Admin penalties for outstanding corporate income tax returns

In general, all registered companies must submit corporate income tax (“CIT”) returns within 12 months of the end of the company’s financial year-end. This is applicable to all companies that are resident in South Africa, that receive source income in South Africa, or that maintain a permanent establishment or a branch in South Africa.

On 29 November 2018, the South African Revenue Service (“SARS”) issued a media release confirming that SARS will soon start imposing administrative non-compliance penalties as provided for in Chapter 15 of the Tax Administration Act[1] for outstanding CIT returns. To date, these penalties were only imposed on individuals with outstanding income tax returns.

This announcement follows a media release earlier in November 2018 which stated that SARS is once again embarking on a nationwide awareness campaign to reinforce taxpayers’ obligations to submit outstanding tax returns, specifically targeting companies.

In this regard, the fixed amount penalties in terms of section 211 of the Tax Administration Act range from R250 (where the company is in an assessed loss position) to R16,000 (in instances where the company’s taxable income exceeds R50 million) for each outstanding return. Once the penalty has been imposed, the penalty will increase by the same amount for every month that the non-compliance continues.

In order to determine the amount of the penalty to be imposed, SARS will consider the year of assessment immediately prior to the year of assessment during which the penalty is assessed.

The penalties will furthermore be imposed by way of a penalty assessment. Any unpaid penalties will be recovered by means of the debt recovery steps.

According to the media release, the administrative non-compliance penalties will be imposed for outstanding CIT returns for years of assessment ending during the 2009 and subsequent calendar years. Please note that this will also apply to dormant companies with no receipts or assets.

SARS will, however, issue the relevant company with a final demand which will grant the company 21 business days from the date of the final demand to submit the outstanding returns before the penalties will be imposed.

Companies may request remittance of the penalties imposed from SARS and have the right to lodge an objection via eFiling should the request for remittance be unsuccessful.

The takeaway is that all companies with outstanding CIT returns (whether these companies have assessed losses for those outstanding years or not) should complete and submit these returns as soon as possible in order to avoid the administrative non-compliance penalties being imposed.

[1] No. 28 of 2011

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Non-resident sellers of immovable property

Section 35A of the Income Tax Act[1] came into effect on 1 September 2007 and sets out the capital gains tax consequences of the sale of immovable property situated in South Africa in instances where the seller is not a South African tax resident.

In terms of these provisions, the purchaser of the immovable property is obliged to withhold the specified amount of tax from the purchase price payable, provided that the property is disposed of for an amount in excess of R2 million.

The amount to be withheld in these circumstances is 7.5% of the purchase price where the seller is a natural person, 10% of the purchase price where the seller is a company and 15% of the purchase price where the seller is a trust.

The amount of tax withheld in these circumstances must be paid to the South African Revenue Service (“SARS”) within 14 days after the date on which the amount was so withheld in instances where the purchaser is a South African tax resident. The period is extended to 28 days should the purchaser not be a South African tax resident.

The non-resident seller of the immovable property may, however, request a tax directive from SARS confirming that tax be withheld at a lower or even zero rate, depending on the specific circumstances applicable to that non-resident seller. In this regard, SARS will take into account factors such as any security furnished for the payment of any tax due on the disposal of the immovable property, whether the seller is subject to tax in respect of such disposal and whether the actual tax liability of the non-resident seller is less than the amount to be withheld in terms of section 35A.

In order to request such a tax directive, the non-resident seller must complete the relevant form NR03 and submit this to SARS, together with the offer to purchase, the relevant capital gains tax calculation and all other relevant supporting documentation. According to SARS’ website, the processing of this declaration or directive application is 21 working days.

The amount withheld from any payment to the non-resident seller is an advance payment in respect of that seller’s liability for normal tax for the year of assessment during which the property is disposed of by the non-resident seller.

Please note that if the non-resident seller does not submit an income tax return in respect of that year of assessment within 12 months after the end of that year of assessment, the payment of the amount under section 35A is a sufficient basis for an assessment in terms of section 95 of the Tax Administration Act.[2]

[1] No. 58 of 1962

[2] No. 28 of 2011

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Simulation

In addition to specific anti-avoidance provisions and the general anti-avoidance provisions (GAAR) in the Income Tax Act,[1] the South African Revenue Service can apply another established principle to attack the validity of transactions and arrangements, namely the common law doctrine of simulation, or the plus valet doctrine. This is a fundamental principle of the South African common law that concerns itself with the true legal nature rather than the outward form of a transaction, essentially considering the substance of a transaction, rather than its form.

