DECEMBER 2008 – ISSUE 112 CONTENTS GENERAL GROSS … · Integritax Issue 112 – December, 2008...

Integritax Issue 112 – December, 2008 ©SAICA, 2008 page 1

DECEMBER 2008 – ISSUE 112

CONTENTS

GENERAL

1681. Recovery of Securities Transfer Tax

1682. Interpretation of tax legislation

GROSS INCOME

1688. Shares issued at a discount

DEDUCTIONS

1683. Intellectual property

FRINGE BENEFITS

1689. Interest rates

PROVISIONAL TAX

1684. Significant changes to second payment

EXCHANGE CONTROL

1690. Loop structures

ASSESSED LOSSES

1685. When can they be carried forward

INTERNATIONAL TAX

1691. Debt push-down and BEE deals

VALUE-ADDED TAX

1686. Long-term projects

1687. Forfeited deposits

SARS NEWS

1692. Interpretation notes, media releases and

other documents

GENERAL

1681. Recovery of Securities Transfer Tax

The Securities Transfer Tax Act, 2007 (“the STT Act”), and the Securities Transfer Tax

Administration Act, 2007 (“the STT Administration Act”) were passed into law on 1 July 2008.

The STT Act provides that securities transfer tax (“STT”) must be levied in respect of the

transfer of every security. The STT Administration Act contains the administration provisions

governing the payment of STT. The STT Act merges the taxes imposed by the Stamp Duties

Act, 1968 (“Stamp Duties Act”) and the Uncertificated Securities Tax Act, 1998 (“UST Act”).

The two taxes were combined in an attempt to simplify the administration of the taxes imposed

on the transfer of all securities and to ensure that the rules governing both listed and unlisted

securities are consistent.

Previously, stamp duty was levied on the transfer or cancellation or redemption of an unlisted

marketable security and uncertificated securities tax was levied in respect of every change in

beneficial ownership of a listed security.


STT is a combination of stamp duty and uncertificated securities tax and is charged at a rate of

0,25% on the taxable amount of the transfer of every security issued by a company or a close

corporation incorporated in SA, or a company incorporated outside SA but listed on an exchange

in SA, subject to certain exemptions.

A de minimis exemption has been introduced into the STT Act by the Revenue Laws

Amendment Bill No. 80 of 2008, to lessen the administrative burden of paying small amounts of

STT. In terms of the exemption, taxpayers will be exempt from paying STT of less than R100 in

respect of the transfer of all securities during a month. This exemption comes into operation on

1 January 2009 and applies in respect of the transfer of a security on or after that date. The

exemption will ease the administrative burden particularly on the acquisition of shelf companies

where the shares in the company are usually acquired for a nominal amount.

The transfer of any qualifying share in a company or a member’s interest in a close corporation

is subject to STT. The word “transfer” is broadly defined and includes the transfer, sale,

assignment or cession or disposal in any other manner of a security. The cancellation or

redemption of a security is also regarded as a transfer unless the company is being liquidated.

However, the issue of a security that does not result in a change in beneficial ownership is not

regarded as a transfer. The STT Act does not define the term “beneficial ownership” in relation

to a security. Through this exclusion it is intended that only a transfer of the economic

ownership of a security is subject to STT. However, if the term “beneficial ownership” is

narrowly interpreted, certain temporary transfer arrangements could be excluded from the tax.

STT is levied on the taxable amount of a security. The taxable amount of a listed security is the

greater of the consideration for the security declared by the transferee or the closing price of that

security. The taxable amount of an unlisted security is the greater of the consideration given for

the acquisition of the security or the market value of the unlisted security. The taxable amount is

specifically defined to prevent the manipulation of the amount of STT payable by ensuring the

amount of tax paid is based on the market value of the security where the consideration paid for

the security is not market-related. In the case of a transfer of a listed security, either the member

or the participant or the person to whom the security is transferred is liable for the tax. The tax

must be paid within a period of 14 days from the transfer. The liability for tax in respect of the

transfer of listed securities lies with the party facilitating the transfer or the recipient of the

security, which is consistent with the previous UST Act.

However, where the listed security is still in certificated form and is held in custody by either a

member or participant, the company issuing the listed security is responsible for the payment of

the STT, unlike previously where the payment of the tax was the responsibility of the recipient of

the listed security.

The liability for STT in respect of the transfer of unlisted securities differs from the previous

Stamp Duties Act. Under the Stamp Duties Act, the recipient of the unlisted security was liable

for the payment of stamp duty; however, under the STT Act the company that issues the unlisted

security is liable for the payment of such tax. It is understood that the reason for this change was

to streamline the collection process of STT in respect of unlisted securities by having a

centralised collection point. However, this collection mechanism places an increased

responsibility on the company issuing the shares when compared with the previous Stamp Duties

Act.


The STT must be paid by the company issuing the unlisted security within two months from the

date of the transfer of such security. It is the responsibility of the recipient of the unlisted

security to inform the company which issued such security of the transfer within 30 days from

the date of transfer. The STT Act provides that the company that issued an unlisted security may

recover the tax paid by it from the recipient of such security. However it does not place any

obligation on the recipient of the unlisted security to reimburse the tax paid by the company.

Accordingly, it may be difficult for the issuer of the unlisted security to recover the STT from the

recipient.

Furthermore, where a listed company holds shares in certificated form, it is responsible for the

payment of STT on the transfer of its shares, but there is no provision in the STT Act which

allows the listed company to recover the tax paid by it from the recipient of the shares, similar to

that provided for in respect of unlisted securities. In this situation, the listed company may not

be able to recover the tax paid.

The STT Administration Act provides that the Commissioner for the South African Revenue

Service may declare the person to whom a security was transferred to be liable for the tax

payable; however, this is at the discretion of the Commissioner and it is unclear if and how the

Commissioner will exercise this discretion.

Therefore, when entering into any agreement in respect of the transfer of any unlisted security or

a listed security in certificated form, it would be prudent to include a clause that will secure the

recovery of the tax from the recipient before the STT is due to be paid by the company. This

would ensure the tax is recovered from the recipient and also alleviate any possible cash flow

constraints for the issuing company that may result from the payment of the tax.

Edward Nathan Sonnenbergs Inc.

