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[2014] ZASCA 4
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Commissioner for the South African Revenue Service v Mobile Telephone Networks Holdings (Pty) Ltd (966/2012) [2014] ZASCA 4; 2014 (5) SA 366 (SCA); 76 SATC 205 (7 March 2014)
THE SUPREME COURT OF APPEAL OF SOUTH AFRICA
JUDGMENT
Case no: 966/2012
Reportable
In the matter between:
COMMISSIONER FOR THE SOUTH AFRICAN
REVENUE
SERVICE
.................................................................................................
APPELLANT
and
MOBILE TELEPHONE NETWORKS HOLDINGS (PTY)
LTD
......................
RESPONDENT
Neutral citation:
Commissioner
for the South African Revenue Service v Mobile
Telephone Networks
Holdings (Pty) Ltd
(966/12)
[2014]
ZASCA 4
(7 March 2014)
Bench:
Ponnan,
Shongwe and Wallis JJA and Van Zyl and Legodi AJJA
Heard: 18 February 2014
Delivered: 07 March 2014
Summary
:
Income Tax Act 58 of 1962 – s 11(
a
)
read with ss 23(
f
)
and (
g
) –
audit fees incurred for a dual or mixed purpose – apportionment
of.
ORDER
On appeal from
:
South Gauteng High Court,
Johannesburg (Victor J (Horn and Wepener JJ concurring)) sitting as
court of appeal.
(a) The appeal is upheld
with costs, such costs to include those consequent upon the
employment of two counsel.
(b) The order of the court
below is set aside and in its stead is substituted the following
order:
‘
(1) The appeal
is dismissed with costs, including those of two counsel.
(2) The cross appeal
is upheld with costs, including those of two counsel.
(3) The order of the
Tax Court that “50% of the audit fees incurred for the 2001,
2002, 2003 and 2004 tax years is deductible
from “income”
(as defined) for those tax years” is amended by the deletion of
“50” and the substitution
therefor of “10”.’
JUDGMENT
Ponnan JA (Shongwe
and Wallis JJA and Van Zyl and Legodi AJJA concurring):
[1] The respondent,
Mobile Telephone Network Holdings (Pty) Ltd (Holdings), is the
holding company of five directly held and a number
of indirectly held
subsidiaries and joint ventures. It, in turn, is a wholly owned
subsidiary of the MTN Group Limited. The collective
business of the
operating companies within the group is the operation of mobile
telecommunication networks and the provision of
related services to
customers in Cameroon, Nigeria, Rwanda, South Africa, Swaziland and
Uganda.
[2] Apart from the
dividends it received from its subsidiaries, which were its primary
source of income, Holdings also loaned funds
to those subsidiaries
for application in their businesses primarily on an interest-free
basis. It also facilitated a group employee
debenture scheme whereby
it borrowed funds (through issuing the debentures) and loaned those
to group companies at a higher interest
rate. It thus had two sources
of income – a dividend income and an interest income. Holdings
had no employees of its own
and conducted no other business other
than those investment holding and lending activities.
[3] Holdings employed
auditors to perform a statutory audit of its financial statements for
each of the 2001, 2002, 2003 and 2004
tax years. The amount expended
by Holdings on audit fees for each of those years was R365 505,
R647 770, R427 871
and R233 786, respectively (the
audit fees). In addition, during the course of the 2004 tax year
Holdings paid an amount of
R878 142 to KPMG in relation to, what
was described in the evidence as the ‘Hyperion’ computer
system (the KPMG
fee). In its income tax returns for those tax years
filed with the appellant, the Commissioner for the South African
Revenue Services
(the Commissioner), Holdings claimed as deductions
all of the audit fees, as also the KPMG fee.
[4] The Commissioner:
(a) disallowed the KPMG fee in its entirety; and (b) apportioned the
annual audit fees by permitting a deduction
of between two and six
per cent thereof. The apportionment employed by the Commissioner in
each instance was based on the ratio
of Holdings’ interest
income as against its total revenue (ie revenue from both dividend
and interest income).