Application of the doctrine was recently under the spotlight again in the Supreme Court of Appeal in the matter of Sasol Oil v CSARS (923/2017) [2018] ZASCA 153 (9 November 2018). Sasol successfully appealed a judgment by the Gauteng Tax Court, which found that certain back-to-back transactions by entities in the Sasol Group were simulated and not genuine. Instead of Sasol in South Africa purchasing oil directly from a Sasol company incorporated in the Isle of Man, a UK company was interposed between the local entity and the Ilse of Man entity, the effect of which was that certain controlled foreign company rules in South Africa did not apply.

The court analysed statements from witnesses in the Sasol Group to determine what the reasons and commercial rationale were for the interposed UK entity. These witness accounts appear to have been crucial (if not the deciding factor) in the decision of the court that the transactions were not simulated or dishonest. In writing for the majority, Lewis JA found that:

“The transactions had a legitimate purpose. There was nothing impermissible about following…advice, and so reducing Sasol Oil’s tax liability. The transactions were not false constructs created solely to avoid…taxation.”

What is arguably more interesting, is the basis on which the minority found that the transactions were indeed simulated. Mothle JA, considering the same evidence, found that the transactions lacked commercial rationale, and this appears to be one of the main reasons for his dissent, demonstrated by the quotes below:

“At the risk of repetition, the…structure perpetuated duplication, with the identified inherent risk of absence of a commercial justification.”

“I would find that Sasol Oil failed to demonstrate to the Tax Court the commercial justification for interposing SISL (UK company) in the supply chain.”

“The failure to provide commercial justification for SISL revealed the absence of bona fides behind the transactions and as such, the additional assessments were justified.”

In the present case, Sasol was successful in proving the commercial rationale for their arrangement to the court. The important takeaway for taxpayers from the judgement is that the facts and circumstances of arrangements should be carefully documented when entering into transactions. Supporting documents, such as minutes of meetings, business plans and even internal notes could all prove to be vital in the assessment if a transaction is genuine, and not simulated.

[1] No. 58 of 1962

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Management’s responsibility

Throughout the audit of a set of financial statements, the phrase “management / director’s responsibility” appears. It is included in the engagement letter, the financial statements and the auditor’s report. But what does it mean?

Management is responsible for the management of the business, for implementing and monitoring of internal controls in the business, and in terms of the Companies Act (“the Act”), for maintaining adequate accounting records and the content and integrity of the financial statements. These financial statements must be issued annually to reflect the results thereof.

These financial statements are used by various users (shareholders, directors, banks, SARS, etc.) to make certain decisions (buying and selling of shares, valuations, credit terms, etc.), and therefore need to be a true representation of the business. It is therefore critical that all transactions are valid, are recorded accurately and completely in the correct financial year, are classified correctly, and that all assets and liabilities that exist are recorded at the true cost / value thereof.

In terms of the Act, financial statements are to be prepared using either International Financial Reporting Standards (“IFRS”) or IFRS for Small to Medium-sized Entities (“IFRS for SME’s”). Luckily management is not responsible to be experts in the above-mentioned standards, as the Act does allow for management to delegate the task of preparing the financial statements to someone with the knowledge and skill set to be able to perform this task. The Act does, however, not allow management to delegate the responsibilities that go along with it too, so they need to ensure that when they do delegate the task, that it is to a responsible person and that they review the financial statements before approving it.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

S129 notice to the consumer and “delivery”

There are many reasons why a consumer may default in his payments to a credit provider. Notwithstanding these reasons, the credit provider must follow certain procedures to enforce the agreement.

The first step, is for the credit provider to deliver to the consumer a written notice in terms of Section 129(1)(a) of the National Credit Act 34 of 2005 (“NCA”), notifying the consumer of the default and proposals as to what the consumer may do to resolve any disputes that he/she may have with the agreement or to work out a plan for the payments due under the agreement to be brought up to date. The consumer has ten business days to respond to the credit provider once he/she has received the letter. It must be noted though, that the consumer is under no obligation to respond to the notice in terms of Section 129(1)(a) (“the S129 notice”).

