Business Tax and Company Law Quarterly

Publisher:
Sabinet African Journals
Publication date:
2021-07-19
ISBN:
2219-1585

Description:

A quarterly journal that provides invaluable, practical and highly accessible opinions on relevant issues pertaining to tax in the business environment and to company law, particularly as it impacts the conduct of business in SA. The journal is edited by three of South Africa’s leading tax and corporate consultants.

Issue Number

Latest documents

  • Navigating the VAT Maze

    This article provides a comprehensive analysis of the evolving legal land-scape governing value-added tax (VAT) input tax deductibility for holding companies in South Africa, as well as for private equity structures. It examines the seminal judgments in Commissioner for the South African Revenue Service (CSARS) v De Beers Consolidated Mines Ltd, the recent landmark case of CSARS v Woolworths Holdings Limited, and the corroborating Tax Court decision in IT 76795. The analysis reveals a fundamental jurisprudential shift away from the restrictive, transaction-focused approach established in De Beers towards the holistic, purpose-driven framework solidified in Woolworths. This evolution presents both significant opportunities and new compliance imperatives for corporate structures, particularly within the private equity (PE) sector.\r\nThe central principle emerging from this body of case law is the critical importance for a holding company to define, structure, and evidence its status as an ‘active investment holding company’. To successfully claim input VAT on acquisition, capital-raising, and other strategic expenses, a holding company must demonstrate that its core enterprise involves the continuous and regular provision of taxable supplies – such as management, financial, or administrative services – to its underlying portfolio companies for a fee. The mere passive holding of shares and receipt of dividends or interest is insufficient to constitute a VAT enterprise for the purposes of deducting input tax on associated costs.\r\nThe core thesis of this article is that the test for deductibility has evolved. The question is no longer whether an expense has a ‘direct and immediate link’ to a specific operational transaction, but rather whether it has a clear ‘functional link’ to the company’s overall, continuous enterprise. The Woolworths judgment has affirmed that costs incurred in furtherance of strategic expansion, such as capital-raising fees, are deductible if they serve to enhance and grow an active investment management enterprise.\r\nFor the PE industry specifically, this represents a pivotal moment. The strategic imperative is clear: PE holding companies must proactively structure their operations to align with the principles of the Woolworths judgment. This involves establishing formal management service agreements, charging market-related fees, and maintaining meticulous records that evidence active strategic involvement in portfolio companies. By doing so, they can create a defensible basis for claiming input VAT on a wide range of transaction costs, thereby mitigating tax leakage and enhancing overall fund returns.

  • Editorial
  • Equity Equivalent Programmes

    The concept of ‘Equity Equivalents’ in the context of BEE ownership rules and regulations is rearing its head once more. Foreign organisations seeking investable presence in South Africa are cautious about giving up true equity. Ownership points play a key role in the ‘BEE score card’ table. The Department of Trade, Industry and Competition has historically accepted an alternative basis to transfer equity to black owned small and medium organisations. The alternative is referred to as an ‘Equity Equivalent’ programme.\r\nThe programme typically envisages a percentage of turnover over a period of time (typically seven to ten years) to be deployed in qualifying beneficiaries or participants in categories of investment such as supplier development, training and research.\r\nThis article considers the tax deductibility of the EE expenditure in terms of section 11(a) of the Income Tax Act (‘the Act’).\r\nIt is submitted that expenditure is ‘actually incurred’ not at the time of signing the framework agreement with the DTIC, but when the contractual obligation to pay beneficiaries arises.\r\nThe ‘in the production of income’ test focuses primarily on the act giving rise to expenditure. In the Warner Lambert case (see below for detail), the court concluded that expenditure incurred in respect of social responsibility obligations meets the ‘in the production of income’ test. It is submitted that BEE related expenditure incurred to retain and grow market share meets this test. So too, it is submitted, does expenditure incurred in respect of the EE programme meet this test. The purpose of concluding this programme is to maximise earnings covering existing and new markets.\r\nThe more sensitive issue in respect of EE related expenditure is the capital versus revenue nature of the expense. Generally, expenditure incurred in performing the income-earning operations of a business is revenue in nature. Expenditure incurred as part of the cost of establishing or enhancing or adding to the income-earning structure is capital in nature. Supplementary tests are the ‘once and for all test’ and the ‘enduring benefit’ test.\r\nWarner Lambert, supra, considered the social responsibility expenditure in the context of capital and revenue. It concluded that the taxpayer’s income-earning structure had been erected long ago. The expenditure it incurred was to protect its earnings. Accordingly, the judgment concluded that the expenditure was revenue in nature. In the case of companies having erected their income-earning structure long ago, the EE related expenditure does not create an additional structure. Ownerships points are but one of the elements of the BEE scorecard. But the key feature of the expenditure is to maintain and improve market share, thereby protecting the entity’s earnings. As a result, it is submitted, such expenditure is not of a capital nature. The same conclusion should prevail, it is submitted, where a foreign organisation establishes presence in South Africa for the first time and seeks to maximise its market share. Using this income-earning structure to seek profitable business and as a result incur EE related expenditure, does not, it is submitted, label such expenditure capital in nature.