Securities Transfer Tax Act No. 25 of 2007

Securities Transfer Tax Administration Act No. 26 of 2007


1682. Interpretation of tax legislation

There has long been a dispute about the correct way to approach the interpretation of tax

legislation. At one extreme is the view that one need look no further than the actual words of the

section under consideration and, in the absence of an absurd result, have no regard for what the

lawmaker might or might not have intended. Perhaps the classic judicial expression of this

approach is the oft quoted statement by Lord Cairns many years ago in Partington v The

Attorney-General (21 L.T. 370):

“If a person sought to be taxed comes within the letter of the law, he must be taxed, however

great the hardship may appear to the judicial mind to be. On the other hand, if the Crown,

seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is

free, however apparently within the law the case might otherwise appear to be. In other words, if

there be an equitable construction, certainly such a construction is not admissible in a taxing

statute, where you can simply adhere to the words of the statute.”

In recent years, in both tax and other litigation, a tendency, some would say a disturbing

tendency, has emerged for the court to enquire as to the perceived intention of the legislature and

to interpret the legislation accordingly. Not that this approach is entirely new; as long ago as

1975 in Glen Anil Development Corporation Ltd v SIR 37 SATC 319, Botha JA had this to say in

finding that the taxpayer had been trafficking in an assessed loss:

“Section 103 of the Act is clearly directed at defeating tax avoidance schemes. It does not

impose a tax, nor does it relate to the tax imposed by the Act or to the liability therefore or to the

incidence thereof, but rather to schemes designed for the avoidance of liability therefor. It

should, in my view, therefore, not be construed as a taxing measure but rather in such a way that

it will advance the remedy provided by the section and suppress the mischief against which the

section is directed… The discretionary powers conferred upon the Secretary should, therefore,

not be restricted unnecessarily by interpretation”.

The purposive approach was adopted by a narrow majority of the Supreme Court of Appeal in

November 2007 in CSARS v Airworld CC & Another 70 SATC 48. Mr. J H Retief was the sole

member of two close corporations (the “CCs”), which conducted successful mail delivery

functions on behalf of the Post Office. He had established a family trust, of which he and his

wife and their children were the discretionary income and capital beneficiaries. In addition,

Retief was a trustee, along with two of his employees and his auditor.

During 1995 and 1996 both CCs enjoyed strong inflows of cash and it was decided that these

funds should be lent to the trust, which would then invest them. The trust invested the proceeds

of the loans in insurance policies, fixed properties and two farms. By the end of the 2000 tax year

the loans in both CCs had reached some R27.5 million, on which no interest was charged, and in

respect of which no terms of repayment had been determined.

The situation was thus that the CCs, of which Retief was the sole member, were making profits

and lending these to the trust, of which their sole member was both a trustee and a discretionary

beneficiary. CSARS applied the provisions of section 64C, which provides that, where a CC

makes loans to a member, or to a relative of a member, or to a trust of which a member is a

beneficiary, the loan will be deemed to be a dividend to the extent that the CC has profits

available for distribution. The implication of this decision by CSARS was that the CCs were

liable for the secondary tax on companies on the deemed dividends. The taxpayers contended

that, as the Act read at the relevant time, “beneficiary” in that context meant vested beneficiary,

not a discretionary beneficiary as Retief was.


The taxpayers argued that, having regard to the definition of “beneficiary” for the purposes of

defining “connected person” in section 1 of the Act, it appeared that the legislator intended to

draw a distinction between a beneficiary with a vested right and one with a discretionary right, in

that the latter was only a potential beneficiary until the trustees exercised their discretion to

confer benefits on him or her.

The Cape tax court had accepted this argument, hence the appeal of CSARS to the SCA, where

the majority recognised that the legislator foresaw that a company or CC might find ways of

transferring its profits to its shareholders, other than by the process of distributing them directly

in the form of dividends and so the “mischief” which the legislator sought to prevent by enacting

section 64C was the avoidance of liability for STC by disguising what was in truth a dividend

distribution as a loan. The crucial question, in the view of the court, was: what did the legislature

intend the word “beneficiary” to mean in section 64C? The first part of the process of

interpretation was to consider the words of the section in order to decide whether their meaning

was clear. In this regard, the word “beneficiary” could have more than one meaning, a situation

that was by no means novel when it came to the interpretation of language. In other words, was

the word “beneficiary” ambiguous in this context? If so, most of the rules of interpretation had

been devised in order to resolve apparent ambiguity and arrive at an interpretation that accorded

as well as possible both with the language that the legislature had used and with the apparent

intention with which the legislature had used it. In effect, the majority adopted a purposive

approach and justified it by stating that in recent years courts had placed emphasis on the

purpose with which the legislature had enacted provisions under consideration. The interpreter

has to endeavour to arrive at an interpretation that gives effect to that purpose and the purpose

(which was usually clear or easily discernible) will be used, in conjunction with the appropriate

meaning of the language of the provision, as a guide in order to ascertain the legislator’s

intention.

In this instance the meaning of the word “beneficiary” had to be considered in its context.

Section 64C and its sister section 64B deal with a type of tax which is of its own kind (sui

generis) in the Act and the “setting and surrounds” of the word were therefore possibly more

restricted than usual. However, where a distribution was made to a person or entity other than the

shareholder, the question arose: Why would the company decide to confer a benefit on that

particular person or entity? It had to be borne in mind that the type of distributions contemplated

in the section were those that offered little or no quid pro quo to the company; moreover,

companies do not operate without motivation or reason and ordinary commercial companies do

not give their assets away capriciously. Applying these considerations, the purpose (and

accordingly the intention) behind section 64C became clearer: if an apparently gratuitous

distribution is made to a relative of a shareholder, the probabilities are overwhelming that the

proceeds of the distribution are intended to reach the shareholder. On this basis it is clear that

when the legislator used the word “beneficiary” in section 64C it did not intend that word to be

given a restricted meaning. Furthermore, to give it its ordinary meaning of “a beneficiary named

as such in the trust deed” satisfactorily achieves the legislator’s object in enacting the deeming

provisions of section 64C.