The consumer must be in default with his/her payment for at least twenty business days in terms of S130(1)(a) of the NCA, before the credit provider can deliver the S129 notice to the consumer.

The consumer must further be aware that the credit provider is legally bound to deliver the notice in terms of the S129 notice to the address of the consumer that is cited on the credit agreement – the address that the consumer chose when he/she signed the agreement.

The S129 notice, in terms of the Act, must be delivered to the consumer via registered post. The word “delivered” has been interpreted by the courts to give clarity, viz, the notice is to be dispatched to the correct post office for the address chosen by the consumer, when the credit agreement was signed, or to an adult at the location designated by the consumer, when the credit agreement was signed. Should the credit provider follow one of the above methods for delivery of the S129 notice, but the consumer failed to receive it by not collecting the notice from the post office, it would not be the fault of the credit provider and it would be deemed that the credit provider followed the “letter of the law” and would thus be within its rights to proceed with the issuing and serving of the summons.

Thus, it is not a defence for the consumer to raise that the notice was not delivered to him/her, as was explained by the Constitutional Court in the case of Kubyana v Standard Bank of South Africa Ltd, after revisiting the majority decision held by the Constitutional Court in the case of Sebola and Another v Standard Bank of South Africa Ltd and Another.

It falls upon the shoulders of the consumer to inform the credit provider, in writing, by hand or electronic mail, of any changes to his/her designated address in respect of receiving notices which defer from the credit agreement, to enable the credit provider to change the consumer’s records. Should the consumer not inform the credit provider of the new details, the credit provider will be bound to use the address as per the credit agreement and the consequence of this, is that the consumer will not receive the S129 notice, and when the ten business days have expired for the consumer to timeously give  the credit provider his intentions of how he/she wishes to deal with the default payments, the credit provider will be within its rights to proceed with the issuing and serving of the summons, incurring legal costs for the account of the consumer.

This was held in the court case of Robertson v Firstrand Bank Ltd t/a Wesbank.

Reference List:

  • National Credit Act 34 of 2005 read together with Amendment 19 of 2014
  • Kubyana v Standard Bank of South Africa Ltd (2014) ZACC
  • Sebola v Standard Bank of South Africa Ltd 2012(5) SA 142 (CC)
  • Robertson v Firstrand Bank t/a Wesbank (2015) ZAECGHC 7

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

The Public Audit Amendment Act: Groundbreaking for South Africa if properly implemented

On 21 November 2018, the 2017/2018 consolidated national and provincial audit outcomes report was released, which indicated a discouraging fourth consecutive year of regressive compliance with laws and regulations. Fittingly, the long-awaited Public Audit Amendment Act, Act 5 of 2018 (“the Amendment Act”), which substantially amends the Public Audit Act, Act 25 of 2004 (“the Public Audit Act”), had been signed into law by President Cyril Ramaphosa three days earlier, on 18 November 2018. This article explains how the amendments will substantially expand the powers of the Auditor-General and explores what the potential significance of this new law could be for South Africa.

The Amendment Act in comparison to the Public Audit Act

In a nutshell, the Public Audit Act provided the Auditor-General with the authority to establish auditing functions, but the office lacked the necessary power to then enforce the implementation of its recommendations. In comparison, once the amendments come into force, in terms of section 3(1A) of the Amendment Act, the Auditor-General will be able to refer “suspected material irregularities” which arise from an audit to a relevant public body for further investigation. Such public bodies would include the Hawks, the South African Police Service and the Public Protector.

Another significant amendment, as per sections 3(1B) and 4 of the Amendment Act, is that the Auditor-General’s office is under a duty to follow up on whether remedial action recommended in the audit report has been taken. If not, appropriate remedial action to address this failure is required. Where there has been a failure to recover lost funds arising from wasteful and fruitless expenditure, the relevant official or board must be directed to recover the loss from the responsible person. When the official or board fails to do so, in the absence of a satisfactory explanation, the Auditor-General must issue a certificate of debt requiring that official or board to personally pay the amount specified in the certificate to the State.

Why these amendments are a crucial milestone for South Africa

According to the director of the Public Service Accountability Monitor, Jay Kruuse, one of the primary reasons that the Auditor-General’s office had not previously been given the power to enforce its recommendations was due to a universal assumption that State-Owned Enterprises (SOEs) and governmental departments would react to audit reports and any negative findings. However, recommendations made by the Auditor-General to meet acceptable audit norms and standards were simply ignored and/or blatantly disregarded in the past, with non-compliance becoming the norm.

