a period of not less than one year, where-

18

(i) that business is conducted through one or more offices, shops, factories,

warehouses or other structures;

(ii) that fixed place of business is suitably staffed with on-site managerial and

operational employees of that controlled foreign company who conduct the

primary operations of that business;

(iii) that fixed place of business is suitably equipped for conducting the primary

operations of that business;

(iv) that fixed place of business has suitable facilities for conducting the primary

operations of that business; and

(v) that fixed place of business is located outside the Republic solely or mainly for

a purpose other than the postponement or reduction of any tax imposed by any

sphere of government in the Republic…”

In the modern globalised economy, many multi-national enterprises conduct more than

one business from a single fixed place of business, or conduct various businesses from

different locations, but these businesses are housed in one legal entity. The question that

arises is: Can a CFC have more than one FBE, or can this exemption only be relied upon

for one of the businesses that is conducted through the legal entity which constitutes a

CFC?

It is common business practice (and has been recognised in a number of South African

cases) that different businesses may be housed in one legal entity, for example, where one

legal entity conducts business through separate divisions.

As set out above, an FBE is defined as a fixed place of business of that CFC, which is

used for the carrying on of the business of that CFC, subject to certain further

requirements pertaining to the employees, structures, equipment and facilities. Relevant in

this regard, is how these further requirements are worded, referring to that business and

the primary operations of that business.

By making use of the phrase “a fixed place of business”, which is then followed by the

further requirements having reference to “that [fixed place of] business” and not the

19

CFC, in our view, the legislature did not preclude the application of the FBE exemption

to a CFC which has more than one fixed place of business and/or different businesses are

carried on at a particular fixed place. The fact that the exemption may be relied upon in

respect of more than one FBE is, in our view, further supported by the wording in section

9D(9), which provides that there must not be taken into account any amount that is

attributable to any FBE of that CFC (and specifically not the FBE of that CFC).

Furthermore, it is clear that what needs to be considered in determining whether the FBE

exemption applies to an amount received by a CFC is firstly, whether the business (as

opposed to CFC) in respect of which a particular amount was received, complies with the

requirements of an FBE.

Therefore, in establishing whether a CFC has an FBE, the relevant requirements should be

considered in relation to each of the CFC’s businesses separately.

In our view, it is therefore possible for one of the CFC’s businesses to not meet the

requirements for an FBE without “tainting” the other businesses of that CFC, which may

still meet all the requirements of a FBE. Similarly, it may be possible for certain amounts

received by a CFC to be attributable to its FBE and therefore qualify for the FBE

exemption, while other amounts that are not attributable to the FBE do not qualify for the

exemption and must thus be included in the “net income” of the CFC.

Conclusion

CFC can fulfil the substance requirements of the FBE definition by relying on its

utilisation of the substance of another entity. However, that other entity must itself be a

CFC and part of the same group of companies (as the CFC). It is not necessary that the

other company should have incurred an obligation to pay tax in that other country in the

year of assessment in question.

However, the other entity must be tax resident in the country where the CFC’s business is

located, and as a result the other state may exercise its right to impose tax on any income

20

derived by that other entity. Furthermore, the shared resources must also be located in the

country in which the CFC’s business is located.

Taxpayers who assert that the FBE exemption applies in respect of a CFC, placing

reliance on shared substance, should satisfy themselves that the CFC providing substance

may be taxed in the jurisdiction in which the FBE is situated by virtue of residence, place

of effective management or other criteria of a similar nature and not by reference to source

or attribution to a permanent establishment.

ENSafrica

ITA: Section 9D

TAX ADMINISTRATION

2547. Compromise agreements

The High Court (Gauteng Division, Pretoria) recently handed down judgment in the case

of Malema v Commissioner for the South African Revenue Service (76306/2015) [2016]

ZAGPPHC 263 (29 April 2016). The issue before the court was whether the South

African Revenue Service (SARS) was bound to a compromise agreement entered into

between Malema (Applicant) and SARS as a result of alleged non-disclosures and

misstatements made by the Applicant, who expressly warranted the truth of the facts

furnished by him. The compromise agreement was concluded in accordance with the

provisions of section 200 of the Tax Administration Act, 2011 (TAA).