[5] Its objection to the
disallowance of those amounts having been overruled by the
Commissioner, Holdings appealed to the Special
Income Tax Court. The
Tax Court (per Gildenhuys J) upheld the disallowance of the KPMG fee
on the basis that it constituted expenditure
of a capital nature. It
also rejected Holdings’ contention that the audit fees were
deductible in full, holding instead that
a 50/50 apportionment was
appropriate. It accordingly set aside those assessments and referred
the matter back to the Commissioner
for re-assessment in accordance
with its judgment.
[6] Holdings appealed
those findings to the full court of the South Gauteng High Court. In
the alternative to claiming a full deduction
of the audit fees, it
sought a 94 per cent deduction on an alleged time basis. The
Commissioner cross-appealed the 50/50 apportionment
order. The full
court (per Victor J (Horn and Wepener JJ concurring)) upheld
Holdings’ appeal in relation to the KPMG fees
– allowing
that deduction in full. It also overturned the 50/50 apportionment of
the audit fees and directed the Commissioner
to allow for a deduction
of 94 per cent thereof as contended for by Holdings. It accordingly
dismissed the Commissioner’s
cross-appeal. The appeal to this
court by the Commissioner against those findings is with the leave of
the full court.
[7] Before this court, the
thrust of the argument advanced on behalf of the Commissioner was
that in terms of s 11(
a
) read with s 23(
f
) of
the Income Tax Act 58 of 1962 (the Act):
(a) the audit fees are
deductible only to the limited extent originally allowed by the
Commissioner (or to such other extent as
this court may allow); and
(b) no deduction in
respect of the KPMG fee is permissible, alternatively, the KPMG fee
is subject to an apportionment on the same
or a similar basis to the
audit fees.
[8] Taxable income is
the basis upon which normal tax is levied. It is arrived at by first
determining the taxpayer’s gross
income and then deducting
therefrom any amounts exempt from normal tax in order to arrive at
the taxpayer’s income. The taxpayer’s
taxable income is
then determined by deducting from the income the various amounts
which the Act allows by way of deduction, including
those covered by
s 11(
a)
.
Section 23 prescribes what deductions may not be made in the
determination of taxable income. Subsections (
f
)
and (
g
) of
s 23 represent, what has been described as the ‘negative
counterpart’ of s 11(
a
)
and, in determining whether a particular amount is deductible, it is
generally appropriate to consider whether or not such deduction
is
permitted by s 11(
a
)
and whether or not it is prohibited by s 23(
f
)
and/or (
g
).
(See
Commissioner for Inland Revenue v
Nemojim (Pty) Ltd
1983 (4) SA 935
(A)
at 946H-947C.)
[9] The general deduction
formula laid down in s 11(
a
) of the Act permits the
deduction from the taxpayer’s income of ‘expenditure and
losses actually incurred in the production
of income, provided such
expenditure and losses are not of a capital nature’, whilst
ss 23(
f
) and (
g
) of the Act prohibit a deduction
in respect of:
‘
(
f)
any
expenses incurred in respect of any amounts received or accrued which
do not constitute income as defined in section one;
(
g
)
any moneys, claimed as a deduction from income derived from trade, to
the extent to which such moneys were not laid out or expended
for the
purposes of trade.’
Section 1 of the
Act defines ‘income’ as: ‘the amount remaining of
the gross income of any person for any
year or period of assessment
after deducting therefrom any amounts exempt from normal tax under
Part 1 of Chapter II’.
[10] It is well
settled that ‘generally, in order to determine in a particular
case whether moneys outlaid by the taxpayer
constitute “expenditure
incurred in the production of the income”, important, sometimes
overriding, factors are the
purpose of the expenditure and what the
expenditure actually effects’ (per Corbett JA in
Commissioner
for Inland Revenue v Standard Bank of SA Ltd
1985
(4) SA 485
(A) at 498F-G). And, in this connection the court
has to assess the closeness of the connection between the expenditure
and
the income earning operations (
Nemojim
at 947G-H).
