Anti-avoidance provisions on sham transactions

Many decisions of South African and foreign courts, in the context of tax and otherwise, have described particular transactions as being a “sham”.

The word “sham” is often used in judgments without explanation, as though its meaning was self evident and as though the legal consequences of a transaction being a “sham” are clear.

Both of these assumptions are unwarranted. The criteria for the existence of a “sham”, the precise meaning of the word, and the legal consequences of a transaction being so characterized by a court of law, are far from self-evident.

In Raftland (Pty) Ltd v Commissioner of Taxation [2008] HCA 21, the High Court of Australia put the word “sham” under a strong lens, and the judgment contains a lengthy and illuminating discussion of the concept, its meaning, and its legal consequences. In the court, of first instance, the presiding judge said that — A conclusion that a transaction is a sham means that it may be ignored and regard had to the real transaction. On appeal, the High Court of Australia, said (at para 101) that “it is essential for this court to grapple with the issue of sham”, and pointed out that in Paintin and Nottingham [1971] NZLR 163 at 175 it had been held that the mere invocation of sham does not render a transaction suspect, still less ineffective. Integritax Issue 128 – April 2010 ©SAICA, 2010 page 2 The High Court observed (at para l06) that it has been held in the United States that the courts — “cannot ignore the fact that tax laws affect the shape of nearly every business transaction. Businesses plan their affairs around the realities of competition and tax liability. Subject to the law, that is a taxpayer’s right” and went on to say that the United States Supreme Court has developed a doctrine akin to sham to enhance the power of a judge to disregard artificial transactions. In Sharment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449 the Australian Federal Court, after reviewing the authorities on the concept of a sham, said per Lockhart J that — A sham is … for the purposes of Australian law, something that is intended to be mistaken for something else or that is not really what it purports to be. It is a spurious imitation, a counterfeit, a disguise or a false front. It is not genuine or true, but something made in imitation of something else or made to appear to be something which it is not. It is something which is false or deceptive and the High Court went on to say that — “Important to this description is the idea that the parties do not intend to give effect to the legal arrangements set out in their apparent agreement, understood only according to its terms. In Australia, this has become essential to the notion of sham, which contemplates a disparity between the ostensible and the real intentions of the parties. The courts must therefore test the intentions of parties, as expressed in documentation, against their own testimony on the subject (if any) and the available objective evidence tending to show what that intention really was.” In the United Kingdom case of Bridge v Campbell Discount Co Ltd [1962] AC 600, Lord Devlin said that — When a court of law finds that the words which the parties have used in a written agreement are not genuine, and are not designed to express the real nature of the transaction but for some ulterior purpose to disguise it, the court will go behind the sham front and get at the reality. The concept of a sham was further refined by Diplock LJ in Snook v London and West Riding Investments Ltd [1967] 2 QB 786 at 802 where he said that — If it has any meaning in law, [sham] means acts done or documents executed by the parties to the sham which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. … [F]or acts or documents to be a sham, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a shammer affect the rights of a party whom he deceived. Attempts have been made to broaden the base on which a transaction can be disregarded as being a sham, so as to extend the concept beyond the narrow criteria proposed by Diplock LJ in this latter dictum. To this end, the courts of the United Kingdom developed the concept of “fiscal nullity” which applies where steps having no commercial or business purpose other than tax avoidance are inserted into a Integritax Issue 128 – April 2010 ©SAICA, 2010 page 3 composite transaction (See for example, Furniss v Dawson [1984] AC 474). It has been suggested that this should be viewed as a species of the sham concept. However, the concept of “fiscal nullity” has not found favour outside the United Kingdom. Indeed, even within the United Kingdom, the label of “sham” is attached only where parties intended to create rights and obligations different from those appearing in their documents. In the New Zealand decision of Paintin and Nottingham [1971] NZLR 163 at 175, Turner J made it clear that, in New Zealand, the word “sham” does not apply to a transaction where the parties to a transaction intend it to have effect according to its tenor. A wrong direction In Minister of National Revenue v Cameron [1974] SCR 1062, the Supreme Court of Canada adopted the approach to sham expressed in Snook. Shortly thereafter, in Minister of National Revenue v Leon [1977] 1 FC 249 at 256, the Federal Court of Appeal, in a significant deviation from the Snook principles held that — If [an] agreement or transaction lacks a bona fide business purpose, it is a sham. It took some seven years for the courts to backtrack on this regrettable and confusing detour, but in Stubart Investments Ltd v The Queen [1984] 1 SCR 536, the Supreme Court of Canada per Estey J emphasised that the subjective element of deceit was the core element in a sham. He said in this regard that a lack of business or commercial purpose was insufficient to evidence a sham and that an additional, subjective element was needed. Thus — This expression [‘sham transaction’] comes to us from decisions in the United Kingdom, and it has been generally taken to mean (but not without ambiguity) a transaction conducted with an element of deceit so as to create an illusion calculated to lead the tax collector away from the taxpayer or the true nature of the transaction; or, simple deception whereby the taxpayer creates a facade of reality quite different from the disguised reality.

In the same decision, Wilson J noted that — A transaction may be effectual and not in any sense a sham … but may have no business purpose other than the tax purpose. These dicta put the concept of a sham back on the correct track as importing, not the lack of a genuine business purpose — which is an entirely different notion — but a transaction involving a deliberate and deceitful attempt to disguise the real agreement between the parties. PricewaterhouseCoopers IT Act: s 80A – s 80L

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