SARS's Beady Eye on Intragroup Transactions

In June, the Treasury released the Draft Taxation Laws Amendment Bills, 2011 that contained a proposal that section 45 of the Income Tax Act be suspended with effect from June 3.

Section 45 of the act allows for qualifying intragroup transactions to take place without adverse tax consequences and the South African Revenue Services (SARS) wanted a period of 18 months to allow it time to investigate what it perceived as abuse of the section.

On August 3, the Treasury and SARS issued another media release regarding section 45 intragroup transactions that contained details of more changes to the provision.

In that press release the Treasury and SARS said that information regarding transactions concluded in terms of section 45 had been obtained. The primary concern identified by the Treasury and SARS related to excessive debt being created on the transfer of assets concluded in terms of section 45.

The Treasury has confirmed that commercially orientated transactions should be allowed to proceed where such transactions do not result in an erosion of the tax base. S as result the Treasury has proposed that a new provision, namely section 23K, be introduced in the legislation to restrict the interest deductions associated with debt used to finance the acquisition of assets in terms of transactions concluded under sections 44, 45 or 47.

The Treasury has indicated that the results flowing from transactions concluded under section 45 will face different consequences, depending on the nature of the transactions in question.

It is important that the Receiver has the dedicated
resources to deal with applications promptly.

Interest deductions, relating to transactions that fall into the so-called “green channel,” will be deductible automatically. The interest deduction on debt associated with so-called “amber transactions” will only be permitted upon pre-approval by the authorities. Transactions that are not approved by the authorities will not be entitled to an interest deduction.

The authorities have confirmed that the above-mentioned proposals are intended as a short-tern solution to the problems identified in administering section 45. It is anticipated that a longer-tern set of solutions dealing with the deduction of interest on so-called “excessive debt” and the characterisation of debt, remain on the agenda for 2012 and into the future.

Originally, the Treasury identified concerns regarding the perceived abuse of section 45 and the amendments proposed are intended to take effect from June 3 this year.

SARS and the Treasury have proposed that the restriction on interest deductions associated with debt used to fund the acquisition of assets also apply to sections 44 and 47. The amendments to the interest deduction available in respect of transactions concluded in terms of sections 44 and 47 are proposed to take effect from August 3.

The Treasury has indicated that preference shares will be permitted as a means of funding section 45 transferred assets, subject to the proviso that tax cost associated with intragroup debt and preference shares will be subject to tighter restrictions.

However, those section 44, 45 and 47 reorganisations that rely on interest-bearing debt will be regarded as falling into the amber category of transactions which will, in turn, be classified into two broad groups. Where the interest-bearing debt associated with section 44, 45 and 47 restructures is funded within the group of companies and does not result in any loss or possible loss to the fiscus, automatic pre-approval is required. However, a discretionary approval process will apply where the interest-bearing debt, arising from the restructure, may result in a loss of revenue.

The Treasury has advised that the decision to approve or decline a restructure relying on debt financing will depend on the effect of the interest to be incurred on the tax payable by the debtors and creditors acting as parties to the debt, including the nature of the debt instrument.

As a result of the proposals issued on August 3, those transactions that can be classified as pure intragroup transfers and transactions reliant on financing by group companies should, in the main, fall into the so-called “green channel,” which will be allowed to proceed without securing prior approval from SARS.

However, those transactions regarded as leverage buy-outs and securitisations will fall into the so-called “amber channel” and will be closely scrutinised with SARS o ascertain whether approval for those transactions should be granted.

Those taxpayers, consisting of members of a “group of companies” as defined in the act, will be entitled to restructure their affairs using the intragroup provisions contained in section 45 where no excessive debt arises as a result of corporate restructure.

Clearly, the Treasury is concerned where excessive debt is created with the result that profits, which would otherwise have been subjected to tax, are effectively stripped out through substantial interest deductions, which may be received by either exempt entities or by persons who are not resident and, therefore, are not liable to tax on the interest paid.

The proposal to require that certain transactions be approved by SARS is understood. What is important, though, is that SARS has the dedicated and specialised resources to deal with the applications for approval promptly so as to ensure that legitimate transactions are not stifled in SA.

On August, 12, SARS published a draft guide on the disclosure of reorganisation transactions which summarises the proposed changes to sections 44, 45 and 47 of the legislation, including the insertion of section 23K into the act.

