Supreme Court slaps down Spur over tax deduction claims

The Supreme Court of Appeal (SCA) last week overturned a Western High Court ruling that a R48 million contribution to a Spur employee share trust was an expense in the production of income, and was therefore deductible.

In 2004, Spur launched a share incentive scheme for employees, with Spur Holding Company (HoldCo) being the sole capital and income beneficiary. In December that year, an amount of R48.4 million was paid into the trust by Spur. The trust deed was amended in 2010 to allow participants to benefit from dividends received by the trust, though Spur HoldCo remained the sole capital beneficiary.

“The purpose of the scheme was to promote the continued growth and profitability of Spur,” according to the SCA judgment.

Participants in the scheme were given ordinary shares in an entity (NewCo) and were prevented from dealing freely in these shares for a period of seven years.

Shortly thereafter, NewCo’s share capital was altered to create NewCo preference shares. The trust acquired 1 000 preference shares in NewCo, with an agreement that dividends would be paid at 75% a year of the prime interest rate, to be redeemed five years later – in December 2009.

When 2009 came around, the preference shares were redeemed at the rate of R48.4 million as previously agreed, while dividends amounting to R22.5 million were to be distributed to the trust.

The redemption of the preference shares and the payment of the dividends were settled by way of NewCo distributing to the trust a total of 6.7 million Spur HoldCo ordinary shares.

In December 2009, NewCo declared a dividend of R286.27 per ordinary share totalling R28.6 million to the ordinary shareholders of NewCo.

The share incentive scheme was terminated and NewCo deregistered on December 10, 2012, though the trust continues to hold Spur HoldCo shares that were distributed to it by NewCo.

Deductions claimed

A dispute arose with the South African Revenue Service (Sars) when Spur claimed the contribution of R48.4 million it made to the trust as a deduction against its income in terms of Section 11(a) of the Income Tax Act, with the claimed deductions spread over the period 2005 to 2012.

Spur claimed deductions of R3.46 million in 2005; R6.92 million for the years 2006 to 2011; and R3.46 million for 2012.

According to the SCA ruling, Sars initially allowed the claimed deductions but reversed this decision following an audit. The basis of the disallowance was that the R48.4 million contribution was not incurred in the production of Spur’s income over the period.

Sars reasoned that Spur HoldCo was the only party to benefit from the contribution to the trust.

The participants to the contribution were not beneficiaries, and this was confirmed by a Spur witness who confirmed that the R48 million in the form of Spur Corporation shares is still sitting in the trust, which means the participants have not benefitted directly from the contribution.

‘Misrepresentations and non-disclosures’

“Clearly, there must be a sufficiently close connection or link between the expenditure and the income earning operations of a taxpayer. The determination of whether the necessary link exists will require an examination of all the facts of a particular case,” reads the judgment.

“In light of what I have stated above, I therefore find that the misrepresentations and non-disclosures by Spur caused the Commissioner [of Sars] not to assess Spur correctly within the three-year period after the original statements.”

Though Section 99(1) of the Tax Administration Act does not allow Sars to make an assessment three years after the original assessment, this limited period does not apply where fraud, misrepresentation or non-disclosure of material facts is involved.

Sars’s appeal against the earlier Western Cape High Court ruling in Spur’s favour was upheld by the SCA, and Spur was ordered to pay the costs of the appeal.