Commissioner of Taxes v "A" Company

• Jurisdiction: South Africa
• Judge: MacDonald CJ, Lewis JP and Davies JA
• Judgment Date: 04 January 1979
• Hearing Date: 21 November 1978
• Court: Appellate Division

Lewis JP:

This is an appeal from a decision of the Income Tax Appeals Special Court, leave having been granted by the President of the Court to appeal on grounds of fact and of mixed law and fact, in terms of s 55 of the Income Tax Act Chap 181, as amended. Publication of this judgment is B authorised in terms of the amended s 55 (2); however, in order to protect the anonymity of those involved, I have avoided the use of the names of those persons and companies concerned in this case throughout the judgment, and to this effect I have also made suitable alterations to any passages quoted from the judgment delivered in the Court a quo, or from other parts of the record.

C In its return for the income tax year ended 31 March 1976 the respondent company claimed to deduct, in terms of s 15 (2) (a) of the Act, the sum of $72 000 from its income as a loss of floating capital alleged to have been incurred in respect of a loan of $250 000 to a company, which I shall call "B" Co Ltd, in November 1973, in the course of the respondent's D business as a merchant banker. The claim was rejected, and the Commissioner disallowed the respondent's objection to that decision. Respondent then appealed successfully to the Special Court, and the learned President of that Court directed that the assessment in question be amended by allowing the sum of $72 000 as a deduction. Against his decision, the Commissioner now appeals to this Court.

E It is common cause that "B" company was placed in liquidation on 11 December 1975 at a time when it still owed the respondent the sum of $180 000 in terms of its contract of loan. The loan was secured by a pledge of 550 000 shares in another company which I shall call "C" company. In or about December 1975 the respondent received payment of $100 000 in respect F of 500 000 of these shares and later on another $8 000 from the balance of 50 000 shares, thus reducing the amount owing to it on the loan to the figure of $72 000 claimed. For this balance of $72 000, the respondent ranks only as a concurrent creditor in the liquidation of B company. The estate of one X, a director of B company, who was a surety and G co-principal debtor in respect of B company's loan, has been declared insolvent, and the chances of recovering anything from his estate are negligible.

It is common cause that in the respondent's annual accounts for the year ended 31 March 1976, upon which its income tax return was based, the sum of $72 000 is shown as "bad debt written off", but the learned President H found that no entries to this effect had been made in the respondent's books of account before the end of that tax year and no final decision to write off had been made during that year. He went on to state in his judgment:

"However, I am satisfied that at least a provisional decision that a loss had been sustained which would be reflected in the appellant's accounts had been made by the appellant's managing director and manifested in discussions with one or more other officials of the appellant. The matter was important, the turning of the balance of its security to account was being pursued and it is highly likely that the approximate amount of the loss would have been discussed."

Lewis JP

The learned President came to the conclusion that a formal writing off of the debt during the tax year was not an essential prerequisite to claiming a deduction for that year. Furthermore, after considering a number of authorities cited to him, he also came to the conclusion that the fact A that the exact amount of the loss was not known with certainty during the tax year in question, and would not be known until the precise dividend payable to the respondent in the liquidation was ascertained, did not in law preclude the respondent from being allowed to deduct such amount as it could show, on a balance of probabilities, had been incurred as a loss by B reason of the liquidation.

On the evidence before him, he found that on a balance of probabilities during the year ended 31 March 1976 the amount of the dividend which could be expected by the respondent was 5c in the $1. The following paragraph of the respondent's case in the Court below (then entitled "Appellant's case") was admitted in the Commissioner's case:

"7.

C It is probable (as became apparent during the said year of assessment) that there will be additional costs increasing the amount of the loss incurred by the appellant as the result of the default by B Company on the said contract of loan, being costs incurred in taking over the C shares as aforesaid (estimated at $3 890) and legal and other costs."

These additional costs amounting to $3 890 were taken into account by the D learned President in coming to the conclusion that the respondent was entitled to the deduction of $72 000 as claimed.

The grounds of appeal are as follows:

"1.

That the respondent was not entitled to deduct the sum of $72 000 from its income as a loss incurred by it during the year of E assessment ended 31 March 1976, as the precise amount of such loss had not been quantified by 31 March 1976. Alternatively, the respondent was not entitled to deduct more than $64 800 of the said amount from its income as a loss, in view of the dividend it might receive.

2.

That the respondent failed to establish that, during the year of F assessment ended 31 March 1976, it had decided provisionally or otherwise to write-off the sum of $72 000 as irrecoverable and was accordingly not entitled to deduct the said amount from its income as a loss during that year.

3.

That the learned President erred in taking into account potential expenditure as described in para 7 of the appellant's case as a G factor in assessing the amount of any loss incurred during the said year."

The alternative to ground 1 quoted above involves an issue of fact. It involves the contention that the amount of the dividend to be deducted from the alleged loss of $72 000 should have been 10 per cent, ie $7 200, H and not five per cent. The remaining grounds substantially involve issues of law. Before dealing with the issues of law involved, it would be convenient to resolve the sole issue of fact in this case.

[The learned Judge analysed the evidence on this issue and continued.]

In my opinion, therefore, on the factual issue in this appeal, the learned President must have accepted the figure of five per cent and not 10 per cent as the amount of the dividend, and he was correct in so doing on the evidence before him.

Lewis JP

I turn then to the legal issues involved, which are three-fold.

(1)

Whether it was a necessary prerequisite to a claim for a deduction in the tax year in question that the loss should have been written off in the tax year;

(2)

A whether the fact that the precise amount of such loss had not been quantified in the year of assessment ended 31 March 1976 disentitled the respondent to any deduction at all in that tax year; and

(3)

whether the anticipated expenditure of $3 890 in respect of the B taking over of the C company's shares was properly taken into account in assessing the loss.

As far as the first issue is concerned, there is nothing in the Income Tax Act which makes it necessary for a debt to be formally written off in the tax year before it can be claimed as a deductible loss in that year, and C in this respect our Act differs from the Australian Income Tax Assessment Act 27 of 1976 as amended, s 63 (1) of which specifically restricts allowable deductions of bad debts to those "written off during the year of income".

Counsel were not able to refer us to any decision, either in our Courts or the Courts in South Africa, which lays down such a requirement. The judgment of CURLEWIS JA in the case of Commissioner for Inland Revenue v D Delfos 1933 AD 242 supports the view that there is no such requirement and that the appropriate time for writing off a debt is when the balance sheet and profit and loss account for the tax year in question are drawn up, as was apparently done in the instant case. At 257 of the report, the learned Judge said:

E "The object of making provision for a bad debt is to enable a 'trader' (as defined) to arrive at a statement of his profit and loss for the income tax year. And if in drawing up his balance sheet and profit and loss account for the income tax year a businessman has found it necessary to write off an amount say of £X as a bad debt, and if in rendering his return he proves to the satisfaction of the Commissioner that such debt of £X is indeed a bad debt, the amount of £X will be deducted from his 'income' (as defined) in order to arrive at his 'taxable income' (as defined). His 'taxable income' will therefore not include this bad debt of F £X, which has been excluded as bad and as therefore not being subject to tax, because it does not form part of his 'taxable income'. Whether a debt is bad or not must be decided at the time when the debt is returned as an accrual for the income tax year and according to the then existing financial circumstances of the debtor."

This would seem to accord with ordinary commercial and accounting practice G and, in the absence of express provision to the contrary in the Act, it is difficult to see why the Legislature should not have wanted this ordinary practice to apply. As Mr Goldstone rightly pointed out, in...