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[2018] ZAWCHC 104
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Kangra Group (Pty) Ltd v Commissioner for the South African Revenue Service (A20/18) [2018] ZAWCHC 104; [2018] 4 All SA 383 (WCC); 2019 (1) SA 520 (WCC); 81 SATC 59 (27 August 2018)
IN THE HIGH COURT OF
SOUTH AFRICA
WESTERN CAPE DIVISION,
CAPE TOWN
REPORTABLE
CASE NO: A20/18
(Tax
Court Case No 13671)
In
the matter between:
KANGRA
GROUP (PTY) LTD
Appellant
And
COMMISSIONER
FOR THE SOUTH AFRICAN
REVENUE
SERVICE
Respondent
Coram:
Gamble and Salie-Hlophe JJ, Thulare AJ.
Date
of Hearing: 30 July 2018.
Date
of Judgment: 27 August 2018
JUDGMENT
DELIVERED ON MONDAY 27 AUGUST 2018
GAMBLE, J:
INTRODUCTION
[1]
On 20 April 2017 the Tax Court dismissed an
appeal by the appellant (hereinafter interchangeably referred to as
“
the Group
”
or “
the taxpayer
”)
against a determination by the respondent (“
SARS”
)
that the taxpayer was not entitled to claim a deduction of R90m in
the 2007 tax year, a deduction which was alleged by the taxpayer
to
be an expense in the production of income. The taxpayer approaches
this court on appeal in terms of s133 of the Tax Administration
Act,
28 of 2011 (“
the TAA
”).
[2]
The
history of this matter goes back to the turn of the century. At that
stage, Kangra Group (Pty) Ltd was a private company through
which the
late Mr. Graham Beck conducted his various commercial interests, each
such interest in a separate operating division.
As the evidence
before the Tax Court reveals, Mr. Beck was a South African
entrepreneur of note who had various business interests
over the
years in,
inter
alia
,
the wine industry
[1]
and retail
stores
[2]
, as well as horse
racing and thoroughbred breeding
[3]
.
But these, according to his former accountant and co-director in the
Group, Mr. Alistair John Rogan (who testified on behalf of
the
taxpayer before the Tax Court) were essentially loss making ventures
adjunct to Mr. Beck’s primary business interest
which was the
exploitation, beneficiation and sale of coal.
[3]
Mr. Beck, who died in 2010 in his 81
st
year, was described in various obituaries placed before the Tax Court
as a hard-working person of great entrepreneurial and philanthropic
spirit, albeit that at times he was also dubbed “
a
bit of a rough diamond”
. For
instance, it was said that he was one who concluded deals through
mutual trust and a handshake and was not averse to concluding
informal agreements with clients with the material terms being
recorded “
on the back of a
cigarette box
”. In any event,
over the years Mr. Beck’s company acquired mineral interests in
collieries in KwaZulu Natal from whence
it exported coal extensively
through the port of Richards Bay. In 2006 his net worth was said to
be in excess of R1.08bn.
[4]
Mr. Rogan testified that round about 2000
he advised Mr. Beck of the pending introduction by the Government of
a mining charter
which was intended to promote Black economic
advancement in the mining industry and suggested to him that it was
time to acquire
a Black empowerment partner in the coal business run
by the Group. Mr. Beck was amenable to the suggestion and decided to
approach
the Shanduka Group. His decision in that regard was a
strategic move given that the executive chairman of Shanduka at the
time
was Mr. Cyril Ramaphosa, who in February 2018 was sworn in as
South Africa’s fifth President. According to Mr. Rogan, Mr.
Beck approached Mr. Ramaphosa because of the latter’s long
history of involvement with the National Union of Mineworkers.
[5]
Mr. Rogan explained that in 2003 the coal
business was hived off from the Group and Kangra Coal (Pty) Ltd
(“Kangra Coal”)
was established, with the necessary
mining rights, contracts and the like being transferred to that
entity. Mr. Rogan said that
Mr. Beck valued the coal business at R1bn
and the transfer thereof to Kangra Coal was structured accordingly.
Initially the Group
continued to hold the shares in Kangra Coal and
its management and personnel continued to run the coal mining
business as before.
As Mr. Rogan explained, there was really just “
a
change of
stationery
”.
No money actually changed hands and the sale of the coal business was
essentially an accounting exercise whereby a loan
account was created
in the books of the Group reflecting Kanga Coal’s indebtedness
to it.
[6]
As I understand it, as part of the
restructuring of the coal division, a deal was concluded between the
Group and Shanduka in terms
whereof the latter acquired part of the
shareholding in Kangra Coal for a purchase consideration of R250m and
the assumption of
its outstanding liabilities to the Group. The
directors of Kangra Coal were then Messers Beck, Ramaphosa and Rogan,
but Mr. Beck
remained the driving force (or “
guiding
mind
”) behind the coal business.
Subsequently, Shanduka acquired effective control of Kangra Coal but
that development is not
relevant to these proceedings. Suffice it to
say that all executive and management decisions relevant to this
matter were made
by Mr. Beck personally. Further, I should stress
that the events relevant to this case occurred before Shanduka
acquired control
of Kangra Coal and Mr. Ramaphosa is not in any way
implicated in this litigation.
THE AMCI DEAL
[7]
Before the Tax Court the parties made
common cause in relation to certain facts. It was agreed that on 12
December 2001 the taxpayer
and AMCI Export Corporation (“
AMCI
” – an American coal trader
with its head office in Pennsylvania) concluded an agreement which
was partly oral and partly
written for the delivery of 540 000
metric tons of coal by the taxpayer to AMCI between January and
December 2002. This was
referred to by the taxpayer as “
the
first agreement
” and it is common
cause that both parties duly performed (at least in part) their
obligations in terms thereof.
