Tax court considers allowances claimed in respect of the construction of landfill cells.

On 14 December 2021 the Tax Court of South Africa delivered judgement in the case of W Taxpayer v CSARS (IT 45672). The case relates to an appeal by the taxpayer, a waste management company, against additional assessments raised by SARS for the 2015 and 2016 tax years. SARS disallowed the allowances claimed by the taxpayer in terms of section 12C(1)(a) and 24C of the Income Tax Act 58 of 1962 (“IT Act”).

The main issues considered by the court related to whether the taxpayer was entitled to the allowances claimed in terms of section 12C(1)(a) and 24C of the IT Act. The relevant provisions of the IT Act and the considerations and findings of the court are summarised below.

Section 12C

Section 12C(1)(a) applies to machinery or plant used directly in the process of manufacture or a process of a similar nature. The dispute was whether the taxpayer’s landfill cells were used directly in the process of manufacture, or (as SARS contends) in a process ancillary thereto – namely the storage of waste and treatment of leachate (an unwanted by-product).

The process of manufacture is not defined in the IT Act. The parties agreed, however, that the principal characteristic of such a process is the alteration of a substance or material from one thing into something different. In the present case, for the taxpayer to qualify for the section 12C allowances claimed, what occurs in the landfill cells would have to amount to the alteration of the waste material or waste body into something different.

SARS argued that the taxpayer’s allowance should be limited to 5% per year, as contemplated in section 37B of the ITA, read with section 13 of the ITA.

Section 37B defines “environmental treatment and recycling assets” as any air, water and solid waste treatment and recycling plant or pollution control and monitoring equipment (and any improvements thereto) if the plant or equipment is (i) utilised in the course of a taxpayers trade that is ancillary to any process of manufacture or any other process of a similar nature; and (ii) required by law to protect the environment.

Section 37B also defines “environmental waste disposal assets” as any air, water, and solid waste disposal site, dam, dump, reservoir…if the structure is:

• of a permanent nature;
• utilised in the course of a taxpayers trade in a process that is ancillary to any process of manufacture or any other process of a similar nature; and
• required by law to protect the environment.

The court agreed that the cells qualify as “environmental treatment and recycling assets” as defined in section 37B of the IT Act. The taxpayer would therefore be entitled to a different, smaller allowance in terms thereof.

The court held that the cells are not used in a process of manufacture as they do not drastically change the waste body and by-products once they are stored, whether in terms of utility or value. The cells are used to store already manufactured products.

Section 24C

Section 24C entitles taxpayers to an allowance in respect of income (i) received by or accrued to the taxpayer under a contract; (ii) which will be incurred in a subsequent tax year in performing its obligations under the contract, (iii) the future expenditure must either be deductible under the general rules or be used to acquire an “allowance asset”, and (iv) the income received and future expense to be incurred must arise from the same contract.

The dispute around section 24C, pertains specifically to amounts included in the taxpayer’s deduction calculations as “unwinding effect charged to interest”. These were included in the total deduction claimed by the taxpayer, given that it related to future expenditure to be incurred by the taxpayer. The future expenditure referred to were specifically costs relating to the treatment of leachate (a liquid by-product that enters the landfill from external sources), rehabilitation capping costs and post-closure rehabilitation of the landfill cells in terms of section 24C.

The arguments of SARS and the taxpayer in respect of section 24C

SARS requested a detailed analysis of the amounts claimed under the heading “unwinding effect charged to interest” from the taxpayer. The taxpayer explained that the charges were an estimate of the future expenditure upfront so that it could be incorporated in the cost charged to the end-customer. In other words, the charge related to the present value difference of future costs to be incurred by the taxpayer.

SARS essentially disallowed the deduction as, in its view, the adjustment of the face value of future expenses to present day values cannot qualify as a deduction under section 24C. SARS noted that these constitute finance costs. 

A hypothetical example was presented to the court by way of testimony on behalf of the taxpayer. The testimony highlighted how, for accounting purposes, provisions and contingent liabilities are dealt with when it comes to environmental rehabilitation. It was noted to the court that provisioning was made for an obligation that would crystallise in the future and that key elements of such provision had to be calculated based on the present value.

In calculating the future expenditure, the taxpayer made use of consulting engineers to conduct a “civil estimation” of a number of aspects, in order to calculate total costs. The engineers consider aspects such as the capacity of each cell, the future capping of the cell, the different quantities of components that will be required etc. The taxpayer noted that this calculation is done in year one when the landfill cell is constructed. As mentioned, the rationale for this exercise is to estimate the future expenditure upfront, so that it can be incorporated in the overall cost to the customer

It was noted, in testimony on behalf of the taxpayer, that the calculation constitutes the “best estimate of future costs” which has been claimed by the taxpayer as a section 24C allowance over the “best estimate of the period it will take for the cell to be finally capped, closed and rehabilitated”. The evidence presented to the court indicated that a recalculation was done in each year to reflect the deductions claimed as accurately as possible. It was also noted on behalf of the taxpayer that total anticipated cost is projected forward, using the expected rate of inflation, and then discounted back to the present-day value for accounting purposes. It was consequently noted that the “unwinding of interest”, as the cost is referred to, is simply “moving the discount one year forward in each year”.

It was then illustrated to the court that the deductions claimed are not actually a finance cost, but have been reflected as one given that this was required from the taxpayer in terms of international accounting standards practice.

The court’s finding in respect of section 24C

None of the testimony provided on behalf of the taxpayer, as referred to above, was disputed in cross-examination. The judge consequently noted that there was therefore no dispute as to whether the allowances claimed were finance costs and that the taxpayer discharged the onus of proving the section 24C requirements.

The judge highlights a number of considerations which has been taken into account and which led to the final conclusion that “it would be placing form over substance, and pandering to artificiality, to find that the taxpayer failed to discharge its onus.”

The considerations noted by the judge are:

• An explanation has been provided on how the applicable figures were calculated;
• SARS had all of the financial documentation and information required by it;
• It may be fairly assumed that SARS auditors would be able to scrutinise and understand information provided to them;
• If an hypothetical example is provided by a taxpayer as an explanation, the taxpayer can assume that the auditor at SARS would be able to apply that hypothetical example to the figures before him or her and that they would be familiar with the accounting standards applied; and
• No evidence was provided by SARS in rebuttal of the fact that its auditor was still unable to comprehend how the amounts were calculated.

Based on the above and the fact that the court was satisfied with the taxpayer’s approach in calculating the amounts claimed under section 24C, the taxpayer’s appeal in respect of the section 24C allowances succeeded.

Conclusion

This case illustrates the technical nature of tax allowances available to entities operating within the construction industry. It also serves as an example of how these taxpayers could make use of section 24C to claim allowances in respect of future expenditure, as was successfully argued by the taxpayer in this case.

The case does also raise some interesting aspects regarding the use of present values when calculating deductions.

Find a copy of the judgment here.

By Malan du Toit

25/04/2022