february 2010 – issue 126 contents capital gains tax ... · february 2010 – issue 126 contents...

Integritax Issue 126 – February, 2010 ©SAICA, 2010 page 1

FEBRUARY 2010 – ISSUE 126

CONTENTS

CAPITAL GAINS TAX

1815. Private equity funds structures

INTERNATIONAL TAX

1820. Profits of a foreign partnership

1821. India-Mauritius treaty

EXCHANGE CONTROL

1816. Further relaxation

VAT

1822. Supplies for no consideration

GENERAL

1817. Advance tax rulings

1818. Objections and appeals

1819. Electronic funds transfers to SARS

SARS NEWS

1823. Interpretation notes, media releases and

other documents

CAPITAL GAINS TAX

1815. Private equity funds structures

One of the objectives in structuring a private equity fund is to ensure that the liability for taxes is not

on the fund vehicle itself but on the investors in the fund. Private equity funds are therefore usually

fiscally transparent and in South Africa, private equity funds are generally arranged either as an en

commandite partnership, or as a bewind trust.

Where all the investors in the fund and all the investments of the fund are local, from a tax point of

view, there are, no significant advantages or disadvantages of one structure over the other. This is

different where the fund has foreign investors or makes foreign investments (this situation is not dealt

with in this article).

Tax is often raised as a disadvantage of the en commandite partnership structure as realisation gains

on the disposal of shares are subject to tax in South Africa. In the context of a private equity fund,

realisation gains are usually treated as being of a capital nature even where the relevant shares were

not held for a period of three years prior to the date of disposal, and therefore do not qualify for the

deemed capital treatment. When a partner joins or leaves a partnership, which may happen in the

context of a private equity fund particularly on a second closing of the fund, the partnership

automatically dissolves and a new partnership between the new partners is established. Under strict

common law principles, the partners in the old partnership are considered to have disposed of their

interest in the partnership assets to the partners in the new partnership. As partners in a partnership are

considered connected persons in relation to each other, the disposal would most likely be deemed to

take place at market value. Therefore, in terms of strict common law principles, if the fund has made


investments prior to the second closing and there is an increase in the market value of the partnership

assets (from the date that the assets are acquired by the partnership and the date that a new partner

enters the partnership), the old partners would be deemed to have disposed of their underlying interest

in the partnership assets (at their market value on the date that the new partnership is formed). The

result is a potential tax cost to the old partners in a cashless transaction.

However, the South African Revenue Service (SARS) has indicated in its Comprehensive Guide to

Capital Gains Tax (the CGT Guide) that for practical reasons it is not intended that this strict legal

approach be followed. Instead, each partner must be regarded as having a fractional interest in each of

the partnership assets. According to the SARS approach in the CGT Guide, when a new partner joins

the partnership, the existing partners are treated as having disposed of a part of their interest in the

partnership assets and a capital gain or loss must be determined, but only in respect of the part

disposed of. As the disposal will be to a partner, it will be to a connected person, which means that it

will be deemed to take place at market value. Therefore even in terms of the SARS practical approach

where a new partner enters the partnership, say on a second closing, the old partners may have a CGT

liability even though they do not receive any proceeds from the new partner joining the partnership.

The situation in the case of private equity funds established as bewind trusts is similar. In a bewind

trust, the investors in the private equity fund are the trust beneficiaries, who own the underlying trust

assets but relinquish control of the assets to the trustees who, in turn, appoint a manager to identify

and make investments. As the investors are direct part owners of the trust assets, if new investors are

introduced on a second closing of the private equity fund, and the fund has already made investments,

the old investors will dispose of a portion of their interest in the fund assets. As the disposal will be to

a new investor and a beneficiary of the trust, it will be to a connected person, which means that it will

be deemed to take place at market value on the date that the new investor becomes a beneficiary of the

trust. Again, where an investor enters the fund as a beneficiary of the trust, the old investors may have

a CGT liability even though they do not receive any proceeds from the new investor joining the fund,

but only in respect of the part of the trust assets disposed of.

The SARS practical approach stated in the CGT Guide is not law and a court could choose not to

follow this approach. However, it is unlikely that SARS would tax partners in a partnership when

partners enter or leave the partnership in a manner which is contrary to what is stated in the CGT

Guide. Therefore, in our view, there are no significant tax advantages or disadvantages of the bewind

trust structure over the en commandite partnership structure for private equity funds, where the

investors and investments are all South African. The preferred private equity fund structure will

depend more on the commercial and other legal (non-tax) considerations.

Edward Nathan Sonnenbergs

IT Act: Eighth Schedule


EXCHANGE CONTROL

1816. Further relaxation

In his Medium Term Budget Policy Statement of 2009 delivered on Tuesday 27 October, the Minister

of Finance, Minister Pravin Gordhan, announced a further relaxation of exchange controls and

associated red tape. This statement was further amplified in a number of exchange control circulars

issued on the same day. In the first of these circulars it is explained that “given the strength of our

regulatory system and the shift towards a risk-management approach in line with member countries in

the G20, government is in a position to announce further reforms to lower the cost of doing business

in South Africa, while managing risks in a volatile international environment.”

South African companies

Various reforms have been introduced to reduce the exchange control hurdles and limitations

encountered in respect of certain business transactions. These are listed below.

SADC loop prohibition removed

Most South Africans are aware of the prohibition of so called loop investments. In its simplest form

this entails an investment into an entity outside of the common monetary area (CMA) which then

invests back into the CMA (referred to as the CMA loop). Such an investment is under all

circumstances prohibited. In recent years, a similar prohibition was introduced in respect of

investments into an entity outside the Southern African Development Community (SADC) region

which then invests back into the SADC region (referred to as the SADC loop).

In terms of the circulars issued, in order to promote regional integration by allowing

South African companies to invest in SADC member states through offshore intermediaries, the

prohibition on SADC loops is removed. It should be noted that the prohibition on CMA loops

remains.

Increase in limit for authorised dealer approvals

In the past, foreign direct investments which qualify for the dispensation and do not exceed

R50 million per company per calendar year were capable of being approved by an authorised dealer.

This limit has been increased to R500 million per company per calendar year, but remains subject to

all existing criteria and reporting obligations.

A further clarification was added that passive real estate investments are excluded from this

dispensation.

Customer foreign currency (CFC) accounts and foreign bank accounts

In the past, any foreign exchange accrual in a CFC account was required to be translated to rand

within 180 days from the date of accrual. Although South African companies are still required to

repatriate export proceeds to South Africa, this 180 day conversion rule is now abolished. This only

applies to companies with CFC accounts. The normal 30 day conversion rule still applies in respect of

other accruals.

In the past, South African companies were not permitted to open foreign bank accounts. In terms of

the amendments, South African companies will now be permitted to open and operate foreign bank

accounts for permissible purposes without such prior approval. The bank accounts will however be

subject to certain reporting obligations.