[8]
It was further common cause that on 3
December 2002 the taxpayer and AMCI concluded a further partly oral,
partly written agreement
for the delivery by the Group of a further
750 000 metric tons of coal to AMCI. This was referred to by the
parties as “
the second agreement
”
and pursuant thereto the taxpayer was obliged to deliver that
quantity of coal to AMCI during the period January to December
2003.
The agreement in terms whereof Kangra Coal was established (“
the
sale agreement
”) was concluded on
25 March 2003 with Mr. Beck signing on behalf of both parties. The
effective date of the sale agreement
was 1 July 2003, a date which
fell squarely within the currency of the second agreement.
[9]
The papers before the Tax Court reveal that
AMCI claimed that the Group did not deliver the full quantity of coal
due under both
the first and second agreements by the end of 2003 and
it relied on a further oral agreement extending the duration of the
agreements
so that the balance of the order would be delivered in
2004 at the rate which applied to the second agreement –
US$27.50
per metric ton. That extension agreement was disputed.
[10]
During the currency of the second agreement
there was a significant escalation in the international price of
coal. Mr. Rogan said
that while the rate agreed upon under the first
agreement was US$ 24,50 per metric ton, in the market place it went
up to around
US$ 40 per metric ton in 2003. Notwithstanding the
increase in price, and after the establishment of Kangra Coal, Mr.
Beck accepted
that that corporate entity was contractually bound,
under the sale agreement, to supply coal to AMCI at US$ 27,50/ton.
The effect
of the relevant terms of the sale agreement was that
Kangra Coal was likely to be less profitable because the Group was
locked
into the deals with AMCI and Kangra Coal could not sell its
coal on the open market at the prevailing higher price.
[11]
It seems as if an attempt was made by Mr.
Beck to persuade AMCI to accept the delivery of coal in 2004 at a
higher price but the
buyer stood its ground. Mr. Rogan testified that
Mr. Beck thereafter elected not to abide by the terms of the second
agreement
thereby placing the Group in default of its obligations to
AMCI. In the absence of direct evidence from Mr. Beck as to the
reasons
for this decision, Mr. Rogan was left to tender hearsay
evidence and to resort to speculation. As he put it –
“
Mr.
Beck was running Kangra Coal – he was the boss, and he said
don’t deliver to AMCI. He got tired of their complaints,
about
the quality of the coal. He identified other opportunities in the
market and sold the coal for US$40 to third parties instead
of US$25
per metric ton to AMCI.”
[12]
It is reasonable to infer in the circumstances that Mr. Beck, an
astute businessman
with an eye for a bargain, looked at the numbers
and decided to take his chances on the profits to be made by Kangra
Coal selling
coal on the open market at the higher price per ton
while permitting the Group to default on its obligations to AMCI. In
the result,
during August 2004 the taxpayer refused to deliver the
balance of the order to AMCI, thereby repudiating its contractual
obligations.
[13]
As will appear more fully hereunder, the concession before the Tax
Court by Senior Counsel for the taxpayer (who was not the lead
counsel on appeal) that the repudiation was occasioned by Kangra
Coal
[4]
is wrong in law and the
taxpayer cannot be not bound thereby.
[5]
THE ARBITRATION
PROCEEDINGS
[14]
As a consequence of the Group’s failure to fulfill its
obligations to
AMCI, the latter commenced arbitration proceedings in
Johannesburg in 2006 for contractual damages for the non-delivery of
coal,
claiming in excess of US$15m from the Group. The claim was
based, firstly, on the alleged short delivery of 72 950 metric
tons of coal in 2004 under the first agreement, claiming damages of
US$3 354 717 and legal costs of US$100 000 and
€60 000. The second part of the claim in arbitration
alleged a further short delivery in 2004 of 300 000 metric
tons
under the second agreement. The claim was for damages of
US$12 146 668 and costs amounting to £410 592.
[15]
In formulating its statement of claim, AMCI averred that as a
consequence of
the Group failing to honour its contractual
obligations, AMCI was in turn unable to honour its obligations to a
third party to
which it was contractually bound to on-sell the coal,
a Portuguese company known as CarboPego. In the result, AMCI
said that
it had been exposed to claims for damages by CarboPego and
the legal costs associated therewith in the High Court in England and
sought to recover those amounts from the Group after such damages had
been determined in the English court.
[16]
The arbitration proceedings were opposed but were eventually settled
on 5 September 2007 when Mr. Beck conceded the claims and agreed that
the Group would pay AMCI the sum of R90m. A simple two page
agreement
was concluded between the two corporate principals - Mr. Beck on
behalf of the Group and Mr. Ernie Thrasher on behalf
of AMCI.
[17]
While it was common cause that the exchange rate at the time was
US$1=SAR6,00,
the precise basis for the quantification of the
settlement was never established before the Tax Court given Mr.
Beck’s demise
in the interim. It was assumed by Mr. Rogan that
Mr. Beck had rounded off the claim brought by AMCI with reference to
the prevailing
dollar exchange rate and multiplied that with the
aggregate of AMCI’s claims in the sum of US$15 501 386,
the point
being that Mr. Beck effectively conceded the entirety of
AMCI’s claim and settled it with a lump sum payment which was
due
and payable forthwith. It is common cause that such payment was
duly made by the taxpayer to AMCI the following day, 6 September
2007.
THE TAXPAYER’S
CLAIM FOR DEDUCTION
[18]
When the taxpayer submitted its return for the 2007 tax year it
sought to claim
a deduction of R90m arising from the settlement with
AMCI. Its stance was that that amount had been reasonably and
bona
fide
incurred by the Group in the production of income and that
the amount was wholly and exclusively laid out and expended for the
purposes of the Group’s trade. In 2012 SARS assessed the
taxpayer on the basis that the said amount of R90m was not
deductible,
hence the appeal by the taxpayer to the Tax Court. The
nub of the case before the Tax Court therefore was whether the
payment by
the Group of the amount agreed upon in settlement of the
arbitration proceedings was deductible as “
relevant
expenditure
” in terms of s11(a) read with s23 of the Income
Tax Act, 58 of 1962 (“
the Act
”).
