The deduction of contingent expenditure as envisaged in the 2011 Draft TLAB (Ackermans Case)
08 July 2011
Posted by: SAIT Technical
PWC Tax Synopsis - June 2011
The deduction of contingent expenditure in going concern sales As envisaged in the current draft Taxation Laws Amendment Bill The taxpayer in Ackermans Ltd v CSARS 2011) (1) SA 1 (SCA), 73 SATC 1 may be permitted a wry smile on reading section of the proposed new section 11F in the draft Taxation Laws Amendment Bill of 2011.
In that reported Supreme Court of Appeal decision, SARS contested the taxpayer’s claim for a deduction of contingent expenditure that (so the taxpayer claimed) had become uncontingent, and therefore deductible when the taxpayer sold its business as a going concern on terms whereby the purchaser took over those contingent liabilities in return for a reduced purchase price.
The Supreme Court of Appeal ruled that, in these circumstances, the liabilities in question had not been "actually incurred” and were therefore not deductible by the seller in terms of section 11(a) of the Income Tax Act.
The reason for the taxpayer’s wry smile is that the proposed new section 11F is tailor-made to permit a deduction in precisely the circumstances of the Ackermans decision. The proposed amendment will become effective on 1 April 2012. Perhaps only a tax lawyer can understand SARS’s stance in fighting, tooth and nail, the taxpayer’s claim for a deduction, whilst simultaneously drafting amending legislation that would permit such a deduction.
The explanation for this apparently contradictory stance lies of course in the oft-cited maxim that there is no equity about a tax. The Ackermans case was decided on the law as it stood at the time. The fact that economic rationality and good business sense were on the side of the taxpayer was irrelevant because the Income Tax Act did not support his claim.
The proposed new section 11F reads as follows – Where, in terms of any transaction, a person disposes of a business undertaking as a going concern to a purchaser and
(a) that person is, in terms of that transaction, partially or fully relieved of any contingent liability of that person as a result of the assumption of that contingent liability by that purchaser;
(b) the consideration payable by the purchaser in terms of that transaction has been determined by that person and that purchaser after taking into account the assumption of the contingent liability by that purchaser; and
(c) the contingent liability relates to that business undertaking, the fair market value of that contingent liability must, on the date of that disposal and for the purposes of determining the taxable income derived by that person from carrying on a trade, be deemed to be an amount of expenditure actually incurred in the production of the income of that person derived from trade.
This amendment will be coupled with an amendment to the definition of "gross income” that will provide that a taxpayer’s gross income includes – in the case of any resident, the total amount (in cash or by way of partial or full relief from any liability of such resident or otherwise received by or accrued to or in favour of such resident: Provided that, where the amount is received by or accrued to or in favour of such resident by way of relief from any liability of such resident and that liability is contingent, that total amount must be limited to the fair market value of that liability.
A similar amendment is to apply in respect of the gross income of non-residents. Exactly how the fair market value of a contingent liability will be determined for purposes of the amendment to the definition of gross income is far from clear.
The removal of uncertainty
Aside from creating a deduction where none previously existed, the proposed new section 11F will remove the current uncertainty (or at least the uncertainty that prevailed prior to the Ackermans decision) as to whether, in the sale of a business as a going concern, it is the purchaser or the seller who can claim a deduction for contingent liabilities when and if they materialise. The amendment will make clear that it is the seller who is entitled to the deduction.
A special statutory regime is to be introduced to prevent both purchaser and seller from claiming the same deduction. The seller is to be required to add the assumed contingent liabilities to his gross revenue receipts or capital gains proceeds, depending on whether the relevant consideration is in respect of trading stock or capital assets. However, such revenue receipts or capital proceeds are to be based on the fair market value of those liabilities, and not on their face value.
The value of contingent liabilities assumed by the purchaser will be added to the consideration paid by him in terms of his purchase of the business by being added to cost price or base cost, depending on whether the consideration is allocated to trading stock or capital assets, but the purchaser will simultaneously be provided with an upfront allowance of the same amount. This allowance will be added back and rolled forward in the post-acquisition tax years. This allowance will reduce as payments in respect of contingent liabilities materialize or become remote.