Facts

The dispute mainly pertains to assessments raised by SARS against the Applicant for the

2005 to 2011 years of assessment, totaling the amount of R18 192 295.36 including

interest. The Applicant objected to the assessments and alleged that the amounts in

question constituted donations or dividends in respect of which the Applicant could not be

assessed for tax. The Applicant requested a compromise from SARS on four occasions.

Following three failed attempts to conclude a compromise agreement, the Applicant

21

submitted a fourth application on 21 May 2014 after which the Applicant and SARS

finally concluded such an agreement (Agreement).

The final date to comply with the Agreement was 30 November 2014. By

1 December 2014, the Applicant had paid the amount stipulated in the Agreement and

thus complied with his payment obligations.

On 13 March 2015, SARS contended that it was no longer bound by the Agreement as the

Applicant had not, as was required by the Agreement, made full, verifiable and complete

disclosure of all material facts nor kept his tax affairs current. It is also important to note

that the Applicant was provisionally sequestrated on 10 February 2014 - between his

second and third attempts to conclude a compromise agreement.

Judgment

Section 205 of the TAA states that SARS is not bound by a compromise if:

(a) the debtor fails to disclose a material fact to which the compromise relates;

(b) the debtor supplies materially incorrect information to which the compromise

relates;

(c) the debtor fails to comply with a provision or condition contained in the

compromise agreement; or

(d) the debtor is liquidated or the debtor’s estate is sequestrated before the debtor has

fully complied with the conditions contained in the compromise agreement.

With these considerations in mind, SARS argued that it was no longer bound by the

Agreement as the Applicant had failed to:

identify the donor who offered to donate R4 million to the Applicant to use as

payment towards the amount in the Agreement and to ensure that donations tax was

declared and paid on this amount; and

keep his tax affairs current and paid up to date in that he, among other things, failed

to ensure that donations tax was paid on the part of the compromise amount being

paid by way of donation and failed to make payment of the previously

22

acknowledged liability for the (additional) 2011 and 2012 assessments and

subsequently proceeded to object to the assessments and failed to declare donations

received by his attorney, Brian Khan.

The Applicant further made misstatements in the request for the compromise, for instance

that he was the beneficiary of the JSM Trust which had failed to keep its tax affairs in

order. In addition he failed to disclose an alleged interest in a certain property (Bendor

property).

SARS further argued that the Applicant had unequivocally accepted liability for the 2011

and 2012 assessments. The Applicant disputed this, stating that the amounts were not

taxable as income in his hands as they were dividends or donations.

The Applicant’s main arguments can be summarised as follows:

SARS’s decision to no longer be bound by the Agreement was unlawful;

the Applicant could have treated the matter as unlawful administrative action but

elected to treat it as a matter of private law and not public law;

SARS had to conform to the provisions of the Constitution and the Applicant’s

rights to human dignity, freedom of trade, occupation and profession, and property,

and administrative action had to be complied with by SARS; and

the issue whether the JSM Trust’s tax affairs were regularised or otherwise had

nothing to with the Applicant’s rights and obligations under the Agreement.

The court stated that the real dispute between the parties was how the dividends and

donations received should be classified. The Applicant argued that the donations were

made out of generosity or disinterested benevolence and that the dividends were not

taxable, whereas SARS argued that the donations and dividends were income. The dispute

appeared to be a purely factual one and it was difficult to assess whether the Applicant

had not made a full and frank disclosure as alleged by SARS. The court made the

following observations regarding applicable provisions in the TAA and their

interpretation:

23

in terms of section 194 of the TAA, a compromise of a debt can only take place

when the liability to pay the debt is not disputed by the debtor;

the effect of section 194 is that, under a compromise, the taxpayer loses his right to

object and appeal against an assessment, meaning that SARS cannot be allowed to

enter into a compromise with a taxpayer only to later deny its validity based on

unwarranted grounds;