The majority found that, on the evidence, Retief exercised the effective control over the trust

rather than the trustees. His authority “plainly pervades the trust”. His auditor, the only trustee

who was not an employee of Retief’s, had acknowledged that the founder was a headstrong man

who ignored advice if it did not suit his wishes. The court found that the circumstances were

“strikingly similar” to Badenhorst v Badenhorst 2006(2) SA 255 (SCA), where the appellant’s


trust was found to be his alter ego and accordingly he was the effective owner of the assets of the

trust.

For all practical purposes a payment to the trust was equivalent to a payment to Retief, for he had

the power to direct it. It would have been ludicrous for the CCs, in order to avoid liability for

STC, to be able to rely on the circumstance that the trustees had not yet made a decision to vest

any amount in any of the beneficiaries, and such a result would fly in the face of the legislator’s

clear intention. Accordingly, the appeal was upheld; the payments made by the respondents were

subject to section 64C and the CCs were liable for STC.

The fact that two of the five judges disagreed in applying the purposive interpretation is cold

comfort to tax advisers, who will take a feeling of disquiet from this decision. They can,

however, at least console themselves with the knowledge that they have yet another argument

with which to convince clients who establish trusts of the crucial need to surrender control, both

legal and effective, over the assets of the trusts.

Finally, it should be noted that the definition of “beneficiary” has since been amended to include

those with only discretionary rights.

Deneys Reitz

IT Act: s1 definition of “beneficiary”, s 64B and 64C

Editorial comment: This approach was also followed in the recently reported case of

Metropolitan Life Ltd v SARS [2008]( 70 SATC 162).


DEDUCTIONS

1683. Intellectual property

The recently released Revenue Laws Amendment Bill, which has passed through the

Parliamentary Portfolio Finance Committee, contains a redrafted section 23I that comes into

operation on 1 January 2009. The section will deny a deduction of expenses incurred for the use

of intellectual property (such as licence fees and royalty payments) made by South African

licensees under certain circumstances.

In essence, the legislation aims to deny or reduce a deduction of expenditure incurred for the use

of intellectual property by South African licensees which was previously owned or developed by

a South African taxpayer and where the licensor is not subject to income tax on the receipt of the

royalties or licence fees (or is subject to tax at a reduced rate).

The rationale behind this anti-avoidance legislation is to ensure that the South African taxpayer

benefits from the income produced by intellectual property that was developed in South Africa,

the cost of which was directly or indirectly borne by the South African tax base.

The proposed legislation could have far reaching effects on South African licensees. For

instance, a sale of intellectual property by a South African business to a foreign company falling

outside the South African tax net may result in the deduction of licence fees for the use of the

intellectual property being denied with effect from 1 January 2009, if the intellectual property is

subsequently licensed to a South African user. This situation often occurs in international group

formations and restructures.

Clients currently incurring licence fees or royalties for the use of intellectual property would

need to consider the provisions of the new anti-avoidance legislation as it will also apply to

existing agreements.

Important definitions

The term “intellectual property” is defined widely to include all categories of intellectual

property (whether or not registered).

Tainted intellectual property is a broad definition that essentially is intellectual property that was

previously devised/created or owned by an end user or a connected person in relation to the end

user. In this regard, the connected party definition for companies is much narrower than the

section 1 definition and effectively includes all company shareholdings of at least 20%.

A “taxable person” is any person other than a non resident and a variety of exempt institutions

such as government and local government, quasi government institutions, superannuation funds,

PBO’s and recreational clubs

An “end user” is defined as a taxable person or a person with a permanent establishment within

South Africa that uses intellectual property to derive income, but excluding a person that earns

income from the granting of the use of intellectual property.

Disallowance of deduction

The general rule is that a deduction of royalty/licence payments for the use of tainted intellectual

property will be disallowed in the hands of a South African taxpayer to the extent that the

payments do not constitute income to the recipient.


Limited deduction

If the royalties or licence fees that are paid to a non resident in respect of tainted intellectual

property is subject to South African withholding tax (currently 12% of the gross payments),

without any double tax treaty relief, one third of the expenditure will be allowed as a deduction

in the hands of the South African licensee.

Where double tax treaty relief exists, the one third deduction will still apply provided that the

withholding tax rate is not reduced to less than 10%. Should the double taxation agreement result

in a reduction below the 10% threshold, no deduction will be allowed in the hands of the South

African payee.

Conclusion

Any taxpayer making payments of licence fees or royalties to non-residents and tax exempt

institutions in South Africa must ensure that the underlying intellectual capital did not originate

in South Africa. If it has, careful consideration should be given to the deductibility of such

payments. Taxpayers should perform a proper due diligence before royalty and licence contracts

are entered into and ensure that the necessary tax indemnities are in place.

Grant Thornton

IT Act: s 23I


PROVISIONAL TAX

1684. Significant changes to second payment

The Revenue Laws Amendment Bill No.81 of 2008, which is awaiting the President’s signature,

contains a significant change for provisional taxpayers. The amendment contained in the Bill

removes the safe harbour of using the “basic amount” in avoiding penalties on the underpayment

of the second provisional payment. Provisional taxpayers will now have to ensure that their tax

affairs are sufficiently up to date before the financial year end in order to ensure that the estimate

of taxable income is within 80% of the final actual amount assessed by SARS.

SAICA provided written comments on the draft Revenue Laws Amendment Bills 2008 (13

August 2008), which originally required provisional taxpayers to be within 90% of the final

amount assessed by SARS. SAICA followed this submission up with oral representation made to

the Portfolio Committee on Finance where this specific point was raised separately (20 August

2008). SAICA made further oral representation to National Treasury (27 August 2008). National

Treasury called a meeting at the request of SAICA with all commentators on the Bill to discuss

the written comments verbally to ensure that the comments were understood.

National Treasury / SARS then released their response document (9 September 2008). The

required percentage was reduced from 90% to 80%.

SAICA further engaged both SARS and National Treasury during October and November,

through further written submissions and oral presentations at meetings.

We are pleased to note that although the legislative requirements cannot be altered, SARS is

prepared to assist with a transitional arrangement for second provisional tax payments due on or

before 28 February 2009.

