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[2011] ZAGPJHC 94
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Mobile Telephone Networks Holdings (Pty) Ltd v Commissioner for the South African Revenue Service (A5033/10) [2011] ZAGPJHC 94; 73 SATC 315 (1 July 2011)
SOUTH
GAUTENG HIGH COURT, JOHANNESBURG
CASE
NO: A5033/10
TAX
COURT CASE NO: 12401
DATE:01/07/2011
In
the matter between:
MOBILE
TELEPHONE NETWORKS
…......................................................................
Appellant
HOLDINGS
(PTY)
LIMITED
..........................................................
(Appellant
in the court a quo)
and
THE
COMMISSIONER FOR
THE
...........................................................................
Respondent
SOUTH
AFRICAN REVENUE SERVICE
..................................
(Respondent
in the court a quo)
JUDGMENT
VICTOR,
J:
[1]
This is an appeal from the Special Income Tax Court. The issues to be
determined in this appeal are:
1.1. Whether the Commissioner was
entitled to disallow appellant's expenditure incurred in respect of
audit fees for the years 2001,
2002, 2003 and 2004 tax years; and
1.2.
Whether the expenditure of R878 142 by the appellant in respect of
professional fees charged by KPMG for the training of staff
on a new
accounting package was wholly deductible,
[2]
The appellant initially appealed the Commissioner's finding to the
Special Tax Court and succeeded partially on the first issue
of the
auditing fees by obtaining a deduction of 50 percent on the auditing
fees for those tax years. It failed on the second issue
of the
deductibility of the cost of training of staff for the new Hyperion
accounting package.
[3]
The Special Tax Court referred the issue of the deductibility of
audit fees back to the Commissioner to enable him to make new
assessment for the years 2001, 2002, 2003 and 2004 tax years. The
Special Tax Court also confirmed that the expenditure of R878
142 in
respect of professional fees was of a capital nature was therefore
not deductible,
[4]
The respondent cross appealed in respect of the first issue and
submitted that the deduction of 50 percent of the audit fee
was
incorrect. The Commissioner had a allowed a very small deduction for
the audit expenses for the years in questions hence its
main
submission that no deduction should be allowed is puzzling and must
fail. It is the respondent's alternative argument that
the 50 percent
deduction ordered by the court a quo which must be considered in the
cross appeal on the issue of the audit fees.
[4]
The issues in the Special Tax Court related to the proper
interpretation of the Income Tax Act No 58 of 1962 (the act)
pertaining
to the deduction of expenses incurred in the production of
income. In terms of s 11(a) of the Income Tax Act 58 of 1962
expenditure
and tosses incurred in the production of income are
deductible whilst in terms of s 23(f) and (g) expenses which do not
constitute
income or laid out for the purposes of trade are not
deductible.
RELEVANT
BACKGROUND FACTS
[5]
The appellant is a wholly-owned subsidiary of the MTN Group Ltd and
has five wholly-owned subsidiaries. The collective business
of the
MTN Group is the provision of mobile telecommunication networks and
related services. It is common cause that the appellant
carries on a
trade. This aspect was agreed in a pre-trial meeting. The audit fees
(which were partially disallowed) were incurred
for the purposes of
complying with its statutory obligations to have its accounts audited
as well as for the purpose of trading.
The professional fees relating
to the second issue which were wholly disallowed were incurred when
the services of KPMG were provided
in order to train staff on the
computer accounting system known as the Hyperion system.
[6]
It is common cause between the parties that the appellant traded
during the years in question. Upon analysis the audit required
the
input and consideration of an auditor in respect of both the
dividends and accruals in the form of interest. The appellant
lent
money to its subsidiaries and also earned dividends from investments
made. The total dividend income represented the largest
portion of
its income of between 89 percent and 99 percent during the years in
question.
[7]
The applicable legal principles are clear but its application to the
facts introduces the complexities. In order for the expenditure
to be
deducted it must be incurred in the bona fide performance of the
operation
1
,
must have been incurred in the production of income and need not be
causally related to the income
2
, and regard must be had to the purpose of the expenditure and to
what it actually affects
3
.
[8]
The court a quo did not accept that the cost of statutory compliance
necessarily means that such costs amount to expenditure
incurred in
the production of income.
4
In applying the principle in Joffe &Co Ltd v Commissioner for
Inland Revenue
5
the court a quo found that the auditing fee was a function
necessarily attached to the earning operation. Without the audit it
could not comply with the JSE requirements to give comfort to
creditors and access further loans.