[11] In
Joffe & Co
Ltd v Commissioner for Inland Revenue
1946 AD 157
, Watermeyer CJ
held (at 163) that:
‘
All
expenditure, therefore, necessarily attached to the performance of
the operations which constitute the carrying on of the income-earning
trade, would be deductible and also all expenditure which, though not
attached to the trading operations of necessity, is yet
bona
fide
incurred for the purpose of carrying them on, provided such payments
are wholly and exclusively made for that purpose and are not
expenditure of a capital nature.’
It was not disputed
by the Commissioner that the business of the operating companies
within the group could only have been conducted
in the corporate form
adopted by the group or that consolidation (and the preparation of
consolidated financial statements for
the group) and audit planning
activities would have been necessary irrespective of whether Holdings
lent money at interest or not.
Nor was it in dispute that Holdings
was statutorily obliged
[1]
to appoint an auditor and to have its financial
records audited. In those circumstances, the fees for a statutorily
prescribed procedure
such as an audit had to have been incurred by
Holdings. Accordingly, it has to be accepted, that the audit fee
expenditure was
a part of Holdings’ general overhead expenses
enabling it to carry out all of its activities, irrespective of
whether they
involved the investment in subsidiaries, the lending of
money interest-free to subsidiaries or the lending of money at
interest.
It follows that the Tax Court’s conclusion that
‘[t]he auditing of financial records is clearly a function
which is
“necessarily attached” to the performance of
[Holdings’] income-earning operations’, cannot be
faulted.
[12] Where - as here -
expenditure is laid out for a dual or mixed purpose the courts in
South Africa and in other countries, have,
in principle, approved of
an apportionment of such expenditure (
Secretary for Inland Revenue
v Guardian Assurance Holdings (SA) Ltd
1976 (4) SA 522
at
533E-H). Thus in
Nemojim
, Corbett JA stated:
‘
As
pointed out in the
Rand
Selections
case
supra
at 131E-G, the Income Tax Act makes no provision for apportionment.
Nevertheless, apart from the
Rand
Selections
case, it is a device which has previously been resorted to where
expenditure in a globular sum has been incurred by a taxpayer
for two
purposes, one of which qualifies for deduction and one of which does
not . . . It is a practical solution to what
otherwise could be
an intractable problem and in a situation where the only other
answers, viz disallowance of the whole amount
of expenditure or
allowance of the whole thereof, would produce inequity or anomaly one
way or the other. In making such an apportionment
the Court considers
what would be fair and reasonable in all the circumstances of the
case.’
[13] Over time, the
courts have applied various
formulae
to achieve a fair apportionment. In
Nemojim
(at 958D-F), Corbett JA applied the
following formula to determine the extent of deductible expenses:
‘
A
= (B + C) X _
___D____
D
+ E
where
A = deductible expenses
B
= general expenses relating to share-dealing
C
= total cost of acquisition of shares in companies subjected to
dividend stripping in tax year
D
= total proceeds of the sale of such shares
E
= total dividends received in respect of such shares.’
And, in
Commissioner for
Inland Revenue v Rand Selections Corporation Ltd
1956 (3) SA 124
(A), Centlivres CJ (who delivered the majority judgment) stated:
‘
.
. . but, in my opinion, it was not legally competent for him to allow
as a deduction from the “income” an amount which
is
arbitrary. In my opinion the obvious method of apportioning the
expenditure is to adopt the following formula (X being the
expenditure incurred, Y the amount of “income” and Z the
amount of the “dividend”):
X
multiplied by
____ Y
_____
Y
plus Z . . . .’