There was also a R250 000 limit on advance payments for imports. In terms of the amendments, this

limit is removed and henceforth authorised dealers are permitted to provide foreign exchange in

respect of advance payments for permissible imports against presentation of the necessary

documentation.

The current paper-based monitoring system of exports is to be replaced with a more efficient

electronic system in due course.

Individuals

The foreign capital allowance for South African resident individuals has been increased from

R2 million to R4 million, and the single discretionary allowance has been increased from

R500 000 to R750 000.

Non-residents

Currently, various restrictions exist in respect of local financial assistance granted to

non-residents or foreign owned South African companies (affected persons). Going forward, these

restrictions are withdrawn in respect of what is described as “bona fide foreign direct investments in

South Africa”. Specifically excluded from this relaxation are the acquisition of residential properties

and funds used for financial transactions such as portfolio investments, securities lending, hedging,

repurchase agreements etc. by non-residents and affected persons. The current 1:1 ratio thus remains

applicable to these transactions.

Conclusion

The amendments referred to above certainly represent a further relaxation of exchange controls in line

with government’s stated policy over the last few years. The circulars state that:

“South Africa continues to welcome foreign direct investment (FDI) and encourages local firms that

wish to diversify offshore from a domestic base. Moreover, government recognises the need to

modernise the investment framework. In support of these objectives, the National Treasury proposes

to improve the current exchange control regulatory framework for approving investments. The key

proposals that will form part of the modernised approach will be announced in the 2010 budget.”


South African Reserve Bank Exchange Control Circular


GENERAL

1817. Advance tax rulings

What are ATRs?

Taxpayers who require clarity and certainty on the Commissioner's interpretation and application of

the tax laws can obtain a binding private ruling or binding class ruling from the South African

Revenue Service (SARS). The ruling will generally be binding on the Commissioner when the

proposed transaction is assessed provided all relevant facts have been fully and accurately disclosed.

Publication of ATRs

All Binding General Rulings, Binding Private Rulings and Binding Class Rulings are published in

edited form. They are published on the SARS website, www.sars.gov.za the link is on the left hand

side of the Home Page under "Quick Contacts".

The ATRs are published as general information and a third party may not rely upon or cite a Binding

Private Ruling or Binding Class Ruling in any proceedings before the Commissioner.

The published rulings are useful in that they provide guidance on how SARS might interpret specific

provisions of the legislation under given circumstances. Taxpayers should however proceed with

caution in relying on the rulings as they are not published with the same detail and clarity as one

would expect in a published Court decision.

Latest published rulings

We have provided a summary of the latest published binding private rulings. For the full ruling please

refer to the SARS website.

BPR062 Payment of bank debt of resident company by foreign group company

BPR061 Foreign incorporated limited partnership regarded as a controlled foreign company

BPR060 Deductions in relation to 'short sale' transactions

BPR059 Corporate formation transaction involving a close corporation

BPR058 Transferring a business to a subsidiary and selling shares in subsidiary to directors

BPR057 Deductibility of interest where shares acquired and business subsequently distributed to the

acquirer

BPR056 Resident private equity fund housed in a vesting trust

BPR055 Whether amount paid in redemption of participatory interest in a foreign collective

investment scheme is 'a dividend'

BPR054 Steps to be taken by a co-operative to show it has taken steps to liquidate or deregister when

amalgamated in terms of an amalgamation transaction (section 44)

BPR053 VAT implications where buildings donated to a VAT exempt recipient

BPR052 Application of foreign dividend exemption when a controlled foreign company distributes

profits accumulated while taxable and exempt

BPR051 Deductibility of environmental expenditure

BPR050 Deduction and spreading of deduction in relation to grants made to share incentive trusts

BPR049 Capital/revenue nature and part disposal in relation to a 99 year lease

BPR048 Foreign business establishment for purposes of section 9D of the Income Tax Act (controlled

foreign companies)


BPR 062 - 20 November 2009

[Based on legislation applicable as at 19 December 2007]

The applicant is a resident company which is indirectly owned 100% by a non-resident company (the

Offshore Company). A third party bank has lent funds to the applicant which is interest bearing and

used by the applicant for the purposes of its trade.

The Offshore Company intends settling the outstanding loan debt owing to the bank without expecting

anything in return.

The ruling is conditional upon there being no delegation of the debt by the applicant to the off-shore

company and no cession of the debt by the bank to the Offshore Company. Furthermore the Offshore

Company will comply with the necessary exchange control regulations and will provide a guarantee

that there will be no repatriation of funds.

The ruling is that –

The proposed transaction falls outside the ambit of section 20(1)(a)(ii) so any assessed loss of the

applicant will not be reduced;

There will be no recoupment under section 8(4)(m) except to the extent that the loan settlement is in

respect of interest already incurred and deducted by the applicant, in which case a recoupment will

arise in the applicant in relation to any interest already deducted by not yet paid by the applicant;

Subsequent to the transaction, paragraph 3(b) read with paragraph 20(3)(b) of the Eighth Schedule

(the CGT legislation) will not apply;

The proposed transaction will not be treated as a deemed disposal under paragraph 12(5) of the Eighth

Schedule;

Since the Offshore Company is not a resident no donations tax will arise; and

No STC will arise as the provisions of section 64C(2) are not applicable.

BPR 061 – 30 October 2009 [Based on legislation applicable as at 7 February 2007]

The applicant is a resident company which will indirectly hold 100% of the shares in Foreign

company B (non-resident). Foreign company B will be the limited partner in a partnership and will

contribute 99% of the capital required by the partnership. The partnership will be a foreign limited

partnership and in terms of the foreign country's Partnership Act will be regarded as a body corporate

with legal personality separate from that of the partners.

The ruling was that –

The foreign partnership, incorporated in the foreign jurisdiction, will be a company as defined in

paragraph (b) of the definition of 'company' in section 1;

The foreign partnership will be regarded as a 'controlled foreign company' as defined in

section 9D(1) of the Income Tax Act, as Foreign company B will indirectly hold 99% of the


participation rights in the foreign partnership and Foreign company B will be indirectly 100% owned

by the applicant. Foreign company B will also be a 'controlled foreign company' of the applicant;

The 'participation exemption' provided for in section 10(1)(k)(ii)(dd) will apply in respect of dividends

received by Foreign company B, as Foreign company B will hold at least 20% of the 'equity share

capital' as defined in section 1 and 20% of the 'voting rights' in the foreign partnership.

BPR 060 – 30 October 2009

[Based on legislation applicable as at 21 October 2008]

The applicant is a trust (the borrower) that intends entering into securities lending arrangements, in

terms of which the borrower will borrow bonds and/or shares with the purpose of facilitating 'short

sale' transactions in respect of the borrowed bonds and/or shares as the borrower expects to profit

from an expected decline in prices of the borrowed bonds and/or shares.

In terms of the securities lending arrangement, the borrower will have an 'unconditional obligation' to

return the borrowed bonds and shares (close out of the securities lending arrangement) to the lender on

an agreed date (the close out date) which might be specified or unspecified. The borrower is under an

obligation to pay a fee to the lender and pay manufactured interest and/or dividends. The borrowed

shares/bonds are disposed of in terms of 'short sale' transactions.