[19]
Prior to the commencement of the proceedings before the Tax Court the
parties
recorded certain common cause facts in terms of Rule 38(2)(a)
of the rules promulgated in terms of s103 of the TAA. In addition
to
that which is set out above, it was common cause that Kangra Coal
delivered coal to AMCI in terms of the second agreement and,
further,
that the taxpayer did not sell coal in the 2007 tax year. In
consequence thereof the parties recorded the material disputed
facts
as follows:
“
16.
Whether Kangra Coal delivered coal to AMCI, in terms of the [second
agreement], on behalf of the Appellant
or on its own behalf.
17.
Whether the Appellant’s obligation to deliver coal to AMCI in
terms of the [second
agreement] were (sic) transferred from the
Appellant to Kangra Coal.
18.
Whether Kangra Coal or the Appellant, on 5 August 2004, repudiated
its further obligations
to deliver coal to AMCI in terms of the
[second agreement].
19.
Whether AMCI did not consent to the cession of rights and delegation
of obligations under
the [second agreement] from the Appellant to
Kangra Coal, as contemplated in clause 12.1 of the [first] agreement.
20.
Whether AMCI did not give prior written consent for the assignment of
any rights or obligations
in terms of the purchase order.
21.
How the [sum of R90m] referred to in the settlement agreement between
the Appellant and
AMCI was calculated and compiled.”
It is axiomatic that the
taxpayer bore the onus of establishing the disputed issues.
[20]
At the commencement of the trial the taxpayer made certain additional
concessions to the effect that:
20.1
Kangra Coal delivered coal to AMCI in terms of the second agreement
on its own behalf and not on behalf of
the taxpayer.
20.2
The obligation to deliver coal to AMCI in terms of the second
agreement was transferred from the Group to
Kangra Coal
[6]
.
20.3
On 5 August 2004 Kangra Coal and not the taxpayer repudiated its
further obligation to deliver coal to AMCI
in terms of the second
agreement.
THE RELEVANT “
GENERAL
DEDUCTION
”
[21]
S11(a) of the Act, which deals with deductions which may legitimately
be made by a taxpayer
in relation to its taxable income, is to the
following effect.
“
11.
General deductions allowed in determination of taxable income
For
the purpose of determining the taxable income derived by any person
from carrying on any trade, there shall be allowed as deductions
from
the income of such person so derived –
(a)
expenditure and losses actually
incurred in the production of the income, provided such expenditure
and losses are not of a capital
nature…”
[22]
The point of departure is whether the taxpayer was carrying on a
particular
trade – an inference which must be made by the court
from the facts - and an inference which ultimately is a matter of
law.
[7]
It is not in dispute in
this matter that the Group carried on trade, both in the 2003 and
2007 fiscal years.
[23]
That criterion having been established, and applying
Sub-Nigel
[8]
,
the
court is then enjoined to apply the provisions of the Act to assess
whether the claimed deduction is in fact deductible.
“
(T)he
court is not concerned with deductions which may be considered proper
from an accountant’s point of view or from the
point of view of
a prudent trader, but merely with deductions which are permissible
according to the language of the Act…
Regard, therefore,
must be had to the Act and the Act alone in order to ascertain
whether the deductions sought to be made…
are permissible.”
[24]
The approach to the question as to whether an expense has been
incurred in the production
of income, as contemplated in s11(a) of
the Act, was articulated thus in
PE
Tramway
[9]
.
“…
(I)ncome
is produced by the performance of a series of acts and attendant upon
them are expenses. Such expenses are deductible expenses
provided
they are
so closely linked
to such acts as to be regarded as part of the cost of performing
them.
A
little reflection will show that two questions arise (a) whether the
act to which the expenditure is attached is performed in
the
production of income and (b) whether the expenditure is linked to it
closely enough
.”
(Emphasis added)
[25]
Accordingly, it has been said that there must a sufficiently distinct
and direct
relationship or link between the expenditure incurred and
the actual earning of the income. However, that relationship or link
may not always be self-evident. In
Nemojim
[10]
,
for instance, Corbett JA pointed out that:
“
(I)t
is correct… that in order to determine in a particular case
whether monies outlaid by the taxpayer constitute expenditure
incurred in the production of income important, sometimes overriding
factors, are the purpose of the expenditure and what the expenditure
actually affects.”
The
learned Judge of Appeal then referred to the earlier judgment of
Schreiner JA in
Genn
[11]
which is to the effect that
“
In
deciding how the expenditure should properly be regarded the Court
clearly has to assess the closeness of the connection between
the
expenditure and the income-earning operations, having regard both to
the purpose of the expenditure and to what it actually
effects.”
[26]
And, as the authors of
Silke
[12]
explain, with reference to
Nemojim
“
These
authorities clearly establish the point that, to rank as a deduction,
the expenditure must not only have been incurred for
the purpose of
earning ‘income’ as defined but there must be a
sufficiently distinct and direct relationship or link
between the
expenditure incurred and the actual earning of the income. As the
ensuing paragraphs reveal, these restrictive tests
result in the
disallowance of a vast number of business expenses that are
necessarily incurred in carrying on business but fail
to satisfy a
requirement that they be laid out for the purpose of earning the
‘income’.
[27]
In the result it was incumbent on the taxpayer to establish before
the Tax Court
that the conclusion of the settlement agreement with
AMCI was linked “
distinctly and directly”
with the
actual earning of income by the Group before it could qualify as a
deduction. To put it differently, it may be asked whether
the
taxpayer proved that such income as was produced by repudiating the
supply agreements with AMCI, was received by the Group
(or accrued to
it) as a consequence of such repudiation. To answer that question it
is necessary to have regard to the interplay
between the relevant
contractual obligations at play in 2003 – 4.
