Author: Frank Mosupa (PwC)
The judgment of the Western Cape Tax Court in ITC 1862 (2013) 75 SATC 34 concerns the general anti-avoidance provision contained in the now-repealed section 103 of the Income Tax Act 58 of 1962 (the “Income Tax Act”) as applied to the implementation of a particular employee share incentive scheme. The case concerned transactions entered into prior to the coming into force of the new general anti-avoidance rule on 2 November 2006 and now contained in Part IIA of the Income Tax Act.
The decision represents another significant defeat for SARS in a dispute over the dividing line between legitimate tax avoidance and unlawful tax evasion. Inevitably, a question arises as to the amount of forethought – including a dispassionate assessment of the taxpayer’s probable credibility in the Tax Court – that goes into a decision by SARS, on a case by case basis, whether to embroil a taxpayer in lengthy (in this case, four years from assessment to a decision by the Tax Court) and costly litigation.
No doubt SARS will interpret the defeat as fortifying its already entrenched view that section 103 has proved inadequate and as confirming its decision to repeal and replace that provision with a new, seemingly more muscular statutory anti-avoidance provision.
The factual background
On their face, the events that led up to this disputed assessment centred on a commercially unremarkable decision by the company in question to create a share incentive scheme for its employees. In terms of the scheme, the shares were to be delivered to employees at future dates. In order to guard against an interim rise in the share price that would make the scheme more expensive to implement, the company decided to create, in advance, a bank of available shares, to be purchased (with an interest free loan advanced by the group’s treasury company) and held by a dedicated wholly-owned subsidiary.
SARS took the view that the approximately eight million shares so held by the subsidiary had not in fact been acquired for the ostensible purpose of being used in the share incentive scheme, and that their acquisition was a step in a multi-stage tax scheme aimed at evading STC. The basis of this belief seems to have been somewhat thin and indeed shaky, namely, an adverse inference that could arguably be drawn from a statement in the company’s 2002 annual report.
In the result, the Tax Court refused to view that statement as anything but neutral and innocuous. In the course of the proceedings in the Tax Court, SARS attacked the testimony of the company’s CEO as “false” but the court said that the aspersions cast on the latter’s veracity were “unfortunate”. It is clear from the judgment that SARS had come to the view that the entire sequence of events involved in the devising of the share incentive scheme, the acquisition of the company’s shares by its subsidiary with an interest-free loan from the group treasury company, and the company’s re-acquisition and cancellation of the shares were pre-ordained steps in an overall “unitary” scheme to evade STC.
In the course of the proceedings in the Tax Court, SARS seems to have realised that this argument was unsustainable and sought to put forward an alternative basis for the assessment, in terms of which the first step (the purchase of the company’s shares by its subsidiary) was admittedly innocuous, and that it was the repurchase of the shares by the company that had no commercial rationale and was the critical step in a section 103 scheme.
The court, however, ruled that SARS was bound by the basis for the assessment put forward in its Rule 10 statement and that, in any event the alternative scheme put forward by SARS was not supported by any evidence.
The taxpayer successfully argued that SARS could not succeed in its invocation of section 103 unless it could discharge the onus resting on it of proving the simultaneous presence of three elements in that section – the existence of a scheme, the effect of avoiding or postponing tax, and the abnormality of the transactions. The taxpayer contended that, even if SARS could succeed in establishing these elements, the requisite sole or main purpose of deriving a tax benefit had not been proven.
The Tax Court held that SARS had failed to prove the component elements of section 103 and, in particular, had not proven that the effect of the transaction had been the avoidance of STC. Moreover, said the court, the evidence “overwhelmingly demonstrates” that the company’s sole or main purpose in concluding the various transactions had not been to obtain a tax benefit. In other words, if a transaction can be explained by reference to other bona fide purposes and not the obtaining of a tax benefit, it cannot be characterised as an avoidance transaction.
The court also found that the normality of the transactions had been established by the testimony of SARS’s own expert witness to the effect that it was normal for companies to repurchase their own shares that were held by subsidiaries. In the result, the Tax Court upheld the appeal and set aside the disputed STC assessments.
It is apparent from the above that the nature of general anti-avoidance rules is such that it applies in an area of the law characterised by a perpetual clash between the taxpayer’s entitlement to avoid taxes permissibly, and SARS’ need to protect the revenue base from impermissible tax avoidance. Therefore, for general anti-avoidance rules to be effective, it must strike a balance between these two competing interests by distinguishing between permissible and impermissible tax avoidance.
To this end, section 103 has been an inconsistent and ineffective deterrent of increasingly sophisticated forms of tax avoidance. However, when one refers to the new, more muscular statutory anti-avoidance provision contained in sections 80A-80L, certain elements of section 103 are contained therein. However, due to the relatively recent introduction of these rules, they remain untested in a court of law and consequently guidance in terms of their application is determined with reference to the old general anti-avoidance rules.