This is a tax court case dealing with an appeal from a taxpayer in respect of additional assessments raised by SARS on the basis that certain deposits (loan repayments) were treated as remuneration.
SARS raised additional assessments deeming loan repayments to have a revenue nature on the basis of substance over form and based on the lack of evidence to the contrary. SARS also contended that the loan repayments by the company repaying the loans were deposited in the taxpayer’s bank account by virtue of employment. The court found that the repayments are in fact capital loan repayments considering the transaction as a whole. It should be noted that the taxpayer did not directly advance the loan funds to the company making the loan repayments, but obtained the recovery right by means of a ceding arrangement. The Court subsequently dismissed the appeal with costs.
The taxpayer was previously employed by GP, a bureau de change.
SARS’ basis for the additional assessments comprised certain deposits into various of the taxpayer’s bank accounts. SARS analysed the relevant bank statements and concluded that the deposits appeared to have been by virtue of the taxpayer’s employment as a director of GP.
The taxpayer lodged an objection, essentially disputing SARS’ contention that he had under-declared income. In terms of the taxpayer’s objection:
- The taxpayer referred to two loans he advanced to GP through D Company, a company incorporated by him in the British Virgin Islands, when he resided in Zimbabwe. Over the years, the taxpayer made loans to D Company of approximately USD 1 500.
- The two loans advanced to GP comprised:
- USD 1 073 591.27 on 1 October 2004; and
- EUR 60 000 on 28 February 2006.
- D Company, in anticipation of it being wound up, ceded its loan claims against GP to the taxpayer during 2007. The taxpayer was substituted as GP’s creditor in the sum of ZAR 8 532 735.00.
- This was the reason why GP repaid the D Company loans to the taxpayer and debited D Company’s loan account.
SARS disallowed the objection and issued a Notice of Disallowance of Objection on the basis that the taxpayer’s affidavit is insufficient and on the basis that GP’s financial statements did not prove the taxpayer’s claim that the omitted amounts constituted loan repayments.
The essence of this appeal is whether the omitted amounts (various loan repayments) are to be characterised as ‘capital’ or as ‘income’.
SARS argued that a report (which had been submitted by the taxpayer into evidence) did not refer to repayment of the loan accounts but referred to ‘withdrawals’ as opposed to ‘loan repayments’. The judge finds that there is no merit in SARS’ argument, noting that: “The fact that the word ‘withdrawals’ was used instead of ‘repayments’ or that the terms were used interchangeably was irrelevant.”
The judge highlights that the issue in the case is the actual or real intention of the contracting parties (i.e. did the parties intend that as between them, the agreement would have effect according to its tenor?). If not, effect must be given to what the transaction really is. A number of cases was furnished by counsel for the taxpayer and considered by the judge in respect of the argument of substance over form.
The judge finds that an examination of the intention underlying the series of transactions in respect of the D Company loan account in GP reveals that the taxpayer advanced the funds to a trust for onward advance to D Company. Subsequently, as and when GP required capital, loans were advanced by D Company to GP. Those loans were recorded in GP’s financial statements during the relevant tax years.
The judge finds that “The purpose of GP’s repayment of the various loan accounts, be that by way of repayments or withdrawals, was to reduce the loan accounts...”
The judge finds that “There was no evidence that supported SARS’ suspicion that the omitted amounts were received by the taxpayer by virtue of his employment with GP or were of a revenue nature.” The following facts were considered by the court in support of the conclusion that the repayments were not of an income nature:
- There is a sufficiently close correlation between deposits received by the taxpayer and the reduction of loan account;
- No PAYE was withheld on the repayments; and
- The taxpayer was an independent majority shareholder during the course of the repayments.
Based on case law referred to, the judge adds that “the ‘substance and reality of the original transaction(s)’ is the ‘decisive factor’. The characterisation of the original transactions as loans is determinative of the outcome of this matter. The result is that the repayment of those loans by way of the omitted amounts is characterised by this Court as being of a capital nature.”
The application is dismissed with costs.
Find a copy of the court case here.