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[2019] ZASCA 124
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Commissioner for the South African Revenue Service v Atlas Copco South Africa (Pty) Ltd (834/2018) [2019] ZASCA 124; [2019] 4 All SA 635 (SCA); 2020 (4) SA 61 (SCA); 82 SATC 116 (27 September 2019)
Links to summary
THE
SUPREME COURT OF APPEAL OF SOUTH AFRICA
JUDGMENT
Reportable
Case
no: 834/2018
In
the matter between:
THE
COMMISSIONER FOR THE SOUTH AFRICAN
REVENUE
SERVICE APPELLANT
and
ATLAS
COPCO SOUTH AFRICA (PTY)
LTD RESPONDENT
Neutral
citation:
CSARS v Atlas Copco South Africa
(Pty) Ltd
(834/2018)
[2019] ZASCA 124
(27
September 2019)
Bench:
Navsa, Ponnan, Zondi and Mocumie JJA and Weiner AJA
Heard:
28 August 2019
Delivered:
27 September 2019
Summary:
Income tax – valuation of stock at year end in terms of s
22(1)(
a
) of the Income Tax Act 58 of 1962.
ORDER
On
appeal from
: Tax Court, Johannesburg
(Opperman J and assessors):
(a)
The appeal is upheld with costs, including those of two counsel.
(b)
The order of the Tax Court is set aside and replaced with one
dismissing the appeal and confirming the additional assessments
for
the 2008 and 2009 years of assessment.
JUDGMENT
Ponnan
JA (Navsa, Zondi and Mocumie JJA and Weiner AJA concurring):
[1]
The Income Tax Act 58 of 1962 (the Act) requires opening and closing
trading stock to be taken into account when determining
taxable
income derived from carrying on any trade in any year of assessment.
Section 22(1) of the Act is concerned with the value
of trading stock
held and not disposed of at the end of the relevant year of
assessment, which is determined with reference to
the diminution
thereof. Sections 22(1)(
a
) and (
b
) of the Act prescribe
the basis upon which taxpayers are to value trading stock at the
beginning and end of each year of assessment.
This appeal by the
Commissioner for the South African Revenue Service (SARS), against a
judgment of the Tax Court, Johannesburg
(Opperman J, sitting with
assessors), turns on the interpretation and application of those
provisions. The dispute relates to whether
the value of the
taxpayer’s trading stock had diminished, entitling SARS to make
a just and reasonable allowance under s
22(1)
(a)
of the Act.
[2]
The taxpayer, Atlas Copco SA (Pty) Ltd, is a member of the Atlas
Copco Group, with its parent company in Sweden. The main business
of
the taxpayer is to sell or lease – and thereafter service –
machinery and equipment (including spare parts and consumables)
that
is imported mainly from Sweden, for use in the mining and related
industries in South Africa. The taxpayer’s parent
company had
conceived a policy known as the Finance Controlling and Accounting
Manual (FAM) or The Way We Do Things (WAY), which
was implemented and
applied by all companies within the group. In terms of the policy,
the taxpayer was to write down the value
of its closing stock by 50%,
if such closing stock had not sold in the preceding 12 months, and by
100% if it had not sold in 24
months.
[3]
The taxpayer applied the policy by writing down its closing stock by
the fixed percentages reflected in the policy. It included
in its
2008 and 2009 tax returns the amounts it claimed the value of its
trading stock had diminished by during those years of
assessment.
SARS, however, took the view that the write down of stock by the
taxpayer did not comply with the provisions of s 22(1)
(a)
of
the Act. SARS accordingly added back R30 191 000 for 2008 and R33 402
000 for 2009 and assessed the taxpayer to tax in respect
of those
amounts on the ground that ‘there was no diminishing in value
at year end for a deduction to be claimed as a result
of damage,
deterioration, change of fashion, decrease in the market value in
respect of stock’. SARS also levied interest
in terms of s
89
quat
of the Act.
[4]
In upholding the taxpayer’s appeal and setting aside SARS’
additional assessments for the 2008 and 2009 tax years,
the Tax Court
identified what it described as ‘the crisp legal dispute
between the parties’ as being:
‘
whether
the nett realisable value (‘
NRV’
)
of the Atlas Copco SA’s closing stock, calculated in accordance
with IAS2, IFRS, South African Statements of Generally Accepted
Accounting Practice (‘
SA GAAP’
)
and the policy, may and should, where it is lower than the cost price
of such trading stock, be accepted as representing the value
of
trading stock held and not disposed of at the end of the relevant
years for purposes of section 22(1)(a) of the Income Tax Act.’
[5]
The Tax Court answered that question thus:
‘
[128]
The NRV of Atlas Copco SA’s closing stock for 2008 and 2009,
calculated in accordance with IAS2, IFRS, SA GAAP and the
policy
(which policy is in line with IAS2 and IFRS), may and should, where
it is lower than the cost price of such trading stock,
be accepted as
representing the value of trading stock held and not disposed of at
the end of the relevant years for purposes of
section 22(1)(a) of the
Income Tax Act.