If these provisional tax payments for years ending on or before 28 February 2009 are:

a) based on estimates that are equal to at least 90% of the taxable income for the year, or

b) the basic amount (effectively the taxable income per the last assessment),

SARS will accept that they have been seriously calculated and have not been negligently

understated. The additional tax/penalty that would otherwise been imposed will, therefore, be

waived.

South African Institute Chartered Accountants

IT Act: Fourth Schedule


ASSESSED LOSSES

1685. When can they be carried forward

Carrying forward a company’s tax loss requires a continuity of trading plus the derivation of

some income. The general rule of income tax is that a taxpayer’s taxable income is determined

for each tax year in isolation. In other words, each tax year is a closed compartment, not affected

by tax events that occurred in previous tax years. Thus, the general rule is that, in a given tax

year, a taxpayer can claim a deduction in respect of expenditure only if it was incurred in that tax

year.

An important exception to this rule is that the Income Tax Act (“the Act”) permits taxpayers,

both individuals and companies, to carry forward the balance of an assessed loss incurred in the

previous tax year into the current tax year, to be off-set against the income of the latter year.

In so far as companies are concerned, section 20(1)(a) of the Act allows an assessed loss

incurred by the taxpayer company to be carried forward and set-off against income of a later year

which is derived from carrying on any trade.

By implication, therefore, such a balance of assessed loss cannot be set off against income

derived otherwise than from trade. Moreover, if the company has not traded at any time during

the current year, there can be no set-off of prior years’ losses in computing the taxable income of

the current year. It was held in SA Bazaars (Pty) Ltd v CIR (1952) 18 SATC 240 that section

20(1)(a), properly interpreted, means that where a taxpayer has not traded at any time during the

current tax year, there is nothing against which the assessed loss brought forward from previous

years can be set-off in that year.

In New Urban Properties Ltd v SIR (1966) 27 SATC 175 this logic was taken a step further, and

it was held that in such a situation there is no “balance of assessed loss” that can be carried

forward into the following tax year.

In Robin Consolidated Industries Ltd v CIR (1997) 59 SATC 199 the taxpayer challenged the

interpretation of the Act as laid down in these two decisions, but the Appellate Division held that

they were “clearly right”.

These principles are extremely important in corporate tax planning.

In relation to taxpayers other than companies, section 20(2A) explicitly nullifies the requirement

that a taxpayer can only set-off the balance of an assessed loss against income from “trade”, but

this restriction is operative in relation to companies.

Consequently, if a company fails to trade for an entire tax year, it loses forever the right to carry

forward any balance of assessed loss from a previous year, even if it thereafter resumes trading.

It was held in SA Bazaars (supra) that if a company trades at any time during the year, it escapes

this restriction; it is not necessary that the company should trade continuously throughout the

year.


Unresolved issue

An important issue which has been left open in all these High Court decisions is whether it is

necessary, in order to escape the restriction on striking a balance of an assessed loss in the

current tax year or on carrying-forward that balance into a future year, that the company, in

addition to trading, actually derives income from the trade.

Taxpayers would much prefer that the answer to this question is in the negative, so that a

company which, for whatever reason – and there could be many – does not derive any income

during a given tax year, can nonetheless carry forward the balance of an assessed loss into the

following year.

To the dismay of taxpayers, the tax court decision in ITC 664 (1948) (16 SATC 125) held that it

was indeed necessary for such a company to derive income from the trade.

But taxpayers’ spirits lifted when no subsequent judicial decision affirmed that interpretation,

and spirits soared when, in ITC 777 (1953) 19 SATC 320, SARS did not even try to argue that

the latter was the correct interpretation. This case concerned a company that owned fixed

property which it had unsuccessfully tried to let, and therefore derived no rental income during

the year.

Academic writers and tax practitioners seemed to be generally of the view that it was illogical for

a company to be barred from carrying forward an assessed loss merely because it did not derive

income in the current tax year. After all, they point out, a company is entitled to a deduction for

non-capital business expenditure even where that expenditure produced no income, for example,

an advertising campaign that did not generate any sales, or travelling expenditure incurred in an

unsuccessful attempt to secure a particular contract.

Why then, it was asked, should the derivation of income be a requirement for the carry-forward

of an assessed loss? Of course, the resolution to this issue lies, not in abstract logic or even

commercial pragmatism, but in an interpretation of the words of the Act.

In Interpretation Note 33, SARS gave notice that it took the view that section 20 of the Act

imposed both a trading requirement, and an income requirement.

Practice Notes and Interpretation Notes do not have the force of law; they merely indicate how,

as a matter of practice, SARS interprets provisions of the Act which interpretation is still

uncertain.

Unfortunately for corporate taxpayers, in the recently reported decision of the Gauteng Tax

Court in ITC 1830 (2008) 70 SATC 123 it was held that a company that had incurred a trading

loss in a particular tax year can carry that loss forward to the following tax year only if it derived

income in the current tax year.

Unlike decisions of the High Court, decisions of the tax court are not, strictly speaking,

precedents. That is to say, a decision of the tax court need not be followed by other tax courts.

This decision is therefore not, technically, binding in future decisions of the various tax courts or

the High Court.

In practice, however, this latest decision is likely to be followed in other cases that come before

the tax courts, unless and until this interpretation is overruled by the High Court.


SARS’s approach

The following extract from Interpretation Note No. 33 provides some prospect of sanity, and

demonstrates the approach of SARS to the issue:

“SARS is of the view that section 20 contains a trade requirement and an income from trade

requirement. Both these requirements must be satisfied before an assessed loss may be carried

forward. SARS does, however, accept that this may have some unintended results.

In dealing with the problem, SARS will accept that as long as the company has proved that a

trade has been carried on during the current year of assessment, the company will be entitled to

set off its balance of assessed loss from the preceding year, notwithstanding the fact that income

may not have accrued from the carrying on of that trade. This concession is limited to cases

where it is clear that trade has been carried on. SARS will apply an objective test in order to

determine that a trade has in fact been carried on. It will not be sufficient that there was a mere

intention to trade or some preparatory activities. The fact that no income was earned during the

year of assessment must be incidental or result from the nature of the trade carried on by the

company.”

