On 7th March 2014 the Supreme Court of Appeal
delivered judgment in the as yet unreported case of Commissioner for the South African Revenue Service v Mobile Telephone
Networks Holdings (Pty) Ltd, (966/2012) [2014] ZASCA 4 (7 March 2014) which
dealt with the deductibility of audit fees incurred for a dual or mixed purpose
and the apportionment thereof for tax purposes in light of section 11(a) of the
Income Tax Act 58 of 1962, as amended (‘the Act’) read with sections 23(f) and
23(g) of the Act.
Mobile Telephone Networks Holdings (Pty) Ltd (‘MTN’) is the
holding company of five directly held and a number of indirectly held
subsidiaries and joint ventures. MTN in turn is a subsidiary of MTN Group
Limited and the collective business of the operating companies within the group
is the operation of mobile telecommunication networks and the provision of
related services to customers in South Africa and other African states.
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| The Commissioner contended that the audit fees should be apportioned and only that part relating to the generation of taxable income |
MTN derived its income primarily in the form of dividends
from its subsidiaries but also loaned funds to its various subsidiaries to
finance working capital in the other countries on an interest-free
basis. In addition, MTN borrowed funds by issuing debentures and on loaning
those funds to group companies at a higher rate of interest. Thus, MTN had two
sources of income, namely dividends received from subsidiaries and interest
received from subsidiaries.
MTN employed auditors as it was required to do to undertake
the statutory audit of its annual financial statements for each of the 2001,
2002, 2003 and 2004 tax years. The audit fees incurred by MTN for each of those
years was R365,505, R647,770, R427,871, and R233,786 respectively. Furthermore,
during the course of the 2004 tax year MTN paid an amount of R878,142 to KPMG,
its auditors, in relation to what was described as the ‘Hyperion’ computer
system. In the tax returns submitted by MTN to the Commissioner: SARS the
company claimed as a deduction the audit fees incurred by it as well as the fee
paid to KPMG regarding the computer system .
The Commissioner disallowed the deduction of the KPMG fee in
full and apportioned the annual audit fees by only allowing a deduction of
between 2% and 6% of the audit fees incurred. The apportionment ratio adopted
by the Commissioner was based on the ratio of MTN’s interest income as a
proportion of its total revenue, that is
the revenue derived in the form of dividends and interest.
MTN lodged an objection against the disallowance of the
audit fees and the KPMG fee and appealed against the Commissioner’s decision to
disallow the objection. MTN’s appeal
was heard by the South Gauteng Tax Court
and was reported as ITC1842 [2010] 72
SATC 118.
The Tax Court decided that a 50/50 apportionment of the audit fees
was just and equitable and therefore allowed the company to claim 50% of the
audit fees against the income derived by it in each of the four years of
assessment. Furthermore, the Tax Court reached the decision that the KPMG fee
of R878,142 constituted an expense of a capital nature and was therefore not
deductible for tax purposes.
MTN was dissatisfied with the decision of the Tax Court and
appealed to the South Gauteng High Court where Victor J in Mobile Telephone Networks Holdings (Pty) Ltd v Commissioner for South African
Revenue Service [2011] 73 SATC 315 allowed
MTN’s appeal regarding the KPMG in allowing the expenditure in full.
Furthermore, the High Court overturned the 50/50 apportionment of the audit
fees decided on by the Tax Court and directed that the Commissioner allows 94%
of the audit fees as a deduction for tax purposes.
The Commissioner was dissatisfied with the decision of the
High Court and therefore appealed to the Supreme Court of Appeal with the leave
of that Court.
The Commissioner contended that the audit fees should be
apportioned and only that part relating to the generation of taxable income,
which in the instant case constituted interest, should be allowed for tax
purposes with the balance of the expenditure not being allowed.
The
Commissioner also contended that no deduction regarding the KPMG fee should be
allowed or alternatively that the fee should be subject to apportionment on the
same basis as the audit fees.
The Court reviewed various leading cases regarding the
deductibility of expenditure such as Commissioner
for Inland Revenue v Nemojim (Pty) Ltd, Commissioner for Inland Revenue v
Standard Bank of SA Ltd and Joffe & Co Ltd v Commissioner for Inland
Revenue.
The Court recognised that the audit fees were laid out for a dual
or mixed purpose in that it related to the receipt of dividends and interest
and was of the opinion that the audit fees should therefore be apportioned. The
Court indicated that apportionment of expenditure is essentially a question of
fact depending upon the particular circumstances of each case and the Court
therefore referred to the summary of MTN’s trading for the various tax years
which set out the quantum of dividends received and interest received and the
audit fees as a proportion of its income.
The Court indicated that the audit function involved the
auditing of MTN’s affairs as a whole, the greater part of which related to the
consolidation of the subsidiaries results into MTN’s results.
The Supreme Court
of Appeal expressed the view that any apportionment of the fees must
be heavily weighted in favour of the disallowance of the deduction taking
account of the primary role played by MTN’s equity and dividend operations
compared to its more limited income earning operations. The Supreme Court of
Appeal therefore reached the conclusion that a 50/50 apportionment was too
generous to MTN and decided that only 10% of the audit fees claimed by MTN for
each of the tax years in question should be allowed.
The Court reviewed the
nature of the KPMG fee and referred to the evidence heard by the Tax Court
regarding the rationale for the services rendered by KPMG to MTN insofar as the
‘Hyperion’ system is concerned. The Court indicated that it was difficult to
establish whether the KPMG fee could legitimately be deducted by MTN. Thus, the
Supreme Court of Appeal reached the conclusion that the deduction of the KPMG
fee must be disallowed in full.
It is accepted that MTN was required to undertake an audit
of its affairs to comply with its statutory obligations. However, the courts
will take account of the income derived by a taxpayer to determine what portion
of the audit fees should be deductible and in MTN’s case it was decided that
only 10% of the audit fees could be justified as relating to the production of
the interest income which was taxable and that the remaining 90% of the audit
fees was related to the receipt of dividends which are exempt from income tax.
It is also important that taxpayers establish the nature of expenditure
reflected by the particular entity so that it can be shown that the expense
relates to that specific entity and not
to any other entity in the group. The Court experienced difficulty in
establishing the true nature of the KPMG fee and whether that related to MTN
itself or other entities in the group and for that reason decided that the fee
was not deductible by MTN.
Dr Beric Croome, Tax Executive, Edward Nathan Sonnenbergs Inc. This article first appeared in Business Day, Business Day Law and Tax Review, April 2014. Image purchased from iStock