Further, it is envisaged that taxpayers will be required to submit a specialised return in terms of section 41(5) where a taxpayer acquires an asset through an asset-for-share transaction in terms of section 42, or a transaction envisaged in section 44, 45 and 47 of the act.

Taxpayers will be required to submit a return under section 41(5) where any f the following circumstances exist:

•            The transactions the taxpayer has entered into to acquire an asset or assets cumulatively exceed R30m over a period of 12 months
•             An asset or assets are transferred to the taxpayer at market value in terms of an intragroup transaction in terms of which section 45 of the act applies and the total value of an asset or assets exceeds R10m; or
•       The taxpayer is required, in terms of section 23K(3) to apply for approval in order to secure a deduction of interest, and such approval was not requested by the company.

Those companies that require approval under section 23K(3) will be required to identify all parties to the restructure transactions and supply details of the debt instruments that are used, directly or indirectly, to acquire the assets in terms of the restructure transaction.

•          Dr Beric Croome is a tax executive at Edward Nathan Sonnenbergs. This article first appeared in the Business Day supplement, Business Law & Tax Review, September 2011. Free Image from ClipArt

Taxpayers' Rights Quiz

How much do you know about your taxpayers rights? 

1. When an SARS employee has been rude to you, what should you do?

a. Yell back at them.

b. Slam down the phone and swear.

c. Ask to speak to a supervisor.

d. Threaten to sue.

2. If you are afraid to go to a SARS meeting, what are your options?

a. Hire a representative to go instead.

b. Have someone go with you.

c. Arrange to record the meeting.

d. All of the above.

3. When you cannot pay all the taxes you owe, when due, what are your options?

a. Don’t file a tax return. That way, the SARS won’t know how much you owe.

b. Set up a monthly payment plan.

c. Lie about your balance due on your tax return.

d. Blame it on the economy and forget it.

4. If you disagree about the amount of your tax liability, what is not a sensible option?

a. Request an appeals hearing.

b. Go to Tax Court.

c. Go to a Tax Specialist.

d. Just give in and pay the tax.

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Answer key below.How did you do? Did you get 100%? If you got less than 100%, perhaps it's time you invested in a copy of "Taxpayers' Rights in South Africa"


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Here’s the answer key:

1. c 2. d 3. b 4. d
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With grateful thanks to Eva Rosenberg for the quiz concept from her article "Do you know your Taxpayer Rights?", adjusted here for South African Taxpayers. Eva Rosenberg, EA, is the publisher of TaxMama.com. Rosenberg is the author of several books and e-books, including “Small Business Taxes Made Easy.” Eva teaches a tax pro course at IRSExams.com and other tax courses at http://www.cpelink.com/teamtaxmama 
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South African Revenue Service: Scam Alert Notifications

The South African Revenue Service (“SARS”) website, namely, www.sars.gov.za, contains various warnings to taxpayers about scams used by criminals to obtain banking details of taxpayers, or other means of obtaining personal information illicitly from taxpayers.

SARS indicates, on its website, that taxpayers must not supply their banking details to anyone via the telephone, sms or e-mail, as SARS will never request banking details telephonically, via sms or via e-mail.

The website contains details of a series of phishing/scam e-mails and letters, which were purportedly sent by SARS to taxpayers whereas such letters and e-mails were, in fact, submitted by persons who have nothing whatsoever to do with SARS.

Taxpayers must remember that under the provisions of the Income Tax Act, Act 58 of 1962, as amended (“the Act”), SARS is empowered to audit a taxpayer’s affairs, but in order to do so, must make prior arrangements with the taxpayer in terms of section 74B of the Act.  The law requires that the Commissioner must give the taxpayer reasonable prior notice of a requirement to submit information to SARS, or to conduct an audit.

Furthermore, any person arriving at business premises, contending to be a SARS official, is required, upon request, to furnish a copy of an authorisation letter as envisaged in section 74A of the Act.

The Act specifically defines an “authorisation letter” as a written authorisation granted by the Commissioner, for any person designated by the Commissioner for such purpose, to an officer to inspect, audit, examine or obtain information as contemplated in section 74B of the Act.  Where a person arrives at business premises without prior notice, demanding access on the basis that they are an official of SARS, such person can lawfully be ejected from the premises and refused access to those premises.  The only occasion whereby a SARS official may arrive at business premises, without prior notice, is where the High Court has authorised the issue of a search and seizure warrant in terms of section 74D of the Act.