It seems clear that, notwithstanding the decisions in the courts, SARS will not universally adopt

an “all or nothing” approach on the income requirement, but will be prepared to allow an

assessed loss where it may be clearly demonstrated that the lack of income was reasonable in the

circumstances, provided that a trade is being carried on.

PricewaterhouseCoopers

IT Act: s 20(1)(a) and 20(2A)

Editorial comment: The Tax Court did look at SARS’ Interpretation Note 33 of 4 July 2005 in

which it gave a concession that in certain instances an assessed loss may be carried forward,

despite the fact that in the subsequent year no income was received from the trade conducted,

but held that SARS does not have the authority to change the law by making concessions which

are clearly contrary to the plain wording used by the legislature.


VALUE-ADDED TAX

1686. Long-terms projects

Where vendors engage in long-term projects that will only yield revenue after a period in time,

for example, mining exploration activities or forest plantation, they often face challenges from

the South African Revenue Service ("SARS") from a Value Added Tax ("VAT") perspective in

regard to registering and recovering input tax incurred prior to generating vatable income.

The first challenge is to register for VAT. The vendor is required in terms of the VAT

registration application form (VAT 101) to furnish the actual or expected total value of taxable

supplies for a period of 12 months as well as the source of the financial information used to

determine the value of such taxable supplies. However, it may not be possible for the vendor to

provide this information because the vendor generally does not expect to make any taxable

supplies within the next 12 month period.

Section 23 of the VAT Act provides that if a taxpayer conducts an "enterprise" as defined, it is

obliged to register for VAT purposes where its taxable supplies exceed or are expected to exceed

R300 000 (R1 million from 1 March 2009). Alternatively, it may voluntarily register if the

annual taxable supplies exceed R20 000.

Section 23(3)(d) of the VAT Act provides that a vendor that conducts an enterprise may register

for VAT where the vendor continuously or regularly carries on an activity, and in consequence

of the nature of that activity, it can reasonably be expected to result in taxable supplies being

made for a consideration exceeding R20 000 only after a period of time.

A vendor engaged in long-term projects from which revenue will only be derived after some

time is therefore entitled to register for VAT if there are reasonable grounds to expect that

taxable supplies in excess of R20 000 per annum will be derived from the activities in the future.

However, the VAT registration form does not cater for this scenario.

The reality is that on registering a vendor for VAT, SARS ticks the boxes on the application

form and if any box is not ticked, the VAT registration is not processed. Although the VAT

registration process has been simplified, no provision was made for taxpayers involved in long-

term projects. The fact remains that in terms of the VAT Act, these vendors are entitled to

register for VAT.

A question that remains is whether an entity can register if there is uncertainty as to whether or

not taxable supplies will be made, for example in the case of mining exploration activities where

taxable supplies will depend on the exploration results, which cannot be predicted beforehand.

Once registered for VAT purposes, the second challenge is to substantiate the vendor’s

entitlement to claim input tax deductions. SARS may, after a few VAT periods of claiming only

input tax, argue that no taxable supplies have been made and thus seek to deny the input tax

previously claimed and deregister the taxpayer for VAT purposes.

The fact is that once the vendor is registered for VAT it is entitled to claim input tax in respect of

goods and services acquired for the purpose of consumption, use or supply in the course of

making taxable supplies (section 16(3) and the definition of "input tax" in section 1 of the VAT

Act refer). The claiming of input tax is not subject to the taxpayer only making actual taxable

supplies of the goods or services acquired. The VAT Act provides that for input tax to be


claimed, the expenses must be incurred for the purpose of use, consumption or supply in the

course of making taxable supplies.

The word "purpose" is not defined in the VAT Act. In the New Zealand High Court case CIR v

National Distributors Ltd (1989) 3 NZLR 661 the Court stated that the test of purpose is

subjective and requires consideration of the state of mind of the purchaser at the time of

acquisition of goods or services. The purpose for which the expenses are incurred must therefore

be determined on a case by case basis.

The phrase "in the course of" is also not defined in the VAT Act. There are a number of South

African income tax judgments dealing with the phrase "in the course of" (see, for example,

Standard General Insurance Co v Hennop 1954 (4) SA 560 (A)). From these judgments it can be

concluded that the phrase means, in the context of the claiming of input tax, that there must be

some relationship between the goods or services acquired and the making of taxable supplies.

Therefore, if there is any nexus between the expense incurred and the making of taxable

supplies, then the VAT on the expense falls within the ambit of "input tax" as defined. It is

further irrelevant for VAT purposes whether or not the expense is of a capital or revenue nature,

as the VAT on both qualify for input tax.

Therefore, for input tax to be claimed on the acquisition of goods and services, the expenses

incurred must be linked to the making of taxable supplies even if such supplies will be made in

the future, and they must be acquired for the purpose of use, consumption or supply for making

such taxable supplies.

SARS is entitled in terms of section 24(5) of the VAT Act to cancel a vendor’s registration if the

Commissioner is of the view that the vendor does not comply with the registration requirements

of the VAT Act. SARS may therefore attempt to cancel the VAT registration retrospectively, and

reverse all input tax previously claimed by the vendor. However, the cancellation of a VAT

registration is subject to objection, and the cancellation of the VAT registration cannot take

effect until the objection has been dealt with.

Vendors that are involved in long-term projects that will only yield revenue after a number of

years are entitled to register for VAT if there is a reasonable expectation that taxable supplies

will be made in future. The registration should be fully motivated in this regard at the time

application for registration is made.

Once registered for VAT, these vendors are entitled to claim input tax in respect of VAT paid on

the acquisition of goods or services for the purpose of enabling the vendor to make taxable

supplies at some time in the future.

Edward Nathan Sonnnenbergs

VAT Act: s 1 definition of “input tax”, s 16(3), 23 and 24(5)


1687. Forfeited deposits

Section 7(1)(a) of the VAT Act requires that for VAT to become payable there must be a supply

of goods or services by a vendor in the course or furtherance of an enterprise carried on by the

vendor. If there is such a supply, then the VAT is payable on the consideration received for the

supply.

The definition of "consideration" in section 1 of the VAT Act specifically excludes a deposit

(whether refundable or not), unless the supplier applies the deposit as consideration for the

supply, or if the deposit is forfeited. Accordingly, VAT only becomes payable on a deposit when

the deposit is applied against the purchase consideration for a supply of goods or services, or

when the deposit is forfeited.