The proceeds received from a 'short sale' transaction will be invested in shares.

When the lender calls on the borrower to close out the securities lending arrangement, the

bonds/shares will be purchased in the market by the borrower and delivered to the lender.


The 'short sale' in respect of the borrowed shares/bonds will result in a receipt or accrual of 'gross

income';

Provided there is an unconditional obligation on the borrower to return the bonds/shares to the lender

on the day the securities lending arrangement is entered into the borrowers unconditional obligation to

close out any securities lending arrangement will be allowed as a deduction (initial deduction) under

the provisions of section 11(a) and section 23(g);

The amount of the initial deduction will be equal to the estimated market value of the borrowed

bonds/shares on the date the securities lending transaction is entered into (provided the estimated

value is the same value used for management reporting purposes); and

In the year of assessment when the borrower acquires the bonds/shares in order to close-out any

securities lending arrangement and the cost of the bonds/share acquired is in excess of the initial

deduction a further deduction in terms of section 11(a) will be allowed and where the cost of the

shares is less than the initial deduction the excess amount will need to be recouped in terms of section

8(4)(a).



[Based on legislation applicable as at 31 July 2007]

The applicant is a sole trader and intended transferring the assets of its businesses to companies and

close corporations. It intended do so in terms of an asset for share transaction as provided for under

section 42 of the Income Tax Act in terms of which the assets would be transferred to the companies

and CCs in exchange for the issue of shares and members interests.

The ruling was inter alia that –

The proposed transactions fell within the ambit of section 42 of the Income Tax Act;

The companies would need to issue further shares in exchange for the assets;

The CCs would not be required to issue any further member's interest in exchange for the assets

transferred to them – the fact that the applicants percentage interest remains unchanged does not affect

the applicability of section 42;

The share premium reflected in the records of the companies, representing the differences between the

par value and the fair value of the shares does not constitute consideration other than shares as

envisaged by section 42(4)(b) of the Income Tax Act (roll-over relief does not apply to the extent that

the transferee receives consideration other than equity shares); and

The proposed transactions conducted in accordance with the provisions of section 42 will not attract

donations tax under the provisions of section 54 of the Income Tax Act.



The applicant company wanted to provide shares to certain directors at an affordable price. It intended

to do this by transferring its business as a going concern to company A in which it would own 70% of

the shares and the relevant directors would own 30% indirectly through a trust. The purchase price of

the business would be left outstanding as a loan, a portion of which would be interest-bearing. The

directors, through the trust, would have been able to acquire the shares at a low value since

presumably the net asset value of the company would have been relatively low.

In summary the ruling was that –

The roll-over provisions in section 45 would apply to the transfer of the business assets;

The applicant and company A would be deemed to be one and the same person for VAT purposes in

accordance with section 8(25) of the VAT Act;

Company A would be entitled to a deduction of interest under section 24J and 23(f) and (g) of the

Income Tax Act; and

Section 8C would apply to the acquisition of the shares by the directors via the trust.



[Based on legislation applicable as at 29 February 2008]

The applicant is a resident company which will acquire the shares in Company A. The primary

objective of the applicant is to acquire the business of Company A and integrate it with the rest of its

operations. The shareholders of Company A however indicated that they were only willing to sell the

shares in Company A and not the business assets.

The applicant intends to acquire the business of Company A by purchasing all the shares in Company

A and then to liquidate Company A and distribute the business assets to be integrated into its business

operations. The shape and character of the proposed transaction are inspired entirely by commercial

reasons.

On the basis that no dividend would be declared to any shareholder of the applicant and that steps

would be taken to liquidate Company A within 6 months, the ruling is that –

The interest incurred on the bank loan to acquire the business of Company A as a going concern (to

form an integral part of its operations through the acquisition of shares in Company A), will be an

expense incurred in the production of income and will be deductible in accordance with section 24J.



The applicant is a resident private equity fund, housed in a vesting trust, which will invest in

infrastructure projects. The vesting beneficiaries are investors (whether resident or non-resident) in

whom the ownership of the trust assets are vested. The fund manager is a resident company that will

manage the applicant.

The applicant will acquire shares in companies or advance loans to companies and will earn income in

the form of dividends, interest, fee income and capital receipts on the disposal of assets. The vesting

beneficiaries will participate in each income stream on the basis of their pro rata participation ratio.

The ruling was that –

Income received or accrued as a result of any investment made by the applicant will be subject to

income tax in the hands of the vesting beneficiaries under section 25B of the Income Tax Act;

Where the vesting beneficiaries have vested rights in the income and capital of the applicant, they will

be liable for any capital gains tax that arises on the disposal of any assets administered by the

applicant;

Paragraph 80 of the Eighth Schedule (CGT legislation) will not be applicable on any capital gain

realised on the disposal of any of the assets as the asset would have vested in the vested beneficiaries

on the date the assets were acquired by the applicant;

The applicant will be required to register under section 23(1) of the VAT Act as a vendor; and

The applicant will be required to apportion the VAT incurred on expenses in accordance with a

method approved by the Commissioner.



[Based on legislation applicable as at 12 December 2007]

A foreign collective investment scheme will redeem or repurchase a participatory interest from the

applicant, a resident collective investment scheme in securities.


The amounts paid by the foreign collective investment scheme upon redemption or repurchase of

shares, units or any other participatory interest will not constitute a dividend as defined in

section 1 of the Income Tax Act.



It was intended that two co-operatives would be amalgamated into the applicant in accordance with

section 44 – Amalgamation Transactions. Under section 44(13) an amalgamated company is required

to have taken steps to liquidate, wind-up or deregister after its assets are sold to the resultant company.

The ruling sets out what steps the co-operatives were required to take to comply with the requirements

of section 44(13).


[Based on legislation applicable as at 15 October 2009]

The applicant company entered into a “Draft Deed of Donation” whereby it undertook to construct

specific buildings and thereafter donate those buildings to a certain tax and VAT exempt recipient

(Recipient). The applicant company would not only be required to pay the contractors and service

providers for the construction of the buildings but it would also have to donate certain building

materials required for the construction of the buildings. Certain of the provisions of the agreement

between the parties required that no consideration would be payable by the Recipient, the donation

would fall within the ambit of section 18A of the Income Tax Act and the Recipient would

acknowledge the donation in its annual financial statements. The Recipient would also be required to

acknowledge the donation by prominently displaying a sign at the entrance of each building and

allowing the applicant company to display a permanent plaque on each building.

The ruling determined that –

The Recipient would not be required to account for VAT on the donation received as it is not a VAT

vendor and will not be making any taxable supplies to the applicant company;

The applicant company would not need to levy and account for VAT on the donation made as the

supply of the buildings is made for no consideration and in terms of section 10(23) of the VAT Act

the value of the supply is deemed to be nil;

The applicant company will be entitled to claim the VAT as and when incurred on the construction

costs of the buildings as input tax in terms of section 16(2)(a), read with the definition of “input tax”

in section 1 and subject to sections 16(2), 17 and 20 of the VAT Act; and

The applicant company will not be required to make an adjustment with regard to the building

materials to be donated in terms of section 18(1) of the VAT Act.


