By Hylton Cameron, Associate Tax Director, Grant Thornton Johannesburg
The Supreme Court of Appeals findings in the matter relating to the tax deductibility of audit fees between CSARS v MTN Holdings (Pty) Ltd (MTN) has highlighted the care companies must take in analysing expenses.
MTN was a holding company and for its 2001 to 2004 years of assessment, it received revenue in form of dividends and interest. Out of its total revenue, in terms of percentages, the dividends accounted for 89%, 94%, 98% and 99%. SARS disallowed the tax deduction of audit fees in terms of the above percentages.
The lower court (South Gauteng High Court), allowed MTN to claim 50% of the audit fees leading SARS to appeal the decision at the Supreme Court.
The Supreme Court stated that the audit fee was part of MTNs general overhead expenses. The Court continued and stated that the lower courts conclusion that the auditing of financial records is clearly a function that is necessarily attached to the production of MTNs income-earning operations, cannot be faulted.
In terms of MTNs defence, part of MTNs argument was that very little work was undertaken in terms of the dividends and much more time was spent on the interest received. Further, the audit is required and that the auditor has to undertake a number of tasks which do not relate to specific income items. MTN contended that if there was to be an apportionment of the audit fees it should be based on the proportion of the time spent on dividends and interest.
The court added the time spent auditing interest and dividends may well have made up a relatively small component of the overall audit time. It further held that the process involved the auditing of MTN as a whole, the major part of which concerned the consolidation of the subsidiaries.
The court then concluded that any apportionment must be heavily weighted in favour of the disallowance of the deduction, given the predominant role played by MTNs equity (which seems to suggest the consolidation part of the audit) and dividend operations as opposed to its far more limited income (interest) earning operations.
The court also stated that analysing each of the years as SARS had done, may be artificial as the court assumed that for the years in question the audit function would have essentially been the same, despite the differences in the proportion of interest revenue for those years. The outcome was the Supreme Court of Appeal allowed MTN to claim 10% of the audit costs.
Where to from here?
Companies that earn non-taxable dividend income and other taxable income should be wary of a challenge from SARS relating to the deduction of its expenses, including as the example suggests audit fees. Companies should therefore be aware of this issue (which is not new) and ascertain if an expense relates to income or exempt income. If the expense relates to both, prior to submitting the tax return, an exercise should be undertaken to analyse what proportion of the expense is tax deductible.