SARS is obliged to secure the highest net income from a tax debt and to enter into

compromises on an informed basis, which is why section 201(4) of the TAA

entitles senior SARS officials to require that an application for compromise be

supplemented by further information;

in terms of section 204(1) of the TAA, once a senior SARS official and a debtor

have signed a compromise agreement, SARS must give an undertaking that it will

not pursue recovery of the balance of the tax debt;

only if any of the circumstances in section 205 of the TAA referred to above are

present will SARS not be bound to the agreement; and

in order to determine whether a term is ‘material’ to a contract, one must assess

whether it was a vital term, as decided in O’Connell v Flischman 1948 (4) SA 191

(T).

The court accepted SARS’s argument that the alleged non-disclosure regarding the

Bendor property was intentional and that such fraud is material, but questioned why

SARS had still entered into the Agreement even though it was aware of the Applicant’s

interest in the property. The court appeared to disagree with SARS’s argument that any

misstatement or failure to make a disclosure would automatically be material.

The court finally held that, because of the factual disputes, the necessity for SARS to

justify its argument regarding materiality by proving the facts that were attendant when

the Agreement was entered into and because of the fact that one cannot decide the issue of

fraud on affidavit, the matter should be referred to trial. The court indicated that it did not

wish to express an opinion on which interpretation of section 205 is correct.

24

Cliffe Dekker Hofmeyr

TAA: Sections 194, 200, 201, 204 and 205

Editorial note: Care should be taken when reading the case as the court refers to the

incorrect sections in the TAA in various instances. The references to the sections have

been corrected in this article.

2548. Relevant material – lifestyle questionnaire

Section 46(1) of the Tax Administration Act, 2011(the TAA), contains provisions giving

SARS the power to require persons to submit relevant material that SARS requires.

The term ‘relevant material’ is defined in section 1 of the TAA and means:

‘… any information, document or thing that in the opinion of SARS is foreseeably relevant

for the administration of a tax Act …’.

For clarity, the term ‘information’ is also defined, in the following terms:

‘‘information’ includes information generated, recorded, sent, received, stored or

displayed by any means.’

The facts

In the matter of Commissioner for the South African Revenue Services v Brown [2016]

78 SATC 255, it was common cause that the respondent (Mr Brown) had not registered

for income tax and had not submitted returns of income for the 2011 to 2015 years of

assessment. SARS had issued a request to the respondent to submit relevant information

by way of completion of a ‘lifestyle questionnaire’ and gave notice that it intended to

launch an investigation into his affairs.

Acting through his attorneys, the respondent had sought to dodge the bullet by calling into

question SARS’ right to require the information that had been requested or to commence

an investigation. To this end, a list of requests was submitted to SARS under the

25

Promotion of Access to Information Act, 2000 (PAIA) calling for information largely

relating to internal processes within SARS by which the respondent had been identified as

a person to whom such a request might be submitted.

Only one of the requests made by the respondent was granted by SARS, but it refused to

concede to the majority of the requests on the basis that to do so would ‘jeopardise the

effectiveness of SARS auditing procedures and methods used to identify taxpayers’. An

internal appeal against this decision was instituted and dismissed.

The respondent did not respond to the request for information and asserted that a

constitutional and statutory right to comply with the request could only be enforced by

SARS once the information requested under PAIA had been supplied.

SARS therefore brought an application before the High Court for an order compelling the

respondent to comply with its request for relevant information.

SARS’ argument

SARS contended that the terms of section 46(1) of the TAA are mandatory. If a request

for relevant material is received, a person ‘must submit the relevant material to SARS at

the place and within the time specified by SARS in the request’, as required under

section 46(4) of the TAA.

The material requested constituted relevant material and it was required for purposes of

the administration of a tax Act (the Income Tax Act, 1962, (the Act) in this case), in that it

related to the compliance of the respondent with that legislation.

