CSARS v Spur Group (Pty) Ltd (320/2020)

Facts:

On 29 November 2019, the High Court, hearing an appeal against the decision of the Tax Court, held in favour of Spur Group (Pty) Ltd (“Spur”), i.e. that the R48 million contribution to the trust was an expense in the production of income and was thus deductible.

Spur is the wholly-owned subsidiary of Spur Corporation Limited (“Spur Holdco”).

During 2004, Spur Holdco established the trust to implement and regulate the employees’ share incentive scheme, and to promote the continued growth and profitability of Spur. Significantly, Spur Holdco was the sole capital and income beneficiary of the trust.

On 7 December 2004, Spur concluded a contribution agreement with the trust in terms of which an amount of R48 million was contributed to the trust.

The trust subscribed for 1000 NewCo preference shares for an amount of approximately R48 million. Newco then used the subscription proceeds to purchase ordinary shares in Spur Holdco from a third party. Newco received dividends through its holding of the Spur Holdco shares.

The preference shareholder of Newco (i.e. the trust) received R48 million upon redemption of the shares plus preference dividends amounting to R22 562 254.

The ordinary shareholders of Newco (i.e. the scheme’s participants) received dividends amounting to an approximate total of R29 million. The trust and Newco were terminated thereafter.

The actual cause of the dispute in this matter occurred when Spur claimed the contribution of R48 million it made to the trust as a deduction against its income in terms of section 11(a) of the IT Act. The claimed deduction was spread over the period of the anticipated benefit to be derived from the payment, from and including 2005 to 2012, in terms of section 23H of the IT Act. [Note: Section 23H refers to prepaid expenses. It limits the deduction of an expense where none of the benefits (or part of the benefits) arise in the years of assessment. The general rule is that one cannot prepay business expenses for a future year and deduct them from the current year’s taxes.]

Issues:

Issue 1: Whether there was a sufficiently close connection between Spur’s contribution to a trust (which regulated an employees’ share incentive scheme) and its income producing operations to qualify for a deduction under section 11(a); and

Issue 2: Whether SARS could raise additional assessments for Spur’s 2005 to 2009 years of assessment or whether prescription had run.

Findings:

Deductibility issue:

Only the trust held the NewCo preference shares, and only it was entitled to the return of the R48 million contribution, plus the preference dividend on those shares. The participants had no right to any part of the contribution, or to the preference dividends that flowed from the investment.

The indisputable factual position therefore is that the participants benefitted directly from their separate investment, at par value in ordinary shares in NewCo.

Mr Field (Tax practitioner at KPMG and Spur witness) confirmed that ‘. . . [t]he participants benefited through NewCo. There was no way they could directly benefit from the trust. There had to be funding that flowed through to NewCo, and they would then benefit in their participation in NewCo.’

In the SCA’s view, the High Court erred in finding that the expenditure directly served the purpose of incentivising the participants (as was the case in Provider v COT), and that a sufficiently close nexus existed between the expenditure and the production of income by Spur. As demonstrated earlier, the R48 million contribution did not itself serve to incentivise the participants. It was an amount that would never accrue to the participants. Instead, it ultimately became available for the benefit of Spur Holdco as the capital beneficiary of the trust.

Applying PE Tramway v CIR, the SCA found that the purpose of Spur in incurring the expenditure was not to produce income, as required by section 11(a) of the IT Act, but to provide funding for the scheme, for the ultimate benefit of Spur Holdco. There was only an indirect and insufficient link between the expenditure and any benefit arising from the incentivisation of the participants.

The contribution was therefore not sufficiently closely connected to the business operations of Spur such that it would be proper, natural and reasonable to regard the expense as part of Spur’s costs in performing its operations.

The deduction was disallowed.

Prescription issue:

The remaining issue was whether the Commissioner was permitted to raise additional assessments on Spur in respect of its 2005-2009 years of assessment.

Spur contended that the Commissioner was precluded from issuing the additional assessments in respect of the 2005-2009 years of assessment by virtue of the provisions of section 99(1) of the TAA. The complaint is that the additional assessments were raised after the period of three years from the date of the original assessments.

Section 99(1) of the TAA provides that the Commissioner may not make an assessment three years after the date of the original assessment by SARS. However, section 99(2)(a) of the TAA, provides that the Commissioner is not bound by the three-year period of limitation where ‘in the case of assessment by SARS, the fact that the full amount of tax chargeable was not assessed, was due to (i) fraud; (ii) misrepresentation; or (iii) non-disclosure of material facts.’

In the 2005 return, Spur answered ‘no’ to the question: ‘Did the company make a contribution to the trust?’

Moreover, in each of the 2005-2008 income tax returns, the amount of deductions claimed in respect of the contribution, which were limited by section 23H of the IT Act, were disclosed by Spur under the category ‘other deductible items’ and not under the line item ‘prepaid expenditure (as limited by section 23H)’.

Spur’s defence to the allegation of misrepresentation and non- disclosure of material facts was that the aforesaid statements were negligently and inadvertently made.

The SCA: “Spur’s assertion that the wrong entries in the tax returns were negligent and inadvertent is patently false. Central to this entire dispute is the contribution of R48 million that Spur made to the trust in 2005. The answer ‘no’ to the question whether any contribution was made to a trust… is, in my view, plainly false and a misrepresentation. Moreover, Spur’s failure to include the said amounts in a separate line item which specifically required a disclosure of deductions limited by section 23H, and their inclusion in a general line item, amounts in my view, to a deliberate misrepresentation and a non- disclosure of material facts. It simply could not, by any stretch of imagination, be ascribed to any inadvertent error.”

Based on the above, the SCA held that SARS is permitted to issue additional assessments to Spur in respect of the 2005-2009 years of assessment.

Find a copy of the case here.

Commentary:

This case has presented an interesting judgement which taxpayers with share incentive schemes should take into account. Tax practitioners have often relied on the Provider case to argue that contributions to trusts pursuant to a share incentive scheme are deductible as it promotes a productive and content workforce. The manner in which Spur and Spur Holdco structured their share incentive scheme seems to have broken this link as the SCA is of the view that the contribution is not sufficiently closely connected to the income earning operations of Spur.

Furthermore, the prescription aspect of the case is equally important for all taxpayers to take note of. One incorrect selection (or “tick”) has resulted in the three year prescription no longer finding application. If this was disclosed correctly by the taxpayer, SARS would have had difficulty in arguing its case. Taxpayers should always carefully review the “yes”/”no” questions on tax returns as this could materially affect court case outcomes.

22/10/2021