THE TAXPAYER’S
VARIOUS CONTRACTUAL OBLIGATIONS
[28]
In considering the application of the relevant provisions of the Act,
it is
necessary to consider the contractual obligations imposed on
the taxpayer. These were two-fold. Firstly there were the obligations
arising from the first and second agreements in terms whereof the
coal was to be delivered by the Group to AMCI. Secondly, there
were
the terms relating to the sale agreement.
[29]
The first agreement was concluded between Messers Beck and Thrasher
when the
latter telephonically placed an order for the delivery of
coal. That order was thereafter partially reduced to writing as
appears
from a purchase order dated 12 December 2001 transmitted by
fax from AMCI to the Group the following day. The purchase order,
which
stipulates the quantity, quality, dates and price of the coal
to be delivered, records that it was subject to the terms and
conditions
attached thereto, of which the following are relevant to
this appeal.
“
1.
AGREEMENT:
This purchase order
represents the entire agreement between Buyer and Seller and is a
binding contract upon the terms and conditions
herein set forth. No
change, modification or revision to this Purchase Order shall be
binding upon Buyer unless made in writing
and signed by one of
Buyer’s authorised representatives. Waiver by the Buyer of a
breach by the Seller of any provision of
this Contract shall not be
deemed a waiver of that breach or any other breach of the same or of
a different nature…
9.
FAILURE TO PERFORM:
If Seller
does not meet the specifications, terms and conditions of this
Purchase Order, or in the event of failure of Seller otherwise
to
perform its obligations as herein provided, Buyer may suspend or
cancel this Purchase Order, and shall be under no obligation
to
accept or pay for any coal not delivered or any services not
completely rendered. Buyer may hold Seller responsible for all
damages to buyer resulting from Seller’s failure to perform
under the terms and conditions of this Purchase Order…
11.
ASSIGNMENT:
Neither
this Purchase Order nor any rights or obligations herein may be
assigned by the Seller without Buyer’s prior written
consent.
Buyer may, during the term of this agreement, assign the rights or
obligations of this Purchase Order to a company which
is associated
with or a subsidiary of the buyer.
TAXES:
Seller agrees to assume all
liability under all laws that impose taxes or other exactions
applicable to the sale of coal under
this Purchase Order.”
[30]
The conclusion of the second agreement evidently followed a similar
modus operandi
:
a discussion between the two corporate principals followed by the
submission of a written purchase order. It is common cause that
the
pro forma
terms and conditions attached to that order (to which I shall
henceforth refer as “
the STC’s”
)
were the same as the first.
[31]
The interpretation of the various agreements (the settlement
agreement,
the purchase orders with their STC’s and the sale of
the coal business) must be considered in accordance with the
established
principles enunciated in
KPMG
and
the cases which follow it
[13]
.
The purchase orders accordingly fall to be interpreted by giving the
language used by the contractants its ordinary grammatical
and
syntactical meaning, the purpose being to achieve a sensible and
businesslike result while always having regard to the contextual
setting of the document. In
Betterbridge
the court usefully summarized the approach as “
a
unitary endeavour requiring the consideration of text, context and
purpose.”
[32]
Accordingly, it will be seen that clause 9 of the STC’s
preserves AMCI’s
common law right to hold the Group liable for
any damages suffered by it as a consequence of the latter’s
failure to perform
in terms of the purchase order. Further, one finds
that clause 11 of the STC’s precludes an assignment by the
Group of its
obligations under either the first or second agreement
to any other party without the prior written consent of AMCI. All of
these
rights and obligations are subject to the sole memorial clause
contained in clause 1 of the STC’s, which precludes reliance
on, for instance, an oral variation of the STC’s.
EXCURSUS
-
CESSION OF CONTRACTUAL
OBLIGATIONS BY THE GROUP TO KANGRA COAL?
[33]
It is perhaps convenient at this stage to deal with a procedural
argument advanced
by SARS. Notwithstanding the clear and express
provisions of clause 11 of the STC’s, SARS contended both in
the Tax Court
and on appeal that the taxpayer had actually ceded the
right to claim any income tax deduction in respect of the settlement
agreement
to Kangra Coal. It based that argument on the express
provisions of clause 12 of the sale agreement which clause traverses
sale
contracts
[14]
(and
policies of insurance) and records
[15]
that the parties would use their best endeavours
“
to
procure that all other parties (‘third parties’) to the
sale contracts… shall consent to the cession of rights
and
delegation of obligations thereunder from the seller to the purchaser
with effect from the effective date.”
[34]
Further, the Group and Kangra Coal expressly provided for the
possibility that the
consent of third parties to the transfer of
rights and obligations under the first and second agreements might
not be forthcoming
by agreeing
[16]
inter
se
that
“
..the
seller and the purchaser agree that, with effect from the effective
date, they will procure, as between them, that the rights
and
obligations under the sale contracts… shall be for the benefit
and account of the purchaser.”
This provision entitled
Kangra Coal to sell directly to AMCI under either the first or second
agreement and to receive the benefits
accruing from such sales and/or
carry the costs thereof.
[35]
Lastly, on this point, the parties agreed
[17]
that
“
all
risk in and benefits to the sale contracts shall be deemed to have
passed to the purchaser with effect from the effective date.”
[36]
To the extent that SARS then seeks to argue that the obligations of
the Group
towards AMCI were effectively transferred to Kangra Coal by
virtue of these terms, the absence of any prior written consent on
the part of AMCI has the effect that any purported cession of the
taxpayer’s contractual obligations towards AMCI is null
and
void in the circumstances
[18]
.
Nevertheless, SARS maintained its stance and asserted that the terms
of the sale agreement between the Group and Kangra Coal effectively
provided for the cession of all existing orders from the former to
the latter and that there therefore must have been such a cession.