[129]
The NRV as determined in accordance with IAS2, IFRS and SA GAAP and
the policy, provides an acceptable and appropriate method
for
purposes of section 22(1)(a) for the determination of the actual
value of trading stock at the end of the year of assessment,
the
application of which leads to a sensible and business-like result. It
constitutes a just and reasonable basis for valuing SA
Copco SA’s
closing stock for 2008 and 2009, as contemplated in such section.’
[6]
During the tax years relevant to this appeal, s 22(1)(
a
)
provided:
‘
(1)
The amount which shall, in the determination of the taxable income
derived by any person during any year of assessment from
carrying on
any trade (other than farming), be taken into account in respect of
the value of any trading stock held and not disposed
of by him at the
end of such year of assessment, shall be –
(a)
in the case of trading stock other than trading stock contemplated in
paragraph (b), the cost price to such
person of such
trading stock, less such amount as the SARS may think just and
reasonable as representing the amount by which the
value of such
trading stock, not being any financial instrument, has been
diminished by reason of damage, deterioration, change
of fashion,
decrease in the market value or for any other reason satisfactory to
the SARS.’
[7]
Section 22(1)
(a)
is concerned with the value
of the trading stock of a taxpayer as trading stock at year end. It
empowers SARS to allow a deduction
from the cost price, by way of a
just and reasonable allowance, in the four circumstances specified
namely, damage, deterioration,
change of fashion or decrease in
market value or for any other reason satisfactory to the SARS. The
rationale for the existence
of these provisions ‘is neither far
to seek nor difficult to comprehend’.
[1]
The section is couched in the past tense. It is concerned with an
enquiry as to whether a diminution in value has already occurred.
In
other words, the cost price must already have diminished. The
circumstances expressly mentioned in the section relate to a
diminution of value as a result of events occurring prior to the
rendition by the taxpayer of its tax return. The exercise is thus
one
of looking back at what happened during the tax year in question.
[8]
The thrust of the taxpayer’s
case, which found favour with the Tax Court, was that the reference
to market value in s 22(1)
(a)
of the Act is the same as
the term ‘net realisable value’ (NRV)
[2]
as employed in the Statement of Generally Accepted Accounting
Practice (AC 108) or International Accounting Standard 2 (IAS 2).
[3]
The Tax Court took the view that:
‘
the
NRV as set out in IAS2 is an appropriate method by which to determine
the actual value of trading stock in the hands of the
taxpayer at the
end of the year of assessment. It provides a sensible and
businesslike result which accords with the purpose of
section 22(1)
being that the cost deduction deferred should be limited to what the
taxpayer can reasonably expect to recover as
at the end of the
relevant tax year.’
The
Tax Court sought support for its approach in
Volkswagen
South Africa (Pty) Ltd v Commissioner for South African Revenue
Service
.
[4]
In that matter, Eksteen J found for the taxpayer, in the main, on the
reasoning that:
‘
The
nett realisable value (NRV) as determined in accordance with IAS2
provides an appropriate method by which to determine the actual
value
of trading stock in the hands of the respondent at the end of the
years of assessment for the purposes of section 22(1) of
the . . .
Act.’
[9]
SARS successfully appealed the
judgment of Eksteen J. On appeal, this court in
Commissioner
for the South African Revenue Services v Volkswagen South Africa
(Pty) Ltd (CSARS v Volkswagen)
(per
Wallis JA) held that Eksteen J had ‘erred in failing to
recognise that s 22(1)
(a)
is
not concerned with contrasting cost price with the value determined
by “an appropriate method by which to determine the
actual
value of trading stock in the hands of the taxpayer at the end of the
year of assessment”’. It concluded: ‘In
looking for
a sensible and business-like manner of valuation of trading stock at
year end [Eksteen J] answered a question other
than the one posed by
the facts and formulated by the parties in the stated case. That
question was whether NRV should be used
to determine the value of
trading stock at year end for the purposes of claiming an allowance
against cost price under section
22(1)
(a)
.
Whether it was a sensible and business-like manner of valuing trading
stock from an accounting perspective was neither here nor
there. The
concern was whether it accurately reflected the diminution in value
of trading stock contemplated in the section.’
[5]
The
correct position, so this court stated, is that:
‘
SARS
may only grant a just and reasonable allowance in respect of a
diminution in value of trading stock under section 22(1)(a),
in two
circumstances. The first is where some event has occurred in the tax
year in question causing the value of the trading stock
to diminish.
The second is where it is known with reasonable certainty that an
event will occur in the following tax year that
will cause the value
of the trading stock to diminish. . . . Both scenarios are consistent
with the basic proposition that the
assessment of income tax relates
to events that have already occurred rather than events that may
occur in the future.’
[6]
[10]
Wallis JA commenced his
judgment in
CSARS v
Volkswagen
, with an
interpretation of s 22(1)
(a)
of the Act and provided
examples of what is contemplated by those provisions. He regarded the
cost price as the ‘baseline
against which any diminution in
value of the goods must be measured’
[7]
and concluded that on a proper interpretation of the section ‘the
cost price of the goods, and not the actual or anticipated
value on
their sale, is the benchmark against which any claimed diminution in
value is to be measured’.