As regards the refusal by SARS to respond to the respondent’s request for information,

the information requested was within ‘SARS confidential information’ as specified in

section 68 of the TAA, and the circumstances specified in section 68(3), which permit the

disclosure of such information, did not apply in this instance. Further, without admitting

that the issue of the questionnaire was administrative action, SARS submitted that its

26

decision to do so was rational and justifiable in light of failures on the part of the

respondent to comply with the requirements of the Act.

The respondent’s case

The respondent argued that he was entitled to expect administrative conduct on the part of

SARS that was fair and reasonable as prescribed in the Promotion of Administrative

Justice Act, 2000 (PAJA). Furthermore, he sought protection under the Constitution from

harassment or invasive conduct on the part of SARS.

He classified the lifestyle questionnaire as a ‘fishing expedition’, alleging that SARS had

failed to justify its deviation from the constitutional provisions upon which he relied. He

contended that he was entitled to understand the nature of the information that SARS had

relied upon in coming to its decision to issue the questionnaire, and was justified in

refusing to comply until the information was supplied or the dispute over his right to

receive such information was finally determined.

In relation to the TAA, he asserted that the general nature of the questionnaire rendered it

arbitrary and capricious, with the result that the information sought did not constitute

‘relevant material’ as envisaged under section 46 of the TAA.

Finally, he asserted that the questionnaire related not to his business but to his personal

information and that it infringed his constitutional right to privacy.

The decision

In delivering judgment, Smith J examined the requirement that a taxpayer must submit the

relevant material to SARS at the place, in the format and within the time specified by

SARS, as provided in section 46(4). Having regard to the language used and to the context

in which the provision appears and its purpose, the Court found that the provisions are

peremptory.

27

Moving then to the issue that SARS was engaged in a 'fishing expedition', Smith J

examined the powers that SARS has to require the submission of ‘relevant material’ under

section 46, and set out the findings in paragraphs 40 to 42:

‘[40] It is in my view similarly manifest that the information sought in the questionnaire

constitutes 'relevant material' since it pertains to the respondent’s assets, liabilities and

expenses. Furthermore, the questionnaire could hardly have been more specific regarding

the information which the respondent is required to provide, and I am accordingly

satisfied that adequate specificity has been provided as required by the Act.

[41] There can also be little doubt that the issuing of the questionnaire was done in the

course of the ‘administration of a tax Act’ since the information sought therein manifestly

relate[s] to ‘the liability of a person or persons for tax in respect of a previous, current or

future tax year’ (Section 3(a)(i)(sic)).

[42] I am accordingly of the view that the applicant has established all the requisite

jurisdictional facts mentioned in section 46. The respondent’s contention that the issuing

of the questionnaire was a ‘fishing expedition’ is thus untenable. The questionnaire was

issued against the background of information to the effect that there may have been non-

disclosure of relevant information by the respondent, coupled with the fact that he did not

register as a taxpayer or submit tax returns. In my view these factors constituted a sound

basis for the issuing of the questionnaire and cannot by any stretch of the imagination be

regarded as ‘a fishing expedition’.’

The respondent’s counsel challenged the procedure adopted by SARS in seeking an order

to enforce compliance, asserting that it was not a competent procedure under the TAA.

This was rejected, with the Court concluding (at paragraph 45):

‘The right to institute civil action to enforce compliance with a request for relevant

material, on the other hand, is ancillary to the powers bestowed on SARS in relation to the

administration of a tax Act, including the power to request relevant material in terms of

section 46 of the [TAA]. That remedy is accordingly available to SARS in terms of the

28

common law and does not require specific statutory sanction. There is nothing in the

[TAA] that suggests the contrary; neither has [counsel for the respondent] been able to

refer me to any authority in support of his contention.’

This left the question of whether the respondent was entitled to seek protection under

PAJA. The respondent contended that the issuing of the questionnaire under section 46

constituted ‘administrative action’, and it followed that if he was aggrieved thereby he

could seek relief on the ground that it was unreasonable administrative action.