There is a direct impact on South Africa’s already-strained public finances. Over the past 13 years, audit outcomes have steadily declined. The 2017/2018 consolidated national and provincial audit outcomes report indicated that fruitless and wasteful expenditure, or spending in vain due to neglect, poor-decision-making or inefficiencies, increased to R2.5 billion. This was a 200% increase from the previous financial year. Unauthorised expenditure went up to R2.1 billion, of which R1.821 billion was due to overspending on predetermined budgets. This resulted in 82 governmental departments failing to settle their debts by the end of the 2017/2018 financial year. Irregular expenditure increased to an alarming R51 billion, which excludes the R28.4 billion wasted by SOEs. It should be noted that irregular expenditure does not necessarily amount to fraud or wastage, but it does mean that procedures, regulations and laws were not followed and, therefore, further investigation is required.

The Amendment Act is aimed at changing this state of affairs, as now the Auditor-General’s office has the power to ensure accountability in the management of public funds. The Auditor-General, Kimi Makwetu, has stated that the aim of the amendments was to provide his office with the necessary power “to directly impact” on audit outcomes. Of course, although the Amendment Act will now make provision for SOEs and provincial and national governments and their accounting officers to be held accountable for contraventions and non-compliance, a collective effort from parliament and law enforcement will be required to ensure that there is sufficient implementation of the new law.

Conclusion

Up until this point in South Africa’s democratic history, there has been a chronic abuse of public finances by corrupt or incompetent politicians and bureaucrats. The fight against corruption and for governmental compliance in respect of spending policies was largely futile, due to a lack of accountability and consequences for those who transgressed the legislative and regulatory framework and for those who were tasked with overseeing governmental expenditure. It is hoped that national governmental departments, as well as both provincial and local authorities, will now feel pressured to comply with governmental objectives and that these amendments will over time lead to more positive developmental outcomes for South Africa. 

Reference List:

  • “After years of barking, the AG gets teeth” Mail & Guardian November 23 – 29 2018.
  • The Public Audit Act 25 of 2004.
  • The Public Audit Amendment Act 5 of 2018.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Helpful tax resources

South African taxes are inherently complex and often involve interpretation, consulting and in exceptional cases, a fair amount of educated guessing on exactly what the legislature intended when the various acts were drafted. However, in order to assist taxpayers through the maze of information, there are some very helpful aids available to taxpayers and tax practitioners. This article provides some of these sources.

  • Binding Private Rulings (BPR’s): Although BPR’s only bind SARS and the taxpayer that is a party to the ruling, it often provides some insight into how statues could be interpreted by SARS. Applying for such a ruling is, of course, always an option for taxpayers, although this process should ideally be undertaken in consultation with a tax practitioner. A summary of all rulings that have been issued is available from SARS at:

http://www.sars.gov.za/Legal/Interpretation-Rulings/Published-Binding-Rulings/Binding-Private-Rulings/Pages/default.aspx

  • Comprehensive Guide to Capital Gains Tax (CGT): The 7th edition of the CGT guide was published on 8 October 2018. The purpose of the guide (consisting of close to a thousand pages!) is to assist the public in gaining a more in-depth understanding of capital gains tax. The guide contains detailed information of all topics related to CGT, with helpful examples and references. The guide is available at:

http://www.sars.gov.za/Legal/Legal-Publications/Find-Guide/Pages/Capital-Gains-Tax-(CGT).aspx

  • VAT 404 Guide for Vendors: The VAT 404 is a basic guide where technical and legal terminology have been avoided wherever possible. It provides several fundamental VAT principles and everyday examples on all VAT-related matters. The most recent version was published on 24 January 2017 and is available at:

http://www.sars.gov.za/AllDocs/OpsDocs/Guides/LAPD-VAT-G02%20-%20VAT%20404%20Guide%20for%20Vendors.pdf 

  • VAT 409 Guide for Fixed Property and Construction: The guide deals with matters concerning the application of the VAT Act in connection with fixed property and construction transactions in South Africa. Since it is a focused guide, it provides some more detailed information compared to the general VAT 404 Guide. The latest version (27 September 2016) is available at:

http://www.sars.gov.za/AllDocs/OpsDocs/Guides/LAPD-VAT-G03%20-%20VAT%20409%20Guide%20for%20Fixed%20Property%20and%20Construction.pdf 