Editorial comment: Refer to Item 1822



The applicant is a South African resident company that used to be exempt from tax. Company Z is a

wholly-owned subsidiary of the applicant. The applicant is currently winding up Company Z and will

be repatriating profits to South Africa in the form of foreign dividends.

Company Z is a controlled foreign company in relation to the applicant and the applicant has included

Company Z's income in its income in accordance with section 9D since 1 January 2001. Since the

income earned out of profits relating to the period 1 January 2001 have been included in the

applicant's income, any distributions out of these profits are exempt under section 10(1)(k)(ii)(cc).


Any dividend declared out of profits accumulated before and after Company Z became taxable is

exempt in accordance with section 10(1)(k)(ii)(dd).


[Based on legislation applicable as at 4 March 2009]

The applicant is a manufacturing company whose manufacturing process has a hazardous effect on the

environment.

The applicant will incur the following expenses at active and non-active decommissioned operations –

The acquisition of new capital structures for environmental protection purposes, such as new waste

disposal sites, storm-water dams, canals, similar permanent structures and improvements to existing

structures, and;

Decommissioning, remediation and clean-up costs in respect of existing waste disposal sites, dams or

other structures of a similar nature.


Environmental expenditure incurred in respect of applicant's active operations will be deductible

pursuant to the provisions of section 11(a) provided the requirements are met;

Environmental expenditure incurred from a trade previously carried on (i.e. non-active operations)

whilst the applicant is trading will be deductible pursuant to section 37B(6); and

The phrase “from a trade previously carried on” as contained in section 37B(6) does not require a

taxpayer to have ceased trading altogether before being eligible for the deduction contemplated under

section 37B(6).



[Based on legislation applicable as at 1 April 2008]

The applicant is a listed company with various employee share-incentive scheme trusts for different

categories of employees and management. The applicant intends making cash grants to the trusts to

enable the trusts to acquire shares to allocate to employees.

The ruling was –

The cash grants made by the applicant to the various share trusts will be deductible under section

11(a); and

The provisions of section 23H will apply to the expenditure to be incurred in respect of the grants to

be made to the various share trusts.



The applicants are co-owners of three properties situated in Botswana. The applicants have been

appointed to administer the properties which constitute capital assets of the applicants in their own

right. The applicants intend –

Forming Newco and subscribing for shares in Newco;

The applicants will grant Newco 99 year leases (renewable for a further 99 years at the option of

Newco) in respect of the properties;

Newco will issue shares in exchange for the rights under the leases; and

The shares in Newco will confer certain rights of use of the properties and of the facilities on the

properties which will be regulated in a Shareholder and Use Agreement.

Based on certain conditions and assumptions the ruling is that –

The proceeds in the form of shares in Newco will be of a capital nature and will be subject to capital

gains tax in the hands of the applicants; and

The leasing of the property will be regarded as a part-disposal of the asset as contemplated in

paragraph 33 of the Eighth Schedule (the CGT legislation).


[Based on legislation applicable as at 8 January 2009]

The ruling deals with the issue of whether the requirements for a 'foreign business establishment' have

been met for the purposes of the exemption from the controlled foreign company rules under

section 9D.

Cliffe Dekker Hofmeyr

IT Act: s 1 para (b) of the definition of ‘company’, s 8(4)(m), s 9D, s10(1)(k )(ii)(dd), s 11(a), s

12(5), s 20(1)(a)(ii), s 20(3)(b), s 23(f) and (g), s 24J, s 25B, s 37B, s 42, s 45, s 54, s 64C(2)

Eighth Schedule: para 3(b) and para 33

VAT Act: s 8(25), s 10(23), s 16, s 17, s 20

Editorial comment: More detailed information in regard to the facts underlying each ruling can be

obtained from the SARS website under the Law and Policy section.


1818. Objections and appeals Aggrieved taxpayers are entitled to ask the South African Revenue Service (SARS) to provide

adequate reasons for an assessment at which it has arrived.

That’s what rule 3(1)(a) promulgated under section 107A (the Rules) of the Income Tax Act No. 58 of

1962 (the Act), says. Written notice of the request must be submitted within 30 days of the date of

assessment and it suspends the running of the 30-day period within which a taxpayer may lodge an

objection.

Ideally, the reasons given by the Commissioner should put the aggrieved taxpayer in a position to

decide whether the assessment should be challenged. After the taxpayer has received SARS’ reasons –

or where the reasons weren’t provided on the grounds that adequate motivation had already been

given, or where the taxpayer did not request any reasons, the taxpayer may lodge an objection against

the assessment.

The Commissioner may allow or disallow the objection. But, where an objection is disallowed by the

Commissioner, either in full or in part, the taxpayer may appeal.

Unlike the issuing of assessments, neither the Rules nor the Act provide an aggrieved taxpayer with a

process to request reasons for the disallowance. Clearly, a taxpayer who is considering appealing

against the disallowance of their objection, and does not have the benefit of requesting the

Commissioner’s reasons and did not previously request reasons, would be disadvantaged.

Section 33 of the Constitution provides that everyone has the right to administrative action that is

lawful, reasonable and procedurally fair. Everyone whose rights have been adversely affected by

administrative action has the right to be given written reasons.

Furthermore, section 5(1) of the Promotion of Administrative Justice Act, 3 of 2000 (PAJA), holds

that any person whose rights have been materially and adversely affected by administrative action and

who has not been given reasons for the action may, within 90 days after the date on which that person

became aware of the action or might reasonably have been expected to have become aware of the

action, request the administrator concerned to furnish written reasons.

It follows, therefore, that a taxpayer, aggrieved by the disallowance of his objection, has the right in

terms of the Constitution and PAJA, to request written reasons for the Commissioner’s decision. On

receipt of the request, under PAJA, the Commissioner is obliged to give the taxpayer adequate written

reasons for the disallowance within 90 days.

While the Act does not confer on a taxpayer the right to request reasons for the disallowance of the

objection to an assessment, the taxpayer does have that right under the Constitution and PAJA.

However, exercising the rights under PAJA comes with some disadvantages. Under PAJA, unlike

under Rule 3 of the Rules, a request for reasons does not stop the running of the period within which

an appeal must be lodged. Therefore, even though PAJA requires the Commissioner to respond to a

request for reasons to SARS within 90 days, the Rules require that an appeal must be lodged within 30

days from the date of the notice of disallowance. In practice, a taxpayer should within the 30-day

period, submit a request for reasons and also lodge a notice to appeal, subject to a reservation of the

right to supplement the grounds of appeal based on the Commissioner’s response to the request for

reasons made under PAJA. Alternatively, a taxpayer could submit the request for reasons and only


once they have been received, submit a notice of appeal against the disallowance of their objection. In

terms of section 83(1A), the taxpayer may submit a notice of appeal after the 30 days period has

passed, provided the Commissioner is satisfied that reasonable grounds exist for the delay in

submitting the notice. The latter option obviously carries more risk, especially in the event the

Commissioner decides on the facts that the delay caused by waiting for written reasons is not a

reasonable ground or that adequate reasons had already been given.

