The Lawfulness of Retrospective Amendments in Tax Law

On 29 May 2017 Judge Fabricius delivered judgment in the Gauteng High Court  in the case of Pienaar Brothers (Pty) Ltd vs Commissioner for the South African Revenue Service and the Minister of Finance, as yet unreported 87760/2014 [2017] ZAGPPHC231 (29 May 2107) in a case dealing with The Taxation Laws Amendment Act No. 8 of 2007 (“the Amending Act”) which inserted section 44(9A) into the Income Tax Act (“the Act”)

The taxpayer sought an order declaring that section 34(2) of the Amending Act is inconsistent with the Constitution and invalid to the extent that it provides that section 44 (9A) of the Act shall be deemed to have come into operation on 21 February 2007 and to be applicable to any reduction or redemption of the share capital or share premium of a resultant in company, including the acquisition by that company of its shares in terms of section 85 of the Companies Act, on or after that date.

Pienaar Brothers approached the Court  seeking a declaration that the amendment to section 44, the so-called amalgamation section in the Act was unconstitutional and invalid on the basis that the amendment was retrospective. 

The company concluded an amalgamation transaction in terms of section 44 of the Act in which it acquired all of the assets of the company then known as Pienaar Brothers (Pty) Ltd on 16 March 2007 with effect from 1 March 2007 in terms of the sale of business agreement. 

Later, on 3 May 2007 the Board of Directors of the Company resolved under the Companies Act to make a distribution to its shareholder’s pro-rata to their shareholding of an amount of R29 500 000.00 out of the taxpayers’ s share premium account. 

On the date of the resolution the tax law excluded from its ambit any amount distributed out of a company’s share premium account. 

The company therefore argued that on 3 May 2007 when the distribution was made it did not constitute a dividend as defined in the Act and thus no secondary tax in companies was due and payable on the distribution on the basis that it was made out of the share premium account. 

The Commissioner, however assessed the amount of R29 500 000.00 to secondary tax on companies on the basis that the amount fell within the amendments introduced to section 44 by way of the Amending Act which was only promulgated on 8 August 2007.

The Court  examined the process whereby section 44 of the Act was amended. It was pointed out that in the 2007 Budget Speech presented  on 20 February 2007 that the then Minister of Finance indicated the intention to pass retrospective legislation to deal with anti-avoidance arrangements relating to STC. 

Subsequently, on 21 February 2007 the Commissioner issued a press-release stating that the STC exemption for amalgamation transactions contained in section 44(9) of the Tax Act was to be withdrawn with immediate effect, that is, from 21 February 2007. On 27 February 2007, SARS and National Treasury released for public comment the Draft Taxation Laws Amendment Bill 2007. 

That Bill proposed the amendment of section 44 addressing the concerns raised by the Minister in his Budget Speech. As pointed out above, the amalgamation transaction, the distribution as well as the introduction of the BEE partner in the company was completed in early May 2007. 

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Thereafter, on 7 June 2007, the 2007 Taxation Laws Amendment Bill was published but instead of proposing the deletion of sections 44(9) and (10) of the Act, it proposed the insertion of a new subsection (9A). 

The Bill also indicated that the amendment would be retrospective to 21 February 2007. 

The company contended that it concluded the amalgamation transaction in May and only later in June 2007 did it become aware that the transaction concluded by it could be covered by the amendment.

On 8 August 2007 The Taxation Laws Amendment Act 2007 was promulgated giving effect to the amendments announced in the February 2007 Budget Speech. 

The company argued that the amendment was invalid under the Constitution because it was retrospective and offended against the principle of legality of the rule of law. 

The company contended that when it completed the transaction in May it was not possible to know that the amount would be subject to secondary tax on companies by virtue of the fact that there was no law in place and that it could not be held liable for interest for this reason and similarly could not be subject to penalties or criminal prosecution for not having submitted an STC return reflecting the reduction of share premium as a dividend liable to STC. 

The judgment deals with both the legal arguments of the company and the Commissioner at length and refers to the position in South African law as well as a number of other countries.

The case is a very useful summary of the legal position regarding retroactive amendments, not only in the tax arena.

The Commissioner’s counsel contended that the taxpayer was given notice of a proposal to amend the law and that it was not correct to argue that there was no prior notification of the proposed amendment to plug the perceived loophole in the STC legislation. 

The Commissioner’s counsel referred to the process whereby the amendment was given effect to and the Court  made it clear that the history of the amendment made it clear that the Minster, SARS and Parliament were determined to close the STC loophole with effect from 21 February 2007. 

The Court  analysed the rule of law in the Constitution and various academic writings dealing with that topic. The Court  referred to the general principle that an amendment to a law should only apply prospectively, that is from a future date unless the amendment makes it clear that it applies from an earlier date. 

The Court  reviewed the position of retroactive amendments in the United States, United Kingdom, Canada and other countries and came to the view that those constitutional democracies do not specifically prohibit retroactive amendments to tax laws. 

The Court  indicated that it is also necessary to weigh up the public interest and the needs of the Treasury when considering retroactive amendments to legislation even though such amendments may adversely effect particular taxpayers. At paragraph 63 the judge stated as follows:

“I am not aware of any authority or legislative provision that provides that a fairly precise warning needs to be given before the legislature can pass retrospective legislation, whether in general, or in the case of a tax statute. In the latter instance, economic demands must be considered in the context of the purpose and effect of an intended statute. If the tax statute is rationally connected to a legitimate purpose, no precise warning is required, if one at all.”

The court pointed out that the Constitution itself does not contain a provision prohibiting retrospective legislation. The court  accepted that Parliament may not legislate with retrospective effect as it pleases but to do so must meet the standard required for the constitutional validity of retrospective amendments. It indicated that reference must be made to the rationality test and the second standard relating to reasonableness or proportionality.

The court referred to various judicial decisions and came to the conclusion that in the particular instance the standards set by the court  had not been violated and therefore decided that the amendment to section 44 was lawful and the taxpayer was liable to the STC as assessed by the Commissioner.

The taxpayer also argued that its right to property had been violated as a result to the manner in which the amendment was enacted and the court  dismissed this contention on the basis that the amendment did not constitute the unlawful deprivation of property.

The court  came to the conclusion that it is not necessary that exceptional circumstances must exist for Parliament to pass retrospective legislation. The court  decided that there was no overriding duty to give notice of intended legislation. It was decided in the present case that there was sufficient notice of general impact and that there is no over-riding duty to give notice that indicates precisely what the intended legislation will encompass.

 In the result the court  dismissed the company’s application to find that the amendment was unlawful under the Constitution. By virtue of the fact that the case related to constitutional issues it made no orders as to costs. It remains to be seen if the case will proceed on appeal to a higher court . 

The judgment is important in that it sets out clearly for the first time the consequences of retrospective amendments to legislation in the tax arena and taxpayers and advisors are well advised to study the comprehensive judgment which is a good summary of the law in South Africa and around the world.

Dr Beric Croome is a Tax Executive  at ENSafrica. This article first appeared in Business Day, Business Law and Tax Review, July 2017.