[8]
In the course of his judgment, Wallis JA passed the following
important observations:
(a)
Whilst annual financial
statements prepared in accordance with a group’s accounting
handbook serve a valuable purpose in providing
a true picture about
the financial affairs of the company,
[9]
they are not necessarily equally applicable to the determination of
liability to tax under the Act.
(b)
Whilst there is obvious scope
for an overlap between the provisions of s 22(1)
(a)
and those of IAS2, not all
of the elements to which the latter refers relate to the same matters
as the section.
(c)
The determination of NRV is
firmly based on an assessment of future market conditions.
[10]
The use of NRV is thus inconsistent with two basic principles that
underpin the Act. The first is that taxable income is determined
and
taxation levied from year to year on the basis of events during each
tax year. By contrast, NRV is explicitly forward looking.
The second
is that using NRV has the effect that expenses incurred in a future
tax year in the production of income accruing to
or received by the
taxpayer in that future tax year, become deductible in a prior
year.
[11]
(d)
The Act’s provisions do
not necessarily accord with current accounting principles. Thus,
whether NRV reflects a diminution
of value of trading stock for the
purposes of s 22(1)(
a
)
depends, not on its acceptance as part of GAAP, but on its conformity
to the requirements for such a diminution in value as determined
on a
proper interpretation of that section.
[12]
(e)
While understandable from an
accounting point of view, from a taxation perspective there were
problems with taxpayer’s approach.
The fiscus is concerned with
the value of trading stock as a whole.
[13]
For tax purposes the question is whether the taxpayer’s trading
stock as a whole had suffered a diminution in value.
[14]
[11]
It follows that, like Eksteen J in the
Volkswagen
matter, the
Tax Court in this matter, also erred. I accordingly turn to consider
whether on the principles laid down by this court
in
CSARS v
Volkswagen
, the trading stock of the taxpayer, which comprised
six categories, namely: (i) slow-moving stock; (ii) overstock; (iii)
demostock;
(iv) Dynapac stock; (v) standard cost items and (vi) goods
in transit, suffered a diminution in value.
[12]
It is difficult to discern the basis on which the taxpayer contended
for a diminution of the value of its trading stock. That
is because
its version migrated from an initial reliance on a deemed
obsolescence to reliance on a group policy in accordance with
IAS2.
The taxpayer did not suggest that there has been a diminution by
reason of ‘damage, deterioration, change of fashion
[or]
decrease in the market value’. It appears to be simply
contending that because the items in question had remained on
its
shelves for a particular length of time, it was entitled to write
down those items by fixed percentages by applying IAS2 to
determine a
new NRV and create provision for obsolescence.
[13]
In that regard, Mr Jan Smit, the taxpayer’s business
controller, who was responsible for ensuring that the group’s
policies were implemented, testified:
‘
Mr
Chohan: . . . And that’s why I put to you, Mr Smit, that on the
information conveyed to the Commissioner, Atlas’s
stance is we
don’t look at anything else. If it falls under a category, by
virtue of its ageing, it is classified as such
and it is then written
off accordingly, either by 50% or 100%. And that’s the method
that was applied in 2008 and 2009. Yes?
Mr
Smit: M’Lady, yes, I agree to that. It’s because that is
the method that has been identified which makes it, I could
say, the
most logical for us to be able to analyse the level of items that we
have to do. I can’t recall that there’s
any other
recommendation from the Commissioner as to what method we should
apply. We just need to get to an assessment, but how
do you get to
it, so this is the method that we’ve used.
Mr
Chohan: Right.
Mr
Smit: Which we believe is the most reasonable.’
That,
as it turns out, is simply a time-based approach, which is not
entirely consonant with the requirements of s 22(1)
(a)
of the
Act.
[14]
In the light of the approach to NRV by this court in
CSARS v
Volkswagen, the evidence of Mr Towlson, who led the taxpayer’s
external audit team, was by and large irrelevant, because the
audit
did little more than apply the taxpayer’s group policy and the
NRV in accordance with IAS2. In that regard, Ms Towlson’s
testified:
‘
Mr
Chohan: Yes. And I’m putting this in very loose terminology Ms
Towlson but you’re more than welcome to correct me.
You look at
it, you say ‘[F]AM says if you’re got stock for 12 months
that has not moved, I’m going to write
it off by 50%’,
you do a control test to see roughly speaking have they complied with
that policy by looking at their inventory
and see whether stock has
not moved for that 12 months period, where [there] had been slight
differences, you make a note of that.
But by and large you have
accepted on your analysis that over the 12 month period the inventory
reflects correctly stock that had
not moved.
Ms
Towlson: Yes, so we’re happy based on the aging that the
provision had been fine in terms of that.
Mr
Chohan: Yes. And then the next test of course you’ve got to
determine is whether or not the write off has been correctly
applied.
So in other words the 50% as applied to those stock that was there
for 12 months and 100% in relation to that stock that
was there for
24 months.
