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A Significant Tax Benefit

Monday, 11 October 2010   (0 Comments)
Posted by: Author: Bernard Geldenhuys
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A Significant Tax Benefit
Section 80c(1): Lack of commercial  Substance–an explanation of the phrase
The new general anti-avoidance rule is enacted in Part IIA of the Income Tax Act 58 of 1962,as amended (the Act).Part IIA contains sections 80A to 80L which targets impermissible tax avoidance arrangements.An impermissible avoidance arrangement is defined as "any avoidance arrangement described in section 80A”.Section 80A has four requirements in order to determine whether an arrangement is an impermissible tax avoidance arrangement.In short, the four requirements are:
1.An arrangement (as defined in section 80L) is entered into or carried out.
2.It results in a tax benefit (as defined in section 80L).
3.Any one of the following tainted elements are present: 
-Abnormality regarding means, manner, rights or obligations.
-Lacks commercial substance (as defined in section 80C) in whole or in part.
-Misuse or abuse of the provisions of the Act (including Part IIA).
The sole or main purpose is to obtain a tax benefit.
The lack of commercial substance requirement is contained in section 80C of the Act.Broomberg and De Koker both indicate that section 80C of the Act could be described as the heart of the new general anti avoidance rule.Section 80C contains both a presumptive test and indicative test to determine whether a lack of commercial substance exists. Section 80C(1),the presumptive test,establishes a general rule for determining whether an avoidance arrangement lacks commercial substance, while section 80C(2) provides a non-exclusive set of characteristics that serve as indicators of a lack of commercial substance.Broomberg argued that the definition of commercial substance in section 80C(1) is of a nature that excludes the application of section 80C(2).He stated that "the meaning ascribed to ‘commercial substance’ in section 80C(1) is supported by international judicial precedent, and it is difficult to envisage any other meaning”.For the purpose of this article attention will therefore be focused on section 80C(1).
In terms of section 80C(1) an arrangement lacks commercial substance if it "would result in a significant tax benefit for a party … but does not have a significant effect upon either the business risks or the net cash flows of that party …”.Section 80C(1), it will be observed,may be divided into two parts: it must result in a significant tax benefit and it must not have a significant effect upon either the business risks or net cash flows of the party.The application of section 80C(1), however, is difficult.The term ‘significant’ creates a problem as there is no indication as to what constitutes a significant tax benefit, or a significant effect on either business risks or net cash flows. The objective of this article is to investigate the meaning and implication of the phrase ‘a significant tax benefit’.As the term ‘tax benefit’ is defined in section 80L of the Act, emphasis will be placed on the adjective significant in construing the meaning of a significant tax benefit.
According to Broomberg Part IIA was culled from the laws of many nations.These nations include, amongst others, Australia and the United Kingdom.  Case law in South Africa is therefore examined in collaboration with that in Australia and the United Kingdom in order to elaborate on the meaning of the phrase ‘a significant tax benefit’. Judgments of the court of other countries, although they do not bind South African courts, are of significance because they have persuasive value.
3.Case law
3.1South African case law
The Afrikaans version of section 80C(1) uses the term wesenlike belastingvoordeel.In Botha v Stadsklerk van Middelburg N.O  Coetzee J prescribed the following meaning to the word wesenlik: ‘wat die kern, hoofsaak raak’. Something is thus ‘significant’ if it affects the crux or the essence of a matter.A decade later,in Kopel v Marshall and Another, Margo J referred to Botha v Stadsklerk van Middelburg N.O and indicated,that the word wesenlik means essentially,fundamentally or materially.
3.2Australian case law
The word substantial, it is submitted,could be regarded as a synonym of the word ‘significant’.In Palser v Grinling Viscount Simon indicated that the word ‘substantial’ is not the same as ‘not unsubstantial’, i.e., just enough to avoid the de minimis principle. The term de minimus is generally used to describe something that is too small or insignificant to be considered; something unimportant: minor relative to the other points and indicia.The term comes from the Latin phrase de minimis non curat lex: the law does not deal with trivial matters. Viscount Simon further indicated that one of the primary meanings of the word substantial is equivalent to considerable, solid, or big. Applying the word in this sense, he stated, "It must be left to the discretion of the judge of fact to decide as best he can according to the circumstances in each case.”