  • The Conflict Between Director Reliance in the Companies Act and Director Liability in the JSE Listings Requirements

    In the film The Pursuit of Happyness, the protagonist, Chris Gardner, juggles the challenges of fatherhood on the one hand, with his failing attempts at an entrepreneurial breakthrough on the other. Throughout the film, each keeps getting in the way of the other, almost as if they cannot coexist. A missive on a film about a struggling entrepreneur and father is perhaps not the most conventional way to start an article on delegation and reliance in company law; but the purpose of the anecdote is to emphasise the concept of two attempts at doing the right thing getting in the way of each other – a central theme in this article’s analysis of the Financial Service Tribunal ruling in Munro v Johannesburg Stock Exchange (JSE2/2023) [2024] ZAFST 36. More specifically, this article examines the incongruence between the reliance provisions in section 76(5) of the Companies Act 71 of 2008, and the provisions relating to director liability in the JSE Listings Requirements (‘Listings Requirements’).\r\nIn Munro, the Financial Services Tribunal (‘Tribunal’) had to determine, inter alia, whether a (financial) director was liable to be sanctioned for a contravention of the Listings Requirements, resulting from misstatements in the company’s financial statements, where the director relied on information provided to him by other employees of the company. This article asserts that the provisions of the Companies Act and the Listings Requirements result in parallel and conflicting treatment of reliant director conduct. The article further argues that there are instances where the JSE Listings Requirements may unduly impose liability on directors who have, in line with section 76(5), relied on information provided to them by other employees.

  • Editorial

    Tax continues to fascinate me. All aspects of tax, as will be illustrated in the articles included in this edition of this publication. We are fortunate to have two new first-time contributors that deal with interesting and current issues.

  • VAT Apportionment: BGR 16 and Distributions from Trusts

    A vendor engaged in making both taxable and non-taxable supplies may only claim input tax relief in respect of all the goods and services acquired by the vendor to the extent that such goods or services are utilised by the vendor to make taxable supplies. To the extent that the relevant goods and services are utilised by the vendor for the dual purpose of making taxable and non-taxable supplies, the vendor is required to apportion the input tax in accordance with the apportionment ratio prescribed by SARS. The apportionment ratio is prescribed by SARS in Binding General Ruling 16 (BGR 16).\r\nSimply put, the ratio is the value taxable supplies divided by the value of all other supplies or non-supplies made by the vendor. The denominator specifically includes interest (exempt), dividends (out of scope) and capital gains derived on the supply of capital assets. BGR 16 provides for certain exclusions (capital gains derived on the supply of capital goods) and so-called adjustments in other cases, including in relation to interest and dividends. While capital gains are excluded entirely, interest must be included as follows, interest received/accrued × (prime rate – JIBAR), and dividends on the following basis, namely 3-year moving average of dividends received/accrued × (prime rate – JIBAR).\r\nThe crisp question is: how are distributions derived by a vendor qua beneficiary that comprise interest, dividends and capital gains to be dealt with for the purposes of applying BGR 16?\r\nThe premise of this article is that the conduit principal should be applied where income derived is distributed in the same year in which the income is derived by the trust and the receipts should be dealt with for the purposes of BGR 16 as if derived by the vendor qua beneficiary, that is, the receipts retain their characterisation as interest, dividends and capital gains. This is how such distributions are dealt with from an income tax and capital gains tax perspective.\r\nSARS has seemingly adopted a different view and argue that the conduit principal does not apply to VAT and the distributions should fall to be dealt with for the purpose of BGR 16 on the same basis as profit shares derived by members/partners from joint venture or partnership arrangements. A profit share derived form a joint venture/partnership is required to be accounted for in the denominator of the prescribed apportionment ratio on the following basis: 3-year moving average of a profit share received/accrued during the year × (prime – JIBAR).