Dear Taxpayer...
not all letters with the SARS logo are genuine

It would appear that a number of taxpayers have received letters purporting to be from SARS, which, from close examination, indicate that the letters in question were not issued by SARS but by the fraudsters. It would appear that letters advising a taxpayer that a VAT sales enquiry was to be undertaken, did the rounds in Limpopo Province during the course of June 2011 and, more recently, in the Sandton area during July 2011.

From a review of the letter relied on by the perpetrators of the fraud, it is apparent that the letter is deficient, inter alia, in the following respects:

·         Reference is made to the “South African Revenue Services”, which should, in fact, be to the “South African Revenue Service”.

·         Reference is made to the “Special Investigations Unit”, which unit does not appear to exist at SARS.

·         The letter also refers to a “Regional Controller”, which is not a designation of an official employed by SARS.

·         Letters of audit normally refer to the rights which taxpayers have in their dealings with SARS.

It is unclear what the perpetrators of the fraudulent letters hoped to achieve by advising a business that it is intended to subject that business to one or other tax audit.

Taxpayers who receive letters, purporting to be from SARS, which do not contain the details usually reflected thereon, should report the matter to SARS with a view to establishing if the letter was, in fact, issued by SARS or not.

More importantly though, taxpayers need to be aware that they do have certain rights in dealing with SARS, and are fully entitled to establish the bona fides of any person alleging to be an official from SARS, who wishes to have access to the business premises.  It must be remembered that a person who holds himself or herself out as an officer of SARS, engaged in carrying out the provisions of the Act, is guilty of an offence. Perpetrators of these frauds can be fined or imprisoned upon convictions of this offence.

As indicated above, SARS is required, by law, to make a prior arrangement with the taxpayer to conduct an audit, at the taxpayer’s premises, and cannot arrive without prior notice.  The only exception, where SARS may arrive without prior notice is where the High Court has issued a search and seizure warrant or, alternatively, where there is a criminal investigation and a search warrant has been issued under the Criminal Procedure Act No. 51 of 1977, as amended, which is executed by the South African Police Service.

Taxpayers receiving suspicious letters, purporting to be from SARS, need to be on their guard before making arrangements with the perpetrators to audit their affairs, or before they start disclosing personal particulars or banking details to such persons.  Should taxpayers have any doubt whether a letter requesting access to the business records is, indeed, from SARS, legal advice should be sought.

Dr Beric Croome is a Tax Executive at EDWARD NATHAN SONNENBERGS INC. This article first appeared in ENS Tax Ensight August 2011. Image from SARS.

Vital to balance taxpayers’ rights against fiscal laws

In June the Minister of Finance tabled the Tax Administration Bill in Parliament, first mooted in 2005 with the stated purpose of containing the administrative provisions affecting all taxes other than Customs and excise duties.

The bill consists of 20 chapters with 272 draft sections relating to various processes taxpayers will face when dealing with SARS.

SARS has indicated that the tabling of the legislation is the first step in rewriting the Income tax Act, Act 58 of 1962.

Once the bill has been enacted those administrative provisions currently contained in the act and other fiscal statutes will be repealed.

The bill creates a legal framework for the creation of a tax ombud in SA. Under the bill the minister must appoint a tax ombud for a period of three years. SARS has indicated that the tax ombud will follow the model used by the UK in creating the tax adjudicator’s office and the tax ombud’s office in Canada. The bill provides that the staff of the office of the tax ombud must be employed in terms of the SARS Act and will be seconded to the office of the tax ombud from SARS.

The mandate of the tax ombud, according to the legislation, is to review and address complaints by a taxpayer regarding a service or a procedural administrative matter. The tax ombud is required to review a complaint lodged by a taxpayer and resolve it, either through mediation or conciliation, and must act independently in resolving taxpayers’ complaints. The tax ombud is required to follow informal, fair and cost-effective procedures in resolving taxpayers’ complaints.

It's vital to balance taxpayers' rights against fiscal laws as the bill gives SARS the power to conduct a search and seizure operation without a warrant to protect documents from destruction.

The tax ombud may review any issue falling within its jurisdiction on receipt of a request from a taxpayer. The tax ombud may determine how a review is to be conducted and may decide that a review should be terminated before completion in certain cases.

