By Andrew Seaber (DLA Cliffe Dekker Hofmeyr Tax Alert 6 July 2012)
In the context of black economic empowerment transactions (BEE transactions), a
question that has been the subject matter of much debate over the last few years is
whether advisory fees can be deducted for income tax purposes. In this context, the
argument is that empowerment is a cost of obtaining a licence to operate and on this
basis it should thus be seen as part of the income earning operations of the company.
In Warner Lambert SA Pty Ltd v CSARS 65 SATC 346, the court had to deal with the
deductibility of social responsibility expenditure that was incurred by a company
that was, at the time, a subsidiary of a US company that adhered to the Sullivan
Code. The Sullivan Code provided for the non-segregation of races in the workplace,
equal and fair employment for all employees, equal pay, development of training
programmes, increasing the number of disadvantaged persons in management and
supervisory positions and improving the quality of employees' lives outside the work
environment. The principles of the Sullivan Code were very similar to the current
principles governing empowerment in South Africa.
It was held by the court that the relevant expenses incurred by the subsidiary company
were deductible, specifically that it reduced the risk that the taxpayer could lose its
subsidiary status. The court used the analogy of paying insurance premiums and
remarked that the expenditure was to "insure against the risk of losing its treasured
subsidiary status". It was argued that the loss of the subsidiary status could have
resulted in the loss of all kinds of trade advantages and that these expenses were thus
bona fide incurred for the performance of the taxpayer's income earning operations. It
was also indicated that the expenses were not of a capital nature as no capital asset was
created or improved in the hands of the subsidiary. The income earning structure of
the taxpayer had been erected some time before the expenses were incurred and it was
merely a question of protecting the relevant earnings. On that basis there was thus no
creation of a capital asset.
SARS has issued two Rulings dealing with similar types of expenditure. In Binding
Class Ruling BCR 2 it was indicated that expenditure incurred in respect of
Corporate Social Investment (CSI) programmes is deductible. However, it should be appreciated that the expenditure incurred related to bursary
payments made by the taxpayer and was not aimed at increasing
shareholding in the taxpayer from an empowerment perspective.
In Binding Private Ruling BPR 113, SARS equally indicated
that expenditure associated with Broad Based Black Economic
Empowerment would be deductible. However, once again the
taxpayer implemented a so-called Equity Equivalent Programme
given the fact that it was a subsidiary of a foreign company and that
there could not be any change in shareholding in the applicant. The
so-called Equity Equivalent Programme entailed the investment of
4% of the applicant's annual turnover, over a period of seven years,
into selected qualifying small black owned independent vendors.
Such course of conduct would have enabled the applicant to receive
the full 20 empowerment points per annum for the ownership
component of the BEE Scorecard. One of the issues was that the
applicant would not subscribe for any shares in the companies
in which investments were made. It was indicated by SARS that
the equity equivalent expenditure was deductible, even though it
was apportioned over a seven year period in terms of s23H of the
Income Tax Act, No 58 of 1962 (Act) given the fact that the benefit
was to be enjoyed over a seven year period.
One should appreciate that as BEE transactions are designed to
improve the ownership component of the BEE scorecard, the
transaction generally involves the acquisition of shares in a company
which is to be empowered. In many of these BEE transactions,
SARS has refused the deduction of this type of expenditure. Even
though many of these matters were subsequently settled between
SARS and the taxpayer, one of the issues that generally arises is
whether the expenditure is on capital account, given the fact that
it relates to shareholding and that the transaction would thus have
related to the income earning structure as opposed to the income
earning operations of the company. The counter argument is that the
costs are incurred to retain or protect the taxpayer’s income earning
structure akin to insurance premiums. It may be that the taxpayer
implementing the BEE transaction has a mining license which it
wishes to retain. However, for example, where the costs are incurred
to obtain (rather than retain) a mining license the argument is that
the costs are incurred to create a capital asset and are therefore not
deductible for income tax purposes.
Overall, there is a good argument in favour of the deductibility of
the relevant BEE transaction costs but one should expect some
resistance from SARS. Even though it has been indicated by SARS
that expenditure qualifies for a deduction if it is incurred in attaining
the requisite points per the ownership scorecard pertaining to broad-based black economic empowerment, one of the critical issues is
whether the costs incurred are of a capital nature.
Other transaction costs, however, if not linked to the empowerment
transaction, would not qualify for a deduction from an income
tax perspective, including by way of way of example any other
restructuring costs not directly related to the BEE Transaction.
To the extent that the costs are deductible from an income tax
perspective, the costs may have to be apportioned in terms of
s23H of the Act.
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