  • Rethinking Incentives in Africa Due to Pillar 2

    It is well known that base erosion and profit shifting (BEPS) has adversely affected Africa over the years. If African countries do not participate in Pillar 2 it could again reduce African tax collection. Yet very few African countries have to date implemented or taken some form of measure to implement Pillar 2. This is despite the fact that a significant number of African countries signed either the first or the second joint statement of the OECD/G20 Inclusive Framework on BEPS to implement the two-pillar solution.\r\nPillar 2 aims to ensure that multinational enterprises within scope pay a minimum of 15% corporate tax in each jurisdiction in which it operates. The ground rules for Pillar 2 are set out in the Organisation for Economic Cooperation and Development Global Anti-Base Erosion Model Rules. These rules provide for three types of top-up taxes, being the income inclusion rule, the undertaxed payment rule (also known as the undertaxed profits rules) and the qualified domestic minimum top-up tax rule (also known as a domestic minimum top-up tax).\r\nThe African Tax Administration Forum strongly recommends that African countries immediately enact the qualified domestic minimum top-up tax rule as provided for under Pillar 2, to protect themselves from giving away taxing rights to other jurisdictions applying the top-up tax under Pillar 2 arising from tax incentives. However, not all tax incentives are affected by the GloBE Rules to the same extent. South Africa has various tax incentives and incentive regimes that may lower the effective tax rate to below 15%. This article considers some of these incentives in the context of the GloBE Rules.

  • Going Concern(ed): Potential Challenges in Sale-Of-Business Transactions

    One of the fundamental tenets of any sale-of-business transaction is that the business to be transferred must be a going concern, and be transferred as such. Not only is the concept of a going concern given life in the provisions of a sale-of-business agreement, it is also found in various pieces of legislation that apply to the transfer of a business. Examples include the Value-Added Tax Act 89 of 1991, the Labour Relations Act 66 of 1995 and, to some extent, the Companies Act 71 of 2008. Each of these statutes contains provisions where the status of a business as a going concern is a key consideration. As such, one might expect that the term ‘going concern’ ought to be defined in each of these Acts. That assumption would be incorrect, as none of these statutes provide a direct and objective definition of the term ‘going concern’.\r\nThis article examines the absence of a definition for ‘going concern’ in South African legislation applicable to the transfer of a business, and the risks arising from the lack of legislative clarity. The article considers the relevant provisions of the aforenamed statues. Absent a legislative definition, the article examines the attempts made by the courts to define the term ‘going concern’ in two cases, namely, Kopeledi (Pty) Ltd v Madontsela and Others (2009) 30 ILJ 158 (LC) and NEHAWU v University of Cape Town (2003) 24 ILJ 95 (CC), and the challenges resulting from those definitions.\r\nThirdly, the article also explores the approach taken in the International Accounting Standards (IAS), and discusses the challenges also present therein. The article submits that, despite being an internationally accepted set of standards, IAS is not particularly instructive to the present cause.\r\nThe article then delves into the potential impact of all these lacunae on sale-of-business transactions, and concludes with an attempt at legislative drafting, proffering a proposal for what a definition of ‘going concern’ might look like.

