ABC (Pty) Ltd v CSARS
09 October 2013
Posted by: Author: PwC
Attention to detail is vital in high value transactions
The judgment of Davis J in the Cape Town Tax Court in ABC (Pty) Ltd v CSARS (19 August 2013 unreported) concerned a single, crisp question – whether the proceeds of the disposal of a plantation by the appellant taxpayer had been correctly included in its gross income for the 2004 tax year of assessment in terms of s 26 (1) of the Income Tax Act 58 of 1962 read together with paragraph 14 (1) of the First Schedule to the Act.
We reported on this decision in the August issue of Synopsis in which we dealt with the merits and issues. The decision warrants further consideration as a reminder to tax practitioners and businesspersons alike that attention to detail is of vital importance where high value transactions are involved.
The factual background
The common cause factual background to the litigation was as follows. The appellant had purchased a plantation business in terms of a ‘sale of business agreement’ dated 3 October 2001. The purchase price of R11 956 121 was attributed to the standing timber. The appellant later disposed of the plantation to E (Pty) Ltd in terms of certain ‘heads of agreement’ dated 21 February 2003,read with a ‘settlement agreement’ dated 29 July 2004. The consideration for the plantation over and above the cost of the land was R144 700 000.
The appellant’s argument
The appellant argued that –
- it had acquired ownership of a plantation as an investment and
- it had contracted with E on terms whereby the farming operations regarding the plantation would be carried on for E’s benefit on E’s behalf and for E’s account,
- in due course, the appellant had disposed of the plantation to E, and that the plantation was never part of its business operations as the appellant was not, itself, engaged in farming.
In short, the appellant argued that it had been a mere passive investor; that after acquiring the land it retained the bare dominium of that land and granted E a usufruct; that the appellant had earned no income from the land and that the farming operations in relation to the plantation had been undertaken exclusively by E for the latter’s benefit.
Such an arrangement was not only legally feasible, but was, in principle, entirely credible. In the context of farming operations, it is common for ownership of the land to be vested in one legal entity, while the farming operations are carried on by another entity.
The question was whether this was what had actually occurred in the present case or, more precisely, whether the appellant had discharged the onus of proof in this regard by showing that this had been the actual arrangement in legal and fiscal terms.
The evidence adduced in the Tax Court
The oral evidence led by the appellant sought to establish that there had been an oral agreement between representatives of the appellant and E to the effect that the company would acquire the property and that it would permit E to farm the property and retain the income so derived.
When cross-examined on the accuracy of the information recorded in the written heads of agreement, the witnesses indicated that the heads of agreement did not reflect the actual agreement that they had made. In particular, the heads of agreement for the sale of the property recorded that E had managed the business on behalf of the appellant; however, E’s director denied that this had been the case, and the director of the appellant protested that he had seen that there were errors in the heads of agreement, but had signed on the understanding that the heads of agreement constituted a preliminary document that would be superseded by a subsequent formal agreement.
The evidence then dealt with a settlement agreement that had been subsequently drawn up to resolve issues of interpretation of the heads of agreement. In this agreement, the appellant agreed to pay a "bonus management fee” to E in recognition of the exemplary manner in which it had performed its stewardship obligations towards the appellant’s plantations. The parties under examination regarded the term "management fee” to be an inappropriate description. The one witness described it as a "rebate on the value of the forest” and the other stated that it was a misnomer, and that the fee recognised stewardship rather than management.
SARS attacked the witnesses’ evidence by comparing what they asserted with the terms of agreements, resolutions and other documents. They dealt first with the agreement for the original acquisition of the property by the appellant and noted that it had agreed to purchase the business of the seller as a going concern. The business was described in that agreement as "the business of forestry, timber growing, plywood manufacturer and property leasing as conducted by the sellers...” They then turned to the heads of agreement in which the appellant warranted that it was the lawful owner of "the business”, which it agreed to sell as a going concern. The directors of the company subsequently resolved to approve of "the sale of the forestry business as a going concern”. Finally, the annual financial statements contained a note that the growing of timber was one of the main objectives of the appellant.
SARS therefore urged that:
"… the court should not consider what he referred as ‘litigation-focus semantics’ but rather examine carefully the substantive evidence as to the continuous and close link between appellant and the farming operations, supported by various unguarded statements made by the parties themselves describing the relationship accurately in terms of it being a plantation business.”
The approach of the Court
The Court (Davis J) took the approach suggested by Miller J in ITC 1185 35 SATC 122 at 123, where it was stated:
"The Court’s function is to determine, on an objective overview of all the relevant facts and circumstances, what the motive, purpose and intention of the taxpayer were. The Court added:
‘In other words, whatever a taxpayer may tell the Court has to be analysed through the prism of the objective facts presented to the Court.’"
Thus, Davis J felt compelled to seek corroboration for the statements made by the witnesses from the documentary evidence that was before the Court.
‘When the objective evidence, particularly the range of documents to which I have references [sic] including contracts and financial statements are considered. They all indicate in the direction that appellant was conducting a business of plantation farming. Even in the event that beneficial consideration is given to appellant’s case by virtue of amendments to various documents, it would appear that the thrust of contemporaneous documentation supports respondents’ case to the extent that appellant has not discharged the onus of proving that its intention differed from that which is recorded in these financial documents, contracts, minutes and resolutions, namely that it had bought and sold the plantation businesses as a going concern and that it employed E to manage its plantation business on its behalf.’
The Tax Court was therefore not persuaded by the oral evidence and found that the evidence suggested that the appellant was indeed carrying on farming operations
It appears that the heads of agreement may well have been prepared on the basis that the disposal should be structured as a zero-rated transaction for VAT purposes, namely a sale of a going concern. This intention may well have coloured the manner in which the heads of agreement were drawn. The parties were subsequently advised that the transaction was a standard rated transaction, but it appears that there was no subsequent rectification made to the heads of agreement or resolutions authorising the transaction. The matter again emphasises that the documentary evidence is crucial in establishing the reliability evidence given in a Court. Documents are a contemporaneous record of events. On the other hand memory fades and the recollection of events that occurred a decade earlier is difficult and prone to potential inaccuracy.
This article was first published on pwc.co.za (Tax Synopsis: September 2013)