[14] Gildenhuys J held:
‘
[21]
In all the above cases, the apportionment had an arithmetic basis,
either through the use of a formula, or by allocating specific
components of expenditure to deductible and non-deductible
categories. Circumstances may occur, however, where it is not
possible
to devise a fair and reasonable formula, and also not
possible to break down the expenditure into deductible and
non-deductible
components. In a case where the apportionment of
expenditure between revenue and capital was at issue,
Tuck
v Commissioner for Inland Revenue
,
1988 (3) SA 819
(A), Corbett CJ said at 834J-835B:
“
The
problem in this case is to establish an acceptable basis of
apportionment. The appellant has all along suggested apportionment
on
a 50/50 basis; and this was Mr
Welsh
’s
suggestion to us. Having regard to the inherent nature of the receipt
and its origin in the plan, it is not possible to
find an
arithmetical basis for appointment (
cf
Commissioner for Inland Revenue v Rand Selections Corporation Ltd
1956
(3) SA 124
(A) at 131; the
Nemojim
case
supra
at 958
)
but I do not think this should constitute an insuperable obstacle.”’
The
learned Judge accordingly concluded:
‘
[26]
Since neither the appellant nor the respondent suggested an
acceptable basis of appointment, I am free to devise a basis which
would in my view be fair. All in all, I am of the view that a 50/50
apportionment of the audit fees would be just and equitable.
It will
recognise not only the greater importance of the audit for the
dividend earning operations, but also the longer time spent
by the
auditors on the interest earning operations. In the result, the
appellant would be entitled to claim 50% of the audit fees
as a
deduction from “income” in respect of each of the four
years of assessment.’
[15] Apportionment is
essentially a question of fact depending upon the particular
circumstances of each case (
Local Investment Co v Commissioner of
Taxes (SR)
22 SATC 4).
As Beadle J put it in
Local Investment
Co
(at II):
‘
It
does not seem possible to me to lay down any general rules as to how
the apportionment should be made, other than saying that
the
apportionment must be
fair
and reasonable, having regard to all the circumstances of the case.
For
example, in one case an apportionment based on the proportion which
the different types of income bear to the total income might
be
proper, as was done in the
Rand
Selections Corporation’s
case,
supra
.
In another case, however, such an apportionment might be grossly
unfair; for example, in the case where the bulk of the expenditure
was clearly devoted exclusively to operations intended to earn
income, but which unfortunately in fact earned very little income,
with the result that in the particular year of assessment the company
earned very little “income”, but from operations
which
incurred little expense earned relatively large non-taxable amounts.
In such a case to apportion the bulk of the expenses
to the
non-taxable amounts would be unfair. In another case a fair method of
apportionment might be to take the proportion which
the capital
invested in the operations earning the non-taxable amount bears to
the total capital invested, as was done in I.T.C.
No 832 of 1956,
supra
.’
[16] Gildenhuys J
usefully summarised the financial results of Holdings’ trading
for the relevant tax years and the audit
fees at issue that were
disallowed by the Commissioner, as follows:
Source of Revenue
2001
2002
2003
2004
Dividends
R 170,000,000
R 350,000,000
R1,125,273,121
R 717,000,00
Interest
R 21,765,415
R 22,223,856
R 21,636,279
R 6,000,000
TOTAL INCOME
R 191,765,415
R 372,223,856
R 1,146,909,400
R 723,000,000
Tax Year
Revenue from dividends
Revenue from interest
2001
89% of total revenue
11% of total revenue
2002
94% of total revenue
6% of total revenue
2003
98% of total revenue
2% of total revenue
2004
99% of total revnue
1% of total revenue
Expenses
2001
2002
2003
2004
Audit fees
R 365,505
R 647,770
R 427,871
R 233,786
Audit fees disallowed
R 323,884
(89%)
R 609,094
(94%)
R 419,799
(98%)
R 231,826
(99%)
[17] An audit is
directed towards signing off an audit opinion. And, as Carel Gericke,
the general manager: group tax within the
MTN group, testified, an
auditor has to undertake a wide range of general tasks which do not
relate to specific income items. Holdings’
contention was that
if an apportionment were to be made, it should reflect the relative
time spent or work done by the auditors
on auditing Holdings’
interest and dividend income. But as it was put in
ITC
1017
(1963) 25 SATC 337
(F) at 337
‘[i]t is no good saying how little time and effort is devoted
to the property company unless one can establish
how much is devoted
to the other ventures, for any such apportionment can only be on a
comparative basis’.