[37]
Despite a call by SARS for the discovery of all documents recording
such cessions,
none emerged in the proceedings before the Tax Court.
There is therefore no evidential basis for SARS’ bald assertion
that
the obligation to deliver the balance of the coal due under the
second agreement must have been ceded by the taxpayer to Kangra
Coal.
On the contrary, the deeming provisions of clause 12.3 apply to the
facts at hand. That, in my view, is the complete answer
to SARS’
argument regarding the purported cession. In the circumstances,
absent any such cession, there was no privity of
contract between the
AMCI and Kangra Coal and it could only look to the Group for its
contractual damages
[19]
.
[38]
As a matter of fact, the parties conducted themselves accordingly.
AMCI asserted
its claim for contractual damages in arbitration
against the taxpayer and there was no defence raised by the Group
that the claimant
had sued the wrong party. In the circumstances, I
am driven to conclude that the Group was contractually bound to AMCI
to deliver
the quantity of coal agreed upon and, when Mr. Beck gave
the instruction not to deliver further, the taxpayer (and not Kangra
Coal)
was the party which repudiated the first and second agreements.
Further, such repudiation was fundamental to the settlement
agreement concluded by Messers Beck and Thrasher on 9 September 2007:
no other reasonable interpretation can be placed on the agreement
in
the circumstances.
[39]
SARS referred further in argument to the opening address of lead
counsel
for the taxpayer before the Tax Court in which the following
was stated with respect to the document filed under Rule 38(2)(a)–
“
It
is accepted by Kangra [the taxpayer] that the delivery by Kangra Coal
was made for its own benefit so there should be no issue
in dispute
any longer in respect of [disputed item] 16 (sic) we accept that the
deliveries were made by Kangra Coal for its own
benefit. What
deliveries were made, invoiced for and money paid would have gone
into the account of Kangra Coal.”
[40]
The concession raises two point. Firstly, the fact that with effect
from 1
July 2003 the Group no longer owned a coal division is neither
here nor there: it could readily procure the coal it was obligated
to
supply to AMCI from any source. As it happened, at that stage Mr.
Beck was still in effective control of Kangra Coal
[20]
and would have had no difficulty in seeing to it that the taxpayer
met its obligations to AMCI. Secondly, the fact that Kangra
Coal
invoiced AMCI directly for the coal it supplied to it and received
payment therefore directly from AMCI, does not negate or
undermine
the existence of the taxpayer’s on-going obligation
vis-à-vis
AMCI
to deliver coal to it. Kangra Coal was obliged, in terms of clause
12.3 of the sale agreement, to assume the taxpayer’s
obligations to AMCI and it was entitled, as an
adjectus
solutionis causa
,
to receive payment directly from AMCI.
[21]
[41]
Finally, it must be noted that under clause 12 of the STC’s the
parties
expressly agreed that the Group would be liable for any tax
implications arising from,
inter alia,
the second agreement
and pursuant thereto this obligation naturally fell at the door of
the taxpayer.
WAS THE PAYMENT OF
R90M LINKED TO THE EARNING OF INCOME?
[42]
SARS pointed out that during cross-examination Mr. Rogan was referred
to the
Annual Financial Statements (“
the AFS”
) of
both the Group and Kangra Coal for the period 1 July 2003 to 30 June
2004. These recorded that during that fiscal year the
sale of coal
was reflected as accruing to Kangra Coal and not the Group. Further,
the AFS showed a marked decrease in the revenue
of the taxpayer –
of the order of R411,63m - while Kangra Coal’s revenue shot up
by R381,02m. This state of affairs
is consistent with the terms of
clause 12.3 of the sale agreement.
[43]
There can be no debate therefore that coal was delivered to AMCI by
Kangra
Coal and that it (and not the taxpayer) received payment for
such deliveries. It is evident that Kangra Coal was the party which
would thus have attracted the liability to pay income tax in respect
of such revenue (if any such tax was payable), and it would
have been
the party entitled to make the relevant general deductions under
s11(a) of the Act.
[44]
As I have said, the sale agreement reflects that,
inter se,
it
was agreed that Kangra Coal was liable to deliver to AMCI the coal
which the taxpayer was contractually obligated to deliver.
And so,
when Mr. Beck gave the instruction that no further deliveries were to
be made to AMCI in 2004, he effectively wore two
hats – thereby
knowingly causing the taxpayer to default on its obligations to AMCI
and at the same time affording Kangra
Coal the opportunity to sell
its coal elsewhere at a better price and thereby increase its
revenue.
[45]
In this regard, it is self-evident that the refusal by Mr. Beck
to
deliver to AMCI meant that there was a significant tonnage of coal
available to Kangra Coal for delivery to another interested
buyer: a
buyer that was prepared to pay US$40/ton. But in order to afford
Kangra Coal the opportunity to earn that increased income
it was
necessary to repudiate the agreements with AMCI. However, that
repudiation came at a cost to the Group – it ultimately
had to
pay AMCI damages.
[46]
According to the statement of claim in the arbitration, the mass of
coal
that was not delivered to AMCI in breach of the first and second
agreements was of the order of 373 000 metric tons. The cost
of
this short delivery to AMCI (together with the attendant costs
relating to the litigation in England) amounted to just more
than
US$15m which it claimed as damages flowing from the breach. As stated
above, applying the applicable exchange rate at the
time this
amounted to the equivalent of around R90m, which formed the basis for
the settlement agreement.
[47]
In that context, therefore, it seems to me that it can be said that
the
settlement agreement was the price that was paid for the
opportunity to earn additional income from selling coal at US$40
rather
than US$25/ton: a return of more than 60% over what would have
been received had the coal been sold to AMCI. The question that
follows is, once again, two-fold. Can the payment of contractual
damages such as that incurred by the Group in settling the
arbitration
claim be termed expenditure in terms of s11(a) of the
Act? And, if so, did such expenditure result in the taxpayer earning
income?