[9]
The court a quo found that the expenditure was for a dual purpose and
in the circumstances was thus entiled to apportion the
expenditure
between two purposes
6
and considered various formulae for the apportionment and arrived at
the 50 percent apportionment. The court a quo found it inappropriate
to apply an arithmetical basis and relied on Tuck v CIR
7
where
the relative importance of each element was weighed against the
other. The apportionment was done on the basis of value of
the income
and not the amount of work done.
[10]
In my view the acceptance that it was common cause that the appellant
was a trading entity constituted an essential element
in determining
the issue. In addition the undisputed contention of the appellant
that on average only 6 percent of the entries
in its books of account
such as the cash book, and ledger related to dividends was an
important consideration.
[11]
The respondent contends that audit expenditure is of an ex post facto
nature in that it verifies expenditure the year after
it was
incurred. These services do not advance the trade of the company and
the production of its revenue. Its main submission
being that all
audit fees should be disallowed, however, based on the fact that the
Commissioner himself had allowed a small deduction
the respondent was
driven to submit that the 50 percent ordered by the court a quo was
overly generous and that such deductions
as the Commissioner had
allowed were appropriate.
[12]
In developing its main submission the respondent contended that the
audit fee was of a statutory nature and relied on an Australian
authority where the expenditure was disallowed for undertaking a
statutory task e.g. expenditure incurred in assessing the fairness
of
a takeover
8
.
The similarity in thinking emerges in the writing of Professor J L
Pretorius
9
which the court a quo referred to with approval. Emphasis was placed
on the primary role of an auditor in company law as not being
related
to the generation of income but as being a in the vanguard of
protecting the interests of investors, potential investor
and
creditors. Whilst the evolution of the statutory role of an auditor
in auditing a company may involve non-income producing
aspects, in
this case the evidence which the appellant led was not undermined on
the necessity of the auditor's role in its income
generating
activities. The application of this evolving jurisprudence has no
application in this case since the factual matrix
is clear.
[13]
The parties accepted that the appellants business constituted trading
and therefore fell within the purview of s 1 of the act
which defines
"trade". Trade is given a wide definition and "is
intended to embrace every profitable activity"
10
.
The appellant's evidence that it embraced "every profitable
activity" was not undermined.
[14]
It was common cause that the amount of work by the auditors extended
beyond the verification of interest income and the receipt
of
dividends. But these additional tasks did not detract from the
appellant's main submission that the costs related to the income
earning activities.
[15]
Upon a proper application of the law pertaining to the apportionment
of expenses, the facts are clear. Only 6 percent of time
was spent on
the dividend section of the audit.
[16]
I am of the view that the appellant's evidence cannot be rejected.
The facts as proven i.e. the amount of work done must remain
the
yardstick or benchmark and not the value of the dividend payments.
The testimony of Messrs Steyn and Van Doorene on behalf
of the
appellant was clear. Only 5 percent or 6 percent of the auditor's
time was spent on the dividends, the rest was in relation
to the
interest which was its income-producing activity. The expenditure was
incurred to directly facilitate the carrying on of
its trade not only
in a legally compliant manner but to generate income.
[17]
The appellant does not have to show a direct causal link or
connection but a closeness of connection between the expenditure
and
the income e.g. cost price of expenditure incurred for a product
which is later sold by appellant for profit. Such direct causal
link
is not the only link required in terms of section 11(a) of the Act,
There are instances where expenditure does not causally
produce the
income but is still deductible in terms of section 11(1) of the Act.
[18]
In determining the causal connection between the expenditure regard
must be had to the purpose of the expenditure and what
it actually
affects
11
.
The court a quo placed importance on the role of the auditor in
company law statutory requirements as suggested by Professor
Pretorius. The facts in this case are not probative of the learned
Professor's work and the court a quo's finding cannot be upheld.
[19]
The only fair basis would be on the evidence as established and that
is 94 percent in favour of the appellant.
[20]
In ITC
1589 57 SATC 153
(Z) the court accepted that expenses relating
to the portion of the accountancy work relating to dividend income
should be disallowed
and the remainder of the accountancy work
relating to income producing activities should be allowed. This was
the only fair and
reasonable approach having regard to all
circumstances.
[21]
The principles in ITC 1589 supra apply. In this case the bulk of the
auditor's fee should be apportioned to the operating and
income
producing section of the appellant's business.
CROSS
APPEAL
[22]
The cross appeal was based on whether the court a quo erred in
finding that the test in Joffe supra was satisfied on the
apportionment.
