The Effect Of CSARS v BP Judgement On The Deductibility of Rent Payment By Petroleum Companies SA
01 February 2007
Posted by: Author: M.J Maluleke
The Effect Of CSARS v BP Judgement On The Deductibility of Rent Payment By Petroleum Companies In SA
The CSARS v BP (hereinafter the BP case) was an appeal by CSARS (hereinafter the Commissioner) to the Supreme Court of Appeal against a judgment in the Cape Tax Court upholding an appeal by BP Southern Africa (PTY) Ltd (hereinafter BPSA) against the Commissioner’s income tax assessment for a particular year of assessment.This case dealt with two issues, namely the deductibility of interest from income payable by BPSA in respect of a loan by its only shareholder and rental expenditure incurred by BPSA in respect of filling station sites. In this article only the latter would be dealt with.
The facts relevant to this aspect are briefly as follows: BPSA, like other oil companies in South Africa, is not allowed to operate service stations.It sells its products to independent dealers who in turn sell to the public.BPSA therefore has an interest in the sale of its petrol and in securing sites from which its petrol could be sold.
This is done by either acquiring such sites and leasing them to dealers or by leasing sites from the owners thereof in terms of long term head leases and subletting them to dealers, which can be the owners themselves.The head leases in question here were for a period of 20 years. Each of the head leases provided for payment of rental by way of a lump sum in advance.
These lump sum payments put the owner in a position to build a service station on the site where no service station existed before, or to improve an existing service station in accordance with the requirements of BPSA.Very important in this case, the head leases also provided for the registration of servitudes over the leased properties as security for the repayment of prepaid rental in the event of the termination of the lease by BPSA.The lessor and any other occupiers of the properties were in terms of these servitudes precluded from selling any petrol or petroleum products from the properties other than those supplied by BPSA from time to time.BPSA claimed as deductions from its income the rental payments in respect of the relevant sites in terms of s 11(a) to which the Commissioner objected.
The Commissioner’s contention was that these lump sum rental payments were of a capital nature and therefore not deductible from income in terms of s11(a).The court aquo held these to be deductible reasoning that had there been no prohibition for BPSA to operate its own service stations on the leased properties, the rental payable would have been deductible, since the premises would have, been occupied by BPSA for the purposes of its trade, as these rentals would have in that event and in the absence of such a prohibition, been expenditures which were ‘an essential part of the business of BPSA’.BPSA’s contention on the other hand was that the reasoning of the court aquo was correct, thereby submitting that there is no material difference between a lease in terms of which rental is paid by way of a lump sum ‘up front’ and a lease in terms of which periodic rental payments are made.
The Supreme Court of Appeal in delivering its judgment ruled in favour of the Commissioner finding that the ‘up front’ lump sum payments were expenditures of a capital nature and therefore not deductible in terms of s11(a) but in terms of s11(f).In making the above ruling, the court enquired into the purpose of these expenditures and said at para 22 of the judgment:
‘In the present case the purpose of the lump sum payments ‘up front’ was to secure sites from which BPSA’s petrol could be sold.The registration of the servitudes referred to above ensured that the sites would be used for this purpose, even after termination of the leases by BPSA, for as long as prepaid rental remained in the hands of the lessor.The expenditures were, therefore, intended to secure sites from which BPSA could sell its products even in situations where there was no lease.
By paying the lump sums BPSA secured these sites for a period of some 20 years i.e it acquired assets which were intended to endure for 20 years and which were going to produce income for 20 years without any further expenditure required in respect of the acquisition of the assets’.
Furthermore, the court found that the purpose of BPSA was to establish a base for its income producing operations for the next 20 years and held that under such circumstances the lump sum expenditures were more closely related to the income-earning structure of BPSA than its income-producing operations.
The court said that these rental payments were incurred not to carry on the business of BPSA but to establish it.The court relied heavily on the judgment of Lord Reid in Regent Oil Co Ltd V Strick  3All ER 174 (hereinafter the Regent case).The principles articulated here were also alluded to in the Commissioner for Inland Revenue v George Forest Timber Co Ltd 1924 AD 516.Analysis of the Ratio dicidendi.
A consideration that seems to have servitudes are registered against title deeds of proper ties in order to protect/secure a right or interest of some sort and also to create a public record to third parties. Furthermore, it is trite law that once such registration has been endorsed against the title deeds of the properties in question by the Deed Office, the sought protection is achieved because these servitudes become limited real rights.It is submitted that as from that moment the servitudes in question are tantamount to a restrictive condition of the title deeds concerned as to the use or other dealings with the property.It is common cause that such restrictions are binding on all successors in title of the property concerned.The requirement of registration in the deeds office is also to establish a notice to all third parties regarding the existence of the servitude and its content.
It is clear from the facts in this case that the content of the servitudes in question was such that the lessors and any other occupiers of the proper ties were precluded from selling any petrol or petroleum products from the properties other than those supplied by BPSA from time to time.It is submitted that this restriction with regard to the use of the land in question strongly persuaded the court in arriving at a conclusion that the expenditures (rental payments) were incurred for purposes of establishing the income-earning structure of BPSA as opposed to its income-producing operations.This was strongly supported by the fact that only BPSA’s products would be sold on the land in question even after termination of the leases.It is in this way that BPSA in my view created an income-earning structure and the court was accordingly correct in disallowing the deductions from income sought in terms of s11(a) as these were of a capital nature.
There is a school of thought that seems to suggest that the reasons of the Supreme Court of Appeal in this case were based solely on the fact that the rentals being dealt with were paid ‘up front’ and as lump sum payment as well as the fact that the resulting advantage created in favour of BPSA endured for 20 years.It is submitted that it is not the form of payment that determines the capital or revenue nature of the transaction but the purpose of the expenditure and what the expenditure actually effects.The judgment would be very unfair and improper if it can be said that it was solely based on the fact thatthe rentals in question were ‘up front’ lump sum payments and the basis that the advantage created endured for 20 years.The court in casu never placed any emphasis on any of these factors but instead reinforced the words of Lord Wilberforce in the George Forest Timber case which correctly pointed out that: ‘no rule can be laid down as to a minimum period of endurance for a capital asset or a maximum permissible period for an item of stock or circulating capital, though obviously the more closely the period of endurance is related to an accounting period, the easier it is to argue for a revenue character, but no doubt there is a penumbra the width of which may vary according to the nature of the trade’.
It is submitted that there is a weakness in the so-called test of the period of endurance as applied in case law.That weakness is that it is a test of degree more than anything else. It is submitted further; how long an asset or advantage lasts before it can be concluded that the expenditure connected with it is of a capital or revenue nature will depend upon the facts of each case.It is submitted that special circumstances existed in the BPSA case which influenced the court in disallowing the deductions sought under s11(a) same being capital in nature.As already pointed out, these circumstances related mainly to the registration of servitudes against the title deeds of the properties concerned.
In conclusion, it is submitted that the outcome of this judgment would have been different had the leases in questions not been subjected to the registration of servitudes restricting the use of the properties in favour of BPSA.The result of this judgment is that all Petroleum Companies operating in the Republic of South Africa, especially those who apply this business model (of registering restrictive servitudes against the title deeds of the properties leased), may not deduct their rental payments as deductions from income under s11(a).
The court in casu allowed the deductions sought in terms of s11(f) as an allowance in respect of any premium or consideration in the nature of a premium paid by a taxpayer for the right of use or occupation of land or buildings used or occupied for the production of income or from which income is derived.
Source: By M.J Maluleke (TaxTALK)