Some commentators have raised concerns about the fact that the tax ombud will be housed within SARS and will not be created as a separate and distinct office outside SARS.

Practically, the tax ombud is required to obtain access to taxpayer information and can only do so where the ombud is regulated by the secrecy provisions contained in the fiscal statutes. The housing of the tax ombud within a tax authority is not that unusual when reference is made to the models used as a basis to create a tax ombud in SA, and is also the manner in which the taxpayer advocate’s office was created in the US, which seeks to deal with taxpayer complaints lodged against the Internal Revenue Service.

The Tax Administration Bill also seeks to ensure that taxpayers’ rights are protected where a taxpayer faces a criminal investigation. The bill requires that audits and criminal investigations are separated, ensuring that the rights of an accused under the constitution are protected.

The one power contained in the bill that has attracted comment is SARS’s power to conduct a search and seizure operation without a warrant to protect documents from destruction by taxpayers.

Currently under the act SARS may only search taxpayers’ premises and seize documents when authorised to do so by a warrant issued by a court in terms of section 74D of the act. Clause 63 of the Tax Administration Bill confers on a senior SARS official the power to search premises and seize documents without a warrant when that senior official, on reasonable grounds, is satisfied that there may be an imminent removal or destruction of records likely to be found on the premises and that the delay in securing a search and seizure warrant would defeat the object of the search and seizure.

Clearly, the power to conduct a search and seizure operation without a warrant is not aimed at those taxpayers who comply with the fiscal laws of the country but is aimed at those who choose to operate outside the law.

A concern that arises, though, is the possibility of the power contained in clause 63 of the bill being abused by senior SARS officials, particularly as there is no oversight by a third independent party as to when it is appropriate to search premises and seize documents.

It would be preferable if SARS exercised the power it seeks such that the court, after the search and seizure operation, reviewed the decision made by an official to conduct a warrantless search and seizure operation.

The difficulty that arises is that a search and seizure operation conducted without a warrant constitutes an invasion of the rights of a taxpayer to privacy under the constitution. On the other hand, SARS has a statutory duty to ensure that taxpayers comply with the fiscal laws and faces taxpayers who, once an audit commences, seek to destroy documents.

It is, therefore, necessary to strike a balance between the rights of the taxpayers on the one hand and the statutory duty which SARS has of ensuring that taxpayers comply with the fiscal laws.

It would appear that the decision which may be made by a senior SARS official to conduct a warrantless search and seizure operation constitutes administrative action as envisaged under the rules of administrative law.

That being the case, it is important that any official making a decision under clause 63 of the bill does not have a pecuniary interest in the outcome of the decision made by that official based on the general principles of administrative law in SA.

It is unclear whether SARS officials receive incentives or bonuses directly relating to the tax that they collect. Should an official have a pecuniary interest in the outcome of the decision, that would be indicative of the official being biased.

SARS should, therefore, clarify whether its officials are in receipt of incentives directly related to the taxes collected by them and, if that is the case, it raises a question as to whether clause 63 is constitutionally valid.

It remains questionable whether clause 63 complies with the constitution, particularly when reference is made to the strict rules in place in so far as issuing search and seizure warrants under the Criminal Procedure Act are concerned and, particularly, in the light of the decision of the Constitutional Court in Minister for Safety and Security v GW van der Merwe and Others, where the Constitutional Court held that the provisions of the North-West Gambling Act No 2 of 2001 authorising an inspector to enter unlicensed gambling premises without a warrant , were unconstitutional and invalid.

It is important that taxpayers note that many of the administrative provisions currently contained in the act and other fiscal statutes will continue to exist in the Tax Administration Bill.

It is unclear at this stage when the bill will be enacted and when it will take effect. It is more than likely that the provisions of the bill will become effective on different dates and taxpayers will need to take account of the provisions so that they understand the powers that SARS has under the legislation and the rights which are contained therein.

·         Dr Beric Croome is a tax executive at Edward Nathan Sonnenbergs. This article first appeared in Business Day, Business Law & Tax Review August 2011. Image free from ClipArt

Search warrants must spell out the offence

WARRANTS were issued as a result of a suspicion by the Commercial Crime Unit of the South African Police Service (SAPS) that a G van der Merwe and three other suspects, and several companies in which he had a financial interest, were involved in money-laundering and financial and tax irregularities.

