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[2011] ZAGPJHC 190
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Mobile Telephone Networks Holdings (pty) Ltd v Commissioner for the South African Revenue Service (A5033/10) [2011] ZAGPJHC 190 (8 July 2011)
REPORTABLE
SOUTH GAUTENG HIGH COURT, JOHANNESBURG
CASE NO
:
A5033/10
TAX COURT CASE NO: 12401
DATE:08/07/2011
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
)
J U D G M E N T
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 2011,
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% 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 issues 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% of the audit fee was correct.
The Commissioner had
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%
deduction ordered by the court
a
quo
which must be
considered in the cross appeal on the issue of the audit fees.
[5] 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 losses 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
[6] 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 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.
AUDIT FEE
[7] 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% and 99% during the years in question.
[8] The applicable legal
principles are clear but their 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, 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
.
[9] 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.
[10] The court
a
quo
found that the
expenditure was for a dual purpose and in the circumstances was thus
entitled to apportion the expenditure between
two purposes
6
and considered various formulae for the apportionment and arrived at
the 50% 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.
[11] In my view the acceptance by both parties that it was common
cause 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% of the entries
in
its books of account such as the cash book and ledger related to
dividends was an important consideration.
[12] 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% ordered by the court
a
quo
was overly
generous and that such deductions as the Commissioner had allowed
were appropriate.
[13] 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 in the vanguard of protecting the interests of
investors, potential investors and creditors. Whilst the
evaluation
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.
[14] The parties accepted that
the appellant’s 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.
[15] 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.
[16] Upon a proper application of the law pertaining to the
apportionment of expenses, the facts are clear. Only 6% of time was
spent on the dividend section of the audit.
[17] 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% or 6% 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.
[18] 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 s 11(a) of the Act. There
are instances where expenditure does not causally
produce the income
but is still deductible in terms of s 11(1) of the Act.
[19] 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.
[20] The only fair basis would
be on the evidence as established and that is 94% in favour of the
appellant.
[21] 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.
[22] 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
[23] 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 that there are
additional expenses for audit fees and the
legal obligation is
unrelated to the earning of income. The Commissioner however is not
seeking to disallow the expenses in totality
but allowed only 11%
(2001), 6% (2002), 2% (2003) and 1% (2004). This ambivalence in
approach by the respondent resulted in fortifying
its alternative
argument where it did assume in favour of the taxpayer 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.
[24] 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.
[25] Clearly the facts in this
case are distinguishable from
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 was the testimony of Mr
Steyn on behalf of the appellant and which 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 year. His evidence was that the amount
of audit work done on the income-producing side was similar.
[26] 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 audit would take.
In this matter, however, they testified that there was
such a
correlation.
[27] The grounds relied upon by
the respondent for income apportionment method is factually and
legally incorrect. Similarly the
finding of the 50% 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
[28] 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.
[29] 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.
[30] 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
appellant’s normal
day-to-day operation or day-to-day trading expenses.
[31] 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.
[32] It was neither owned nor
located in the appellant’s information technology main frame.
It was made available for use
by another company in the appellant’s
group. Before the appellant used the Hyperion System, the system was
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.
[33] The system enabled the
appellant to consolidate its financial statements and took care of
90% 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
trial balance that they ultimately had to submit
to the appellant
”.
The subsidiaries did not derive any benefit of significance from the
system.
[34] 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.
[35] 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 was expenditure
incurred in order to achieve the results mentioned above.
[36] 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.
[37] 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.
[38] 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.
[39] The appellant is obliged in terms of its business arrangements
to report its results to other companies within the MTN group
and
such a function is in the ordinary course of business 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.
[40] The criticism by the
respondent that the appellant has not provided sufficient information
so as to cause it to deal with
the deductions 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.
[41] 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 the subsidiary companies in 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.
[42] 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
”.
[43] 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 necessary attached to the carrying on of a trade
where
the trading vehicle is a company, must succeed.
[44] 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.
[45] 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.
[46] The appellant’s
appeal on the issue on the deductibility of the expenses incurred on
the Hyperion System is upheld.
[47] The appellant has been substantially successful and the costs
must follow the result.
The order that I would make the following:
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%
being deductible in respect of the audit fee.
The Commissioner is ordered to allow the deduction of the
expenditure relating to the fees of KPMG for the training on the
Hyperion System.
The cross appeal is dismissed with costs including the costs of two
counsel.
The respondent is ordered to pay the costs of the appeal including
the costs of two counsel.
____________________________
VICTOR J
I concur
_____________________________
HORN J
I concur
_____________________________
WEPENER J
1
Port Elizabeth
Tramway Co Ltd
1936
CPD 241.
2
CIR v Drakensberg
Garden Hotel (Pty) Ltd
1960
(2) SA 475 (A)H-480A.
3
Commissioner for
Inland Revenue v Genn & Co.
4
CSARS v Akharwary
68 SATC 41.
5
1946 AD 157.
6
CIR v Nemojenm
1983 (4) SA 935
(A).
7
1988 (3) SA 819
(A).
8
FCT v The Swan
Brewery Co Ltd
[1919]
11 ATR 295.
9
1986
Modern Business
Law
82 at 90.
10
ITC 770
(1954) 19 SATC 216
at 217.
11
CIR v Genn supra
.
12
1960 (1) SA 746
(A).