In Tillmanns Butcheries Pty Ltd v Australasian Meat Industry Employees Union  the Federal Court of Australia elaborated on the meaning of the phrase ‘substantial loss or damage’.  Bown CJ stated that the word ‘substantial’ require a loss or damage that is more than trivial or minimal.   He indicated that the word is quantitatively imprecise and that it cannot be said that it requires any specific level of loss or damage. According to him it imports a notion of relativity, that is to say, "one needs to know something of the circumstances of the business affected before one can arrive at a conclusion whether the loss or damage in question should be regarded as substantial in relation to that business”. Dean J noted that the word ‘substantial’ is not only susceptible of ambiguity, but is a word calculated to conceal a lack of precision.  He indicated that the word can mean real or of substance as distinct from ephemeral or nominal.It can also mean large, weighty or big. It can be used in a relative sense or can indicate an absolute significance,quantity or size.
3.3United Kingdom case law
In Lambeth LondonBorough Council v Grewal  Lord Justice Mustill indicated that the word significant cannot be arrived at by assuming that it is the obverse of insignificant.This is in accord to that prescribed by Viscount Simon in Palser v Grinling with regard to the meaning of the word substantial: not the same as not unsubstantial.Lord Justice Mustill then preceded and noted that the word significant has more than one meaning.It is capable,in some contexts, of meaning more than trifling.This is in accord to that prescribed by Bown CJ in Tillmanns Butcheries Pty Ltd v Australasian Meat Industry Employees Union with regard to the meaning of the word substantial: more than trivial or minimal.In other contexts,Lord Justice Mustill stated the word significant sets a higher standard: "how much higher cannot be prescribed by any rule of thumb”.The phrase ‘a significant tax benefit’ has been debated by several tax scholars.The opinions of these scholars are now examined.
4.Tax scholars
De Koker indicates that a significant tax benefit, presumably, implies that the tax benefit is significant in the context of the taxpayer ’s annual net profit or his net assets or even his financial affairs in general. According to Clegg and Stretch, there is no indication of what would constitute a significant tax benefit. They presume that the tax benefit will have to be significant in the context of the particular taxpayer’s financial affairs in general.  
Both De Koker and Clegg and Str etch indicate that a significant tax benefit will have to be evaluated in the context of the taxpayer’s financial affairs. This view corresponds with that of Bown CJ in Tillmanns Butcheries Pty Ltd v Australasian Meat Industry Employees Union: "the word imports a notion of relativity”. The tax benefit should thus, presumably, be significant in relation to the taxpayer’s financial affairs.
Davis et al indicate that a significant tax benefit implies a material or relevant tax benefit, with de minimis benefits being disregarded.This view is in accord to the judgment of Margo J   in  Kopel   v  Marshall and Another: wesenlik means essentially, fundamentally, materially.The concept of materiality is important in the field of auditing.A materiality   level has to be determined for each entity during the planning and concluding phase of an audit.For guidance in attempting to quantify a significant tax benefit one could consider the measures utilised to  ascertain materiality for audit purposes.
The opinions of both De Koker and Clegg and Stretch is that one should evaluate the tax benefit in the context of the taxpayer’s annual net profit or his net assets or financial affairs in general. This approach, it is submitted,closely shadows the quantitative measures employed to establish audit materiality. These measures appeared in the partially superseded Discussion Paper 6: Audit risk and materiality (Discussion Paper 6) issued by SAICA in 1984.Although Discussion Paper 6 has been partially superseded, the recommendations contained in it are still regarded as useful, as can be inferred from Marx et al. The measures are summarised in Table 1.  