Left: Constitutional Court rules that a searched person must understand the reasons for the invasion of their privacy. The High Court declared the three warrants invalid  and set them aside on the basis that they did not stipulate the offence.

In Minister for Safety and Security v G W van der Merwe and Others, the Constitutional Court was required to adjudicate whether the search and seizure warrants issued in terms of section 21 of the Criminal Procedure Act were valid or not.

The SAPS caused search and seizure warrants to be issued by a magistrate in Cape Town. The search warrants did not specify the offences which Van der Merwe and others were alleged to have committed and, as a result, those warrants were set aside as invalid by both the High Court and the Supreme Court of Appeal.

In terms of section 74D of the Income Tax Act, 1962, the Commissioner may approach a judge of the High Court for the issue of a search and seizure warrant, whereby the Commissioner’s officials may then search premises and seize records without prior announcement. In Van der Merwe’s case the Criminal Investigations Unit of the South African Revenue Service (SARS) suspected that Van der Merwe and others had committed financial irregularities and were involved in criminal activities. 


Therefore, SARS collaborated with the Director of Public Prosecutions and SARS caused the Commercial Branch of SAPS to investigate possible violations of the act, fraudulent claims in contravention of the Value-Added Tax Act, and moneylaundering.

The SAPS was, therefore, assigned the case for investigation and when the need arose for search and seizure operations to be conducted at premises linked to Van der Merwe and others, SAPS officials and employees of SARS deposed to affidavits in support of the issuing of search and seizure warrants in terms of section 21, read with section 20, of the Criminal Procedure Act.

It is important to note that neither the search warrants issued, nor their annexures, specified the offences under investigation, nor did those documents describe the nature of the investigation. Members of SAPS and SARS conducted the search and seizure operations in terms of the warrants issued by the magistrate in Cape Town and removed several items from the targeted premises.

Van der Merwe and others chose to challenge the validity of the warrants in the Western Cape High Court on the basis that the suspected offences were not stipulated in the search warrants and that the magistrates failed to apply their minds to the applications for the warrants, and this rendered the warrants fatally defective in law. 


The High Court declared the three Cape Town warrants invalid and set them aside on the basis that they did not stipulate the offence. The Minister was dissatisfied with the decision of the High Court and took the matter on appeal. The Supreme Court of Appeal upheld the decision of the High Court in respect of the Cape Town search warrants.

The Minister was unhappy with the decision and approached the Constitutional Court for leave to appeal. The Constitutional Court held that the application dealt with a constitutional issue and that it was in the interests of justice for the court to pronounce on the validity of the search warrants in question and whether the search and seizure warrants should specify the offence to which the search relates.

Under the provisions of the Criminal Procedure Act, a person, subjected to a search and seizure warrant, is entitled to a copy of the warrant only after the search has been completed. The Constitutional Court indicated that it had not previously been required to consider the validity of search and seizure warrants issued in terms of sections 20 and 21 of the Criminal Procedure Act. The Constitutional Court pointed out that warrants issued in terms of section 21 of the Criminal Procedure Act are important tools used by SAPS in carrying out their constitutional mandate of preventing, combating and investigating crime.


However, the Constitutional Court also recognised that by using search and seizure warrants, those warrants inevitably interfere with the constitutional rights of individuals and, therefore, safeguards must be in place to ameliorate the affect of any interference arising out of the exercise of such warrants.

The Constitutional Court referred to the intelligibility requirement for a valid search and seizure warrant and pointed out that it is a principle derived from the common law introduced by the Courts and is quite separate and distinct from the statutory requirements in the Criminal Procedure Act.

Intelligibility requires that the police officer exercising the search warrant understands the authority in the warrant in order to enable him or her to carry out the duty required, and also that the searched person understands the reasons for the invasion of their privacy.

The court pointed out that none of the warrants issued by the Cape Town magistrate disclosed the offences which Van der Merwe and others were alleged to have been guilty of. Therefore, the Constitutional Court held that the search and seizure warrants issued to the SAPS to conduct a search and seizure operation against Van der Merwe and others were invalid due to the failure to comply with the offence specification requirement.

In terms of section 74D of the act, the Commissioner may, in certain prescribed cases, seek the issue of a search and seizure warrant from a judge of the high court.

Section 74D(4) of the act specifically requires that any warrant issued under the provision must refer to the alleged noncompliance or offence in relation to which the warrant is issued.