The commissioner had already permitted certain
deductions. In Joffe supra the test considers the expenditure which
is linked to
the performance of income -earning operations. It is the
respondent's case that audit fees do not attach to those operations
as
there is no statutory obligation to have audited financial
statements. Where there is trading through a company then the trader
must accept it must accept that there are additional expenses for a
percent udit fees and the legal obligation is unrelated to
the
earning of income. The commissioner however is not seeking to
disaliow the expenses in totality but allowed only 11, (2001),
6
percent (2002), 2 percent (2003) and 1 percent (2004). This
ambivalence in approach by the respondent resulted in fortifying
its
alternative argument where it did assume in favour of the tax payer
that expenses were incurred in the production of revenue.
Once that
is so then the respondent must accept that audit expenses are not
related to an election made to trade through a company
(which
requires audited accounts as opposed to an individual which does
not). Such an approach would provide enormous obstacles
to the world
of commerce and trade.
[23]
The respondent then went on to analyse the nature of the business as
regards the generation of income and submitted that the
appellant
comprised the holding of shares in its subsidiaries from which
dividends were earned as well as interest from lending
of money to
its subsidiaries some of which were interest free. Interest free
loans were not productive of income. Only lending
money at interest
was. Again the respondent relies on value as being the benchmark and
not the amount of work involved in the audit
process. No heed was
paid to the amount of work involved.
[24]
Clearly the facts in this case are distinguishable form Swan supra. I
accepted the evidence of the appellant's witnesses despite
the fact
that the person involved in the negotiating of the audit fee for 2001
to 2004 was not available to testify, instead a
Mr Steyn testified on
the apportionment of the work. The basis for this that the testimony
of Mr Steyn on behalf of the appellant
was not undermined. Mr Steyn
was a partner at the firm Sizwe Ntsaluba VSP from 2003 to 2007. The
firm was responsible for the audit
of the appellant during the
relevant years except for 2001. Mr Steyn attended the 2006 audit and
was familiar with the business
activities of the appellant in that
year as well as the previous years. His evidence was that the amount
of audit work done on
the income producing side was similar.
[25]
It was the opinion of Messrs Van Doorene and Steyn that as a
generalisation there is no precise correlation between the number
of
journal entries of a taxpayer and the time that an auditor would
take. In this matter, however, they testified that there was
such a
correlation.
[26]
The grounds relied upon by the respondent for income apportionment
method is factually and legally incorrect. Similarly the
finding of
the 50 percent apportionment by the court a quo must fail since it is
unchallenged that the audit functions and its
concomitant cost
related to the interest-producing operations and not the
dividend-producing operations,
THE
COST OF TRAINING ON HYPERION COMPUTER MANAGEMENT SYSTEM
[27]
The system was introduced in the 2004 tax year in order to capture
record and index certain aspects related to the appellant's
financial
affairs. The system assists in the conduct of its business in
particular it assists in the consolidation of financial
results and
the reporting of its results to others.
[28]
The professional fee was incurred with its auditors in relation to
them rendering services about the implementation, adjustment,
fine
tuning and user operation of the system.
[29]
Mr C H Gericke testified on behalf of the appellant. He testified
that the Hyperion system assists the appellant in the consolidation
of its financial results. It assists the underlying companies and the
superior ones. Auditors assisted in facilitating the consolidation
of
its results based on the new system. Mr Gericke also testified and
was adamant that expenditure was part and parcel of the appellants
normal day to day operation or day to day trading expenses
[29]
The majority of transactions in the appellant's financial records
relate to interest income and therefore they must necessarily
use the
Hyperion system. It is not used in relation to the dividend income.
[30]
It was neither owned nor located in the appellant's information
technology main frame. It was made available to use by another
company in the appellant's group. Before the appellant used the
Hyperion system the system already implemented and ready for use
but
this was done by a different company MTN International. It was when
the appellant used the system that costs were incurred
to operate the
system. It had to be customised for the appellant and the cost to the
appellant was to get someone to explain the
running of the system and
teach the appellant's staff how it worked. Mr Gericke was adamant
that the fees were for the purposes
of the appellant operating the
system. It had to be programmed to use a particular IT language. The
employees of KPMG who performed
the services were not specialist IT
people they were auditors who had knowledge of accounting system
services.
[31]
The system enabled the appellant to consolidate its financial
statements and took care of 90 percent of the accounting work
that
would otherwise have had to be performed manually. It could not
perform its accounting consolidation requirements without
such a
tool. The Hyperion system was used purely for the benefit of the
appellant as its subsidiaries would not have "bothered
if there
was Hyperion or not, they would still be able to produce the thai
balance that they ultimately had to submit to the appellant'.
The
subsidiaries did not derive any benefit of significance from the
system.
[32]
The system was used on a daily basis in the appellant's operations.
It assisted with the preparation of budgets, forecasts,
monthly
reports and complex calculations, Ms Sibiya was quite clear that the
services were rendered to teach the staff how to operate
the system
and in this regard they were not vague. Ms Sibiya had direct
knowledge of the system.