One can understand that VAT becomes payable when the deposit is applied against the purchase

consideration, because there is an underlying supply. However, in view of the requirement of

section 7(1)(a) that there must by a supply of goods or services before VAT is payable, one can

argue that in the case of a deposit that is forfeited, no supply has taken place. Although a

forfeited deposit falls within the definition of consideration, such consideration is not in respect

of, in response to or for the inducement of the supply of any goods or services, because no such

supply took place in the first instance, hence the deposit being forfeited.

In the first Australian VAT case that was recently heard by the Australian High Court,

Commissioner of Taxation v Reliance Carpet Co Pty Ltd, this was exactly what the vendor

argued. The taxpayer, Reliance Carpet, entered into a contract for the sale of a commercial

property. In terms of the contract, a deposit of 10% was payable. The contract of sale was

entered into consequent on the exercise of an option to purchase by the purchaser. The purchaser

paid the deposit but failed to pay the balance of the purchase price by the settlement date.

Reliance Carpet then issued a notice to the purchaser to remedy its default within 14 days. The

purchaser failed to remedy its default and the deposit was forfeited as a result. Reliance Carpet

was assessed for VAT on the forfeited deposit. Reliance Carpet objected to the assessment on the

basis that it did not make any supply of the property for which the deposit was paid, and

therefore no VAT was payable.

The High Court examined all the events that actually occurred and found that there was indeed a

supply, and provided two reasons for reaching such conclusion. Firstly it found that there was a

supply because the vendor entered into various obligations when the contract was concluded.

There was the primary obligation to transfer title to the purchaser upon payment of the balance of

the purchase price, but there were other obligations as well, such as maintaining the property in

its present condition, to pay all rates, taxes, assessments, fire insurance premiums and other

outgoings in respect of the land and to hold the existing policy of fire insurance for itself and in

trust for the purchaser to the extent of their respective interests. The carrying out of such

obligations comprised a supply.

Secondly, the vendor granted rights to the purchaser in relation to the land, and the granting of

such rights also comprised a supply. The Court then considered whether the deposit comprised

"consideration" as defined, which includes, amongst others, any payment "in connection with" a

supply. The Court found that such a connection was apparent in this case, and noted that there

was an obvious connection between the payment of the deposit and the contract entered into

between the parties. The forfeited deposit was thus held to be subject to VAT.

The question is whether the Australian High Court judgment will also find application in the

South African context. The definition of "supply" in the South African VAT Act seems to be


even wider than that of the Australian Act, and includes "all forms of supply". The definition of

"services" is equally wide and includes "anything done or to be done, including the granting,

assignment, cession or surrender of any right, or the making available of any facility or

advantage".

It therefore seems that one cannot simply argue that there was no supply if a deposit is forfeited

even though it may seem so on the face of it. Each element of the contract needs to be carefully

considered to determine whether there is not another type of supply which may trigger a VAT

liability when the deposit is forfeited.

Edward Nathan Sonnenbergs

VAT Act: s 1 definition of “consideration”, s 7(1)(a)

Editorial Comment: SARS has not issued any rulings or decisions regarding the matter. It

seems that SARS is simply applying VAT whenever a deposit is forfeited by relying on the proviso

to the section 1, definition of "consideration", which provides that a deposit becomes

"consideration" when it is forfeited.


GROSS INCOME

1688. Shares issued at a discount

It is not unusual to find companies issuing shares to an existing shareholder, or even a new

shareholder, at a discount to the current market value of the company’s shares. In fact a number

of black economic empowerment deals have been structured on this basis. The parties rarely

consider the income tax implications of such an issue of shares as they assume that the

acquisition of the shares should be tax neutral in the recipient’s hands. However, closer scrutiny

of the gross income definition and relevant case law suggests otherwise.

The “gross income” definition contained in section 1 of the Income Tax Act, No. 58 of 1962

("the Act") defines the gross income of a resident as the total amount, in cash or otherwise,

received by or accrued to a resident, which is not of a capital nature.

If one therefore has regard to the situation where a person obtains the right to subscribe for

shares in an entity for consideration which is less than the market value of those shares, the

question is whether it could be said that an amount has been received by or accrued to that

taxpayer? Clearly the acquisition of a right to subscribe for shares at a discount to the market

value of those shares results in an accrual of a benefit in the taxpayer’s hands.

The benefit, i.e. the discount at which the shares are subscribed for, has a monetary value which

can easily be determined and should therefore, based on case law, be regarded as an amount that

accrued to the taxpayer. This principle has been confirmed in the recent case of Commissioner:

SARS v Brummeria Renaissance (Pty) Ltd [2007] (69 SATC 205) where the court held that the

benefit of an interest-free loan resulted in an accrual to the borrower equal to the value of that

benefit. It follows that a taxpayer who becomes entitled to the right to receive shares (whether by

transfer from a third party or by the issue and allotment by the company itself), for less than the

market value of the shares, acquires a right which is capable of being valued in money and,

therefore, an amount equal to the value of that right accrues to the taxpayer for the purposes of

the definition of "gross income".

In the Ochberg v CIR (1931) 5 SATC 93 the majority of the judges held that the issue to the

taxpayer of shares in consideration for the cession of a lease and the granting of certain financial

assistance and suretyships resulted in an amount falling within the gross income of the taxpayer.

In his judgment De Villiers CJ stated that the shares were received by appellant and were issued

to him for services rendered and as remuneration for use or occupation of premises during that

year and that the shares would fall under income unless for some valid reason they can be said to

be receipts or accruals of a capital nature.

It is thus apparent that there is sufficient case law to support the contention that the acquisition of

shares, at a discount, would result in an accrual in the acquirer’s hands.

However, the real issue to consider is whether or not the accrual of the amount will be of a

capital or a revenue nature. As mentioned earlier, an amount would not form part of a taxpayer’s

gross income if that amount is of a capital nature.

The determination of whether or not the amount is of a capital nature will usually depend upon

the consideration or cause for the issue of the shares at a discount. In the event that the issue of

the shares at a discount represents the quid pro quo for some service rendered or to be rendered

by the acquirer, it could be argued that the difference between the market value of the shares and

their subscription price should be included in the acquirer’s gross income. Based on case law it is


trite that consideration received for services rendered or the advance of loan capital would be

regarded as a receipt of a revenue nature.