Ms
Towlson: Correct.
Mr
Chohan: You don’t test and nor were those your instructions, to
test whether the stock that had been there for 12 months
or 24 months
should be written off at a lesser percentage or a higher percentage.
Ms
Towlson: No, that wasn’t part of our audit, that would have
been looked at by the Group audit team . . .
Mr
Chohan: Correct. Whatever procedures they undertook, that you are
unaware of. Ms Towlson: I’m unable to testify what they
did
specifically.
Mr
Chohan: And you accepted as I understood, coming in as KPMG SA this
is the policy, I’m told that this is the policy that
they have
to [apply] and I now test to see whether they’ve applied it.
Ms
Towlson: Yes, and they implied that it was in terms of IFRS.’
It
follows, despite the Tax Court’s acceptance of Ms Towlson’s
evidence, that her evidence did little to advance the
taxpayer’s
case. If anything, Ms Towlson’s evidence serves to fortify the
view that the taxpayer’s employment
of a fixed and rigid
company policy was arbitrary and did not present the most reliable
evidence available at the time in respect
of any diminution in value.
[15]
Moreover, although fleeting references were made to market value, as
the following exchange between counsel for SARS and Mr
Smit makes
plain, no proper explanation or evidence was proffered, other than
reliance on the group policy and the application
of NRV:
‘
Mr
Chohan: I’m heartened by that, Mr Smit, because when I look at
each of these items . . . you will notice that the
one thing
that is missing, in relation to all of these examples, is the actual
price at which the item was sold. . . . And may
I offer you an
explanation for why that information was not provided? It was
not provided, because it wasn’t
considered by Atlas in
determining whether or not the value of its stock, held in 2008 or
2009, had diminished. And the reason
for that is because Atlas
applied strictly the Way Forward Policy. If it fell in a bucket, 50%
write-off, that’s 12 months,
and 24 months, 100%. Yes?
Mr
Smit: M’Lady, if that’s the interpretation of the
Commissioner, from that side, from our side, we, you know, we apply
a
method. Because if we look at, we have about 20000 items actively,
any day in time, to go and to try and to do that specific
verification item by item, with the relevant pricing confirmations,
will be a gigantic and an impossible task to do.
Mr
Chohan: So, the answer to my question is yes, Atlas did not take into
account the price at which it had sold stock during that
year? It
relied on a method, in terms of which it had applied a 50% write-off,
if it fell into a 12 month bucket, and a 100% write-off
if it fell in
a 24 months bucket?
Mr
Smit: I can, M’Lady, I can agree to the process we followed.
So, basically, what we also do is we do monthly, a profitability
analysis, where we first look at which items have we sold in a period
of time below cost. Because those items is the first items
we have to
address and to see whether it is, if the pricing is market related or
not, and why are we selling it below cost. Because
those items would
then be from a valuation perspective, over value.
.
. .
Mr
Smit: The next step is then, we then turn to the, this ageing bucket,
ageing process, which is calculated, because that’s,
at the
moment, looking at the number of items we have to deal with, it’s
the only method that we can currently apply in assisting
us to
identify items that potentially could have a reduction in their nett
realisable value.
Mr
Chohan: So, the starting point, you say, and this is, I must say,
quite a revelation, is to assess the price at which the items
were
sold at below cost price, in order to determine reasons, market
fluctuations, etcetera. Where do I find any evidence of that,
Mr
Smit? Would there be minutes of those meetings?
Mr
Smit: M’Lady, there won’t be minutes for it, but what we
used to do is, we had Excel spreadsheets, which was an extract
from
our sale statistics, and it was then monthly sent to the
relevant business Line Managers to say, please, let’s
look at
all the negative gross profit developments.
.
. .
Mr
Chohan: Has that been provided to the Commissioner by Atlas?
Mr
Smit: Looking at all this, no.’
[16]
Significantly, during the audit, Ms Towlson and her team also
identified products that had been sold below cost in order to
determine whether they should be written down and by what percentage.
In this regard, she only identified three product lines that
had been
sold below cost and on average those products were sold at
approximately 24 to 26% less than their cost. The true factual
position is thus a far cry from the application of a fixed 50 or 100%
write off in terms of the group policy. This historical evidence
ought to have featured in the determination of whether or not there
was any diminution in value of the trading stock as contemplated
by s
22(1) of the Act. But it did not. Instead, the taxpayer chose the
application of a fixed percentage based policy grounded
on an aging
analysis. What is more, Ms Towlson’s audit team recorded that
the taxpayer’s group policy was ‘a
very aggressive
policy’ and for that reason, the risk of inventories being
carried at more than their NRV was deemed low
‘considering the
aggressive write down policy’.
