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Major Setback For SARS In Tax Avoidance Judgement ?

01 November 2008   (0 Comments)
Posted by: Author: Terry McCarthy
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Major Setback For SARS In Tax Avoidance Judgement ?
The Johannesburg Tax Court’s ruling in Case 11345 will probably be viewed by SARS as a major setback – and as proof that the common law and the Income Tax Act are unable to deal adequately with sophisticated tax avoidance schemes involving the financial structuring of large business deals.

The Johannesburg Tax Court’s ruling on 4 July 2008 involved a loan structured in such a way that, taken with ancillary agreements, enabled the taxpayer to deduct the full cash outflows it incurred as interest on the loan.The impetus to arrange the loan in this way did not come from the taxpayer(a public company that was previously an agricultural co-op) but from its bank.

On the face of the loan agreement, the taxpayer borrowed R96 million from a subsidiary of the bank in 1998, repayable in 2003.The loan was to be repaid not in money but through delivery to that subsidiary of 109 000 tonnes of white maize.The taxpayer procured a R46 million hedge of its obligation with a division of the bank.

The taxpayer was to pay interest at a fixed rate on the R96 million at six monthly intervals by way of promissory notes with a face value of R74 million.This was the amount which it claimed as a deduction under the general deduction formula of the Income Tax Act – and which SARS allowed it to deduct between 1999 and 2003.But in 2003, SARS concluded that taking into account the complex web of hedging transactions and cessions in securitatem debiti entered into as adjuncts to the loan, the true loan was not R96 million but R50 million.SARS thereupon issued additional assessments disallowing deduction of interest on a R96 million loan as previously allowed, and imposing 200 per cent additional tax plus interest.

The taxpayer objected to the additional assessments and the matter came before the Johannesburg Tax Court, where it was heard by a judge and two assessors.SARS argued that the taxpayer should be allowed only a deduction of interest on R50 million, which it contended was the true amount of the loan. The ostensible loan of R96 million, SARS contended, involved "deliberate simulation and intentional tax evasion”.

The judgment went in favour of the taxpayer and set aside the additional assessments for 1999- 2003. The court concluded that the loan transaction had not been deliberately disguised to conceal an underlying "tacit understanding or unexpressed agreement” on the part of the taxpayer.The court said the central issue was the taxpayer’s "true intention”.Did the taxpayer intend to contract with the bank on the terms reflected in its agreement?  Or had it engaged in deliberate deception?

The court answered this question in favour of the taxpayer, despite strong argument by SARS that many apparent anomalies in the agreement for delivery of the maize pointed to a disguised and deliberately deceptive arrangement.Crucial to the tax court’s conclusion was that the taxpayer had trusted the bank’s expertise in the structuring of financial transactions, and had acted in good faith.The bank may well have had a different state of mind, but this could not be attributed to the taxpayer.

The ruling starkly exposed the difference between commercial substance (a cornerstone of financial reporting), on which SARS placed reliance, and legal substance (the cornerstone of the reality of the transaction).The former examines the financial effect of net cash flows in the transactions whereas the latter examines whether the parties truly intended to enter into the transactions.

It must be stressed that these transactions arose when the old general anti-avoidance rules (GAAR) of the Income Tax Act were applicable, and the court ruled that the anti-avoidance provisions could not be applied in the alternative.The new GAAR provisions specifically entitle the application of GAAR as an alternative.It is therefore possible that a challenge to a similar transaction under the new GAAR could have a different outcome. 
Source: By Terry McCarthy (TaxTALK)


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