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A (Pty) Ltd v the Commissioner for the South African Revenue Services

Thursday, 04 July 2013   (0 Comments)
Posted by: Author: Commisioner of SARS
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Author: Commisioner of SARS

Background to the case

In 2001 M Ltd, a listed company in the furniture industry, encountered financial difficulties whilst it owed a large amount of debt to a certain bank (hereafter referred to as ABC bank). As a result the bank was exposed to significant financial risks and sought a rescue plan for M Ltd in an attempt to reduce its financial exposure. Consequently a German entrepreneur, Mr Z, was approached to invest fresh capital into M Ltd and a portion of the debt owed to the bank was converted into equity. It followed a merger whereby M Ltd shares were exchanged for FG shares. Mr Z acquired 5/6th of these shares for R500 million of which half was held by the appellant and the other half was held by O et Cie (Mr Z’s German company).  

The appellant represented a special purpose vehicle (SPV) and its sole purpose was to acquire and hold the FG shares. ABC bank funded the appellant through the issue of three year and one day preference shares worth R100 million. In exchange ABC bank required the appellant to be a ring fenced SPVwhich concluded no activity other than the holding of the FG shares. In addition the appellant was also funded by a shareholders loan of R150 million from KL, D Ltd’s sole shareholder (D Ltd was the sole shareholder of the appellant). These funds were made available by D Ltd on the condition that it will be used by the appellant to acquire the FG shares and D Ltd obtained a reversionary right in respect of the FG shares pledged to ABC as partial security for the repayment of the funding advanced to KL. In other words, the latter represented an "equity kicker” where the appellant offered D Ltd an ownership position (equity) in the company in exchange for the shareholder’s loan. 

The acquisition of the FG shares placed the following obligations on the appellant: It needed to grant D Ltd its share of any gain derived with the disposal of the FG shares (as repayment for the ‘equity kicker’ received from KL via D Ltd). Furthermore it accepted its share of an indemnity obligation (amounting to R62.5 million) which the FG Group had towards ABC bank in respect of certain liabilities of M Ltd. In the 2005 year of assessment the appellant concluded an agreement with O et Cie (the German company of Mr Z that obtained the other half of the FG sharesacquired by Mr Z) in which the appellant committed to an unconditional obligation to pay its portion of the tax indemnity to O et Cie (equal to R55 million, irrespective of whether or not one half of the actual indemnity payable by O et Cie exceeds this amount) which accepted full liability for the indemnity to ABC bank.

Mr Z reassessed his investment portfolio in South Africa due to a significant decrease in the Rand-value. He decided to realise some of his South African investments since it had an increased financial risk attached to it. Consequently the FG shares were sold to the E group on 21 April 2004 who made payment for the shares to the appellant. 

The appellant was of the opinion that the proceeds from the disposal of these shares were capital in nature and included a taxable capital gain in its taxable income for that particular year. SARS regarded the receipt to be revenue in nature and issued an additional assessment on 1 May 2010. Subsequently the matter was brought before the tax court, which had to determine the following:

  1. The nature of the proceeds earned with the disposal of the shares (capital or revenue in nature)
  2. The deductibility of the expenditure that was actually incurred by the taxpayer in order to obtain the shares. 
  3. Interest levied by the respondent as a result of the additional assessment.

 Outcome of the case

Nature of the proceeds

The court considered the objective factors relating to the transaction as well as the intention of the appellant at the time of acquiring the shares and at the time of the sale thereof. Since the appellant arranged to repay the equity kicker provided by D Ltd through the subsequent sale of the FG shares, there was an initial intention to resell the shares for a significant profit. The question was not whether a disposal would take place but rather when it would occur. Furthermore, the fact that the appellant held the shares for a very short period before it was sold together with the mixed intention relating to these shares supported the profit intention of the appellant. It could not be proved to the court that the dominant purpose of the appellant was to keep the shares as a long term investment. Based on the facts presented to the court, it was determined that the proceeds with disposal of the shares were revenue in nature.

Deductibility of related expenses 

According to the SARS the equity kicker of R45 123 050 payable by D Ltd , the sole shareholder of the appellant, to KL did not qualify for an Income Tax deduction in the applicant’s hands. The respondent argued that the agreement was between KL and D Ltd. Therefore there was no legal obligation on the appellant and it settled D Ltd’s liability to KL. As a result the expenditure was not actually incurred by the appellant and not deductible in terms of the General Deduction formula. 

The court disagreed and allowed a deduction for the above expenditure. The meaning of "actually incurred” was determined with reference to the CIR v Golden Dumps (Pty) Ltd case in which it was concluded that the word "actually” means "in act or fact, in reality”. On these grounds it concluded that the appellant "really” incurred the obligation and was therefore entitled to claim the deduction.

Furthermore, the court granted the appellant a deduction for the indemnity settlement amounting to R55 million. The court found that an unconditional liability to pay the amount has been created during the 2005 year of assessment and therefore qualifies for a deduction. 

Interest remitted

The appellant was discharged from the obligation to pay the interest charged by the respondent as a result of understating income in the 2005 year of assessment. It was determined that the appellant acted in good faith when it included a capital gain, instead of the total income from the disposal in its 2005 tax return.



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