[17]
It must follow from what has thus far been stated that the taxpayer’s
approach to the valuation of its trading stock
is flawed. That,
ordinarily at any rate, ought to be dispositive of the appeal against
it. However, in the light of the objections
raised, explanations
proffered and the circumstances giving rise to the appeal, it is
necessary to turn to a consideration of each
of the six categories
that made up the taxpayer’s closing stock. Given the overlap in
evidence, it will be convenient to
consider the slow-moving and
overstock categories together. The taxpayer asserted that inasmuch as
it operated within the mining
sector and had to meet orders at
relatively short notice, it was necessary to keep larger volumes of
stock to hand than would otherwise
have been the case. Whilst it may
be difficult to quarrel with that as a general theoretical
proposition, the taxpayer oftentimes
had difficulty explaining the
sheer volume of stock to hand or the treatment of such stock for tax
purposes. In that regard the
evidence ran:
‘
Mr
Chohan: Mr Smit, I’m not contesting your need to keep stock or
to buy stock to appease your customers. I’m
contesting
the treatment of that stock as overstock, simply because in 12 months
you bought two items, your sold one, the other
one you didn’t
sell, and Atlas now regards it as an overstock item, which it writes
down by 50%. That’s what I’m
challenging.
Mr
Smit: M’lady, in that perspective it’s correct, but that
one that’s left in stock now, is not to say that we
will be
able to sell it, because for 12 months we were only able to sell one.
So, who’s to tell or what’s to tell that
we will be able
to sell the other one as well.
Mr
Chohan: And who’s to [tell], so you won’t be able to sell
it?
Mr
Smit: Exactly. It is an estimate.
Mr
Chohan: Ja. Atlas, it seems, as I understand your evidence, prides
itself on efficiency, that was your opening comments yesterday
when
you gave evidence. One would think, given the drive for efficiency,
you would have some sort of historical data indicating
what items
should be bought and at what levels they should be bought in order to
maintain that efficiency. Yes?
Mr
Smit: Yes.
.
. .
Mr
Chohan: I’d like to take the pneumatic drill as an example . .
.
You
had sales of 18 rock drills over a 12 month period, but you had kept
388 items in stock. So, Atlas, obviously bought too many
of these.
Mr
Smit: M’Lady, what I wanted to say on the, previously, was that
we do have systems that assist us programmatically, or
automatically
to review stocking levels of items. So, in the background these are
systems with logic that does review the consumption
and then make
proposals as to what we should keep in future in stock. We also have
the opportunity to manually intervene in those
system decisions,
based on market information that we get from our sales people, where
they are negotiating future contracts with
customers, with the
potential of securing that business. So, those adjustments to the
logics, obviously then, governs what the
level should be. But the, we
not always 100% secure of that business, that a contract will
materialise. So, it could be that there’s
suddenly a change in
market demand, changes from customers, that they change their mind,
they go to a competitor, or alternative
suppliers. And then we sit
with the unfortunate situation where we have overstock.
Mr
Chohan: My logic tells me that that logic was wrong in relation to
this particular item, because, obviously, you have far too
many items
held in stock for that period. Whether it was due to market
conditions, people going to competitors, etcetera, that’s
the
result. Is that not so?
Mr
Smith: M’Lady, that is the result, yes. But we need to also on
this item actually go and fundamentally understand the detailed
background of it, why did we end up in this situation, was it a
system error from an employee in our company, or was there a contract
that was cancelled by a customer, that effected this result.
Mr
Chohan: Right. And you can’t tell us exactly what the reasons
are for it at the moment, as you sit here today?
Mr
Smit: Yes, I can’t tell it for each and every item, no.
Mr
Chohen: And the Commissioner doesn’t know whether this is an
error, or whether there’s some reason behind it, etcetera.
All
it is given is this document on which it must make an assessment?
Mr
Smit: Yes’
The
taxpayer thus appears to have taken no account of any diminution in
value in respect of such stock. Its approach simply was:
because we
had not sold all of the items, who is to know whether we will be able
to sell what remains of the stock. The write off
was thus at best an
unmotivated guesstimate.
[18]
The third category, described by the taxpayer as ‘goods in
transit’, were goods for whatever reason that had to
be
returned to the taxpayer’s parent company in Sweden. Mr Smit
testified:
‘
Court:
. . . is there a Way Policy applicable to how these goods are
treated?
Mr
Smit: M’Lady, the only I can recall, there is a write up on, in
our Way Policy about goods in transit, how it should be
treated, but
it does not specifically say what the specific amounts is that you
need to account for, because that is on a case
by case basis, as we
agreed with the supplying counter Atlas Copco company, as to what
it’s going to be. Because there’s
various things they
need to take into account. There could be items that we want to
return that is no longer in production, or
there’s no longer
any demand in the market for it. Even if it’s not in South
Africa, maybe even in other countries
there’s not a demand for
it, so the product company will not take it back, because if they do
take it back, they will have
to, on their end, make a valuation
assessment whether they should scrap it or not, if they can’t
then supply it to another
Atlas Copco company. So, there, it’s
a whole evaluation process we have to undergo with them. And then
only they’ll
say you are now allowed to return this list of
items, with these quantities, and then it’s also still
subjected to a final
inspection process, from a quality perspective,
as to what we are returning to them.
Assessor:
How do you val[u]e them? At the original cost or at the agreed value,
or, you know, in this provision?