[33]
Mr Steyn testified and he was certain about the activities of the
appellant. He was adamant that without the Hyperion system
the
appellant would have missed its deadlines for producing consolidated
accounts. This would have resulted in loans becoming immediately
repayable. The audited financial statements produced by the system
were required for the appellant to carry on its trade. Failure
to do
so would result in a breach of the relevant legislation. The
appellant installed the Hyperion system and the concomitant
professional fees were expenditure incurred in order to achieve the
results mentioned above.
[34]
The professional fees are closely connected to the earning of the
interest income and should properly be regarded as a cost
incurred in
order to generate the income. In my view the Hyperion system was
directly related to its trading activities.
[35]
The other companies in the group derived a benefit from the Hyperion
system because of its interconnected structure in which
the companies
within the group trade. I find that the ancillary benefit does not
undermine the primary purpose of the Hyperion
system. The fact of
trading more effectively does not convert expenditure into a capital
item. The fact that the Hyperion system
aids in assisting the
appellant to report its trading results is not a justifiable reason
to disallow the expenditure,
[36]
The respondent disallowed the professional fee because the Hyperion
system aids in the presentation and reporting of results
of the
appellant and the consolidated results in the group. In so doing it
has disregarded the factors referred to above.
[37]
The appellant is obliged in terms of its business arrangements to
report its results to other companies with the MTN group
and such a
function is in the ordinary course of business and related to its
trading activities. This function necessarily relates
to the ongoing
production of its income in a manner consistent with its obligations
to other companies in the group.
[38]
The criticism by the respondent that the appellant has not provided
sufficient information so to cause it to deal with the
deductions is
to be assessed must fail. I find that appellant has discharged the
onus by providing all the relevant information
in relation to the
Hyperion System. It is the respondent who failed to consider the
relevant information before disallowing the
auditors' training fee.
[39]
The Hyperion system constitutes a tool in the appellant's business as
a trader. The appellant's trade is based on the fact
that the
appellant's activities are that of a money-lender. The scale of the
investment by the appellant in the shares of its subsidiary
companies
is such as to amount to the carrying on of trade. It is the
appellant's contention that if one of the activities amount
to trade
then it is entitled to a deduction in respect of that expense.
[40]
In Joffe supra expenditure has to be a necessary concomitant of the
income-earning operation and once it is a necessary concomitant
then
the cost is deductible. A necessary concomitant is defined as "all
expenditure ... necessarily attached to the performance
of operations
which constitute the carrying on of the income-earning trade which
would be deductible".
[41]
The appellant's contention that the audit opinion and the production
of audited financial statements and the consolidation
thereof where
there is a group of companies must be regarded as expenditure
necessarily attached to the carrying on of a trade
where the trading
vehicle is a company must succeed.
[42]
In CIR v Hickson
12
a physically disabled appellant required someone to accompany him
overseas on business trips and this was held to be a necessary
expenditure connected with travel.
[43]
In this case the expenditure on the Hyperion System was necessary for
the appellant to conduct its income-earning business
(interest) and
is deductible irrespective of whether or not there is also in a
non-income-earning advantage for the appellant.
[44]
The appellant's appeal on the issue on the deductibility of the
expenses incurred on the Hyperion System is upheld.
[45]
The appellant has been substantially successful and the costs must
follow the result.
The
order that I would make is the following:
1.
The issue of the deductibility of the audit fees is remitted to the
Commissioner to enable him to make new assessments for the
years
2001, 2002, 2003 and 2004 in accordance with the apportionment 94
percent being deductible in respect of the audit fee.
2.
The Commissioner is ordered to allow the deduction of the expenditure
relating to the fees of KPMG for the training on the Hyperion
System.
3.
The cross appeal is dismissed with costs including the costs of two
counsel.
4.
The respondent is ordered to pay the costs of the appeal including
the costs of two counsel.
VICTOR
J
HORN
J I concur
WEPENER
J I concur
1
Port
Elizabeth Tramway Co Ltd
1936 CPD 241
2
CIR
v Drakensberg Garden Hotel Pty Ltd 1960(2)SQA475(A)H-430A
3
Commissioner
for Inland Revenue v Genn &Co
4
CSARS
v Akharwary 68SATC 41
5
1946
AD 157
6
CIR
v Nemojenm.1983(4) SA 935(A)
7
1988(3)
SA819(A)
8
FCT
v the Swan Brewery co Ltd (19191) 22ATR 295
9
1986
Modern Business law 82 at 90
10
ITC
770
(1954) 19 SATC 216
at 217.
11
CIR
vGenn supra
12
1960
(1)SA 746 (A).