Judgment in the case of Mariana Bosch and Ian McClelland v Commissioner for the South African Revenue Service (case no A94/2012) was handed down on 20 November 2012 by a full bench of the Western Cape High Court.
The main judgment was written by Davis J (Baartman J concurring) and a separate judgment was written by Waglay J. The matter was on appeal from the Tax Court.
The appellants were employees of the Foschini group of companies and participants in an employee share incentive scheme run by that group. The appellants were assessed by SARS for income tax in respect of shares received in respect of the scheme.
The type of scheme was what is referred to as a ‘deferred delivery scheme’. In essence, employees were granted options to purchase shares, which they had to exercise within 21 days. Once the option was exercised, delivery and payment in respect of the shares were delayed and would take place in three tranches, each two years apart. Before delivery and payment, the employees could not dispose of or encumber the shares, were not entitled to dividends and could not vote the shares. The risks and benefits did not pass to the employees until delivery and payment.
The scheme was subject to a stop loss provision, which provided that employees could sell their shares back to the employer if the share price fell below the consideration that was payable on delivery. Further, employees were also obliged to sell their shares back to the employer for the same consideration payable on delivery if they terminated their service for any reason other than sequestration, death, superannuation, or ill health.
The effect of the scheme was that the provisions of s8A of the Income Tax Act No 58 of 1962 (Act) were bypassed. Only gains arising within the 21 day option period would be caught by s8A and be taxable as income in the hands of the employees, as opposed to the full gains over the longer periods until delivery and payment.
One of the arguments raised by SARS was that the scheme was a simulated transaction and that there was no real unconditional sale at the time of exercise of the option, but that the parties actually intended that the sale be subject to the suspensive condition that the employees remain employed until the date of delivery and payment. This was evidenced by the fact that an obligation to sell the shares back to the employer arose where an employees employment is terminated. SARS relied on Commissioner for the South African Revenue Service v NWK Ltd 2011 (2) SA 67 (SCA).
The court took the opportunity to analyse the NWK judgment. Davis J states that in the NWK case the court was faced with what was clearly a simulated transaction, illustrated by the facts. The parties had not created genuine rights and obligations but simulated a loan that was for a larger amount than it actually was, only to allow the taxpayer to get a tax benefit. Davis J further makes the following important remark:
“Beyond this finding, there is nothing in the careful judgment of Lewis JA which supports the argument that the reasoning as employed in NWK was intended to alter the settled principles developed over more than a century regarding the determination of a simulated transaction for the purposes of tax.”
Davis J then goes on to say that the NWK judgment needs to be read within the context of previous decisions on simulation such as Commissioner for Customs and Excise v Randles, Brothers and Hudson Ltd 1941 AD 369, Zanberg v van Zyl 1910 AD 302 and Erf 3138 / Ladysmith (Pty) Ltd v CIR 1996 (3) SA 942. This is so to ensure that “the body of precedent is read coherently rather than NWK as being an unexplained rupture from more than a century of jurisprudence.”
Davis J interprets the test in respect of simulation as laid out in NWK as being that the commercial sense of a transaction needs to be examined. Where the form of a transaction attempts to present a commercial rationale, but there is no commercial rationale, and the sole purpose of the transaction is to avoid tax, then the approach taken as in NWK is justified. The court seems to suggest that there must firstly be an agreement that purports to have a commercial rationale and secondly, there must in fact be no commercial rationale, such as the one purported, but some other purpose such as tax avoidance (ie something other than what is purported), before it can be said that there is simulation. The fact that a transaction aims to achieve the avoidance of tax does not as such make it a simulated transaction.
Davis J concludes the analysis of NWK by stating that, since there is no express declaration in the judgment that it departs from previous jurisprudence, it should be interpreted “to fit within a century of established principle, rather than constituting a dramatic rupture.” On the evidence Davis J found that there had been no simulation.
In a separate judgment, Waglay J differed from Davis J in his interpretation of the NWK case. Waglay J states that the NWK judgment does depart, and dramatically so, from the case law on simulated transactions.
Waglay J interprets the NWK as laying down the rule: “any transaction which has at its aim tax avoidance will be regarded as a simulated transaction irrespective of the fact that the transaction is for all purposes a genuine transaction.”
Waglay J, however, is of the view that the NWK judgment does not constitute binding precedent that lower courts have to follow. For a judgment to form a binding precendent it must be “clear and unequivocal, it must be plain, unmistakable and explicit in its rejection of previous judgments which it seeks to reverse.” The rejection of the previous judgments do not have to be express, but it must be clear from the reasoning.
In the judge’s view the NWK judgment does not provide any reasons as to why it departs from previous judgments. He also states that the problem is “compounded by the troubled equivalence in the judgment of the phrases ‘tax avoidance’ and ‘tax evasion’ two very distinct concepts.”
The judge notes that the NWK judgment cannot be authority for setting aside a transaction as simulated if the aim of that transaction is tax evasion because tax evasion is a criminal offence and stands to be set aside automatically by virtue of the fact that it is unlawful.
If the NWK judgment is authority for setting aside a transaction as simulated where the aim of the transaction is tax avoidance, then it goes against established law, which in principle allows transactions that avoid tax.
Waglay J therefore seems to suggests that the uncertainty and confusion in addition to the lack of reasons indicates that the judgment cannot be used as a precedent that is binding on the lower courts.
SARSs argument as to simulation was rejected. For this and other reasons the appeal was upheld.