[18] In assessing
Holdings, the Commissioner apportioned the audit fees on the basis of
the ratio between the taxable interest income
and the exempt dividend
income (which was the vast majority of its revenue). Although some
interest-bearing loans were made, by
far the greater part of the
loans made by Holdings appear to have been interest free. The
interest-earning operations of Holdings,
which related primarily to
supporting the employee incentive scheme, were relatively small in
comparison to the activity of holding
shares and earning dividends
and the related activity of advancing the businesses of subsidiaries
by large interest free loans.
Indeed, on a proper conspectus of all
of the evidence, Holdings’ value overwhelmingly lay in its
principal business as a
holding company of extremely valuable
subsidiaries. Accordingly, the lending of moneys at interest in the
context of its share
incentive scheme was relatively modest. In any
event it appears that the time spent specifically on dividend and
interest entries
between them may well have made up a relatively
small component of the overall audit time. Moreover, the audit
function involved
the auditing of Holdings’ affairs as a whole,
the major part of which concerned the consolidation of the
subsidiaries’
results into Holdings’ results. It follows
that any apportionment must be heavily weighted in favour of the
disallowance
of the deduction given the predominant role played by
Holdings’ equity and dividend operations as opposed to its far
more
limited income-earning operations. It may as well be artificial
to differentiate between each of the relevant tax years as the
Commissioner did, inasmuch as the audit function would essentially
have been the same for each of those years notwithstanding the
proportion of Holdings’ interest revenue as against its total
revenue. It follows that whilst I agree with the Tax Court
that in
this case to invoke the arithmetical
formulae
laid down in cases such as
Rand
Selections Corporation
and
Nemojim
may well lead to anomalous results, on the facts here present a 50/50
apportionment of the audit fees was far too generous to the
taxpayer.
In all the circumstances I consider that it would be fair and
reasonable that only ten per cent of the audit fees claimed
by
Holdings for each of the tax years in question should be allowed.
[19] Turning to the KPMG
fee: In its Rule 11 statement, Holdings alleged that the KPMG fee was
incurred in respect of the ‘implementation,
adjustment, fine
tuning and user operation of the [Hyperion] system’. The Tax
Court took the view that Holdings should be
held to that description.
Ms Philisiwe Sibiya, the MTN group financial manager, who had joined
the group after the Hyperion system
had been acquired and obviously
bore no personal knowledge about the matter, admitted as much during
cross examination as the following
excerpt demonstrates:
‘
MR
KOEKEMOER
And that provides a breakdown. Do you have any personal knowledge of
on what these fees were expended and what they achieved?
MISS
SIBIYA
Personal
by was I there, no, sir, I wasn’t there, but from what I know
from Ron Stewart … [intervention]
MR
KOEKEMOER
So
from what other people told you?
MISS
SIBIYA
Yes.’
Mr Gericke, who like Ms
Sibiya, also joined the group after the Hyperion system had been
acquired, was no more illuminating. His
evidence ran thus:
‘
MR
KOEKEMOER
Now this system, do I understand you correctly to imply that it is a
software program?
MR
GERICKE
Yes
MR
KOEKEMOER
Which
is loaded on whose servers?
MR
GERICKE
On
whose server?
MR
KOEKEMOER
Well,
I take it the software must run on a computer, a mainframe somewhere.
MR
GERICKE
Yes
MR
KOEKEMOER
Now,
this mainframe, to whom does it belong?
MR
GERICKE
I’m
not aware of that. I don’t know. Honestly, I don’t know.
. . .