Mr
Smit: M’Lady, in this provision, the amount that’s in the
provision is an estimate, what we said, shortfall, which
we will
expect where the product supplying company will deduct an amount for
the administration fee for returning it to them. So,
that’s
really just for he handling administration fee is the portion that we
provide for.’
Once
again, the taxpayer relied on an unsubstantiated estimate. Ms
Towlson’s evidence did not help matters. According to her:
‘
Mr
Chohan: Let me see, I’m not sure you answered my question, so
let me put it to you again. What audit work did you do in
relation to
testing whether the adjustment by Atlas for goods in transit was
correct or not, or did you – in other words
did you have regard
to those credit notes? Did you have regard to an actual adjustment
having been made or did you accept management’s
explanation
that they get normally a 20% adjustment on goods that are sent back
to Sweden?
.
. .
Ms
Towlson: Okay, so the note we’ve written here is that the CTO
land cost factor can be anywhere between 10 and 32%. That
would have
been based on . . . .
Mr
Chohan: On an explanation.
Ms
Towlson: No.
Mr
Chohan: Or on a document?
Ms
Towlson: On the work that we would have done. So we would have
independently said that we would expect it to be 10 to 32% and
therefore we would expect, the credit expected would be generally
between 70 and 80% so we would have expected a larger percentage.
And
then because the percentage was lower, we then obtained explanations.
So in this instance they were returned – they were
left on the
dock, they suffered rust damage and therefore they only expected to
receive a credit of 20%.
.
. .
Mr
Chohan: So based on the explanations that were given by management
regarding the particular inventory that had been sent back,
you then
made provision, or at least evaluated it and you were happy that the
adjustment was correctly made.
Ms
Towlson: So we were happy that there was a 70 to 80% (indistinct) the
20 yes.’
[19]
Importantly, even though the group policy did not apply to the
demostock, Dynapac stock and standard cost items, the taxpayer
dealt
with them no differently to the first three categories. Insofar as
the demostock, which was supplied to the taxpayer’s
customers
on consignment, was concerned, the process that should have been
followed by the taxpayer was to identify items and value
them in
order to determine any diminution thereof. Instead, it simply wrote
down the value of such stock by 50% as though the group
policy
applied. What is more, some of the demostock was written off by 100%
based on the external auditor’s inability to
find such stock.
This, in circumstances where Mr Smit was unable to say which stock
this related to, or why the auditors had made
such a note in their
working papers. If the demostock was purchased by the taxpayer’s
customers, well and good. If not, according
to Mr Smit:
‘
Court:
And then the third category is the demonstration items. Is that
correct? And there’s no Way Policy for how that’s
calculated?
Mr
Smit: No, M’Lady, the demo stock is, it was, we classified it
as demo, and we kept it as part of an inventory, but in reality
we
should have actually taken it out of inventory, and put it in a, like
in a fixed asset register, where you have normal depreciation,
as
deprecation on it as the customers would be using it. But from an
administrative process, we kept it as part of the inventory,
but
segregated on, in a unique warehouse. So, it was then not part of
this ageing reporting, so that we can still keep traceability
on
these items and know where it is, and where it are, and then do
valuations on them as, at point in time.
Assessor:
That valuation is at 50% of cost, or was there a difference in some
categories.
Mr
Smit: M’Lady, on the demo stock, if you go and look
at the calculation, I think on those it was all 50%, taken
across all
items at the time, at the end of December 2008.
.
. .
Mr
Chohan: Right. So, let me just see if I understand that correctly.
The Auditors, having conducted their audit, say to you that
in
relation to demo stock, we have found that this stock has been . . .
on consignment. It is located either at customers or, in
some
instances, at various warehouses. I assume Atlas’s warehouses?
.
. .
Mr
Smit: Yes.
Mr
Chohan: We know from what you’ve said earlier on that instead
of valuing it a 50% provision was made for slow moving items
of these
demo stock, but then there are those demo stock which, presumably,
your system has picked up exists as part of your inventory,
but which
you cannot locate or find, or which the Auditors couldn’t
locate or find?
Mr
Smit: The items, they are shown in inventory in a specific warehouse,
or warehouses.
Mr
Chohan: Right.
Mr
Smit: Which doesn’t form part of any of the ageing reports,
because it’s a unique classification. So, but we know
which
items is demo and where is it, in which warehouses, and the
warehouses normally reflects the location where it is.
Mr
Chohan: Okay. What I’m enquiring, Mr Smit, is the Auditors
comment that a 100% provision was created for demo stock that
could
not be located, or was missing. So, if the demo stock is kept in a
warehouse, and you know it’s kept separately from
other items,
you have a system, it seems a very sophisticated system, that keeps
track of all your stock, demo stock, separately.
This is stock that
the Auditors were unable to locate for one or other reason, in the
warehouse.
Mr
Smit: M’Lady, I don’t know what, at that stage, what the
Auditor, his interpretation was on this. Whether there
was
specific items that they were looking for, which they could not find,
and whether it was based on the feedback that we gave
them to say if
we, because what we do is with those different warehouses, if the
people that’s at the warehouse tells us
the item is no longer
there, because the system shows you should have it, then we will
write it off and scrap it, because it’s
missing. So, this
could, I’m not, I don’t know what the interpretation of
the . . . .
