Simulation

Tax , ,

In addition to specific anti-avoidance provisions and the general anti-avoidance provisions (GAAR) in the Income Tax Act,[1] the South African Revenue Service can apply another established principle to attack the validity of transactions and arrangements, namely the common law doctrine of simulation, or the plus valet doctrine. This is a fundamental principle of the South African common law that concerns itself with the true legal nature rather than the outward form of a transaction, essentially considering the substance of a transaction, rather than its form.

 

Application of the doctrine was recently under the spotlight again in the Supreme Court of Appeal in the matter of Sasol Oil v CSARS (923/2017) [2018] ZASCA 153 (9 November 2018). Sasol successfully appealed a judgment by the Gauteng Tax Court, which found that certain back-to-back transactions by entities in the Sasol Group were simulated and not genuine. Instead of Sasol in South Africa purchasing oil directly from a Sasol company incorporated in the Isle of Man, a UK company was interposed between the local entity and the Ilse of Man entity, the effect of which was that certain controlled foreign company rules in South Africa did not apply.

 

The court analysed statements from witnesses in the Sasol Group to determine what the reasons and commercial rationale were for the interposed UK entity. These witness accounts appear to have been crucial (if not the deciding factor) in the decision of the court that the transactions were not simulated or dishonest. In writing for the majority, Lewis JA found that:

 

“The transactions had a legitimate purpose. There was nothing impermissible about following…advice, and so reducing Sasol Oil’s tax liability. The transactions were not false constructs created solely to avoid…taxation.”

 

What is arguably more interesting, is the basis on which the minority found that the transactions were indeed simulated. Mothle JA, considering the same evidence, found that the transactions lacked commercial rationale, and this appears to be one of the main reasons for his dissent, demonstrated by the quotes below:

 

“At the risk of repetition, the…structure perpetuated duplication, with the identified inherent risk of absence of a commercial justification.”

 

“I would find that Sasol Oil failed to demonstrate to the Tax Court the commercial justification for interposing SISL (UK company) in the supply chain.”

 

“The failure to provide commercial justification for SISL revealed the absence of bona fides behind the transactions and as such, the additional assessments were justified.”

 

In the present case, Sasol was successful in proving the commercial rationale for their arrangement to the court. The important takeaway for taxpayers from the judgement is that the facts and circumstances of arrangements should be carefully documented when entering into transactions. Supporting documents, such as minutes of meetings, business plans and even internal notes could all prove to be vital in the assessment if a transaction is genuine, and not simulated.

 

[1] No. 58 of 1962

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Ring-fencing of assessed losses of certain trades – part 1

Tax , ,

Persons are generally allowed to set off any losses incurred in respect of one trade against the income derived from another trade, thereby reducing their overall tax liability.

 

However, section 20A of the Income Tax Act[1]ring-fences losses incurred by natural persons from certain trades under specific circumstances. If applicable, the natural person will not be able to set off the loss incurred from that trade against the income from any other trade, but may only set off the loss against future income derived from the trade to which the loss relates.

 

The rationale for this provision was to disallow natural persons to conduct hobbies disguised as trades in order to set off expenses from that hobby against other income such as salary income or professional income.

 

The first requirement for section 20A to apply, is that the natural person must fall within the highest income tax bracket during the relevant year of assessment.[2] For the 2019 year of assessment, the person’s taxable income and any assessed loss or balance of assessed loss of the taxpayer must be equal to or exceed R1.5 million.

 

The second requirement relates to the nature of the trade carried on by the natural person.[3] In this regard, he or she (or any relative of that person) must be engaged in one of the following trades. These include the practising of any sporting activity, any dealing in collectables, any animal showing by that person, any form of performing or creative arts or any form of gambling or betting performed.

 

Also included are the rental of residential accommodation or vehicles, aircraft or boats (unless at least 80% of the accommodation, vehicle, aircraft or boat is used by persons who are not relatives of the natural person for at least half of the year). Farming or animal breeding will also fall within section 20A unless such activities are engaged in on a full-time basis.

 

Furthermore, he or she must have incurred an assessed loss in at least three of the preceding five years of assessment, ending on the last day of the relevant year of assessment.[4]

 

Both these requirements must be met in order for the loss in respect of the specific trade to be ring-fenced.

 

The take away is that taxpayers with additional income sources should carefully consider the provisions of section 20A to the extent that the current ITR12 income tax return for individuals require taxpayers to indicate whether or not the losses are ring-fenced. Taxpayers may also be requested by the South African Revenue Service to confirm why section 20A should not apply in instances where that question was answered ‘no’.

 

[1] No. 58 of 1962

[2] Section 20A(2)

[3] Section 20A(2)(b)

[4] Section 20A(2)(a)

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Changes to Income Tax returns for trusts

Tax , ,

The South African Revenue Service (“SARS”) implemented several changes to the income tax returns for trusts (the ITR12T) on 26 February 2018. These changes apply in respect of the year of assessment ending on or after 28 February 2017, unless taxpayers have already saved or submitted the relevant 2017 ITR12T prior to the implementation of these latest changes.

