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Tax Court Judgement On So-Called Sham Transactions

Wednesday, 02 September 2009   (0 Comments)
Posted by: Author: Graeme Fraser
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Tax Court Judgement On So-Called Sham Transactions
SARS is clamping down on any transactions where there could be even the faintest whiff of foul play and this has given rise to interesting cases brought before the Tax Court.A recent case refers to the approach of some taxpayers to dress up the transactions they enter into in order to change the impact of tax on their business dealings.
In the appeal of Catherine Elizabeth Sevillano-Barredo, case no 11711, the Income Tax Special Court had to determine the validity of a purported restraint of trade agreement.
The  facts can be summarized as follows:
C was employed by a merchant bank (RAD) and qualified to purchase shares in the company that were funded on loan account by the employer.This arrangement ran into trouble when the interest rate on the loan was exceeding the returns from the shares (which were also falling in price), and this was accompanied by other unhappiness among the staff. In response, the Board of RAD accepted a suggestion that it enter into a restraint of trade agreement with its senior employees, and would use portion of the payment to settle the outstanding loan account. C eventually agreed to accept an amount that would be payable in two tranches - most of the first tranche was used by to settle C’s loan account for the shares and the payment of the second tranche was deferred. 

When C resigned from RAD some years later,she received the second tranche when it became payable in accordance with the agreement. C ‘s uncontested evidence was that :
(a)She had played no part in devising the proposal regarding the restraint payment, and not aware of discussions that had taken place with any other persons at the time she had accepted the restraint of trade arrangements;
(b)When she left the employment of RAD she had been at pains to ensure that all her actions accorded with the terms of the restraint, which she had considered binding, and she knew that RAD had enforced other restraint of trade agreements when they had been contravened.SARS argued that the payments were an attempt to disguise payments in consideration for services rendered or to be rendered, and sought to tax C on their receipt.
The Court reiterated the principle that in deciding whether parties entered into an agreement,whether there was any fraud on their part, whether the agreement was a genuine or simulated one and what in the final result was the true substance of the agreement concluded between them, the Court would have regard to all the relevant circumstances.Among other factors, the Court would look into the historical background to the transaction,the nature of negotiations between the parties and the purpose entering into the transaction.
The Court would also consider the various options available to the parties to achieve their purposes; the terms of the agreement concluded by them in the light of the surrounding circumstances,the manner in which it was implemented, and the subsequent conduct of the parties. 
The intention of the parties as declared in the agreement or in evidence given by the parties would also be considered, as would any indication that the parties did not intend to implement the agreement as recorded, or that the agreement did not reflect their true intention.
What the Court found:

In this case, the Court considered that all the evidence indicated that the taxpayer had not entered into a sham transaction, and her subsequent conduct was consistent with her having regarded the restraint of trade as being operable against her when she left the employment of RAD.Accordingly, the Court dismissed the attempt of SARS to tax her on the receipt of the restraint payment.This writer concurs with both the legal and factual outcomes of  the decision.
Source: By Graeme Fraser (TaxTALK)



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