WAS THE PAYMENT OF
R90M EXPENDITURE UNDER S11(a)?
[48]
It was submitted on behalf of the appellant before us that it
appeared
from the terms of the settlement agreement that the taxpayer
had paid the globular figure of R90m in full and final settlement of
its contractual obligations arising from the purchase orders placed
with it by AMCI. With reliance on
ITC
461
[22]
this
was said to constitute “
expenditure”
relating to the Group’s income generating activities in respect
of the first and second agreements.
[49]
The issue as to whether amounts paid in respect of damages and/or
compensation
constitute expenditure under the Act are dealt with in
some detail by
Silke
in Vol 2 at Para 7.27,
which passage includes a brief discussion of
ITC 461.
The approach is summarized by the authors thus at Vol 2, 7-61.
“
For
expenditure and losses paid by way of damages or compensation
resulting from negligence during the course of earning income
to be
deductible there must be a very close connection between the trade or
business carried on and the cause of the liability
for damages or, as
it has been put by the courts, the negligence must have constituted
an ‘inevitable concomitant’
of the trade.”
[50]
One of the leading Appellate Division cases on the point is
Joffe
[23]
.
The
matter involved an engineering company which supplied reinforced
concrete. A workman was killed due to the negligence of the
company
in executing a contract and it was required to pay damages to the
dependents of the deceased. The company’s claim
for a deduction
of the amount so paid was disputed by the Revenue and rejected by the
Appellate Division on the basis that the
company’s trading
operation was to intended to provide reinforced concrete, and that
negligent construction was not a necessary
concomitant of that
business. Watermeyer CJ dealt with the issue thus.
“
There
is nothing in the stated case to suggest that such negligence, and
the consequent liability which such negligence entailed,
were
necessary concomitants of the trading operations of a reinforced
concrete engineer; nor was it shown that the liability was
incurred
bona fide
for the purpose of carrying on any trading operation. Consequently,
according to the interpretation which I have suggested above,
the
payment of damages was not made for the purposes of trade.”
[51]
Applying that reasoning to the facts at hand one could ask the
following question.
“
Does
the business of delivering coal to A in terms an agreed contract of
sale with that party necessarily entail the concomitant
(or
simultaneous) duty (or right) to breach that contract in
circumstances where it is more profitable to conclude a contract with
B for the sale of the same
merx?”
I have little doubt that
the answer to that question is in the negative
.
Courts expect
contractants to honour their obligations to each other and where they
fail to do so the law penalizes such conduct,
for instance, by
granting the innocent party the right to resile from the agreement or
by awarding damages against the guilty party.
[52]
In
Joffe
[24]
,
it
was argued on behalf of the taxpayer that
“
(E)ven
if the expenditure in question was not the necessary concomitant of
the business of a reinforced concrete engineer, it was
an expenditure
necessarily arising out of the business methods employed by the
appellant and, consequently, was a deductible expenditure.”
The Chief Justice gave
this argument short shrift.
“
This
argument can be put in a slightly different form as follows:
Appellant has chosen to conduct his business in a manner which
necessarily leads to accidents in which third parties are injured and
in respect of which appellant has to pay damages, consequently
such
damages are a deductible expenditure. It is possible that this
argument can be refuted upon more grounds than one, but I shall
only
mention the following one: there is nothing in the stated case to
show that the appellant’s method of conducting business
necessarily leads to accidents, and it would be somewhat surprising
if there were. Consequently the basis of… [the] argument
disappears and it cannot be supported.”
[53]
It may well be that an incident of trading in coal is the breaching
of
a contract of sale. For example, there may be a breakdown in the
railway system resulting in the load not reaching the port on time
and the supplier may have to face a damages claim from the buyer
arising out of non-delivery. But that is a wholly different situation
to one where the supplier wantonly breaches its obligations in order
to secure a more lucrative contract elsewhere. As the authors
of
Silke
[25]
point out most of the cases discussed by them are fact-specific but
it seems to me that the answer probably lies in the following
dictum
of
Roper J in
ITC
815
[26]
.
“
[N]egligence
in itself affords no reason why a loss caused by it should be held to
be non-deductible. And there is no reason in
principle why it should
make any difference whether the negligence is that of employees or of
the taxpayer himself. Negligence
is an element of inefficiency, and
an inefficient taxpayer is taxed upon the income which he actually
earns and not upon that which
he would have earned had he been
efficient. Whether or not a loss caused by negligence would be
deductible, would depend upon the
facts of the particular case and
upon such matters as the nature and degree of the negligence and the
character of the business.”
[54]
If the law will not tolerate the consequences of commercial
inefficiency
for purposes of a deduction how can it be suggested that
an intentionally unlawful act can qualify as such? This is precisely
what
the court held in
PE
Tramway
[27]
.
“
If
the act done is unlawful or negligent and the attendant expense is
occasioned by unlawfulness or possibly the negligence of the
act then
probably it would not be deductible.”
[55]
In the result I must conclude that payment of the sum of R90m by
the
taxpayer in settlement of the claim in arbitration does not
constitute expenditure as contemplated under s11(a). But even if
I am
wrong on that score, I am of the view that the payment cannot be
regarded as allowable expenditure under the Act because it
was not
incurred in the production of the taxpayer’s income. I say so
for the reasons that follow.
[56]
As already stated, Mr. Beck’s conscious decision not to deliver
the full amount of coal due to AMCI resulted in that volume of the
mineral being available for sale on the open market at the higher
rate. But, that commercial opportunity only eventuated in 2004 when
the contract with AMCI was repudiated. At that stage the Group
was no
longer involved in the coal business having disposed of it to Kangra
Coal and the opportunity was therefore only capable
of being
exploited by Kangra Coal. This it did, as appears,
inter alia
,
from the increase in turnover of that company in the 2003/4 fiscal
year and the concomitant reduction in turnover on the part
of the
taxpayer.