SARS, in ensuring that taxpayers comply with the obligations they face under the fiscal laws of SA, may apply for a search and seizure warrant under section 74D of the act or, alternatively, hand the matter over to the SAPS, where it is a criminal matter, and rely on the SAPS to procure a warrant under sections 20 and 21 of the Criminal Procedure Act. It is important though that any warrant issued complies with the requirement specified in the judgment of the Court in Minister for Safety and Security v GW van der Merwe and Others.

It is clear that strict rules are in place as to the requirements for a valid search and seizure warrant. In light of the decision of Magajane v Chairperson Northwest Gambling Board and Others, it is debatable whether the power conferred on SARS in the Tax Administration Bill to conduct a warrantless search is valid under the Constitution.
Dr Beric Croome is a tax executive at ENS. This article first appeared in Business Day, Business Law & Tax Review, 11 July 2011. Free Image from ClipArt

National Treasury Suspends Intra-group Relief Contained in Section 45 of the Act

On Thursday, 2 June 2011, National Treasury released the Draft Taxation Laws Amendment Bill, 2011 ("DTLAB"), Explanatory Memorandum on the DTLAB 2011, Draft Taxation Laws Second Amendment Bill, 2011 ("DTLSAB"), as well as a Media Statement on the DTLABs 2011.

The DTLAB comprises 183 pages of significant changes to the fiscal laws of South Africa.

The one change that requires specific comment is Government's proposal to suspend the intra-group relief available in section 45 of the Income Tax Act, Act 58 of 1962, as amended ("the Act"), with effect from 3 June 2011.

Most of the proposals contained in the DTLAB were announced in the 2011 Budget presented to Parliament by the Minister of Finance on 23 February 2011.

From an examination of the 2011 Budget Review, published by National Treasury, it is clear that no mention whatsoever was made of the proposal to suspend section 45 of the Act. It has become customary that most of the changes contained in the Tax Bills are announced in the Budget documentation so that taxpayers know what changes they are likely to face and, more importantly, the likely date on which those changes may take effect.

Section 45 forms part of the so-called "group restructuring rules", which were introduced into law by section 44 of the Second Revenue Laws Amendment Act No. 60 of 2001. This section has undergone significant amendments over the years as the authorities have sought to refine the provisions and curtail the perceived abuse thereof.

The corporate restructuring rules were introduced into the Act with effect from 1 October 2001, that is, the date on which capital gains tax took effect in South Africa, to enable groups of companies to restructure their affairs without adverse tax consequences arising. 

There were similar measures in place since 1988 to allow for companies to restructure their affairs without incurring tax liabilities where a qualifying group of companies restructured its affairs.

The Media Statement issued by National Treasury on 2 June 2011, refers to the fact that the DTLAB contains a number of new anti-avoidance measures and contained a separate annexure dealing with the suspension of intra-group roll-over relief currently contained in section 45 of the Act. The DTLAB specifically provides that section 45 will not apply in respect of any asset disposed of on or after 3 June 2011 and before 1 January 2013. Thus, section 45 has, for all practical purposes, been suspended for a period of 18 months to allow the National Treasury to investigate the perceived abuse of the section.

National Treasury, in its Media Statement, points out that the section 45 intra-group roll-over relief was originally intended to facilitate transfers amongst companies which constituted a group as defined in the Act. Thus, the purpose of section 45 was to ensure that the tax system did not pose a barrier to intra-group transfers, whether the transfer took place by way of an exchange of shares, debt or cash, or as a dividend. National Treasury makes the point that intra-group relief is a common feature of most advanced tax systems around the world.

National Treasury is concerned about the way in which section 45 is being used, as taxpayers have, in its view, sought to use it as a means of acquiring businesses and that the section involves what is referred to as "debt push-down structures". National Treasury contends that section 45 allows for the use of excessive debt schemes and creates the means whereby taxpayers utilise so-called "funnel schemes", whereby debt proceeds are indirectly linked to tax-free preference share dividends.

Left: In light of the suspension of intra-group relief, big corporations are reviewing their corporate structures on an on-going basis. 