Smith J first set out the definition of ‘administrative action’ at paragraph 47:

“[47] Administrative action is defined by the PAJA as: ‘any decision or failure to take a

decision by an organ of state (i) exercising a power in terms of the Constitution or a

Provincial Constitution; or (ii) exercising a public power or performing a public function

in terms of any legislation which adversely affects the rights of any person and which has

a direct, external legal effect.’”

The judgment then cited the test whether an action constitutes administrative action, as

laid down in the matter of Transnet Ltd v Goodman Brothers (Pty) Ltd 2001 (1) SA 853

(SCA).

‘(a)Administrative Law is an incident of the separation of powers under which courts

regulate and control the exercise of public power by other branches of government;

(b)the question relevant to section 33 of the Constitution is not whether the action is

performed by a member of the executive arm of government, but whether the task itself is

administrative or not, and the answer to this is to be found by an analysis of the nature of

the power being exercised; and

(c)what fall to be considered in this regard are, inter alia, the source of the power

exercised, the nature of such power, the subject matter, whether it involves the exercise of

a public duty, and how closely it is related, on the one hand, to policy matters which are

not administrative, and on the [other] hand, to the implementation of legislation …’

Smith J supported the contention of counsel for SARS that:

29

‘… [The] request for information in terms of section 46 is a preliminary investigation by

SARS which may or may not lead to a more formal audit or inquiry under the [TAA]. It is

only when SARS has been placed in possession of the requested information that it will be

able to determine whether or not there are indeed grounds for a further inquiry or an

audit. It is at that stage that the principles of administrative justice must be observed.’

There is clear authority that a request for information does not constitute administrative

action, said Smith J, at paragraph 51:

‘In Competition Commission v Yara (SA) (Pty) Ltd and Others 2013 (6) SA 404 (SCA)

the Supreme Court of Appeal (per Brand JA) held that the initiation of a complaint by the

Competition Commission or a private person in terms of the Competition Act, 89 of 1998

is a preliminary step that does not affect a person’s rights …’

The respondent’s last desperate defence that the questionnaire infringed his right to

privacy under the Constitution also got short shrift (at paragraphs 54 and 55):

‘[54] Insofar as the respondent’s right to privacy, guaranteed in terms of section 14 of the

Constitution, may have been infringed by the issuing of the questionnaire, I am satisfied

that the provisions of section 46 of the [TAA] constitute a justifiable limitation to that

right as envisaged in section 36 of the Constitution. In the event, there has not been any

challenge to the constitutionality of that section.

[55] [Counsel for the respondent] also argued that the information sought by SARS does

not relate to his business affairs, but is personal information which is protected in terms

of his constitutional right to privacy. This argument is also untenable. All that SARS is

required to show is that the information sought is 'relevant material' necessary for the

administration of a tax Act. For the reasons mentioned above, the information sought by

virtue of the questionnaire is manifestly relevant for that purpose.’

The upshot was that an order was issued requiring the respondent to submit his response

to the lifestyle questionnaire within two weeks of the date of the order.

30

The court order further stipulated that if the respondent fails to submit the questionnaire

within the two weeks or at all, the applicant may apply on the same papers for an order in

the following terms:

‘[59] … 2.1 that the respondent be held in contempt of court;

2.2 committing the respondent to imprisonment until such time as he complies with the

court order.’

In addition, the respondent was ordered to pay the applicant’s taxed costs of suit on the

party-and-party scale, including the costs of two counsel.

PwC

Constitution: sections 14, 33 and 36

TAA: Sections 1 ‘information’ and ‘relevant material’ definitions, 3, 46 and 68

PAIA

PAJA

VALUE-ADDED TAX

2549. Interest-free credit

It is the long-standing practice of traders and service providers to grant customers

extended payment terms for the goods or services they supply as a means to enhance

turnover. Where the credit provided is interest-free, the question that arises is whether the

provision of such credit impacts on the entitlement of the supplier to claim input tax for

value added tax (VAT) purposes.