[57]
In the result, I am not persuaded that the taxpayer established that
the relevant expenditure resulted in it earning any income, either in
that tax year or subsequent thereto: all income from coal
sales after
1 July 2003 accrued for the benefit of Kangra Coal. Furthermore, the
fact that the taxpayer continued to earn income
from other sources
after the disposal of the coal division to Kangra Coal in 2003 does
not in my view establish a sufficiently
direct link between the
expenditure claimed and the income earned by the Group.
[58]
It is evident, furthermore, that any income associated with the
alleged
expenditure actually accrued to the benefit of Kangra Coal.
That was the entity which reflected a substantial increase in
turnover
for the fiscal years in question and that entity has already
rendered its tax returns and claimed all related expenditure for
those
years. Mr. Beck’s decision to claim the deduction, not on
behalf of Kangra Coal but the Group, seems rather to have been
influenced by a number of other developments.
[59]
Firstly, Mr. Beck no longer had effective control of Kangra Coal at
the
time the deduction was claimed – control of the entity then
vested in Shanduka - and he was powerless to interfere in the
corporate affairs of the latter and seek to claim the deduction
through that entity.
[60]
Secondly, the terms of the sale agreement provided that the Group was
only liable for contingent liabilities which existed at the time of
the sale, all other liabilities having been transferred to
Kangra
Coal. The claim (and subsequent settlement) in the arbitration
proceedings was manifestly not a contingent liability at
the time the
coal business was sold as the repudiation of the AMCI deal had not
yet even occurred, let alone been acted upon.
[28]
[61]
Thirdly, as the Trial Court observed, Mr. Rogan testified that Mr.
Beck
was obviously reluctant to become embroiled in any dispute with
Shanduka as that might jeopardise the relationship with the purchaser
of the coal division which had paid a substantial amount of money for
the company. His decision to vest the claim in the Group
was
therefore a strategic one at the end of the day.
[62]
In the result I agree with the conclusion arrived at by the Trial
Court that
the taxpayer did not discharge the onus of establishing
that it was entitled to claim the general deduction contended for and
the
appeal against that finding must fail.
SECTION 89
QUAT
INTEREST
[
63]
Relying on the erstwhile provisions of s89
quat
(3)
of the Act, SARS levied interest on the taxpayer’s assessment
accordingly. The Tax Court rejected the taxpayer’s
argument
that it had contended that it was not liable for the deduction on
“
reasonable grounds
”
and confirmed the interest calculation. That finding by the Tax Court
is a further ground of appeal before us.
[64]
S89
quat
(3) of the Act, as it read at the relevant time, was to
the following effect.
“
(3)
Where the Commissioner having regard to the circumstances of the case
is satisfied that any amount
has been included in the taxpayer’s
taxable income or any deduction, allowance, disregarding or exclusion
claimed by the
taxpayer has not been allowed, and the taxpayer has on
reasonable grounds contended that such amount should not have been so
included
or that such deduction, allowance, disregarding or exclusion
should have been allowed, the Commissioner may, subject to the
provisions
of section 103(6), direct that interest shall not be paid
by the taxpayer on so much of the said normal tax as is attributable
to the inclusion of such amount or the disallowance of such
deduction, allowance, disregarding or exclusion.”
[65]
In his evidence before the Tax Court Mr. Rogan testified that, to his
knowledge,
the Group had taken legal advice from 2 independent
practitioners in relation to the arguments advanced to the respondent
in claiming
the deduction. One such practitioner was identified as a
Senior Counsel practicing at the Bar in Johannesburg who has
particular
expertise in tax law. However, those opinions were not
placed before the Tax Court which criticized the taxpayer for failing
to
do so. I am not sure that production of the opinions would have
made any difference in the circumstances as it could hardly have
been
the function of the Tax Court to assess the plausibility of the
advice furnished in circumstances where it refused to uphold
the
appeal before it.
[66]
In argument we asked the parties to address us on the correct
interpretation of the
phrase “
on
reasonable grounds”
as
it appears in s89
quat
(3)
and they were granted an opportunity to file a post hearing note in
that regard. In their respective additional submissions,
the parties
concurred that the test for such reasonableness was an objective one.
In
Attieh
[29]
the
Full Bench cited with approval the following passage from
Juta’s
Income Tax
Vol 2 –
“
The
test as to whether the grounds are reasonable, is objective, in
relation to the actions of the taxpayer. A mere subjective belief
by
the taxpayer that a deduction should be allowed, without taking
advice on the matter, is unlikely to be reasonable. On the other
hand, the reliance by the taxpayer on expert advice, even if this is
wrong, will in most cases constitute reasonable grounds for
the
action taken.”
[67]
In
Foskor
[30]
the Supreme Court of Appeal upheld the taxpayer’s claim for the
remittance of interest in circumstances where it had acted
on legal
advice for two decades, notwithstanding that a decision of the
erstwhile Appellate Division delivered in the interim had
found
differently on the law point in issue in that matter. The point is
that the court did not penalize the taxpayer for relying
on advice
which had subsequently been rendered wrong by virtue of the decision
on appeal. Further, the Supreme Court of Appeal
confirmed in
Foskor
that a court of appeal was at liberty to consider the question of
interest afresh and to substitute the decision of SARS in an
appropriate case.
[68]
In
Eveready
[31]
the
Supreme Court of Appeal commented as follows in regard to the
reliance on professional opinions.
