Commissioner, South African Revenue Service v BP South Africa (Pty) Ltd

• Jurisdiction: South Africa
• Judge: Howie P, Streicher JA, Nugent JA, Cloete JA and Heher JA
• Judgment Date: 25 May 2006
• Citation: 2006 (5) SA 559 (SCA)
• Docket Number: 92/05
• Hearing Date: 03 May 2006
• Counsel: P A Solomon SC (with L F Fichardt) for the appellant. O L Rogers SC and A R Sholto-Douglas SC for the respondent.
• Court: Supreme Court of Appeal

Streicher JA:

[1] This is an appeal by the Commissioner of the South African Revenue Service (the Commissioner) against a judgment in the Cape Tax Court (the Tax Court) upholding an appeal by BP Southern Africa (Pty) F Ltd (BPSA) against the Commissioner's income tax assessment for the 1993 year of assessment. In terms of the assessment, the Commissioner disallowed the deduction from income of interest in the amount of R81 755 944 payable by BPSA in respect of a loan by its only G shareholder, British Petroleum Company plc (BP plc), and rental expenditure incurred by BPSA in respect of filling station sites of R13 483 420 (less R31 008 and R71 464). The Tax Court held that these expenditures constituted expenditures incurred in the production of income and that they were to be treated as expenses deductible from BPSA's income for the 1993 year of assessment. H

Deduction of interest

[2] BPSA markets petroleum products in South Africa. Some of the petrol that it markets is refined by South African Petroleum Refineries, a joint venture by BPSA and Shell. BP plc, the holding company of BPSA, is a company incorporated outside the Republic. It I required that dividends of profits available for distribution be declared quarterly. As at 25 March 1990 BPSA held distributable profits amounting to R682 499 575 which it would have liked to retain. BP plc, on the other hand, considered its investment in South Africa risky, wanted to take the J

Streicher JA

money out and insisted that a dividend be declared. Eventually, in terms of an agreement reached with the A management of BPSA, a general meeting of the members of BPSA, on 6 August 1990, resolved that the amount of R682 499 575 be declared as a dividend and that a loan of R348 374 594 granted by BP plc be accepted by BPSA. In terms of the loan granted by BP plc interest at an agreed rate was payable on the capital amount outstanding from time to B time. At the time, BPSA had the necessary cash resources to pay the dividend in full but, as a result of the loan, only the difference between the amount of the dividend and the loan (after deduction of the non-resident shareholder's tax, being an amount of R300 000 000) was remitted to BP plc on 20 August 1990. C

[3] Mr McClelland, the financial director of BPSA, who negotiated the loan with BP plc, was the only witness who testified at the hearing of the appeal in the Tax Court. He conceded that BPSA would have been better off had the dividend not been declared, in that the declaration of the dividend brought about a liability to pay interest on the amount of the loan. The payment of the dividend also D brought about a lowering of the local borrowing ceiling of BPSA imposed by the South African Reserve Bank. For this reason, a dividend would not have been declared had it not been for the insistence of BP plc. The loan, together with the partial restoration of the local borrowing ceiling brought about by such loan, was required to fund various capital expenditure programmes which were being contemplated by E BPSA at the time. These included the expansion of the refining capacity of South African Petroleum Refineries; maintaining other parts of the refinery; the building of new service stations; rebranding them in due course; and replacing delivery vehicles. The major item was the expansion of the refinery. It would have been seriously disadvantageous F to BPSA not to have expanded the refining capacity of the refinery. However, at the end of 1990, BPSA, notwithstanding payment of part of the dividend, still had R427 million in cash, which was more than was required to pay the balance of the dividend in full. It would therefore have been possible to run the business of BPSA until the end of 1990 G but, at some stage during 1991, the company would have experienced serious financial difficulties.

[4] In the event, essentially all expenditure in respect of the refinery was financed by way of hire-purchase contracts and long-term leases and at least a substantial part of the loan was used as working capital. According to McClelland, the money, while it was in the bank, H helped BPSA to overcome shortfalls in working capital.

[5] The Commissioner disallowed the deduction of the interest on the loan on the basis that it had not been incurred in the production of BPSA's income as required by s 11(a) of the Income Tax Act 58 of 1962 ('the Act'). The Tax Court overruled the I Commissioner's assessment and held that the purpose of BPSA, insofar as the loan was concerned, was to continue its income-producing activities; and that the interest paid on the loan was an expense incurred in order to produce income within the meaning of s 11(a). J

Streicher JA

[6] Section 11(a) provides that there shall be allowed as deductions from income, for the purpose of determining the A taxable income derived by a person from the carrying on of any trade, 'expenditure and losses actually incurred in the production of the income, provided such expenditure and losses are not of a capital nature'. In order to determine whether expenditure has been incurred in the production of income 'important, sometimes overriding, factors are the purpose of the expenditure and what the expenditure actually B effects'. (Per Corbett JA in Commissioner for Inland Revenue v Nemojim (Pty) Ltd 1983 (4) SA 935 (A) at 947F - H.) In Commissioner for Inland Revenue v Giuseppe Brollo Properties (Pty) Ltd 1994 (2) SA 147 (A) at 152I - 153D Nicholas AJA said: C

'(T)he enquiry relates primarily to the purpose for which the money was borrowed. That is often the "dominant" or "vital" enquiry, although the ultimate user of the borrowed money may sometimes be a relevant factor. Where a taxpayer's purpose in borrowing money upon which it pays interest is to obtain the means of earning income, the interest paid on the money so borrowed is prima facie an expenditure incurred in the production of income. See Commissioner for Inland Revenue v Allied Building Society D 1963 (4) SA 1 (A) at 13C - G . . . .

If, on the other hand, the purpose of the borrowing was for some other purpose than obtaining the means of earning income (for example, to pay a dividend), the interest is not deductible.'

[7] In Ticktin Timbers CC v Commissioner for Inland Revenue 1999 (4) SA 939 (SCA), certain trading reserves and income E were credited to the loan account of Ticktin Timbers' only member, Dr Ticktin, who had bought the shares in a company which he had then converted into a close corporation, Ticktin Timbers CC. Dr Ticktin contended that 'he was entitled to whatever dividends he wished to declare; and that all the credits were passed in respect of dividends which he had declared but retained in the business as an F interest-bearing loan in order to finance its day-to-day operations'. [1] Interest was credited annually on the accumulated balance in the loan account. This Court had to decide whether the interest credited to the loan account qualified as expenditure actually incurred in the production of income. The issue was, therefore, the purpose for which the loan was G made. [2] It was held that a scheme had been devised with the obvious aim of ensuring that Dr Ticktin would be able to pay the interest on the purchase price in respect of the shares he had bought and possibly the purchase price itself. Hefer JA said: [3]

'I agree with the Court a quo that the loan was not needed for the appellant's income-producing activities and that the intention was to increase Dr Ticktin's income, not that of the H appellant.'

[8] Counsel for the appellant contend that 'the principle which emerges from Ticktin is that, where the loan giving rise to the relevant liability for interest is incurred pursuant to a scheme devised to benefit the shareholder company and which results, not in additional income for the taxpayer...