In the Guide on Tax Dispute Resolution, SARS expresses the view that, where a taxpayer has already

been provided with adequate reasons, whether in terms of Rule 3, PAJA or otherwise, that taxpayer

will not again be able to request reasons in respect of the same assessment or decision. Should this

view be correct, it is even more important for the Rules to be changed.

There is, therefore, a lacuna in the law, specifically in the provisions of the Act and the Rules, as

neither provides the taxpayer with a process to exercise his/her rights to request reasons provided for

under the Constitution and PAJA. A process of this nature would enable the taxpayer, prior to noting

an appeal, to request reasons for the disallowance of an objection.

This inconsistency should be rectified by an amendment to the Rules to recognise the taxpayers’ right

to request reasons even after the objection stage. An amendment to this effect would not be complex

as the Rules could be drafted on the same principles as the current Rule 3, which governs the request

for reasons in respect of assessments.


IT Act: s 83(1A), s 107A Rule 3(1)(a)

Promotion of Administrative Justice Act, 3 of 2000: s 5(1)

Editorial comment: The issue has now been addressed in the new Draft Tax Administration Bill.


1819. Electronic funds transfers to SARS? This article considers the question as to when a taxpayer has fulfilled the obligation to pay the South

African Revenue Service (SARS) if such payment is made via electronic funds transfer (EFT).

The discussion will centre on the following example: in terms of paragraph 2(1) of the Fourth

Schedule to the Income Tax Act No.58 of 1962 (the Act), an employer has an obligation to pay SARS

the employees' tax (PAYE) he has withheld from remuneration paid to his employees within seven

days after the end of the month during which the amount was deducted or withheld. Suppose an

employer proceeds to transfer such amount to SARS on the seventh day by EFT. However, the funds

are only reflected in SARS bank account the next day. Has the employer failed to pay SARS within

the seven days permitted?

It appears that SARS is of the view that payment has only been made once the relevant amount is

reflected in its bank account (for example, the SARS Reference Guide Provisional Tax,

10 July 2010 states at page 7 that “where payments are done electronically, provision must be made

for your bank's cut-off times and for a clearance period that could take between two and five days”).

If this is correct, then the employer in our example above will be liable for a penalty of 10%

(paragraph 6(1) of the Fourth Schedule) and interest (section 89bis).

However, "paid" is not defined in the Act and there are no other provisions in the Act, nor do there

appear to be any tax cases, which provide guidance as to whether or not "paid" means that SARS must

actually have access to the funds, or if the funds must merely have been transferred by the taxpayer.

In Nedbank Ltd v Pestana [2009] (71 SATC 97), the Supreme Court of Appeal (SCA) had to consider

whether or not a bank could reverse an EFT made by a bank in contradiction of a notice issued by

SARS in terms of section 99 of the Act. The court held that a completed and unconditional payment

had been effected when the bank credited the plaintiff's account, with the result that the bank could

not unilaterally reverse the credit. Whilst this case provides guidance as to the unconditional nature of

an EFT, it does not provide clarity as to when payment by EFT is considered to be effected.

There is no legislation in South Africa governing EFTs and little guidance as to the legal

consequences arising from transactions of this nature. Fein in Law of Electronic Banking (2000 at xxi

quoted in Schultze SA Merc LJ (2008) at page 290) goes so far as to say that "any research on the

legal principles underlying electronic credit transfers is no more than an exercise in search of a law

where little is to be found at present".

Meiring Juta's Business Law (1998) at page 39 states that the legal principles established in court

decisions concerning the moment of payment of cheques should apply with equal force to EFTs,

because they are both effected through the same system (this system is discussed below). If this is

correct (the rules of this system are confidential and it is not clear if a cheque payment is processed in

the same way as an EFT once in the system), then guidance in respect of the moment of payment for

EFT can be found in such court decisions.

In Volkskas Bank BPK v Bankorp BPK (h/a Trust Bank) en ‘n Ander [1991] 2 all 324 (A) (Volkskas),

the then Appeal Division (AD) had to determine when payment by cheque had been effected. The AD

held that the issue had to be answered in the context of the system which the banks use to clear

cheques, namely the system operated under the auspices of Automated Clearing Bureau (Pty) Ltd

(ACB). Malan on Bills of Exchange, Cheques and Promissory Notes in


South African Law (2009) (Malan) at page 244 states that the ACB was established by the

South African clearing banks in 1973 to provide for the computerised collection and payment of

cheques. This system uses sophisticated electronic data equipment and processes cheques by means of

magnetic ink character recognition. Provisional debits and credits are generated in the books of the

collecting and drawee bank which become final in the absence of notice of dishonour by the drawee

bank to the collecting bank within a prescribed period.

The AD in Volkskas applied the law of obligations and held that payment is a bilateral juristic act

which requires the co-operation of both parties. Therefore, the mere decision by the drawee bank to

pay a cheque does not constitute payment. The court found in effect that, in light of the way in which

the ACB operates, ordinarily payment is made when the time limit allowed by the ACB for

dishonouring has expired and there has been no notification of dishonour (the position could be

different where the collecting bank and the drawee bank are one and the same). Until then, payment

can be countermanded. As previously mentioned, the rules governing the ACB are confidential and

the court therefore had to rely on testimony by bank representatives who had knowledge of how the

system operates.

At first blush, Volkskas seems to support the proposition that payment made by EFT is not effected

merely when the taxpayer decides to pay SARS and initiates transfer of the funds by EFT. However, if

one assumes the ACB processes EFTs in the same way in which cheque payments are processed, it

could lead to an attractive argument that payment by EFT is made as soon as the payer initiates the

EFT, based on the premise that an EFT cannot be countermanded (discussed below).

In Take and Save Trading CC and Others v Standard Bank of South Africa Ltd 2004 (4) SA 1 (SCA)

(Take and Save Trading), the SCA dealt with an appeal against the decision of the judge in the court a

quo (Combrinck J) not to recuse himself for bias.

Two questions before the court a quo that are applicable to this discussion were:

• whether or not the defendant had given instructions to reverse an EFT that he had made and, if so,

• whether such instructions could have been carried out.

A bank representative ("Ms B") was called as a witness to explain how electronic banking works.

Ms B told the court a quo that an EFT amounts to an immediate transfer of money by a client from

one account to another. She also testified about an inter-bank agreement under the auspices of the

ACB which provides that without the beneficiary's consent an EFT cannot be reversed.