  • External Guide for Provisional Tax 2019: The publication contains generic information to guide provisional taxpayers to correctly complete and submit the IRP6 return and to make the necessary payments on time. With second provisional tax payments for 2019 due at the end of February for individual taxpayers, this guide should come in handy. Available at:

http://www.sars.gov.za/AllDocs/OpsDocs/Guides/IT-PT-AE-01-G01%20-%20Guide%20for%20Provisional%20Tax%20-%20External%20Guide.pdf

The guides above are only some of the more pertinent guides that are available. Other categories of guides available include:

  • customs and excise;
  • dividends tax;
  • employment tax incentive;
  • income tax;
  • tax administration; and
  • transfer duty.

Self-educating is an important part of being an informed, aware and responsible taxpayer and these resources are available exactly for that reason. Taxpayers should always ensure that they use the most recent versions of guides, especially if there have been any legislative amendments.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Form requirements for objections

Dispute resolution with the South African Revenue Service (SARS) generally has a two-pronged approach. Firstly, taxpayers must present their case on the merits – this will include the factual basis and background that has led to the dispute. Secondly, and equally important (if not more so), is the procedural process. This deals with timeframes, form requirements, notices of delivery etc. The procedural aspects are dealt with in the Tax Administration Act[1] (in the Act itself and further in dispute resolution rules promulgated in terms of the Act). The procedural process to an objection is crucial since non-compliance can result in a negative outcome for the taxpayer, despite having very strong merits. The following are some of the more important procedural aspects:

Timeframe: Assessments must be objected to within 30 days after the date of an assessment. Where reasons have been requested for an assessment, the objection must be delivered within 30 days after receipt of the reasons. Importantly, “days” are business days (days other than Saturdays, Sundays, public holidays and the period between 16 December and 15 January of the following year annually).

Forms: Depending on the tax type (income tax, VAT, PAYE, etc.), SARS prescribes certain forms that must accompany the objection. For taxpayers who can submit disputes via eFiling, there is a guided process that populates the correct form. For taxpayers who do not use eFiling, manual forms are available on the SARS website.

Address: If eFiling is not used, taxpayers must specify an address where SARS’s decision of the objection or other documents can be delivered. The taxpayer who makes use of eFiling must always ensure that their most recent and up to date particulars (physical address, email address, contact persons etc.) are captured on the system, to ensure proper delivery of documents.

Grounds: The grounds on which the taxpayer objects are crucial, since a taxpayer may not appeal on a ground that constitutes a new ground of objection (if the dispute goes past the objection phase). Objections should therefore not only deal with the principal matter at hand but also any understatement penalties, provisional tax penalties and interest.

After the objection has been submitted, SARS is allowed to request additional substantiating documents to make a decision on the objection, these documents must be delivered to SARS 30 days after the request. If no additional documents have been requested, SARS has 60 days within which to consider the objection. If they did request documents, they are afforded a period of 45 days after delivery of the requested documents.

The above merely sets out the basics in terms of the procedural requirements for objections to assessments. Despite the standardised forms and prompts that have been included on SARS eFiling to assist taxpayers with objections, they are strongly advised to seek advice from a tax practitioner when entering the dispute resolution process, since dispute resolution has become a specialist field, which requires a hands-on approach.

[1] No. 28 of 2011

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Changes to bad debt allowance

Most South African businesses are at some point in time exposed to credit risk in the form of bad debts. Although taxpayers would undoubtedly prefer to recover the debts, the Income Tax Act[1] provides for some relief in cases where debts have become bad, or doubtful.

Not only does section 11(a) provide for the deduction of losses actually incurred in the production of income, section 11(i) and 11(j) are specifically aimed at a deduction or allowance for bad and doubtful debts respectively. These two provisions are, however, contentious mainly for two reasons. Firstly, there is no guideline in the Act, or clear test that has been established in case law, for when a debt is only considered to be bad, or “doubtful”, or has, in fact, become “bad”. This is an important consideration since it determines whether taxpayers can claim a permanent full deduction of the amount in terms of section 11(i), or merely an allowance in respect of section 11(j), that must be included in taxable income again in the subsequent year.

