This is an appeal against the decision by SARS to disallow deductions in terms of 11(a) and 12C of the Income Tax Act (“IT Act”) and its decision to impose an understatement penalty (“USP”). The court dismissed the appeal with costs.
All reference to ‘section’ are to sections in the Income Tax Act 58 of 1962 (as amended) (“IT Act”), unless indicated otherwise.
During the 2011 tax year, ABC Trading (Pty) Ltd (“ABC”) acquired assets including three aircraft from JKL (Pty) Ltd (“JKL”), a connected party, as a going concern. The aircrafts were said to be valued at R 36 million. As payment, JKL was allotted 200 ordinary shares in ABC (said to be valued at R34 million) and ABC also assumed the on-going liability on the assets.
CSARS questioned the value placed on tools and equipment which were initially acquired by JKL from a connected entity and then on-sold to ABC, another connected entity.
Originally, ABC’s assessments for 2011 and 2012 reflected a nil tax balance due to its large taxable loss. Its balance sheet reflected that ABC had no assets and appeared to be dormant up to the date of the sale transaction.
Following an audit, SARS raised additional assessments on ABC in respect of the 2011 and 2012 tax years. The tax debt increased to a total of over R3 million. ABC was afforded an opportunity to consider the audit findings and submit further documentation as required. ABC did not respond and filed this appeal instead.
- Whether ABC was entitled to claim a section 12C deduction of 20%, in respect of assets it acquired from a connected person, JKL. The assets comprised of stock, aircraft parts, furniture, tools and equipment;
- Whether the appellant was entitled to claim a deduction in respect of finance charges under section 11(a), which finance charges arose from loans initially acquired by JKL from B Bank, which the appellant allegedly took over as a liability; and
- Whether the USP was appropriated imposed in terms of section 222 read with section 223 of the Tax Administration Act 28 of 2011 (“TA Act”).
Section 12C makes it clear that a deduction is allowed on the machinery owned or acquired by the taxpayer of 20% of the cost thereof. One of the considerations in the present matter is how ABC determined the value of its shares, issued in consideration for its acquisition of the assets.
CSARS submitted that when the sale was concluded, ABC had 1000 authorized ordinary shares. By implication, if 200 shares were equivalent to R34 million, the appellant’s 1000 shares were as the date of sale transaction worth about R170 million. There was no explanation by ABC as to how the value of its shares was determined. Furthermore, ABC was dormant prior to the sale transaction and owned no assets, accordingly, the valuation of R170 million seemed unlikely in the court’s view.
A witness for ABC testified that ABC reflected, in its financial statements, the cost of tools and equipment at R11 million and claimed depreciation at 20% on a straight line basis. He stated that there were no values and no cost attached to the individual items. This is because all the tools and equipment were acquired in one composite transaction in terms of the sale of business agreement, at a depreciated tax value in terms of the books of JKL.
When ABC submitted its statement of grounds for appeal, its witness prepared a complete list of the aforesaid tools and equipment wherein he inserted “new prices” for each item, on the basis that the goods were new and because second hand prices could not be obtained.
The effect of the letter of audit findings issued by SARS was that the depreciation of the tools and equipment was not taken into account as there was neither proof of nor payment related to the transaction.
The court ultimately held that ABC’s valuation methodology, in respect of the tools, equipment and its shares, had no legal basis.
- The deduction of finance charges was disallowed because:
- The original copy of the loan agreement signed by the relevant parties could not be found at B. Bank.
- The loan agreement which was provided by ABC was not signed by any of the relevant parties.
- The amount claimed was not reflected on the General Ledger.
- The loan agreement account number is reflected as 77161258 in the unsigned document; whereas the account number on the settlement letter and bank statement is reflected as 77196230.
Even if the court was persuaded that the loan was in the production of income, it would not have ignored some of the undisputed irregularities pointed out above.
Section 223 of the TA Act provides for the imposition of an USP in certain cases. CSARS elected to impose an USP of 100% on the basis of gross negligence on a standard case. In the court’s view, ABC’s conduct of not correcting the statements made on the returns, despite being afforded an opportunity to do so, constituted negligence. Accordingly, CSARS appropriately imposed the penalty.
The appeal was dismissed with costs.
Find a copy of the court case here.