By Heinrich Louw (DLA Cliffe Dekker Hofmeyr Tax Alert)
Executive summary (SAIT Technical)
In a second article, Heinrich Louw further reflects on the recent Western Cape High Court judgment of Bosch and McClelland v CSARS. SARS relied on the 2011 SCA decision in NWK to argue that the transactions were simulated. The present case is likely to go on appeal to the SCA.
Judgment was handed down in the important case ofBosch and McCleland v Commissioner for the South African Revenue Service on 20 November 2012 by a full bench of the Western Cape High Court (a case we have previously reported on).
Davis J (Baartman J concurring) wrote the main judgment while Waglay J wrote a separate judgment.
The court was confronted with the question of whether a sale coupled with a resale provision, in the context of an employee share incentive scheme, was simulated. SARS relied on the decision in the case ofCommissioner for the South African Revenue Service v NWK Ltd 2011 (2) SA 67 (SCA)to argue that the sale and resale structure was in reality a conditional sale. SARS argued that there was no commercial purposes or reason for structuring the transaction as a sale coupled with a resale provision, as opposed to a conditional sale, other than to avoid tax (in this case to avoid the application of s8A of the Income Tax Act to the full gain in respect of the scheme shares).
The decision in theNWKcase was handed down by Lewis JA on 1 December 2010 and has since been the cause of much debate and confusion as to its impact and what the current position is regarding simulation and the structuring of transactions in tax efficient ways.
The root of the debate and confusion is that Lewis JA has seemingly replaced the trite principles and practice regarding simulation and avoidance with a new rule. In addition, there is uncertainty as to what exactly the new rule is. Also, if there is a new rule, does the departure from the established legal principles undermine the rule of law?
The most pertinent issues concerning theNWKjudgment have been pointed out by Eddie Broomberg in his paper entitled 'On NWK and Founders Hill', a paper to which both Davis J and Waglay J refer in their judgments.
He notes that "the bedrock common law principle that applies in South Africa is more than familiar: A transaction will not be regarded as simulated if the parties genuinely intended that their contract will have effect in accordance with its tenor, and that rule applies even if the transaction is devised solely for the purpose of avoiding tax...." This rule had been established by our courts in a string of cases such asZandberg v van Zyl 1910 AD 302, Commissioner of Customs and Excise v Randles, Brothers and Hudson Ltd 1941 AD 369, Erf 3183/1 Ladysmith (Pty) Ltd and another v CIR 58 SATC 229 and CIR v Conhage (Pty) Ltd 61 SATC 391.
Broomberg also notes that this conforms to SARS’s own established practice and application of the legal principles as is evident from Practice Note 5, dating from 1987, which states that "A taxpayer who has carried out a legitimate tax avoidance scheme, i.e. who has arranged his affairs so as to minimise his tax liability, in a manner which does not involve fraud, dishonesty, misrepresentation or other actions designed to mislead the Commissioner, will have met his duties and obligations under the Act...."
Broomberg suggest that it is difficult to determine what exactly the new rule is because, on reading theNWKjudgment, a clear distinction is not always drawn between the terms 'evasion' and 'avoidance'. He further suggests that the new rule laid down by Lewis JA is: "If the purpose of the transaction is only to allow the avoidance of tax then the transaction will be regarded as simulated."
Davis J seems to disagree that a new rule was established by the Supreme Court of Appeal (SCA), even though that has been the popular interpretation of the of theNWKjudgment. He states that: "Broomberg thus viewsNWKas a new and unjustified rule which replaces the previous jurisprudence. In my view, without an express declaration to that effect,NWKshould be interpreted to fit within a century of established principle, rather than constituting a dramatic rupture."
The reason given by Davis J for the view thatNWKhas not "replaced previous jurisprudence" is that Lewis JA does not expressly state that she is departing from established principles.
It would seem as if Davis J sees the principle established in theNWKjudgment as being that the lack of commercial rationale coupled with the purpose of tax avoidance can be an indicator of simulation. For there to be simulation, there must be some underlying understanding between the parties that differs from the purported agreement, and that underlying understanding may very well be the avoidance of tax.
Waglay J differs from Davis J on the point of whetherNWKestablished a new rule, and agrees with Broomberg’s suggestion that there has been a fundamental departure from established lawpractice. Waglay J interpretsNWKas laying down the rule that: "any transaction which has as its aim tax avoidance will be regarded as a simulated transaction irrespective of the fact that the transaction is for all purposes a genuine transaction."
Waglay J then picks up on the issue of the rule of law also identified by Broomberg. Waglay J’s point is essentially that a judgment such asNWKthat is the cause for so much confusion, uncertainty and debate, cannot stand as binding precedent. This is specifically so where there is an established body of law and the judgment
in question appears to depart from that body of law, but does not demonstrate clearly that there is such a departure nor provides reasons as to why the established law is no longer appropriate. The implication is that theNWKjudgment is simply too vague or unclear to be followed by the courts.
It is interesting to note that Waglay J also specifically mentions, as does Broomberg, that if the new rule establishes that any transaction that has as its aim the avoidance of tax (as opposed to evasion) is a simulated transaction, then it "goes against the accepted practice in our income tax law which permits transactions aimed at tax avoidance."
It is anticipated that the case will go on appeal to the Supreme Court of Appeal and it will be interesting to see whether that court will agree with Davis J’s approach of readingNWKas being consistent with established law.