Taxpayer A v Commissioner for the South African Revenue Service (IT 25042)

Facts

Taxpayer A (“Appellant”) is a company incorporated in the Republic of South Africa, conducting the business of property investment and property management.  The appellant leased property for the purpose of earning rental and property management income.  During the 2016 year of assessment, the appellant entered into loan agreements with Propsky.  The purpose of the loans was to fund certain professional costs and expenses plus interest thereon associated with the redevelopment of Mall A. The appellant’s loan account was increased by R7 million, with the description of “structuring and execution fee”.  The appellant also entered into a restated facilities agreement with RMB.  The purpose of this loan was to finance the ABO Shares Consideration amount and a non-refundable debt origination fee. The appellant filed its income tax return for the 2016 year on 30 January 2018 and claimed a finance charge deduction of R19,515,690.  The South African Revenue Service (“SARS”), disallowed the finance charges and raised an understatement penalty (“USP”) of 50 percent since SARS believed that the appellant did not take reasonable care in completing its tax return.  The reason provided by SARS for the disallowance of the finance charges, which comprised of raising fees, debt origination fees, and structuring fees (“the fees”), was that the appellant provided “no or insufficient or relevant material”.  The appellant objected to the additional assessment on 24 May 2018, which was partially allowed. Aggrieved by SARS’s decision, the appellant filed a notice of appeal.

Issues

Issue 1 – Whether the appellant should be allowed deductions for the fees and interest as finance charges as contemplated in section 24J of the Income Tax Act No 58 of 1962 (“IT Act”); and

Issue 2 – Whether the USP was correctly levied in terms of sections 222 and 223 of the Tax Administration Act No 28 of 2011 (“TA Act”):.

Findings

The appellant argued that the funds borrowed from Propsky and RMB were used to facilitate property development and investment.  The appellant was of the view that the finance charges were directly connected to the loans, and thus formed part of the total cost of borrowing.  Accordingly, the interest paid on the loans, together with the fees, is the cost paid by the appellant to obtain capital.  SARS on the other hand contended that the parties to the agreements appreciated the difference between the fees and the interest payable since they were treated separately in the agreements, as well as the fact that Value-Added Tax (“VAT”) was levied on the Fees.  SARS also argued that since RMB and Propsky fees were payable upfront and were once-off, and therefore not linked to the duration of the loan terms, they were not interest.  SARS also relied on the subsequent amendment to the definition of “interest” as set out in section 24J of the IT Act, and much reliance was placed on the Explanatory Memorandum on the Taxation Laws Amendment Bill, 2016 (“Explanatory Memorandum 2016”) in order to support its view that finance charges are not related to interest.

When issue 1 was considered, the court started with the Taxations Laws Amendment Act No 15 of 2016 (“TLA Act”) which amended an element of the definition of “interest” (replacing the term “related finance charges” with “similar finance charges”) in section 24J of the IT Act.  This amendment came into operation on 19 January 2017.  The court was therefore of the view that the amendment to section 24J of the IT Act by the TLA Act, was irrelevant for a year of assessment before 19 January 2017, in this case, 2016.  The court further relied on the Commissioner for Inland Revenue v Genn & Co. (Pty) Ltd, where the court had to deal with the deduction of finance charges in terms of the now repealed section 11(Bb) of the IT Act. In the Genn case, no justification was found to distinguish between the interest on loans, and the commissions paid on those loans. Further, when deciding on the expenditure, the court should assess the closeness of the connection between the expenditure, and the income-earning structure. The appellant was successful in linking the fees, and interest to the income-earning operations, and like in the Genn case, there was no reason to distinguish between the interest and the fees paid.  The court also referred to CSARS v South African Custodial Services (Pty) Ltd, which dealt with the question of whether “introductions fees”; “financial advisory fees”; “margin fees”; “commitment fees” and “initial fees” constituted “related finance charges” under the now repealed section 11(bA) of the IT Act.  In the Custodial case, the court found that those fees could validly be deducted since they were “related finance charges” (in terms of the previous definition of “interest” in section 24J) and were closely connected to obtaining the loan.  Based on the Genn and the Custodial cases, SARS’s argument that the fees and the interest were treated separately, and therefore not the same, was found lacking.  SARS also argued that the fees were capital in nature, and therefore not deductible.  The court explained that section 24J of the IT Act is a “stand-alone” deduction, and is not reliant on the principles of section 11(a) of the IT Act.  A deduction in terms of section 24J of the IT Act must not be conflated with a claim for deduction under section 11(a) of the IT Act, and in terms of section 24J(2) of the IT Act, interest is deductible, even if it is capital in nature.  Lastly, the appellant bears the onus to prove that the amount sought to be deducted was incurred in the production of income.  Based on the facts before the court, it found that it should be common cause that the expense was incurred in the production of income.

The appeal was upheld and the matter was remitted to SARS to enable it to make a new assessment for the 2016 year of assessment in accordance with the judgment.   

Based on various legislations, as well as the principles laid out in Veldman v Director of Public Prosecutions there is a presumption that the law is not intended to be retrospective unless a contrary intention appears in the legislation.  For this reason, SARS was not able to rely on the current (amended) definition of “interest” as provided for in section 24J of the IT Act. The Explanatory Memorandum 2016  states that the purpose of the amendment was to clarify the “policy position that applies to finance charges of the same kind or nature”, which fortunately for the appellant, did not apply to the 2016 year of assessment.  This change is likely to narrow the court’s previous interpretations as to what constitutes “interest”.  To qualify for as a “similar finance charge”, it is submitted that such a charge must be a “finance charge”, and must display similar characteristics to that of interest within the context of its ordinary meaning. We know that SARS attacked the fact that the fees were not linked to the contract period, and was treated differently for VAT purposes, (since interest is treated as an exempt supply), they were not “similar”, or “of the same kind or nature”, and we can therefore only assume that SARS will hold this same view in the future.  The court may have come to a different conclusion if the year of assessment was after 19 January 2017, and the appellant was not able to prove that the fees had characteristics “similar” to interest.

No ruling was made on Issue 2.  However, the USP would have been remitted automatically once SARS amended the additional assessment.

Find a copy of the court case here.

06/09/2022