After hearing this evidence, Combrinck J expressed the view that the second of the two

aforementioned questions before the court could not be answered in favour of the defendant

(i.e. could not be answered in the affirmative). The defendants' legal team then withdrew without

proffering any reason. The judge stated that he thought that the withdrawal occurred because counsel

had lost faith in the case which, he said, was not surprising considering the evidence that had been led.

The defendants argued that the views expressed by Combrinck J created a reasonable apprehension of

bias because the judge had effectively judged the case even before the plaintiff's case had been closed.

The defendants therefore applied by way of notice of motion for the judge to recuse himself. He

refused the application and the defendants appealed this decision.


The SCA dismissed the appeal, stating that a deadly legal point forcefully made by the Court during

argument cannot give rise to an apprehension of bias in the eye of the "reasonable, objective and

informed" litigant in possession of “the correct facts".

If, in fact, an EFT cannot be countermanded once initiated (without the permission of the payee) then,

following the ratio of Volkskas, it could potentially be argued that the moment of payment by EFT

occurs at the point in time when a taxpayer proceeds to transfer funds by EFT and not when the funds

are reflected in SARS bank account. A payee might object to the imposition of the ACB rules on his

affairs since these rules govern inter-bank transactions. However, it is argued in Malan that, in the

same way a person instructing his mandatory to buy or sell in a certain market will be bound by the

rules of that market when they are notorious, certain, reasonable and legal whether or not he has

knowledge of them, a customer instructing his bank to collect payment of a cheque will be bound by

any clearing house rule when it is notorious, certain, reasonable and legal. Presumably the same

should apply to payment by EFT.

It is important to note, however, that Paget's Law of Banking (1996), commentating on English Law,

argues that “payment usually involves the transfer of money, or the performance of some other act,

tendered and accepted in the discharge of a money obligation” and that payment by EFT “will be

deemed to be complete when the creditor is given the unconditional (in the sense of unfettered and

unrestricted) right against his own bank to the immediate use of the funds transferred”.

Accordingly, although the argument that payment is made as soon as the taxpayer initiates payment

could potentially provide a defence against the imposition of penalties and interest by SARS for late

payment when funds are transferred by EFT initiated by the due date. In light of the uncertainty in

respect of the moment of payment when funds are transferred by EFT, it would be prudent to ensure

that payments to SARS by EFTs are made timeously so as to reflect in SARS's account within the

prescribed period. Where the payments are substantial and the time value of money cost of paying a

day or two early is material, clarity should be sought from SARS or National Treasury as to whether

or not a payment effected by the taxpayer on the due date for payment by EFT will satisfy the

requirement of the relevant revenue Act.

There are a number of other issues that arise with regard to EFTs which cannot be dealt with in this

article but should be kept in mind. For example, who is entitled to the interest on the funds once the

taxpayer has initiated payment by EFT but the funds are not yet reflected in SARS's account? Further,

does it matter what time of day the payment is initiated by the taxpayer? In light of the prevalence of

payments by EFT, further clarity on the legal nature of such payments would be a welcome addition to

our law.


IT Act: s 89bis, Fourth Schedule par 2(1) and par 6(1)


INTERNATIONAL TAX

1820. Profits of a foreign partnership

The decision of the Tax Court in ITC 1819 [2007] (69 SATC 159) has now been upheld by the Free

State High Court on 17 September 2009 in Grundlingh v CSARS [2009] ZAFSHC 88.

Grundlingh, an attorney, was a resident of South Africa. He was admitted to practice as an attorney in

both South Africa and Lesotho.

He was a partner in the firm known as Webbers in Bloemfontein, and was also a partner in the

separate Lesotho-based partnership, known as Webber Newdigate, which had a fixed place of

business in Lesotho.

Grundlingh’s share in the profits of Webber Newdigate was taxed by the Lesotho fiscal authorities.

SARS included those self-same profits in Grundlingh’s taxable income for the tax years in question,

and credited him (in terms of Article 22(1) of the South Africa — Lesotho Double Tax Agreement)

(the DTA) with the amount of tax he had paid to the Lesotho revenue authorities on those profits.

Grundlingh objected to the assessment and contended that, in terms of the DTA, his share in the

profits of Webber Newdigate was taxable only in Lesotho, and were not taxable in South Africa.

It is clear (see the judgment at para [10.1]) that, in terms of South Africa’s residence-based tax system,

a resident of the Republic is taxable on his world-wide income, subject to the provisions of a DTA.

Grundlingh argued that article 7(1) of the DTA provided such an exception and was applicable in the

present case. Article 7(1) of the DTA provides that —

The profits of an enterprise of a Contracting State, shall be taxable only in that State unless the

enterprise carries on business in the other Contracting State through a permanent establishment

situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be

taxed in the other State but only so much of them as is attributable to that permanent establishment.

The court rejected Grundlingh’s argument, holding (at para [10.8]) that Article 7(1) was inapplicable

because the partnership, Webber Newdigate, was not an “enterprise” that was taxable in Lesotho.

The court reached this conclusion (see para [10.3]) on the basis that, in Lesotho, as in South Africa, a

partnership is not a separate taxable entity. In terms of Lesotho’s income tax system, a partnership is

taxed on the same basis as in South Africa, namely (see the judgment at

para [10.5]) that the partners are taxable as individuals, and the partnership is not liable to tax in its

own right.

Thus, as a partner in Webber Newdigate, it was Grundlingh who was liable to tax, and not the

partnership.

The court pointed out that, in terms of section 24H(2) of the South African Income Tax Act No.58 of

1962, each partner in a partnership is deemed to be carrying on the business of the partnership.


For tax purposes, therefore (see the judgment at para [10.8]) Grundlingh was deemed to be carrying

on the business of Webber Newdigate, and any portion of the profits of the partnership that were

received by Grundlingh, was deemed, in terms of section 24H(2), to be generated by him.

Consequently, relief from double taxation in the present case was provided by Article 22(2) of the

DTA which provided that —

In South Africa, taxes paid by South African residents in respect of income taxable in Lesotho, in

accordance with the provisions of this Agreement, shall be deducted from the taxes due according to

the South African fiscal law. Such deduction shall not, however, exceed that part of the income tax, as

computed before the deduction is given, which is attributable to the income which may be taxed in

Lesotho.

In the result, SARS’s assessment of Grundlingh, in terms of which his share in the profits of Webber

Newdigate was included in his taxable income and he was credited with the tax he had paid to the

Lesotho revenue authorities (see para [2]) was held to be correct.

Grundlingh’s appeal against the assessment was therefore dismissed and the assessment confirmed.

PricewaterhouseCoopers

IT Act: s 24H(2)

Articles 7(1) and 22(1) of the South Africa – Lesotho Double Tax Agreement


1821. India-Mauritius treaty During the past decade, Mauritius has become the single largest foreign investor in India and is

responsible for 44% of all investments routed through Mauritius. Investors mainly enter India via

Mauritius because of the favourable double tax agreement concluded by the two countries.