 

One of the important changes includes the updating of the supporting trust participant schedule to the ITR12T in order to identify loans granted to the trust that are subject to the provisions of the newly introduced section 7C of the Income Tax Act.[1] This section deals with interest-free or low-interest loans to a trust that are made directly or indirectly by a natural person or a company in certain specific circumstances. Should these provisions apply, section 7C deems the interest foregone on the loan to be a continuing annual donation that attracts donations tax. This donation is deemed to be made on the last day of the year of assessment of the trust[2] (which is generally the last day of February) and is payable by the end of the month following the month during which the donation takes effect (which would then be the end of March).[3]

 

Also, trusts that are collective investment schemes or employee share incentive schemes are no longer required to disclose information relating to the details of persons that transacted with the trust. However, all other trusts must ensure that income distributed by the trust to other persons are fully disclosed. Additional validations in this regard were therefore also introduced.

 

Other amendments to the ITR12T include the introduction of a new local income type which relates to dividends that are deemed to be income in terms of section 8E and section 8EA of the Income Tax Act. (These provisions are aimed at penalising debt instruments that have been disguised as equity in order to avoid tax.)

 

The ITR12T also includes a new detailed schedule relating to learnerships for purposes of claiming the deduction in terms of section 12H of the Income Tax Act. Separate disclosure is required for learners with a disability and learners without a disability for both NQF levels 1 to 6 and NQF levels 7 to 10. Also, the number of learners and the allowance amount for each of these fields must be completed.

 

The take away is that trusts should carefully consider these new requirements in order to ensure that the new ITR12T is completed correctly.

 

[1] No. 58 of 1962

[2] Section 7C of the Income Tax Act

[3] Section 60(1) of the Income Tax Act

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Tax deductions against salary earnings

Tax , ,

Our clients who earn only a salary will know that very few tax deductions are available against salary income for income tax purposes and whereby they may reduce the taxable income derived ultimately from such remunerations. Section 23(m) of the Income Tax Act[1] provides that none of the deductions ordinarily available to taxpayers in terms of section 11 are allowed against salary income, other than for a limited few. We set out these deductions which are available below:

 

  1. Contributions made by taxpayers to a pension fund, provident fund or retirement annuity fund may be deducted against salary income in accordance with the provisions of section 11F;
  2. To the extent that an individual incurs legal fees, wear and tear-related costs or bad or doubtful debts as part of his/her employment, such expenditure will be deductible.[2] (Although it is possible that a wear and tear-related allowance may be available against a laptop or textbooks acquired as example, it is in our experience practically highly unlikely for legal fees, bad debts and doubtful debts to arise from an employment trade);
  3. Where amounts received, either as a restraint of trade payment or as ordinary remuneration for employment services rendered, are refunded by the employee, those amounts refunded may be legitimately claimed as an income tax deduction;[3] and
  4. Expenses incurred towards rent of, cost of repairs[4] of or expenses in connection with any dwelling, house or domestic premises, those costs may be claimed as deductions, to the extent that it is incurred as part of the individual’s employment and on condition that it does not offend the provisions of section 23(b) which deal with “home office” expenses.

 

Other than for the above, very few other deductions are available for individual taxpayers earning only a salary. Outside the ambit of section 11, the only other deductions which we typically encounter are medical aid contributions incurred, amounts claimed against travel allowances received or donations made to qualifying public benefit organisations. Of late, investments in section 12J “venture capital companies” may also be claimed as income tax deductions against salary income.

 

The above limitations only apply to salaried income received from employment though. Where an individual is also engaged in another trade (such as the renting out of an apartment), the above limitations do not apply to that separate trade. In such case, section 23(m) will not make the deductions in section 11 unavailable, although this is only as relates to the separate (rental) trade.

 

[1] No. 58 of 1962.

[2] Sections 11(a), (c), (i) and (j) respectively.

[3] Sections 11(nA) and (nB) respectively.

[4] In terms of section 11(d).

 

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

CGT exit charge

Tax , ,

In terms of section 1 of the Income Tax Act[1] a natural person will be a “resident” for tax purposes if that person is ordinarily resident in the Republic of South Africa (“the Republic”). Persons who are not at any time during the relevant year of assessment ordinarily resident in the Republic, will also qualify as “residents” if they meet the so-called physical presence test. The definition of “resident” furthermore specifically excludes any person who is deemed to be exclusively resident of another country for purposes of the application of any double tax agreement entered into between South Africa and that other country.

 

When leaving the Republic to go work and live in another country, it may therefore result in such person ceasing to be a “resident”. In these circumstances, careful consideration should be given to the possible capital gains tax (“CGT”) consequences which may arise.

 

Section 9H of the Income Tax Act provides that where a person ceases to be a resident for tax purposes, the person must be treated as having disposed of his/her assets for an amount equal to the market value of such assets (the so-called “CGT exit charge”), in other words, a price which would be obtained between a willing buyer and a willing seller on an arm’s length basis. This disposal is deemed to take place the day immediately before the individual ceases to be a tax resident. The person is furthermore deemed to immediately reacquire such assets at a cost equal to this same market value, which expenditure must be treated as an amount of expenditure actually incurred for the purposes of paragraph 20(1)(a) of the Eighth Schedule. In other words, the market value of the assets at the time of the exit will be treated as the base cost of such assets in the future.

 

The CGT exit charge does not apply to immovable property situated in the Republic held by that person or any asset which after cessation of residence becomes attributable to a permanent establishment of that person in the Republic. Also excluded are certain qualifying equity shares received in terms of broad-based employee share plans,[2] as well as qualifying equity instruments or rights to acquire certain “marketable securities”.[3]

 

Persons leaving the Republic either permanently or for extended periods should therefore consider whether or not they cease to be residents in the Republic for tax purposes and whether the CGT exit charges may apply to them.

 

[1] No. 58 of 1962

[2] See section 8B

[3] See sections 8A and 8C respectively

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

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