[25]
Section 89(
quat
)(2)
levies interest on unpaid tax in certain circumstances but the
Commissioner may in his discretion waive that interest. On appeal
from his decision it is for the Tax Court to exercise that
discretion. The Tax Court found that Eveready had claimed the
deduction
in good faith on the basis of opinions that it had received
from 2 professional advisers. We are not sure that those opinions
were
quite as unequivocal as Eveready suggests but that is
immaterial. It is open to us to interfere only if the Tax Court
failed properly
to exercise its discretion. We do not think that
there are any grounds for finding that it did so and the cross-appeal
must fail.”
[69]
In my view, therefore, the authorities clearly establish that
reliance on incorrect
professional advice is not a bar to claiming a
remittance of interest. What matters only is whether such advice was
sought by the
taxpayer. It follows that the failure on the part of
the taxpayer in this case to produce the opinion from Senior Counsel
before
the Tax Court in order that that court could assess the
cogency of the advice rendered to the client, was not fatal to its
case.
What is important is the fact that the taxpayer took such
professional advice – something which was not disputed by SARS
– and therefore behaved reasonably in the circumstances.
[70]
In the result, I consider that the Tax Court failed to properly
exercise its
discretion in considering whether to grant a remission
of the interest levied by SARS and that it is open to this court to
interfere.
I should add that in delivering the argument in reply on
behalf of SARS, its legal representative very frankly and fairly
submitted
that the argument advanced by the taxpayer in this case had
caused a considerable amount of debate within SARS’ legal team,
thus demonstrating, once again, that the point was reasonably taken
by the taxpayer.
[71]
Consequently, the appeal against the refusal of the Tax Court to
grant the
taxpayer a remission in the payment of interest should
succeed.
COSTS
[72]
Costs will usually follow the result in an appeal, but where the
result is
not an unqualified success for one party then the costs
will, generally, be awarded in favour of the party that has achieved
substantial
success in the matter. In this case, both parties have
been successful. While we do not know what the extent of the
remittance
of
s89quat
interest translates to in monetary terms
we can assume, given the amount of the capital involved and the
duration of the period
over which it was liable to be levied, that it
is not an insignificant figure. That having been said, the bulk of
the time devoted
in argument, both in the heads and in court, was
directed to the deduction issue. In the result, it seems to me to be
fair to permit
SARS to only recover 50% of its costs on appeal.
ORDER OF COURT
A.
The appeal against the levying by the
respondent of interest in terms of s89
Quat
(3)
of the Income Tax Act, 58 of 1962 (“
the
Act”) in this matter succeeds.
B.
It is directed that the interest so levied
by the respondent in terms of s89
Quat
(3)
of the Act should be remitted to the applicant.
C.
Save as aforesaid, the appeal is dismissed.
D.
The applicant is to pay 50% of the
respondent’s costs on appeal.
GAMBLE,
J
I AGREE:
SALIE-HLOPHE,
J
I
AGREE:
THULARE,
AJ
[1]
Graham Beck Wines from the Madeba Estate near Robertson were served
at the inauguration dinners of Presidents Nelson Mandela
and Barak
Obama.
[2]
Stuttafords and Garlicks Department stores were once owned by the
Group.
[3]
The Highlands Stud bred many winners in the racing industry
[4]
See para 20.3 below
[5]
Government
of the Republic of South Africa and others v Von Abo
2011 (5) SA 262
(SCA) at [18] - [19]
[6]
As will appear hereunder this was based solely on a term of the sale
agreement.
[7]
CIR v
Stott
1928 AD 252
at 259.
[8]
Sub-Nigel
Ltd v CIR
1948 (4) SA 580
(A) at 588.
[9]
Port
Elizabeth Electric Tramway Co v CIR
1936 CPD 241
at 245.
[10]
CIR v
Nemojim (Pty) Ltd
1983 (4) SA 935
(A) at……
[11]
CIR v
Genn & Co (Pty) Ltd
1955
(3) SA 293
(A) at 299G
[12]
Silke
on South African Income Tax
Vol 2 para 7.8
[13]
KPMG
Chartered Accountants (SA) v Securefin Ltd
2009 (4) SA 399
(SCA) at [39]. See also
Natal
Joint Municipal Pension Fund v Endumeni Municipality
2012 (4) SA 593
(SCA) at [19],
Dexgroup
(Pty) Ltd v Trustco Group International (Pty) Ltd
[2014] 1 All SA 375
(SCA) at [10] – [17] and
Betterbridge
(Pty) Ltd v Masilo and others NNO
2015 (2) SA 396
(GNP) at [8].
[14]
Defined in the sale agreement with reference to an annexed list of
contracts which included the first and second agreements,
and which
fell to be transferred by the Group to Kangra Coal as a consequence
of the sale of the coal business contemplated in
the sale agreement.
[15]
Clause 12.1
[16]
Clause 12.2
[17]
Clause 12.3
[18]
Born
Free Investments 364 (Pty) Ltd v FirstRand Bank Limited
[2014]
2 All SA 127
(SCA) at [15]
[19]
Norman
Kennedy v Norman Kennedy Ltd
1947 (1) SA 790
(C) at 802.
[20]
“
There
was just a change of stationery
”
[21]
Norman
Kennedy
ibid.
[22]
(1940)
11 SATC 191
[23]
Joffe &
Co (Pty) Ltd v CIR
1946
AD 157
at 163
[24]
At 165
[25]
Vol
2 p7-64
[26]
(1955)
20 SATC 487
at
488
[27]
At 246
[28]
Commissioner
for Inland Revenue v Golden Dumps (Pty) Ltd
[1993] ZASCA 89
;
1993 (4) SA 110
(A) at 118G
[29]
Attieh
v Commissioner for the South African Revenue Service
[2016] ZAGPJHC 371 (11 August 2016) at [34]
[30]
CSARS v
Foskor
[2010]
3 All SA 594
(SCA) at [51]
[31]
Eveready
(Pty) Ltd v The Commissioner for the South African Revenue Service
[2012] ZASCA 36
(29 March 2012) at [25]