  • Asset-for-share Transactions: THE NUMBER-OF-SHARES CONUNDRUM*

    This article relates to asset-for-share transactions under section 42 of the Income Tax Act and addresses the question as to how many shares must be issued to the transferee company in exchange for the asset or assets transferred, so as to comply with the section.\r\nThe author gives examples to illustrate the operation of section 42 and the problems that can arise in asset-for-share transactions, particularly where assets have different values and more than one share is issued in exchange. It is suggested that if there are insufficient shares available to match the relative value of the assets being exchanged, the solution is to allocate the aggregate base cost of the assets to the shares issued. This solution will not, however work in the case of pre-valuation date assets, for which there are different methods prescribed for determining value. In such a case, the solution suggested is to allocate shares with distinctive certificate numbers to particular pre-valuation date assets based on their relative market value. The author suggests that, alternatively, it may be time for legislative intervention to simplify matters, by the introduction of a rule similar to that in paragraph 76B of the Eighth Schedule to the Act.\r\nThe article suggests that SARS should give comfort to taxpayers by adopting the suggested solution for post-valuation date assets in an Interpretation Note, or perhaps resorting to legislation to resolve the complexity.\r\nFinally, the article also considers the application and effect of the value-for-value rule in section 24BA of the Income Tax Act, which applies to section 42 asset-for-share transactions.

  • The Deferral of Unrealised Foreign Exchange Gains and Losses Rules, and the Applicability to Parties Other Than the Lender or Borrower

    This article considers the tax rules in relation to the deferral of unrealised foreign exchange gains and losses (referred to in tax terms as ‘exchange differences’) in respect of foreign loans between related parties and whether the deferral rules can be extended to include parties to the loan agreement other than the debtor and creditor. The rules applicable to foreign exchange gains and losses are dealt with in section 24I of the Income Tax Act, 1962 (‘the Act’). This provision subjects realised gains or losses to income tax, but defers the tax treatment of exchange differences on certain loans and debts to subsequent years in which the underlying asset is brought into use.\r\nUnrealised foreign exchange gains and losses (referred to as ‘exchange differences’) in respect of foreign currency loans (loans in foreign currency constitute ‘exchange items’) between related parties are deferred until the settlement or realised date of the loan, meaning that these gains and losses are not reflected in taxable income while the loan is not settled.\r\nThe deferral rules applicable to a ‘group of companies’ and ‘connected persons’ are found in section 24I(10A)(a) of the Act. The rules are comprehensive, but the particular issue for consideration in this article is the meaning of the words in the following extract:\r\n\r\n‘… [N]o exchange difference arising during any year of assessment in respect of an exchange item … shall be included in or deducted from the income of a person in terms of this section—\r\n\r\n\r\n(i) if, at the end of that year of assessment—\r\n\r\n\r\n(aa) that person and the other party to the contractual provisions of that exchange item—\r\n\r\n(A) form part of the same group of companies; or\r\n\r\n(B) are connected persons in relation to each other …’ (my emphasis).\r\nThe key question considered in this article is whether a guarantor to a loan agreement or any other party for that matter, being a party to a loan agreement, brings the agreement within the ambit of section 24I(10A)(a)(i)(aa), where such party or parties are either a ‘connected person’ in relation to the borrower or part of the same ‘group of companies. The hypothesis here is that these entities are party to the contractual provisions of the exchange item, namely the loan. The crisp issue is whether ‘the other party’ referred to in section 24I(10A)(a)(i)(aa) is intended to apply narrowly to a typical lender-borrower relationship or whether it should apply broadly to any party to the contractual provisions of an exchange item.\r\nThe article considers principles of statutory interpretation applicable to the definitive article ‘the’ in respect of ‘the other party’. It is submitted that the legislature could have used phrases such as ‘a party’, ‘any party’ or ‘another party’ but instead deliberately chose the phrase ‘the other party’. The article concludes that the provisions must have been intended to apply to an arrangement between the borrower and lender in the context of a loan arrangement and not any other party to the contractual provisions of the loan arrangement.\r\nAccordingly, it is submitted that the deferral of unrealised gains and losses in respect of a foreign loan or debt between parties within a ‘group of companies’, or who are ‘connected persons’, is restricted to the debtor and creditor in relation to the loan agreement and does not extend to other persons (such as a guarantor) that may be party to such an agreement.

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