ABCDE SA (Pty) Ltd v CSARS (SARSTC IT 24596)

Facts

The appellant, i.e ABCDE SA (Pty) Ltd (“ABCDE”), is a company incorporated and registered in South Africa and a South African taxpayer.  ABCDE owns one hundred percent of the shares in XYZ Ltd, which in turn owns all the shares in ABCDE Ltd (“AB”), a company incorporated and registered in the Republic of Ireland.  It is common cause, firstly, that AB is a controlled foreign company in accordance with the Income Tax Act, No 58 of 1962 (“the Act”). Secondly, it is controlled by the taxpayer by virtue of its ownership of the shares of XYZ Ltd who in turn owns the shares in AB.  In terms of the pleadings, it was not disputed that when the taxpayer submitted its income tax returns for the 2012 year of assessment, it excluded the net income of AB from its taxable income. This was consistent with its returns for 2011 and subsequent returns for the year 2013.  In April 2015 SARS conducted an audit of the appellant for the three years of 2011, 2012 and 2013.  An additional assessment was raised by the respondent, i.e SARS, to which the appellant raised an objection.  The respondent reduced the sum, but a significant part of the additional liability remained.  The appellant took further issue with the reassessment, resulting in this appeal.  The respondent asserts that in terms of section 9D of the Act, the net income of AB had to be included in the appellant’s income for the purposes of taxation.  The basis upon which the appellant persist in seeking to exclude from its income the net income of AB is that the appellant is claiming the money is subject to the foreign business establishment exemption, (“the exemption”).  The exemption is granted in terms of subsection 9D(9)(b) of the Act.

Issues

As can be discerned from the aforegoing, the issue can be summarised as follows:

Issue 1: Whether section 9D(9)(b) of the Act, is applicable or not.

Issue 2: If the court dismisses the appeal, whether the respondent is entitled to the penalties which it imposed on the appellant.

Issue 3: Whether to uphold the imposition by the SARS of interest.

Issue 4: The respective parties’ liability for costs.

Finding

With regards to the first issue, the appellant, i.e ABCDE, must prove that the net income of AB are excluded because AB is a foreign business establishment (“FBE”).  To determine whether AB is an FBE, the court must be satisfied that it complies with all of the five requirements, as set out below. 

Not necessarily in this order, firstly, its fixed place of business is located outside the Republic of South Africa. Secondly, the place of business is conducted in a physical structure.  Thirdly, that the place of business is suitably staffed. Fourthly, this place is suitably equipped to conduct the business.  Fifthly and clearly the most important, that it is located outside the country, not for the purpose of postponing or reducing tax imposed in South Africa.  The fifth requirement is to a degree dependant on the proof of the second to fourth requirements, being factors the legislature has identified as relevant.  The fifth requirement goes to the motive or intention.  The appellant is required to prove its case on a balance of probabilities, as required by section 102(1) of the Tax Administration Act No 28 of 2011, (“the TA Act”). 

The court was satisfied, for the reasons below, with the evidence provided by the appellant that ABCDE complied with requirements one through to five of subsection 9D(9)(b) of the Act.  The parties were both in agreement about the applicable five conditions that need to be proven in terms of the Act.  In broad terms, there was also agreement that the first requirement was satisfied.  In terms of requirements two to four, the parties disputed whether the appellant has proven that the primary operations of AB were conducted in the Republic of Ireland.  The words, “primary operations”, are contained in requirements two to four.  SARS contended that the primary operations of AB were investment management and the proof was provided that this was not conducted in Ireland.  The investment management was delegated by AB to CI Ltd, a company registered in the United Kingdom.  The appellant argued that it is a fund manager and that investment management is only part of the duties of a fund manager.  Through evidence, ABCDE proved that AB was a fund manager, primarily operating from the Republic of Ireland. 

Turning to requirement number five, namely the purpose of creating and operating AB, both parties submitted that the law was developed to address the creation of foreign entities to avoid tax, and therefore, section 9D of the Act was included.  However, the legislature realised that it was necessary to provide various exemptions to ensure that a balance is struck between the objective of preventing the deferral or avoidance of tax and the potential prejudice to South African taxpayers conducting legitimate business abroad.  The appellant satisfied the court that an interest in AB was acquired to create opportunities for its client, which it could not provide in South Africa.  AB was not illusory, or a non-substantive business undertaking, and it has economic substance and does not merely exist on paper. For this reason, SARS was directed to issue the appellant with a reduced assessment, in which no amount is included under section 9D of the Act.

Since the court did not dismiss the appeal, no determination was necessary on the penalties and interest imposed by SARS.

The court ordered that each party shall pay their own costs.  The court was of the view that due to the complexity of the case, the grounds of assessment appealed against were not unreasonable.     

The appeal was upheld with each party paying their own costs.

 Find a copy of the court case here.

21/01/2022