National Treasury has indicated that section 45 will be suspended for a period of approximately 18 months, during which period the purpose of the section will be re-evaluated, particularly to deal with the concerns that National Treasury has regarding excessive debt. National Treasury has identified the following issues relating to section 45 as part of a larger set of problems and these include:

• The free use of excessive debt to eliminate substantial amounts of operating income for an extended duration.
• The seeming freedom to re-characterise shares as debt (or debt as shares) with little regard for accounting and commercial concepts.
• Excessive tax losses available in the tax system and the potential to move losses amongst entities if a viable business purpose can be asserted.
• The need for section 45 within an intra-group context, as well as the need for the movement of losses within a single domestic group.
• The need to allow for interest deductions stemming from leveraged buy-outs, regardless of the form of that acquisition.

It must be remembered that South Africa does not impose tax on a group basis and, thus, section 45 alleviated the adverse tax consequences that would otherwise arise where business assets are moved from one company in a group to another.

To summarily to suspend section 45 of the Act, without prior notice in the Budget documentation, by way of a Media Statement, is extremely draconian.

It is questionable also whether this proposal be enacted is valid under the Constitution of the Republic of South Africa, Act 108 of 1996, as amended. Numerous companies have prepared agreements to transfer businesses in terms of section 45 of the Act and the costs they incurred would now appear to have been wasted as a result of this immediate suspension of section 45. It is unfair that businesses should be expected to carry these costs in light of the manner in which section 45 has been suspended. The proposal undermines the rule of law insofar as the tax system is concerned, and cannot be supported.

In addition, corporates are reviewing their corporate structures on an on-going basis and, no doubt, many companies in South Africa were in the process of evaluating the most appropriate manner to rationalise their businesses in South Africa. 

The manner in which section 45 has been suspended in the proposals relating thereto create great uncertainty for taxpayers in South Africa and does not bode well for foreign investors who own groups of companies in South Africa, who are currently in the process of reviewing the manner in which those operations are structured. Investors in a country require certainty as to the legal framework within which they are required to operate. 

The manner in which section 45 has been amended, effectively by way of a press release, seriously undermines the certainty to which both domestic and foreign investors have come to expect in South Africa. This cannot bode well for future economic growth and development and job creation in South Africa.

It is hoped that Parliament will recommend that the proposals contained in the DTLAB, insofar as section 45 are concerned, should be removed from the DTLAB and that the matter should be investigated further before the section is summarily suspended. 

If National Treasury and the South African Revenue Service ("SARS") have concerns about the manner in which section 45 is being utilised by taxpayers, the authorities should rely on the General Anti-Avoidance Rule ("GAAR") contained in sections 80A – 80L, which was introduced in November 2006, and not merely suspend the section whilst the matter is investigated further. The GAAR was introduced after much discussion and debate to replace the anti-avoidance rule contained in section 103(1) of the Act. 

However, it would appear that the Commissioner: SARS is reluctant to rely on the GAAR to attack a perceived abuse of the tax system by taxpayers. This also raises the question of whether the GAAR serves any purpose in the Act, with no cases yet having been reported dealing with the application of the GAAR.

This article first appeared in taxENSight, June 2011 edition. Free Image from ClipArt.

SARS argues company crossed the tax Rubicon

THE Supreme Court of Appeal delivered judgment last month in the case of Founders Hill (Pty) Ltd v the Commissioner for the South African Revenue Service which dealt with the capital versus revenue nature of proceeds received by a realisation company that acquires land in order to dispose of it.

The leading commentators on tax in SA have expressed the opinion previously that when a company acquires an asset with the purpose of reselling it the proceeds so realised constitutes income liable to tax, with the only exception relating to socalled realisation companies, which are not created in order to dispose of assets as part and parcel of a scheme of profit-making.

In Founders Hill, the company was created for the purpose of realising land formerly owned as a capital asset by its holding company, namely AECI Limited. When a company is referred to as a realisation company it means an entity that has been created to facilitate the disposal of property, and the company does no more than to realise the asset owned by it.

Left: SARS argues company crossed the tax Rubicon: capital vs revenue nature of the proceeds of company's land that was sold for a profit was at issue and the Tax Court...held that...the surpluses realised on the disposal of land was capital in nature.

In the Founders Hill case, SARS contended that the company had crossed the Rubicon when it sold the land on which it realised surpluses. The company on the other hand argued that it had merely realised a capital asset to its best advantage and that the proceeds constituted a receipt of a capital nature and that no tax was payable on the basis that the proceeds were realised prior to the introduction of capital gains tax.