Secondly, the value of the allowance that taxpayers can claim in respect of “doubtful” debts has been a topic of dissent between taxpayers and SARS. Traditionally, taxpayers have claimed a 25% allowance in respect of such debts but some taxpayers, especially in the retail and unsecured debts market, have been challenged by SARS on the reasonability of the allowance. Recently, however, there has been an effort from the legislature to provide some certainty around the bad debts regime, at least in respect of the second value of allowances for “doubtful” debts.

Since 1 January 2018, banks can claim 25% of an impairment loss calculated in terms of the International Financial Reporting Standards (IFRS). In the Draft Taxation Laws Amendment Bill 2018, the legislature looks to extend this rate of allowance to other taxpayers as well, and specifically as follows:

  • Companies reporting in terms of IFRS: 25% of the loss allowance relating to impairment as calculated in IFRS 9 (excluding lease receivables); and
  • Companies that do not report in terms of IFRS: 25% of the face value of doubtful debts that are 90 days past due date.

Although the proposal to provide certainty is welcomed, some tax practitioners have made representations to National Treasury on the different treatment of taxpayers that report in terms of IFRS, and those who do not.

Whereas IFRS 9 makes provision for either a general or a simplified approach (or a combination thereof) that may be applied across a group of financial assets (debts) and that can also consider historical information, taxpayers that do not report in terms of IFRS 9 will be required to make an individual assessment of each debt to determine if such a debt is 90 days or more in arrears. This could cause practical difficulties where debtors have different terms or when payments are due (e.g. 30 days after invoice date or 30 days after statement date), especially where taxpayers have a significant number of low-value debtors.

It is suggested that there should not be any distinction between taxpayers that report in terms of IFRS 9 and taxpayers that do not, but rather that the guidance of IFRS 9 can be used to determine any impairment, even for taxpayers that do not report in terms of IFRS 9. This will also remove any inconsistent treatment of taxpayers, depending on the financial reporting framework that they are subject to. The suggestion is, therefore, that any taxpayer not reporting in IFRS may elect to apply IFRS 9 in determining its section 11(j) allowance. Submissions are currently being considered by National Treasury.

[1] 58 of 1962 (‘the Act’)

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Valuation of preference shares

In income tax, the question of valuation of shares often causes a great deal of uncertainty, especially where shares are not traded on a recognised exchange. Although the Eighth Schedule to the Income Tax Act[1] in paragraph 31 gives some guidance on the market value of certain assets, the ‘catch-all’ method is the price that could have been obtained upon the sale of an asset between a willing buyer and a willing seller dealing at arm’s length in the open market.

The rules of capital gains tax determine that a person is deemed, on the date of their death, to dispose of all their assets (except for a limited number of exclusions) for an amount equal to the market value of those assets. Market value, and how it should be determined, is therefore a very important consideration.

Recently, the Supreme Court of Appeal in CSARS v The Executors of Estate Late Sidney Ellerine 2018 ZASCA 39 recently provided some more guidance on the valuation of preference shares in such a case, by considering the rights attached to those preference shares. The South African Revenue Service (SARS) argued that at the time of the deceased’s death, he was entitled to convert preference shares that he held in a company to ordinary shares and that the shares should be valued on that basis. This was a crucial consideration since it made the difference between the shares being valued at R563 million compared to its nominal value of R112 000.

After the Tax Court initially found that the deceased was not entitled to convert the preference shares to ordinary shares, the Supreme Court of Appeal considered certain amendments made to the company’s Memorandum of Incorporation (as it then was) as well as two special resolutions. Factually, based on these documents, the court found that the deceased was indeed entitled to convert the preference shares to ordinary shares on the date of his death. The shares, therefore, had to be valued at R563 million instead of R112 000.

There are two key lessons from this judgement. Firstly, the precedent that has been set that where a person has the right to convert preferences shares to ordinary shares, the preference shares should be valued on that basis.

Secondly, the true intention of parties should be reflected in the wording and construction of all documents. The legal team for the respondent in the Ellerine-case argued strongly that a purposive and contextual approach should be adopted in considering the Memorandum of Incorporation and special resolutions. The court was, however, not persuaded and indicated that while intention is important, the basic interpretation should be made with reference to what is recorded. Taxpayers are encouraged to seek professional advice prior to executing agreements to ensure that their true intention and the purpose for which they execute documents are clear from the wording used.

As can be seen from the Ellerine-case, failure to do so could be very costly.

[1] No 58 of 1962

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)