Table 1:Quantitative measures employed for establishing audit materiality
Category Range
Revenue based  0.5% to 1% of turnover
1% to 2% of gross profit

5% to 10% of net income
Asset based 1% to 2% total assets
Equity based 2% to 5% of equity
A tax benefit is generally established by estimating what the tax consequence would have been had the arrangement not been entered into.This is evidenced from the judgment of Wunsh J in ITC 1625(1996):a tax benefit has been obtained if the taxpayer would have suffered tax but for the transaction.Once the tax benefit has been calculated, it is submitted, the measures specified in Table 1 could be applied to establish whether a significant tax benefit was obtained.The measures, it is submitted, should be elected on the basis of the taxpayers business or trade.
By employing a percentage range these measures are applied in relation to each taxpayer’s financial affairs. This proposal, it is submitted, is in accord to that prescribed by the Australian court in Tillmanns Butcheries Pty Ltd v Australasian Meat Industry Employees Union : it imports a notion of relativity by taking into account the circumstances of the taxpayer affected.  A significant tax benefit, it is submitted, could therefore suggest a quantitative threshold or cut-off point for the tax benefits adherent to an arrangement. The threshold or cutoff point, nevertheless, will vary according to the taxpayers financial affairs.
6.A significant tax benefit: the implications
According to the economist Adam Smith in his book, Wealth of nations - 1776, one of the basic principles of any tax system should be that individuals can determine the amount of tax payable by them with certainty. The words ‘a significant tax benefit’, it is submitted, introduce uncertainty as it is an ambiguous and imprecise phrase.This is evident from the various meanings that could be ascribed to it. The ambiguous nature of the phrase, however, may work to the benefit of the taxpayer.
Section 82 of the Act places the onus on a taxpayer to show,inter alia, that any amount is not liable to tax.In CIR v Conhage Pty Ltd , however,the court held that since section 82 dealt with the onus of proof in general terms, the special presumption in section 103(4),would have been redundant if section 82 was meant to apply to section 103 in general.A similar presumption as to the purpose of an arrangement is contained in section 80G of the Act It is,therefore, assumed that the burden of proof, with regard to a lack of commercial substance, will rest on the Commissioner.
A significant tax benefit is one of the prerequisites for the application of section 80C(1). The existence of a mere tax benefit will not suffice; a significant tax benefit must exist. The legislature,by not confining section 80C(1) to a tax benefit, it is submitted,intended a higher threshold for the application of section 80C(1).This could place a heavier burden upon the Commissioner when contemplating an attack under section 80C(1).In addition, on the basis of the contra fiscum rule, ambiguity has to be resolved in favour of the taxpayer.The court could thus, it is submitted, impose a wide interpretation on the phrase a ‘significant tax benefit’.This, also, could place a heavier burden upon the Commissioner when contemplating an attack under section 80C(1).
A significant tax benefit is more than a trivial or nominal tax benefit.It sets a higher standard than  that of merely escaping the de minimus principle.The phrase is not the obverse of an insignificant tax benefit.A significant tax benefit could imply an essential, fundamental, considerable, big, large,weighty, substantial, relevant or material tax benefit. It seems to be quantitatively imprecise: a phrase calculated to conceal a lack of precision. In addition, a significant tax benefit seems to import a notion of relativity: one needs to take into consideration the circumstances of the taxpayer; that is, his annual net profit or net assets or even his financial affairs in general, before one can arrive at a conclusion whether a significant tax benefit was derived or not. An examination of the concept of materiality, in auditing, revealed that a significant tax benefit could, possibly, be established on a quantitative level by applying the measures used to determine audit materiality.By not confining section 80C(1) to a mere tax benefit, the legislature intended a higher threshold for its application. Also, on the basis of the contra fiscum rule, the phrase could,presumably, be construed in favour of the taxpayer.This could result in a wide interpretation of the phrase a ‘significant tax benefit’ and bestow a heavier burden upon the Commissioner when contemplating an attack under section 80C(1).
Source: By Bernard Geldenhuys ( TaxTALK)



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