The court took the view that Founders Hill had acquired the property from AECI for the purpose of developing the land and reselling it. Originally, the Commissioner did not assess Founders Hill to tax on the profits made on the land disposed of. However, it subsequently issued revised assessments subjecting those profits to tax.

Founders Hill objected to the assessments issued to it on the basis that the proceeds of the sales were capital in nature and proceeded on appeal to the Tax Court once the Commissioner disallowed its objection. The Tax Court upheld the appeal lodged by Founders Hill.

The Tax Court held that Founders Hill had acquired the land as a capital asset and that it did not change its nature by the time that it was sold and therefore the capital gain realised was not taxable.

AECI Limited had owned the land in excess of its requirements for some time and in 1989 it was recommended that a strategic plan, which had been developed, be accepted, namely that AECI makes the decision to sell or develop the land and commences the process to do so. As a result of this decision Founders Hill (Pty) Ltd was created as a subsidiary of AECI to acquire the land from AECI and to realise that land to best advantage.

Founders Hill itself had no employees and its sole shareholder was AECI and its directors were those of AECI. The land located at Founders View was subdivided and developed by AECI before being transferred to Founders Hill and the profits accrued to Founders Hill. Founders Hill argued that it always intended to realise the land held by it as a capital asset and submitted that it was entitled to realise an asset to best advantage. The court was required to determine whether Founders Hill realised the land owned by it to best advantage or whether it embarked upon the business of selling land.

In Founders Hill the Commissioner argued that the company had crossed the Rubicon and therefore any surpluses realised on the disposal of the land owned by it constituted income liable to tax. The Tax Court, however, held that the Rubicon had not been crossed and that the surpluses realised on the disposal of land was capital in nature.

Judge Lewis, in the Supreme Court of Appeal, pointed out that Founders Hill was created as a “realisation company” on legal advice and that by acquiring the land from AECI and realising same to best advantage it should not cross the Rubicon. The judgment contains an analysis of the tax treatment of realisation entities and particularly the decision of the Court in Berea West Estates (Pty) Ltd v Secretary for Inland Revenue. In that case, the profit realised on the disposal of land by a company formed for the purpose of realising land held by different family members was held to be capital in nature. Judge Lewis noted that an interposed realisation company will be treated as holding assets acquired by it as capital assets from the seller in special circumstances as set out in Berea West’s case and not merely where the realisation company acquires property for the avowed purpose of disposing of same at a profit.

It was pointed out by the court that the fact that Founders Hill said that it had acquired the properties from AECI as capital assets did not mean that they were in fact capital assets for tax purposes. Founders Hill was created to develop the land owned by it and to sell it. The court therefore held that the surpluses realised by Founders Hill on the disposal of the land represented profits made as part of a scheme of profit-making and therefore revenue derived from capital productively employed and was therefore liable to tax. Judge Lewis held that Founders Hill had acquired the land from AECI as stock in trade and then conducted the business of trading in that property, and that the surpluses realised were taxable as income. The court confirmed the Commissioner’s assessments issued for the years in question.

The court was also required to consider the imposition of interest on the underpayment of provisional tax in terms of section 89quat of the act. The court referred to the fact that Founders Hill had acted on legal advice and in the mistaken belief that the disposal of its property as a capital asset as a realisation company should not give rise to the imposition of penalty interest on the underpayment of provisional tax. Therefore, the court directed that the Commissioner must waive the interest levied on the underpayment of provisional tax. Unfortunately, the provisions of section 89quat have been amended such that the Commissioner’s discretion to waive the interest on the underpayment of provisional tax has been narrowed significantly.

It was pointed out above that the Founders Hill case dealt with a tax dispute that arose before the introduction of capital gains tax in SA. When capital gains tax was introduced during 2001 amendments were introduced to the law to cater for the situation where assets held by a person as a capital asset become trading stock. Therefore had capital gains tax been in force at the time that AECI Limited proposed to deal in the land owned by it, it may have been possible for AECI Limited to argue that a certain of portion of the value attributable to the fixed property constituted an amount of a capital nature subject to capital gains tax and not income tax by virtue of the provisions contained in paragraph 12 of the Eighth Schedule to the Act.

Dr Beric Croome is a tax executive at ENS. This article first appeared in Business Day "Business Law & Tax Review" June 2011. Free Image from ClipArt.