The tax court reviews the deductibility of general business expenses

The recent Cape Town Tax Court judgment of S G Taxpayer v The Commissioner for the South African Revenue Service,[1] delivered on 9 May 2018, re-affirmed a number of key concepts regarding the deductibility of expenses for tax purposes generally in terms of the general deductions formula contained in section 11(a) of the Income Tax Act.[2] Significantly, the judgment also illustrates the importance of considering all of the relevant arguments and case law that may be applicable to transactions during dispute resolution or litigation.

The case concerned the deductibility of a contribution to an employee share-incentive scheme by the taxpayer. Based on the complex structure of the scheme and flow of transactions, SARS contended that the beneficiaries of the taxpayer’s contribution to the scheme were not the employees of the taxpayer themselves, but the special purpose vehicle used by the taxpayer to implement the scheme. As a result, SARS disallowed the contribution as a deduction on the basis that there is no sufficiently direct, causal link between the contribution and the production of income.

The court found that the test is that there must be a sufficiently close connection between the expense and the production of income in order to qualify as a deduction. A direct link, as contended by SARS, is not required. Regard must be given to what the expenditure actually affects and the purpose of the expenditure for the taxpayer. A causal connection is not established only with reference to the initial use of the expense and it is not necessary to show that a particular item of expenditure produced any specifically identifiable part of income for a particular year of assessment.

Based on these principles the court found that the purpose of the employee share-incentive scheme and the contribution thereto was to incentivise key staff members to be efficient and productive and remain in the employment of the taxpayer primarily. Accordingly, the contribution should be allowed as a deduction.

Apart from confirming settled principles regarding the deductibility of expenses, what is perhaps more interesting from the judgment is the number of possible arguments that SARS did not rely on, as highlighted by the court. Firstly, they advanced no arguments regarding the ‘negative test’ contained in section 23(g) of the ITA (often read in conjunction with section 11(a)), that does not allow any deduction to the extent that the expense in question was not expended for the purposes of trade. The court found that this omission, by implication, means that SARS accepted that the contribution by the taxpayer was in fact for the purposes of trade. SARS furthermore relied on case law where it was found that money spent by a taxpayer to advance the interests of the group of companies to which it belongs is not regarded as expenditure in the production of income. Despite referencing the case law, SARS never applied the precedent to the particular set of facts.

It is unclear to what extent the outcome may have been different if SARS did use any of these arguments, especially since the court confirmed that a case such as this is very fact-specific. This illustrates the importance of considering all relevant tax provisions, pertinent arguments and related case law when determining the tax consequences of transactions, specifically during dispute resolution or litigation, as it may significantly affect the ultimate outcome.

[1] ITC 14264, as yet unreported.

[2] 58 of 1962 as amended (the ITA).

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)

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