Firms seeking tax benefits face legal repercussions

THE tax consequences of decisions made in the boardroom have been highlighted in some recent court cases, where judgments were made against parties who had entered into transactions that were motivated by the potential tax benefits it would bring rather than the profits they would generate.

A judgment laid down in the case of ABC vs the South African Revenue Service (SARS) heard in the Western Cape Tax Court last year reiterated the importance of paying attention to the details of a transaction as reflected in the financial statements, including related taxes.

ABC acquired land with a forest on it and carried on forestry activities on the land. It then sold the land together with the forest for a specific amount, of which R144.7m related to the forest. The question before the court was whether the R144.7m should be included in ABC’s gross income.

SARS contended that it should on the basis of the first schedule to the Income Tax Act which states: “Any amount received by or accrued to a farmer in respect of the disposal of any plantation shall, whether such plantation is disposed of separately or with the land on which it is growing, be deemed not to be a receipt or accrual of a capital nature and shall form part of such farmer’s gross income.”

The appellant said it was a passive investor in land and acquired the land together with the forest as an investment. It also argued that the company it sold the land to was then given the right to use the property and the forest; and was therefore carrying on the forestry (farming) operations and was using it without paying, the benefit for ABC being that its asset (forest) was maintained, and thus the profit being capital in nature, was subject to capital gains tax and not company tax.

But SARS said ABC was conducting farming operations and appointed the acquiring company (E) to do so on its behalf based on the following:

• The purchase agreement indicated that ABC acquired a business from D in 2001;

• The sale agreement indicated that ABC sold a business to E in 2003;

• A board resolution indicated that ABC transferred a going concern and income earning activity to E; and

• An invoice, which was explained as a bonus for good stewardship, indicated that ABC paid E a management fee.

The judge referred to a case in the Natal Special Court in 1972, where the following was held: “The court’s function is to determine, on an objective overview of all the relevant facts and circumstances, what the motive, purpose and intention of the taxpayer were. In other words, whatever a taxpayer may tell the court has to be analysed through the prism of the objective facts presented”.

SizweNtsalubaGobodo head of taxation services Zweli Mabhoza says: “The test to be applied when it is necessary to determine whether profit made on the sale of property by a taxpayer represents revenue or a receipt of a capital nature has been formulated in many ways, but so far the general approach to the problem has been maintained.

“The fundamental inquiry is whether, in buying and selling the property and thus earning the profit which is the subject of the inquiry, the taxpayer was engaged in carrying on a trade or business or a profit-making scheme. If that is what he was doing, the profits are income and taxable in his hands.”

Based on the signed documentation, which differed from the evidence of the witnesses, the judge concluded that ABC was in fact carrying on farming operations and the proceeds fell within the ambit of the Income Tax Act.

“This judgment is a useful reminder of the importance of considering the detail of any agreement or other document relating to a transaction from a tax perspective,” Mr Mabhoza says.

“Not even an opinion obtained from a tax adviser would be enough to protect the taxpayer from legal recourse, if the discussions are in the boardroom. A related aspect is to ensure that agreements and related documents reflect any tax advice obtained accurately.

“Not doing so is likely to lead to a tax predicament.”

In December last year another tax case involved a taxpayer’s sponsor who did not provide an invoice for a noncash transaction. Tax authorities argued that the taxpayer was liable for value added tax on the noncash element of the sponsorship received.

Attempts by the taxpayer to argue that it did not receive invoices for sponsorship were in vain.

“The wording in the annual financial statements and lack of invoice by sponsors of another taxpayer resulted in unintended negative tax consequences,” Mr Mabhoza says.

“For this reason, companies in South Africa should consider the need for tax directors on their board to ensure this will not happen.”