Assuming the supplier is a registered VAT vendor and the goods or services are not

specifically exempt from VAT, the supplier is required to levy and account for VAT on

the consideration for the goods or services supplied on credit. In some instances, the South

African Revenue Service (SARS) has contended that by granting the interest-free credit,

the supplier is supplying a financial service. SARS contends that such supplier is making

31

both taxable and exempt supplies, and may require the vendor to apportion its input tax

deductions accordingly.

Section 12(a) of the Value-Added Tax Act, 1991 (the VAT Act) exempts the supply of

any financial services from VAT. The activities which are considered to be “financial

services” for this purpose are defined in section 2 of the VAT Act. Section 2(1)(f) includes

in the ambit of a financial service, the activity involving the provision by any person of

credit under an agreement, by which money or money’s worth is provided to another

person who agrees to pay, in the future, a sum exceeding in the aggregate the amount of

such money or money’s worth.

The VAT Act is clear as to the activity involving the provision of credit which is

considered to be an exempt financial service. Firstly, there must be an agreement in terms

of which money or money’s worth is provided. Secondly, the person to whom the money

or money’s worth is provided must, in terms of the agreement, assume an obligation to

pay, in the future, a sum or sums exceeding in aggregate the money or money’s worth that

was provided.

The first requirement will normally be met, as the supplier will enter into an agreement

with the customer which will govern the repayment terms and conditions. Although the

supplier will not supply a sum of money to the customer, the credit amount is considered

to be “money’s worth” which is provided.

However, the second requirement is not complied with because the customer does not

agree to pay in the future sums exceeding the money’s worth that was provided in terms

of the credit agreement. The activity of granting interest-free credit is therefore not a

financial service as contemplated in section 2(1)(f).

The terms and conditions under which the credit is granted may stipulate that the supplier

is entitled to levy interest if the customer does not make the agreed payments within the

interest-free period. Such a provision entitles the supplier to claim interest from the

customer if the customer defaults, but cannot be construed to be an agreement in terms of

32

which credit is provided where the customer now agrees to make payment of sums

exceeding the money’s worth provided. There is, firstly, no agreement in terms of which

the credit terms are extended beyond what was already agreed, and secondly, the interest

charged is a penalty amount payable because the customer is in default, and is not

consideration for the provision of credit under any agreement.

Section 2(1)(c) of the VAT Act also includes the activity involving the issue, allotment,

drawing, acceptance, endorsement or transfer of ownership of a debt security as a

financial service. A “debt security” is defined to mean an interest in or right to be paid

money. A debt security generally includes financial instruments such as bonds,

promissory notes and debentures, and may also include book debts.

The supply of goods or services on credit is, however, not considered to be the issue or

allotment of a debt security as contemplated by section 2(1)(c). The supplier’s right to be

paid money arises from the supply of the goods or services, and not from the creation or

issuing of a debt instrument evidencing a debt obligation. A book debt would comprise a

debt security after the debt is established through the supply of goods or services on

credit. Any subsequent trade in the book debt will be exempt from VAT being the transfer

of ownership of a debt security.

The main purpose of interest free-credit sales is to make products more affordable for

consumers and to drive sales. It also allows the supplier to monitor consumer behavior

and to communicate regularly with customers regarding new products and special

offerings, thereby driving sales further. The supply of goods or services on interest-free

credit therefore forms an integral part of such sales, and does not comprise a separate,

stand-alone activity.

SARS acknowledges in its Interpretation Note: Note 70 that, where a supply is made by a

vendor for no consideration in the context of a business activity or enterprise, then such

supply is regarded to be a taxable supply in the course or furtherance of the enterprise.

The granting of the interest-free credit in this context, is therefore not a non-enterprise

activity, as was held in K C M v Commissioner of South African Revenue Service (VAT

33

711) [2009] ZATC 2 (14 August 2009), where the organisation provided publications for

no consideration, and which was ruled to be a gratuitous disposition.

As the granting of interest-free credit is not an exempt financial service and forms an

integral part of the taxable enterprise activities of the supplier, there is no basis upon

which the taxable expenses incurred in relation thereto should be apportioned.

