SARS is tripped up by a legal fiction of its own devising
03 June 2012
Posted by: SAIT Technical
PWC Tax Synopsis May 2012
No legislation is as replete with legal fictions as the Income Tax Act, most of them signalled by the phrase "shall be deemed” and inserted into the Act for the benefit of SARS. With this magical incantation, circles become squares in the eyes of the law.
It is difficult to recall any instance where this trick of statutory drafting has operated to the benefit of the taxpayer – until the judgment that is the subject of this note.
The Tradehold decision
The Supreme Court decision in CSARS v Tradehold Ltd  ZASCA 61 (in which judgment was handed down on 8 May 2012) came before the court as an appeal from the Cape Town Tax Court.
The background facts were as follows:
On 2 July 2002, at a meeting of Tradehold’s board of directors in Luxembourg, it was resolved that all future board meetings would be held in that country. At a stroke, therefore, as from this date, the ‘effective management’ of the company became located in that country. Nonetheless, the company, which had been incorporated in South Africa, remained a ‘resident’ of the Republic by virtue of the manner in which the term ‘resident’ was then defined in section 2 of the Act, namely, as a juristic person ‘which is incorporated, established or formed in the Republic or which has its place of effective management in the Republic ...’
An amendment to the definition of ‘resident’, which became effective as from 26 February 2003, added the following words to the definition, ‘but does not include any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between Governments of the Republic and that other country for the avoidance of double taxation’.
Additional assessment issued
SARS had issued an additional assessment for the taxpayer company in respect of a taxable gain which, according to the Commissioner, had arisen from a deemed disposal (as envisaged in para 12(1) of the Eighth Schedule to the Income Tax Act 58 of 1962) by the taxpayer of its shares in Tradegro Holdings Ltd (Tradegro) a company incorporated in Guernsey, which in turn owned 65% of the issued share capital of a UK-based company. That deemed disposal had been triggered by Tradehold’s loss of resident status in South Africa.
During the tax year in question, the taxpayer’s only asset was its 100% shareholding in Tradegro, and the deemed disposal, argued for by SARS, resulted in an assessment for an eye-watering taxable capital gain of R405 039 083 by way of what is colloquially referred to as an ‘exit charge’.
Relying on para 12 of the Eighth Schedule, SARS contended that when the taxpayer relocated its seat of effective management to Luxembourg on 2 July 2002 or when it ceased to be a resident on 26 February 2003 as a result of the aforementioned amendment to the definition of ‘resident’, it was deemed to have disposed of all its assets, which in this case meant its sole asset, namely its 100% shareholding in Tradegro, resulting in the taxable capital gain.
The deemed disposal consequent upon a loss of residence status
Paragraph 12 of the Eighth Schedule provides that –
(1) Where an event described in subparagraph (2) occurs, a person will be treated for the purposes of this Schedule as having disposed of an asset described in that subparagraph for proceeds equal to the market value of the asset at the time of the event and to have immediately reacquired the asset at an expenditure equal to that market value, which expenditure must be treated as an amount of expenditure actually incurred and paid for the purposes of paragraph 20(1)(a).
(2) Subparagraph (1) applies, in the case of –
(a) a person who ceases to be a resident, or a resident who is, as a result of the application of any agreement entered into by the Republic for the avoidance of double taxation, treated as not being a resident, in respect of all assets of that person other than assets in the Republic listed in paragraph 2(1)(b)(i) and (ii);
Paragraph 12 must be read with para 2 of the Eighth Schedule which provides that –
‘(1) Subject to paragraph 97, this Schedule applies to the disposal on or after valuation date of –
(a) any asset of a resident; and
(b) the following assets of a person who is not a resident, namely –
(i) immovable property situated in the Republic held by that person or any interest or right of whatsoever nature of that person to or in immovable property situated in the Republic; or
(ii) any asset which is attributable to a permanent establishment of that person in the Republic.’
The court commented (at para  of the judgment) that para 12(1), in referring to a person being ‘treated as having disposed of an asset’, was a deeming provision whereby a fictional disposal of the taxpayer’s assets, except those listed in sub-section 2(1)(b)(i) and (ii), was triggered when a company ceased to be a resident of the Republic or was treated as not being a resident by virtue of a double tax agreement.
The Tax Court held that the capital gain from the deemed disposal was not taxable in SA
In the Tax Court, Tradehold had contended that if there was a deemed disposal of assets during the 2003 tax years, the capital gain from that disposal was not taxable in South Africa but in Luxembourg because Tradehold was deemed to be a resident of Luxembourg in terms of article 4(3) of the Double Tax Agreement between South Africa and Luxembourg which provides that where a company is a resident of both treaty states, it is to be regarded as resident in the state where its effective management is situated – in this instance, Luxembourg.
Article 13(4) of the DTA provides that –
‘Gains from the alienation of any property other than that referred to in paragraphs 1, 2 and 3, shall be taxable only in the Contracting State of which the alienator is a resident.’
The Tax Court rejected the Commissioner’s argument that this reference to ‘gains from the alienation of property’ did not include a deemed disposal (as distinct from an actual disposal) as envisaged in para 12(2)(a) of the Schedule.
Is a deemed disposal equivalent to an actual disposal?
In the Supreme Court of Appeal the Commissioner reiterated his argument that a deemed disposal provided for in para 12(1) of the Eighth Schedule is not an ‘alienation’ as envisaged in Art 13(4) of the DTA.
The Commissioner argued further that, if Art 13(4) indeed applied, it would mean that the ‘exit charge’ could be levied only in the event of a South African taxpayer emigrating to a country which has not entered into a DTA with the Republic which contains a provision similar to Art 13(4), and that this could never have been the intention of the legislature.
The court identified the crisp issue on which the case turned
The Supreme Court of Appeal pointed out that, once it is brought into operation, a double tax agreement has the effect of law in South Africa. The court went on to say (at para ) that –
The crisp question that falls to be determined is whether the term ‘alienation’ as used in the DTA includes within its ambit gains arising from a deemed (as opposed to actual) disposal of assets. As mentioned above the term must be given a meaning that is congruent with the language of the DTA having regard to its object and purpose.
In this regard, the court ruled that –
‘the term ‘alienation’ as it is used in the DTA is not restricted to actual alienation. It is a neutral term having a broader meaning, comprehending both actual and deemed disposals of assets giving rise to taxable capital gains . . . Consequently, Art 13(4) of the DTA applies to capital gains that arise from both actual and deemed alienations or disposals of property. It follows therefore that from 2 July 2002, when Tradehold relocated its seat of effective management to Luxembourg, the provisions of the DTA became applicable and that country had exclusive taxing rights in respect of all of Tradehold’s capital gains’.
The Supreme Court of Appeal accordingly ruled that the Tax Court had been correct in holding that the Commissioner had incorrectly included a taxable gain resulting from the deemed disposal of Tradehold’s assets in its income for the 2003 year of assessment, and that SARS’s appeal against that decision could not succeed.