In terms of Indian domestic law, any gains derived from the sale of shares in an Indian company are

taxable in India, regardless of whether the shareholder is a resident or non-resident, whereas Mauritius

on the other hand, does not impose any tax on capital gains.

Article 13 of the treaty between India and Mauritius (Indian-Mauritius treaty), provides that any gains

derived from the disposal of shares will only be taxable in the country where the shareholder is a

resident. As a result, if a Mauritian incorporated company disposes of shares in an Indian company,

the gain derived from such a disposal will, in terms of the Indian-Mauritius treaty, not be taxable in

India but, the taxing right will move to Mauritius. This effectively results in the gain realised by the

shareholders escaping tax in both India and Mauritius.

Accordingly, in order to utilise the favourable capital gains tax regime in Mauritius, many South

African investors have incorporated intermediate holding companies in Mauritius through which

investments into India are routed.

There have been a number of cases in India in 2008 and 2009 where the Indian Revenue Authority

(IRA) sought to tax the gains on the disposal of Indian assets, despite the provisions of the Indian-

Mauritius treaty. The thrust of these cases was based on whether the provision of a tax residence

certificate (TRC) issued by the Mauritian tax authority was sufficient to entitle the Mauritius company

to claim exemption from capital gains tax in India. Although earlier court cases went in favour of the

taxpayer, more recent cases, and notably in Mumbai, cast some doubt on whether the possession of a

TRC certificate would be sufficient to entitle the company to treaty benefits.

In one particular case, the principle of beneficial ownership was successfully used to deny the

intermediate Mauritius holding company the benefit of the treaty. It was held that the Mauritius

intermediate holding company merely held the interest in an Indian company on behalf of a US

company and therefore, by effectively piercing the corporate veil, the court held that the US-India

treaty and not the Mauritius treaty must be applied. This was on the basis that the Mauritius company

was not the beneficial owner of the shares in the Indian company. In another 2009 case, the IRA

attacked the effective management of the Mauritius company, arguing that as the company's only asset

was located in India, the effective management, and therefore tax residence, of the Mauritius company

was deemed to be in India on this basis. However, it must be noted that the IRA was unsuccessful in

this case.

In a further attempt to 'attack' what the IRA views as a substantial loss to revenue, the proposed

amendments to the Indian Direct Taxes Code (the Code) contains a provision that may significantly

alter, not only the current situation with Mauritius, but may impact also upon the operation of all

Indian treaties.

Currently a non-resident company, which earns Indian sourced income, has the option to select the

application of either the Indian-Mauritius treaty or the local domestic law, whichever is more

beneficial. However, the Code proposes an amendment to India's domestic law, which would

effectively nullify the effects of the treaty. The proposed provision provides that neither the treaty nor


domestic law will receive automatic preferential treatment, but if there is a conflict between the

provisions, the provision which was established later in time will prevail. The practical implication

thereof is that the Code, which is only expected to come into force in 2011, will in a conflict situation

automatically override all the treaties that are currently in force.

The second significant proposal contained in the Code is the amendments to the General Anti-

Avoidance Rules (GAAR). In terms of the Code, the application of the GAAR will be triggered if:

• the main purpose of a transaction is to obtain a tax benefit; and

• such a transaction has been entered into or carried out in a manner not normally employed for

bona fide business purposes, or which has created rights and obligations that would not be

normally created between persons dealing at arm's length, or which will result in the misuse or

abuse of the provisions of the Code; or

• if the transaction lacks commercial substance.

The Code proposes that a sufficiently broad definition for an "Arrangement" to include a wide array of

transactions, including the interposition of an entity or a transaction where the substance of the entity

or transaction differs from the form. Effectively, these proposed changes will empower the IRA to

declare an arrangement as an impermissible avoidance arrangement and, once so declared; the IRA

could ignore the tax treaty, disregard an intermediary holding company and tax the income in the

hands of the parent company. An arrangement would be presumed to have been entered into for the

main purpose of obtaining a tax benefit and the taxpayer would bear the onus of demonstrating that a

tax benefit was not the main purpose of the arrangement being entered into.

In light of the changes proposed by the Code, the risks for South African companies are twofold:

• firstly, the IRA will, upon introduction of the proposed amendment to the Code be able to

disregard the application of the Indian-Mauritius treaty and tax the capital gains in India; and

• secondly, South African groups' intermediate holding companies run the risk of being attacked

under the new Indian GAAR, which may result in the IRA denying the benefits of the Indian-

Mauritius treaty.

South African companies have to be mindful of the proposed expanded version of the GAAR, as

many South African companies have incorporated holding companies in Mauritius with the main

purpose to facilitate investments into India, and as a result many of these Mauritian companies may

lack substance and only comply with the minimum requirements to enable the company to qualify for

the Mauritius TRC, and qualifying as a non-resident for South African tax purposes.

Under the proposed new GAAR, the IRA can look through the intermediate holding company and

apply the South Africa-India treaty. In such an instance, the Double Taxation Agreement (DTA)

between South Africa and India will become applicable and in terms of Article 13 of this DTA, any

gains derived from the alienation of shares, if the assets of such a company consists principally of

immovable property, may be subject to tax in India.

It is important to note that the burden of proof rests on the South African company to demonstrate that

the intermediate holding company arrangement is not in the nature of an impermissible avoidance

arrangement. However, this onus will be discharged with great difficulty if there are no valid

commercial reasons for the incorporation of the Mauritian holding company, other than to obtain a tax

treaty benefit.


Consequently, in order to discharge this burden of proof and avoid triggering the application of the

Indian GAAR, South African companies will have to carefully consider the necessary steps that can

be taken to ensure that there is sufficient commercial substance for the existence of the intermediate

holding companies in Mauritius.


Article 13 of the India - Mauritius Double Tax Agreement


VALUE-ADDED TAX

1822. Supplies for no consideration

The deduction of input tax by associations not for gain was recently considered by the Tax Court in

Case No. VAT 711. The judgment, which was delivered on 14 August 2009, has created quite a stir as

to whether input tax may be deducted when businesses distribute goods or services, including gifts

and samples, free of charge.

The facts

The appellant was KCM, an interdenominational Christian ministry with its sole objective being to

promote, minister and spread the Word of God. Its headquarters are in the USA and it has established

branches in several countries, including South Africa.

KCM’s teachings and messages are spread by the use of television presentations, radio broadcasts,

conventions, books, CDs, DVDs, videos, tapes, magazines, the internet and personal correspondence.

In South Africa, KCM prints a magazine, ‘The Believer’s Voice of Victory’, which it distributes free

of charge. KCM also operates a bookshop where it sells books, CDs, DVDs and other religious

material. However, the profits generated from these sales contributed to no more than 15 per cent of

its total income. The major source of its income consisted of voluntary donations received.

KCM claimed the VAT incurred by it for purposes of printing and distributing the magazine as input

tax. SARS raised an assessment to disallow input tax credits claimed by KCM relating to — what

SARS called — ‘non-taxable supplies’, being the religious magazine distributed free of charge.