MR
KOEKEMOER
So
can we therefore safely assume that this operating system of yours,
this Hyperion System, was installed in one of the other group
companies’ servers or mainframes?
MR
GERICKE
I
don’t know if you can assume that but that’s probably
where – the logical conclusion.
MR
KOEKEMOER
How
much did you pay to acquire this system?
MR
GERICKE
I
don’t know that.
MR
KOEKEMOER
And
who acquired this system, which company within the group?
MR
GERICKE
I
don’t know that either.
. . .
MR
GERICKE
No,
I know what was performed as I said to M’Lord just now, my
knowledge of what KPMG did with respect to the assistance is
exactly
that, that they helped with, you know, maximizing the operational
capabilities of the system and showing us to use it to
exploit its
maximum capabilities.
GILDENHUYS
J
And
who is us?
MR
GERICKE
Well,
in this case the appellant.
GILDENHUYS
J
Did
the appellant have staff that had to be shown?
MR
GERICKE
No,
it didn’t have staff, but it assisted the other employees,
right, of the group who did render this particular –
or who we
were required to do the consolidation.
MR
KOEKEMOER
So
you actually paid for an expense to train people other than the
appellant’s employees because it had none to operate the
system.
MR
GERICKE
No,
look it effectively – I don’t think we paid anybody to
train anybody or anything, right, it was there to assist,
right, the
appellant, well, in doing the required consolidations.
. . .
MR
KOEKEMOER
So
you actually can’t say what these Hyperion fees were expended
upon.
MR
GERICKE
No,
my understanding is that KPMG in those years assisted us with the
operation of this particular system.
. . .
MR
KOEKEMOER
Who’s
the owner of this Hyperion System?
MR
GERICKE
Are
you talking in the group?
MR
KOEKEMOER
Yes.
MR
GERICKE
I
don’t know.
MR
KOEKEMOER
So
we don’t even know whether the appellant is the owner?
MR
GERICKE
Well,
it’s not recorded as an asset in its financial statements.
MR
KOEKEMOER
So,
for all we know, the appellant could have incurred [this]
expenditure, the Hyperion expenditure, on behalf of another
subsidiary
in the group.
MR
GERICKE
I
don’t know. I mean, I’d have to speculate if I have to
answer you.’
[20] There was, it
must be added, no explanation from Holdings for its failure to call
as witnesses persons at Holdings or KPMG
with personal knowledge of
the implementation and workings of the Hyperion system. Accordingly,
given the inadequacy of the evidence
adduced by Holdings, it was
well-nigh impossible to determine whether the KPMG fee fell
legitimately to be deducted by Holdings.
It follows that the
Commissioner cannot be faulted for having disallowed that fee in its
entirety. In the result the contrary conclusion
reached by the full
court to that of the Tax Court that the deduction of the KPMG fee
must be allowed in full, falls to be set
aside.
[21] In the result:
(a) The appeal is upheld
with costs, such costs to include those consequent upon the
employment of two counsel.
(b) The order of the court
below is set aside and in its stead is substituted the following
order:
‘
(1) The appeal
is dismissed with costs, including those of two counsel.
(2) The cross appeal
is upheld with costs, including those of two counsel.
(3) The order of the Tax Court that “50% of
the audit fees incurred for the 2001, 2002, 2003 and 2004 tax years
is deductible
from “income” (as defined) for those tax
years” is amended by the deletion of “50” and the
substitution
therefor of “10”.’
V PONNAN
JUDGE OF APPEAL
APPEARANCES:
For
Appellant: AR Sholto-Douglas SC
MW
Janisch
Instructed
by:
The
State Attorney, Cape Town
The
State Attorney, Bloemfontein
For Respondent:
A Rafik Bhana SC
Julia
Boltar
Instructed
by:
Spencer
& Associates, Randburg
Symington
& De Kok, Bloemfontein
[1]
See for example s 269 read with ss 282, 300, 300A and 301 of the
Companies Act 61 of 1973.