VATCOM, a committee that was established to consider comments and recommendations

on the VAT Bill when VAT was introduced in South Africa in 1991, considered the

granting of interest-free credit and stated that it does not fall within section 2(1)(f) and is

therefore not a financial service. VATCOM further stated that the provision of credit for

no consideration is a taxable supply and no apportionment of input tax would be required

(VATCOM report, comment regarding clause 2(1)(f), page 83). The statement that the

provision of interest-free credit would not require apportionment is repeated in

VATCOM’s comments to clause 2(1)(ℓ)) (refer page 84).

In conclusion, the supply of interest-free credit is not a financial service which is exempt

from VAT in terms of section 12(a), but it is a taxable supply, albeit for no consideration,

which forms an integral part of the supplier’s taxable enterprise activities. No

apportionment of input tax should therefore be required for vendors supplying goods or

services on extended interest-free credit terms.

ENSafrica

VAT Act: Sections 2 and 12

SARS Interpretation Note 70

2550. Contra fiscum rule applied

In ABC (Pty) Ltd v Commissioner for the South African Revenue Service (VAT 1237)

[2016] ZATC 1 (24 March 2016), the Durban Tax Court had to deal with the uncommon

situation where a legislative amendment had a significant impact on a taxpayer’s affairs.

The judgment dealt with the right of the South African Revenue Service (SARS) to levy

interest and penalties on the late payment of value-added tax (VAT).

34

Facts

During December 2009, the taxpayer, ABC (Pty) Ltd, concluded a purchase and sale

agreement with Company D, in terms of which Company D paid US $3,950,000 for

certain of the taxpayer’s assets, excluding VAT.

No VAT was levied on the transaction as Company D believed that the transaction

qualified for VAT at the zero-rate. Thus the taxpayer did not pay any VAT to SARS.

Later, both companies accepted that VAT was payable on the transaction and on

9 November 2012, the taxpayer paid VAT to SARS.

SARS then imposed a 10% penalty and levied interest due to the late payment in terms of

section 39(1) of the Value-Added Tax Act, 1991 (the VAT Act). The interest was

calculated from 1 April 2010 to 9 November 2012. The taxpayer requested that the

penalty and interest be remitted in terms of section 39(7), but SARS remitted only the

penalty and not the interest. After the taxpayer’s objection to SARS’s decision was

unsuccessful, it launched an appeal.

Judgment

Section 39(7) of the VAT Act was amended on 1 April 2010. The coincidental timing of

the amendment gave rise to two questions for the court to decide:

Whether the “old” or “new” section 39(7) applied to the levying and remission of

interest?

Depending on the answer to the first question, whether the taxpayer’s appeal should

be allowed or not?

Prior to 1 April 2010, section 39(7) stated that SARS could remit the interest payable in

terms of section 39(1), if it was satisfied that the failure to pay VAT within the prescribed

period did “not result in any financial loss (including any loss of interest) to the State” or

if the taxpayer “did not benefit financially (taking interest into account) by not making

such payment” within the prescribed period. On 1 April 2010, the new section 39(7) came

35

into force and stated that SARS could remit the interest, in whole or in part, if it was

satisfied that the failure to pay the VAT in the prescribed period “was due to

circumstances beyond the control” of the taxpayer.

The taxpayer’s arguments can be summarised as follows:

As VAT was payable by 25 March 2010, penalties and interest should be assessed

from this date, but that it was SARS’s practice to only charge interest from the first

day of the month after the month in which payment was due. Therefore, interest

notionally started running on the first day after 25 March 2010.

SARS should have based its decision on the law as it stood at the time the VAT was

payable, i.e. 25 March 2010 and not as it stood on or after 1 April 2010.

In the alternative, the taxpayer argued that if the court held that the new section

39(7) was applicable, interest could only be imposed for VAT periods after 1 April

2010. As the next payment date was 25 June 2010, the new section 39(7) could only

apply from 1 July 2010 and thus the old section 39(7) applied to the taxpayer.