The judgment

The Johannesburg Tax Court held that the concept of ‘consideration’ is fundamental to an enterprise

and that a gratuitous act, therefore, cannot constitute a supply of goods or services for a consideration.

It was held that the supplies of the magazines, “having been made by the appellant not for

consideration, but for distribution free of charge accordingly do not qualify as taxable supplies and

must therefore be regarded as non-taxable supplies”.

The VAT Act provides that where a supply is made for no consideration, the value of the supply is

deemed to be nil. KCM argued that this provision does not say that a supply made for no

consideration is not a taxable supply and that input tax can be claimed even in the absence of

consideration. However, the Tax Court disagreed and held that KCM’s appeal must fail.

The implications of the judgment

A Tax Court judgment merely has persuasive value, as it is binding only on the parties involved.

Nevertheless, the judgment has created concern amongst VAT practitioners as many VAT vendors

would be at risk if the judgment represents the approach which will in future be followed by SARS

and the courts.

While the judgment relates to a non-profit organisation, the impact of the judgment could be much

wider. Since the input tax requirements of the VAT Act do not distinguish between non-profit

organisations (other than welfare organisations, which may generally deduct all VAT incurred as input

tax) and commercial businesses, the effect of the judgment is also that commercial businesses handing

out gifts or free samples, or rendering services for free, are not entitled to deduct VAT relating to

those free supplies as input tax.


Such a result would, however, conflict with the practice which has applied since the introduction of

VAT. In fact, SARS previously issued rulings confirming that VAT vendors may deduct input tax in

respect of gifts and samples (unless the input tax denial relating to entertainment applies).

Requirements for claiming input tax

When determining whether VAT incurred by a VAT vendor on the acquisition of goods or services

may be deducted as input tax the only question is whether (and, to what extent) the goods or services

have been acquired for the purpose of consumption, use or supply in the course or furtherance of

making taxable supplies. A ‘taxable supply’ is a supply by a VAT vendor of goods or services made

in the course or furtherance of an enterprise carried on by the VAT vendor. An ‘enterprise’ is an

activity carried on continuously or regularly, wholly or partly in South Africa, in the course or

furtherance of which goods or services are supplied for a consideration, whether or not for profit.

Therefore, the first test is whether a person carries on an ‘enterprise’. Assuming all other requirements

are met, it is evident that a business which generally sells goods or renders services for a consideration

will be carrying on an ‘enterprise’. It is thus not required that all supplies must be made for a

consideration for the activity to constitute an ‘enterprise’. (This is, of course, quite logical, otherwise

very few businesses would have been regarded as carrying on VAT enterprises, as the distribution of

gifts, samples and other free goods or services is often the rule rather than the exception.)

Having established that the business carries on a VAT enterprise, the second test is whether a specific

supply of goods or services will be made ‘in the course or furtherance’ of that enterprise. If the answer

is ‘yes’, the supply will be a taxable supply and VAT incurred to make such a supply qualifies as input

tax. But if the answer is ‘no’ the supply is not a taxable supply and VAT incurred to make the supply

cannot be deducted as input tax.

Thus, whether or not that specific supply is made for a consideration, is not an issue when determining

whether input tax may be claimed. Instead, the crucial question is whether an ‘enterprise’ is carried on

and whether the specific supply is made in the course or furtherance of that enterprise.

Accordingly, it is largely a factual question whether a vendor carries on a VAT enterprise and whether

a supply is made in the course or furtherance of that VAT enterprise. Unfortunately, the Tax Court did

not deal comprehensively with the facts of the case in the judgment, as it was stated that the appeal

falls to be decided by reference to and interpretation of the relevant provisions of the VAT Act. It is

thus not possible to form a view, on a mere reading of the judgment, as to whether input tax should

have been allowed or not.

Has a binding private ruling (BPR 053) cleared the confusion?

The confusion created by the judgment may have been clarified to some extent (whether intentionally

or not) by the issuance of BPR 053 by SARS on 16 October 2009. The facts are that Vendor A pays

for the construction of certain buildings, which will subsequently be donated to B (not a VAT vendor).

B will merely acknowledge the receipt of the donation in its financial statements and annual report

and by prominently displaying a sign at the entrance to each building and by allowing A to display a

permanent plaque on each building.

SARS ruled that B does not have to account for output VAT on the receipt of the donation; A does not

have to account for output tax, as it will supply the buildings for no consideration; and A will be

entitled to claim the VAT incurred on the construction costs of the buildings as input tax.


This BPR is welcomed, as it reconfirms SARS’ established approach to the claiming of input tax,

where goods or services are distributed free of charge under taxable supplies.

Editorial comment: See item 1817 for a summary of BPR053.

Summary

The judgment in Case No. VAT 711 has created a risk that input tax may not be deductible where

goods or services are supplied by a VAT vendor for no consideration. However, the view is held, on

an analysis of the relevant provisions of the VAT Act, that:

• VAT vendors giving away promotional products may claim VAT incurred in acquiring or

producing these products as input tax;

• Associations not for gain (other than welfare organisations, which may generally claim all VAT

incurred as input tax), may claim input tax if the free-of-charge distributions take place in the

course or furtherance of a VAT enterprise;

• VAT vendors expending VAT on social responsibility activities (e.g. building a school and

donating it) will be entitled to input tax deductions, provided the goods or services are supplied in

the course or furtherance of the VAT enterprise (see BPR 053).

PricewaterhouseCoopers

VAT Act:


SARS NEWS

1823. Interpretation notes, media releases and other documents

Readers are reminded that the latest developments at SARS can be accessed on their website

http://www.sars.gov.za

26 February 2010: Legal & Policy : Interpretation Note: No. 54 Section 23(o) of the Income Tax Act,

1962 – Deductions – Corrupt activities, fines and penalties

24 February 2010: SARS reminds taxpayers with car allowance to record their odometer readings

17 February 2010: Impending Changes -subsistence allowances

12 February 2010: Legal & Policy - Interpretation Note no. 53 Section 23A of the Income Tax Act,

1962 - Limitation of allowances granted to lessors of affected assets.

02 February 2010 Legal & Policy: Draft Interpretation Note:- Section 25D of the Income Tax Act,

1962 - Rules for the translation of amounts measured in foreign currencies. Comments can be

submitted to [email protected] before or on 8 March 2010

Editor: Mr M E Hassan

Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof KI Mitchell, Prof

L Olivier, Prof JJ Roeleveld, Prof PG Surtees.

The Integritax Newsletter is published as a service to members and associates of the South African

Institute of Chartered Accountants (SAICA) and includes items selected from the newsletters of firms

in public practice and commerce and industry, as well as other contributors. The information

contained herein is for general guidance only and should not be used as a basis for action without

further research or specialist advice. The views of the authors are not necessarily the views of SAICA.

All rights reserved. No part of this Newsletter covered by copyright may be reproduced or copied in

any form or by any means (including graphic, electronic or mechanical, photocopying, recording,

recorded, taping or retrieval information systems) without written permission of the copyright holders.

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