Mr
Chohan: You don’t know, despite the . . . [c]onversations that
you may have had with the Auditors, you don’t know
what this
means?
Mr
Smit: I don’t know what his interpretation was on this, yes.
Mr
Chohen: And you, therefore, don’t know why the 100%
provision was created for such stock
.
. .
Mr
Smit: It could have been a comment that he made based on our
discussions as to how we handle the transaction.
Mr
Chohan: I don’t want you to speculate, Mr Smit, I want you to
see if you can’t assist me on what you know, as a matter
of
fact.
Mr
Smit: Can you maybe just repeat again, what do I need to know.
Mr
Chohan: Yes. You are unable to assist the Commissioner or the Tax
Court as to what demo stock the Auditor is referring to, and
why the
provision of 100% was made in relation to that.
Mr
Smit: M’Lady, the only thing I have on the demo side is a
listing of the items which we have provided, which makes up the
full
list. Those are the only items I can account for that forms part of
the provision.’
[20]
Turning to the Dynapac stock: The evidence was that Dynapac was
acquired by the taxpayer during October 2008. Unlike the taxpayer,
which was involved in the mining sector, Dynapac was involved in the
supply of heavy duty equipment for road construction. The
taxpayer
included Dynapac’s stock in its closing stock, which it valued
on the basis of the provision allegedly made for
such items by
Dynapac. In that regard Mr Smit testified:
‘
Mr
Chohan: . . . So, you acquired Dynapac’s trading stock, and
that would have included its heavy machinery, capital equipment
and
spare parts. In determining the value of that trading stock that
Atlas had acquired, Atlas had simply adopted the provisions
that had
been made by the seller
.
. .
Mr
Smit: Yes.
Mr
Chohan: You, as Atlas, at the time conducted no independent
assessment of the value of that trading stock.
Mr
Smit: M’Lady, normally how the acquisition process works is we
getting our due diligence processes early in the construction
of the
deal, we look at what the potential seller is using in how they come
to a definition of their cost of their trading stock.
Are they
applying average costs, are they applying standard costing, actual
costing.
.
. .
Mr
Chohan: So, let me come back to my question, just to make it
absolutely certain. As you sit here today, you do not know how that
provision had been calculated?
Mr
Smit: M’Lady, I don’t know how it was calculated, only
that it was based on the historical information out of the
seller’s
financial system, also based on an ageing analysis methodology.
Mr
Chohan: . . . are you able to tell us today what ageing process was
applied by the seller and what percentage write-offs were
applied by
the seller?
Mr
Smit: M’Lady, I can’t say right now, but if I go and look
at the data that we have related to Dynapac in 2008, I
can most
probably then do an analysis on it, but I can’t say right now.
No, I can’t answer that.
.
. .
Mr
Chohan: Now, I understood your evidence to say that, because Dynapac
stock had been only acquired in October 2008, it was treated
differently, because there was no historical data on which you could
rely, for purposes of implementing the Way Policy?
Mr
Smit: M’Lady, yes, it was, we could only take it based on how
the seller has done it.
Mr
Chohan: . . . You’ll see that Ms Simpson says,
‘
Please
could you arrange to have the following . . . stock scrapped. These
items have 100% provision against them as per 24 slow
moving.’.
Can
you assist me in relation to that, Mr Smit? I can only assume that
she is not, referring to Atlas Copco’s policies, because
it
could never have been slow moving in terms of that policy, having
only been acquired in October 2008.
Mr
Smit: M’Lady, yes, it would not, could not have
been part of the Atlas Copco one, because
we had a
separate Excel listing of the items that we acquired from Dynapac.
Mr
Chohan: So, must I assume, when I read this e-mail . . . . That she
is, in fact, referring to the seller’s provisions?
.
. .
Mr
Smit: Yes. And, M’Lady, the reason for it also was, is if we
look at the timing, and the amount of items involved,
we
acquired them in October 2008, so, and then we had, basically, two
and a half months available to conclude the whole acquisition
transaction, because that was also the year end for our annual
financial year end. So, we were under enormous pressure in the
organisation to bring them into our business, so we did not have the,
honestly, the opportunity to do a proper valuation.’
The
approach by the taxpayer to the Dynapac stock was similarly based on
an aging methodology, the basis of which the taxpayer did
not know or
did not bother to ascertain. It simply adopted the provision that had
been made by Dynapac for such stock.
[21]
The taxpayer’s treatment of standard cost items also suffers
from a lack of adherence to s 22(1) of the Act. This category
comprises stock that the taxpayer had purchased from its parent
company, only to be notified by the latter later during the tax
year
of a price increase or decrease. That resulted in a corresponding
price adjustment and had a knock-on effect on the value
of the stock
held at year end (referred to as a standard cost item in the
taxpayer’s accounts). But, the taxpayer was simply
unable to
tender any satisfactory evidence on that score. And, what is more, as
the following excerpt illustrates, Mr Smit also
had difficulty
identifying which items the apparent cost increase or decrease
applied to.