The arguments advanced by SARS were as follows:

In terms of section 39(2) of the Taxation Laws Amendment Act, 2009, the new

section 39(7) of the VAT Act came into operation on 1 April 2010 and applied to

interest imposed in terms of section 39(1)(a)(ii) of the VAT Act, after that date.

In terms of section 39(1)(a)(ii), interest could only be imposed on or after the first

day of the month following 25 March 2010, i.e. 1 April 2010, which was also when

the new section 39(7) came into effect.

The legislature intended to deal differently with penalties for late payment and

interest in terms of section 39 - the penalty could be imposed immediately upon late

payment, i.e. 26 March 2010 in this case, but the interest could only be imposed

from the first day of the next month, i.e. 1 April 2010.

The date from which interest runs is not regulated by a SARS practice directive, but

specifically by section 39(1)(a)(ii), which fixed the date as 1 April 2010 and which

was coincidentally the date on which the new section 39(7) came into effect.

36

The court held that, in essence, “the legislature provided the taxpayer with what may be

viewed as an indulgence not to have to pay interest for the period between the date upon

which the VAT was paid and the end of that month. Thereafter the taxpayer is required to

pay interest”, which “is triggered by the non-payment of VAT, and continues on a monthly

basis until the VAT is paid”. It held that SARS’s argument was thus correct and as the new

section 39(7) came into operation on 1 April 2010 and applied to interest imposed on or

after that date, the taxpayer’s application had to be considered in light of the new section

39(7).

Finding

The court found that the new section 39(7) should be applied to consider whether the

interest imposed in terms of section 39(1)(a)(ii) should be imposed. It accepted the

taxpayer’s argument that the matter should be remitted to SARS as the taxpayer did not

have an opportunity to consider and respond to SARS’s assessment in terms of the new

section 39(7). This is because such a finding “is least prejudicial to the taxpayer”. The

court also held that each party had to pay its own costs.

Comment

The court’s decision to allow the taxpayer to respond to SARS’s assessment in terms of

the new section 39(7) appears to be an application of the contra fiscum rule. In Shell’s

Annandale Farm (Pty) Ltd v Commissioner for South African Revenue Service [2000] 62

SATC 97, the Cape High Court stated that the contra fiscum rule can be invoked where a

statutory provision is ambiguous as to the intention of the legislature and if such

ambiguity is reasonably “implied from the wording of the legislation and such legislation

implies a burden upon the subject then that interpretation must be adopted which is in

favour of the taxpayer”.

The Cape High Court added that the ambiguity must be “neither contrived nor artificial

and…follows a reasonable reading of the text.” In the ABC case, it appears that the contra

fiscum rule was applied to allow the taxpayer a second bite at the cherry, in that the

assessment should be remitted to SARS, as the taxpayer did not have an opportunity to

37

respond to the assessment in terms of the new section 39(7). The decision in the ABC case

could thus be interpreted to extend the application of the contra fiscum rule.

Finally, it should be noted that the levying of interest on outstanding tax will in future be

regulated by section 187 to section 189 of the Tax Administration Act, 2011. Only parts

of these sections have come into force and taxpayers are thus advised to ensure that they

seek professional advice on the legislative provisions that apply to penalties and interest

due to late payment.

Cliffe Dekker Hofmeyr

TAA: Sections 187 to 189

VAT Act: Section 39

SARS NEWS

2551. Interpretation notes, media releases and other documents

Readers are reminded that the latest developments at SARS can be accessed on their web-

site http://www.sars.gov.za.

Editor: Ms S Khaki

Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof KI

Mitchell, Prof JJ Roeleveld, Prof PG Surtees, Mr Z Mabhoza, Ms MC Foster

The Integritax Newsletter is published as a service to members and associates of The

South African Institute of Chartered Accountants (SAICA) and includes items selected

from the newsletters of firms in public practice and commerce and industry, as well as

other contributors. The information contained herein is for general guidance only and

should not be used as a basis for action without further research or specialist advice. The

views of the authors are not necessarily the views of SAICA.

Ref#: 577565