It is interesting to note that if the accrual is of a capital nature the accrual will not be subject to

capital gains tax on the basis that there was no disposal of an asset by the taxpayer where that

taxpayer subscribed for or acquired shares in a company at a discount.

Careful consideration should thus be given as to what the true reason will be for a taxpayer

becoming entitled to subscribe for shares at a discount to ensure that the resultant benefit is not

treated or seen as consideration for services rendered but rather regarded as a receipt of a capital

nature.


IT Act: s 1 definition of “gross income”


FRINGE BENEFITS

1689. Interest rates

If inadequate interest is charged to an employee (including working directors) on loans (other

than for the purpose of furthering his own studies) in excess of R3 000 from his employer (or

associated institution), tax on the fringe benefit may be payable.

Unless interest is charged at the “official” rate or greater, the employee is deemed to have

received a taxable fringe benefit calculated as being the difference between the interest actually

charged and interest calculated at the “official” rate.

For employees’ tax purposes, the tax deduction must be made whenever interest is payable. If

not regularly, then on a monthly basis for monthly paid employees, weekly for weekly paid

employees, etc.

In general, only distributions of income from a company / close corporation are subject to STC.

To the extent that there are profits / reserves available for distribution, loans or advances to or for

the benefit of a shareholder / member will be deemed to be dividends subject to STC unless

interest at the “official” rate (or market related rate in the case of foreign currency loans) is

payable on the loan or fringe benefits tax is payable on an interest free (or subsidised interest)

loan to an employee.

The “official” rate of interest was increased for both the above purposes from 12% per annum to

13% per annum with effect from 1 September 2008.

The “official” rate of interest over the past 6 years is as follows:

With effect from 1 September 2002 - 13,5% p.a.

With effect from 1 March 2003 - 14,5% p.a.

With effect from 1 July 2003 - 13,0% p.a.


With effect from 1 December 2003 - 9,5% p.a.









Horwath Zeller Karro

IT Act: Seventh Schedule, par 1 definition “official rate of interest”, par 11


EXCHANGE CONTROL

1690. Loop structures

Inward listings have become a common feature of recent international transactions involving

South Africa.

The recent primary listing of Pallinghurst Resources Guernsey Ltd is a good example, and the

announcement that British American Tobacco will obtain an inward secondary listing on the

JSE. However, loop structures remain the biggest exchange control stumbling block for South

African resident investors and has probably scuppered more cross-border transactions

contemplated by South African residents than any other exchange control or tax policy.

A loop structure means that South African residents are prohibited from holding any South

African asset indirectly through a non-resident entity. An example would be where South

African residents hold all the shares in a company in Mauritius, which owns or acquires South

African assets or shares in a South African company. The South African resident shareholders

need specific approval to continue to hold their shares in the Mauritian company, despite the

loop. Approval for a loop structure cannot be approved by the South African Reserve Bank’s

Exchange Control Division and must be referred to the finance minister.

Approval is only granted in exceptional circumstances, for example to facilitate substantial black

economic empowerment (BEE) transactions or where it is regarded in the national interest.

However, an exception to this rule is that the South African resident shareholders will be allowed

to continue to hold their shares in the Mauritian company if that entity applies for a listing

(primary or secondary) on the JSE and the South African resident shareholders continue to hold

their shares on the South African share register. For this reason, an inward listing of a non-

resident company is often the only way to obtain the required exchange control approval for a

transaction where South African resident shareholders continue to hold their shares in the non-

resident company.

From a Reserve Bank policy perspective, inward listings are encouraged as they enhance the

retention of South African investor capital, while at the same time encouraging foreign

investment and capital inflows into the country. Recent amendments to both exchange control

policy and income tax provisions indicate that South Africa actively seeks to promote inward

listings by making it more accessible and attractive to South African shareholders. There are

additional incentives where the inward listed entity is an African entity.

Transactions where inward listings are required manifest in a number of ways. Most of these

entail the disposal by South African resident shareholders, in exchange for receiving shares in a

foreign company as consideration. One example is where a foreign acquirer (Bidco) seeks to

make an offer for shares in a South African entity, in exchange for shares. Another example is

where a South African-controlled foreign company acquires a group of companies, which

includes South African companies.

In both of these examples the foreign entity through which the South African assets are indirectly

held must apply for approval to inwardly list, and to offer their shares as consideration for

acquiring shares of the South African residents. The Reserve Bank also requires a maximum of

10% South African resident shareholders at the time of inward listing. This is normally not

problematic where the foreign company is a large foreign listed entity with widely held shares,

but is problematic where the foreign entity is an unlisted entity, controlled by South African

resident shareholders. Based on recent experience, however, the Reserve Bank appears to be


amenable to allowing some flexibility in structuring transactions where direct investment into

South Africa will be stimulated. Practically a South African share register will be opened and all

South African shareholders of the foreign entity will be required to hold, or reacquire, their

shares in the foreign entity on the South African share register.

Normally this will result in a capital inflow into South Africa as South African shareholders will

now hold their shares in the country, while they retain the economic hedging benefits of being

invested in a non-resident entity. This effectively, from an economic perspective, eliminates the

dreaded and restrictive loop structure.

From a tax perspective there are a number of important aspects to bear in mind when planning a

transaction involving an inward listing. Most importantly, the South African resident

shareholders will either have an outright disposal of their shares (especially where an offer is

made for shares) in exchange for shares in the foreign Bidco, or will continue to hold shares in

the same company (the second example above) but reacquire shares on the South African share

register. Whether an exchange of shares is done as a direct disposal or effected, for example,

through the use of derivative instruments, the South African resident shareholders must be

mindful that they could dispose of their shares for purposes of capital gains tax (CGT) and

potentially attract a CGT liability. It is extremely important to determine the disposal and listing

prices in a manner that will ensure maximum tax neutrality.

