In Mobile Telephone Networks Holdings (Pty) Limited v the Commissioner for the South African Revenue Service, the South Gauteng High Court was required to determine whether the Commissioner was correct in disallowing MTN’s deduction of audit fees for the 2001 to 2004 years of assessment and the expenditure incurred by the company, in respect of professional fees charged for the training of staff on a new accounting package.
The company initially appealed the Commissioner’s finding to the Income Tax Court, ITC 1842  72 SATC 118, and succeeded partially on the deductibility of audit fees by securing a deduction of 50% on the audit fees claimed for the 2001 to 2004 years of assessment. The Tax Court agreed with the Commissioner that the costs incurred on the training of staff for the new accounting package, was not deductible for tax purposes.
|SARS loses battle: |
Case provides some clarity
on the deductibility of audit fees and
professional services rendered.
The South African Revenue Service (“SARS”) was dissatisfied with the Tax Court’s decision and cross-appealed in respect of the decision on the audit fees, and contended that the deduction of 50% of the audit fees was incorrect. In deciding whether the audit fees, or the fees paid for professional services, were deductible, the Tax Court was required to consider the provisions of section 11(a) of the Income Tax Act, Act 58 of 1962, as amended (“the Act”), the so-called “general deduction formula”, and also to take account of sections 23(f) and (g), which preclude the deduction of expenses incurred in relation to amounts which do not constitute income, or which are not expended for the purposes of the taxpayer’s trade.
MTN is a wholly-owned subsidiary of the MTN Group Limited (“MTN Group”) and has five wholly-owned subsidiaries. MTN Group conducts business by providing mobile telecommunication networks and related services. Victor J, pointed out that it was agreed in a pre-trial meeting that MTN carries on a trade. SARS disallowed the audit fees, which were incurred for purposes of complying with the company’s statutory obligation to have its accounts audited, as well as for the purpose of trading. Professional fees relating to the second issue, which SARS disallowed in full, comprised services provided in order to train the company’s staff on a computer accounting system.
The judgment points out that it was common cause between the parties that the company traded during the tax years in dispute. The audit required the input and consideration of an auditor regarding the dividends received by the company, and income in the form of interest. The court pointed out that the dividend income represented the largest portion of MTN’s income, ranging between 89% and 99%, during the tax years in dispute.
The Tax Court decided that the audit fees were incurred for a dual purpose and, thus, reached the conclusion that it was appropriate to apportion the expenditure and decided that 50% was deductible and the balance was not.
The High Court pointed out that the taxpayer contended that, on average, only 6% of the entries in its books of account related to dividends, which was not disputed by SARS, was an important factor. SARS contended that the audit fees did not advance the trade of the company and were not directly related to the production of its income and, thus, all audit fees claimed by the company, should be disallowed.
SARS argued that the audit fees were incurred by the company to comply with its statutory obligations, and relied on Australian tax authority where expenditure was disallowed for undertaking a statutory task, FCT v The Swan Brewery Co. Limited (1991) 22 ATR 295.
The court pointed out that it was common cause that the amount of work undertaken by the auditors extended beyond the verification of interest income and receipt of dividends, but that those additional tasks did not detract from the appellant’s contention that the audit fees related to its income-earning activities.
It would appear that only 6% of the audit time was spent on the dividend section of the audit. The court decided that the expenditure incurred by the company on the audit fees, was incurred to directly facilitate the carrying on of its trade, not only in a legally compliant manner, but also to generate income.
The court decided that the only fair basis on which the audit fees should be apportioned was that 94% of those costs should be allowed as a deduction for tax purposes. The court, thus, decided that it was appropriate to take account of the time spent on auditing the interest income, as opposed to the fact that a substantial part of the income derived by the company, comprised dividends.
When dealing with SARS’ cross-appeal, the court indicated that SARS sought to argue that the audit fees did not attach to the company’s operations and even where trading is conducted through the company, the taxpayer should accept that there are additional expenses for audit fees and the legal obligation relating thereto is unrelated to the earning of the taxpayer’s income. The court pointed out that SARS approach would provide an enormous obstacle to the world of commerce and trade if the deduction of audit fees was to be denied on this basis.
In reaching its apportionment ratio, SARS took account of the values of income derived and did not take account of the amount of work involved in the audit process. The court rejected SARS method of apportionment as being factually and legally incorrect. The court held that the bulk of the audit fees related to the earning of interest and not dividends based on the time spent by the auditors on the different tasks required to complete their audit.
In addition, SARS disallowed the professional fees paid for services rendered regarding the implementation of the computerised accounting system. The court pointed out that the majority of transactions in MTN’s financial records related to the interest income derived and that the accounting system was not used in relation to the dividend income received by the company. The expenditure claimed by MTN related to its business only and was not used for the benefit of its subsidiary companies. The court expressed the view that the professional fees were closely connected to the earning of the interest-income received by the company and that the professional fees were directly related to the company’s trading activities.
SARS argued that MTN had not provided sufficient information and decided that the company had not discharged the onus placed in relation to the accounting system. The court was critical of SARS and pointed out that SARS had failed to consider the relevant information, before disallowing the professional fees relating to the accounting system.
Thus, the unanimous decision of the court was that 94% of the audit fees were deductible and that the expenditure relating to the training on the accounting system must be allowed. SARS was, accordingly, ordered to pay the costs of the company’s appeal. The case, therefore, provides some clarity on the deductibility of audit fees and, indeed, professional services rendered regarding the implementation of an accounting system.
- Dr Beric Croome is a Tax Executive at Edward Nathan Sonnenbergs. This article first appeared in Business Day, Business Law and Tax Review, October 2011. Free Image from ClipArt