Any shares traded on the JSE will attract securities transfer tax at 0,25% of their market value,

regardless of whether these are shares in a foreign company. As regards dividends received,

these will be exempt from tax in the hands of the South African shareholder if resident

shareholders collectively hold more than 10% of the shares in a dual listed company. From

January 1 2009 this 10% requirement falls away and all dividends received will be exempt from

tax in SA provided the company distributing the dividends is dually listed.

Where the foreign entity is not listed in another country the dividend will only be tax exempt if

the South African resident shareholders hold more than 20% of the equity shares and voting

rights of the foreign entity.

Tax and exchange control structuring of inward listing needs to address complicated challenges

but this will most likely become an important element of many cross border acquisition

transactions.



INTERNATIONAL TAX

1691. Debt push-down and BEE deals

Preference share funding and notional facilitation structures are important in implementing black

empowerment transactions. The success of these alternatives is based on both subject to the fact

that the price of the shares acquired by the empowerment entity exceeds the cost of the

preference share funding or the notional escalation factor in the context of facilitation structures.

To the extent that the share price does not out-perform the funding rate or the factor used to

determine the number of shares that are repurchased, the empowerment party may have to return

a number of shares in the target company on the maturity date of the transaction. As an

alternative to these transactions, companies also sometimes make use of the so-called debt push-

down structures. In a typical example, a company would transfer a division or a business to a

new company by making use of the intra-group provisions contained in the Income Tax Act No

58 of 1962.

In other words, the transfer of the division or business would not have any negative tax

consequences for the transferor in circumstances where the transferee will acquire the assets at

their base cost or written down tax value, as the case may be. Rollover relief is thus provided in

these circumstances. However, the purchaser would fund the acquisition of the division or

business through means of debt. The debt is generally interest bearing resulting in the purchaser

being able to claim a deduction of the interest expense.

The debt can be provided in one of two ways:

• First, the seller can leave the purchase price outstanding on loan account on the basis that the

loan is repaid as and when the purchaser is able to do so; or

• Secondly, the purchaser can obtain third party funding from a financial institution. In

circumstances where a financial institution provides such funding, it would generally not

only insist upon some form of security with reference to the assets acquired by the purchaser,

but also some form of security made available by the seller.

Alternatively, and depending on the extent of share capital injected into the purchaser, the

financial institution can look only at the assets of the purchaser for satisfaction and servicing of

the loan made by the financial institution to the purchaser. After the implementation of phase one

(the sale of the division or the business), an empowerment party thereafter subscribes for up to

30% of the shareholding in the purchaser.

Such subscription price is generally nominal given the fact that the net asset value of the

purchaser would be very small. The reason for the net asset value being small, is that the assets

of the purchaser would be equal to its liabilities (being the shareholders loan or the loan made

available by the financial institution, as the case may be). No substantial additional funding is

required by the empowerment party in acquiring shares in the purchaser.

The benefit of this type of structure is that the empowerment party does not run the risk of the

30% shareholding in the purchaser being diluted upon termination of a transaction given the fact

that the debt is owed by the purchaser itself and not by the empowerment party. In other words,

the debt in these circumstances is serviced from the cash-flows of the purchaser and not from any

dividends that may be declared by the purchaser to its shareholders. As a result of this structure,

dividends would generally not be paid by the purchaser to its shareholders during the initial term

and until such time as the debt has reduced to satisfactory levels. In these circumstances the


ability to service the debt is therefore not dependent on a share price performance, but the ability

of the purchaser to generate profits from the business that it has acquired.

One of the key issues related to this type of funding is the ability of the purchaser to deduct the

interest associated with the funding obtained in order to acquire the business. In March 2008 the

National Treasury issued a statement dealing with so-called funnel financing masquerades. This

seems to particularly apply in circumstances where funds flow in a circular fashion from the

seller of the business back to the borrower through an intermediary. This applies in those

circumstances where use is made of preference shares which result in the seller potentially

receiving exempt dividends. The benefit associated with the so called debt push-down structures

cannot be denied, especially with reference to the situation where the empowerment party does

not bear the risk of his 30% shareholding in the purchaser ever being reduced. However, it does

seem as if there is concern with reference to some transactions that have been associated with

this type of structure and one will have to see how the legislature is to deal with the concerns

expressed by the treasury.

Edward Nathan Sonnenbergs.

IT Act: s 11(a) and 24J

Editorial comment: SAICA is considering making a submission to Treasury on debt push-down

structures.


SARS NEWS

1692. Interpretation notes, media releases and other documents

09 January 2009 Legal & Policy: Revenue Laws Amendment Act, 60 of 2008 (GG 31781 - 8

January 2009)

09 January 2009 Legal & Policy: Revenue Laws Second Amendment Act, 61 of 2008(GG

31782 - 8 January 2009)

09 January 2009 Legal & Policy: Briefing Note:Release of Draft Tax Guide for Micro

Businesses for public comment by 19 January 2009

09 January 2009 Legal & Policy: Draft Tax Guide for Micro Businesses 2009/10

06 January 2009 Legal & Policy: Draft Excise Rules Send your comments to

[email protected] before or on 23 January 2009

30 December 2008 Media Release: South African Trade Statistics for November 2008

15 December 2008 Legal & Policy: Discussion Paper - International Subsistence

10 December 2008 Media Release:: Changes To Provisional Tax Payments

09 December 2008 Legal & Policy: VAT 409 - Guide for Fixed Property and Construction

04 December 2008 Media Release: 2008 Tax Statistics

28 November 2008 Media Release: South African Trade Statistics for October 2008

Readers are reminded that the latest developments at SARS can be accessed on their website

http://www.sars.gov.za

Editor: Mr M E Hassan

Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof KI

Mitchell, Prof L Olivier, Prof JJ Roeleveld, Prof PG Surtees.

The Integritax Newsletter is published as a service to members and associates of the South

African Institute of Chartered Accountants (SAICA) and includes items selected from the

newsletters of firms in public practice and commerce and industry, as well as other contributors.

The information contained herein is for general guidance only and should not be used as a basis

for action without further research or specialist advice. The views of the authors are not

necessarily the views of SAICA.

All rights reserved. No part of this Newsletter covered by copyright may be reproduced or copied

in any form or by any means (including graphic, electronic or mechanical, photocopying,

recording, recorded, taping or retrieval information systems) without written permission of the

copyright holders.

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