‘
Mr
Chohan: And in order to determine whether or not there had been in
2008 or 2009, any such change, one would expect a notification
or
document, or some sort of a memorandum from the parent company, or
the supplying company, informing Atlas Copco of this price
update.
Mr
Smit: M’Lady, I think in our Group we work, not necessarily, on
a notification like that, we work with transit pricing
agreements,
which is, transit pricing agreements, internationally been agreed
between all the different parties, how we handle
pricing.
.
. .
Mr
Chohan: So, one would have some or other documentary evidence, either
electronically or if you printed it out physically, of
that price
change happening in January of each year, or some time shortly
thereafter?
Mr
Smit: Yes, there will be some communication . . .
.
. .
Mr
Chohan: And that would be, and based on those documents, Atlas Copco
would then, invariably, adjust its pricing for the stock
that is held
by it, either upwards or downwards, depending on the update.
Mr
Smit: Yes, it gets initiated in our system to reflect the new
pricings.
Mr
Chohan: So, in order for the Commissioner to assess whether or not
that had, in fact, occurred, rather than simply just a statement
that
says I reduce this, because of what is described as standard cost
change items, one would expect to see that notification,
I put it,
conveyed electronically in January of each year.
Mr
Smit: Yes, there will be, there is some communications.
Mr
Chohan: We do not have that as we sit here today. You can’t
point to the document? Mr Smit: Ja, I can’t point the
Commissioner to something.
Mr
Chohan: And as Atlas’s witness, you can’t tell me, in
relation to which items the updates applied and in what respect?
Mr
Smit: If we talk about 2008, I can’t, not right now, no.
Mr
Chohan: And, of course, in 2009, in fairness to you, you weren’t
there, so you can’t comment on it.
Mr
Smit: Yes.’
[22]
It is apparent when the evidence relating to all six categories is
considered, that the taxpayer’s approach essentially
boiled
down to this: because it held thousands of items of stock at year
end, it was not feasible for it to individually value
each item. For
that reason, it applied its policy with reference to item
descriptions. This evidence was accepted by the Tax Court
in support
of the proposition that the legislature could not have intended that
a trader assess each individual item of closing
stock in
circumstances were they hold thousands of items of trading stock. But
this was misplaced. SARS never contended that the
taxpayer had to
assess each individual item of stock. On the contrary, as SARS
accepted, the practice of sampling in these situations
is a
well-recognised method of dealing with the challenges of high volume
trading stock. But, that is not what the taxpayer did
in this
instance.
[23]
It follows for all the reasons given that the judgment of the Tax
Court cannot stand. In my view, it cannot be said that SARS
failed to
exercise the discretion conferred by s 22(1)
(a)
reasonably and
properly. Insofar as the imposition of section 89
quat
(2)
interest is concerned, no warrant exists for a remittal in terms of
s89
quat
(3) of the Act. The appeal must accordingly succeed.
[24]
In the result:
(a) The appeal is upheld with costs,
including those of two counsel.
(b) The order of the Tax Court is set
aside and replaced with one dismissing the appeal and confirming the
additional assessments
for the 2008 and 2009 years of assessment.
__________
V
M Ponnan
Judge
of Appeal
APPEARANCES:
For
Appellant: M Chohan SC (with him R Tsele)
Instructed
by: MMMG Attorneys, Rivonia
Phatshoane
Henney Attorneys, Bloemfontein
For
Respondent: J Boltar (with her M van Kerckhoven)
Instructed
by:
Bowmans,
Sandton
McIntyre
van der Post, Bloemfontein
[1]
Per Marais JA in Richards Bay Iron and Titanium (Pty) Ltd &
another v Commissioner for Inland Revenue
[1995] ZASCA 81
;
1996 (1) SA 311
(A). He
went on to explain at 316F-7C: ‘The South African system of
taxation of income entails determining what the taxpayer's
gross
income was, subtracting from it any income which is exempt from tax,
subtracting from the resultant income any deductions
allowed by the
Act, and thereby arriving at the taxable income. It is on the latter
income that tax is levied. The concepts involved
are defined in the
Act. Commissioner for Inland Revenue v Nemojim (Pty) Ltd
1983 (4) SA
935
(A) at 946G-H. Where a taxpayer is carrying on a trade, any
expenditure incurred by him in the acquisition of trading stock is
deductible in terms of s 11(a) of the Act because it is expenditure
incurred in the production of income, and it is not of a
capital
nature. Income generated by the sale of such stock is of course part
of the trader's gross income. Where in his first
year of trading a
trader has bought, and thereafter sold, all the stock which he
acquired during that year, no problem arises.
There will be a
perfect correlation between the trading income earned and the
expenditure incurred in that particular year in
purchasing and
selling the stocks sold, and the difference between the two sums
will give a true picture of the result of the
year's trading. There
will be no stock on hand at the close of the year of which account
need be taken. Contrast with that situation
a situation in which the
trader, having sold all the stock acquired earlier during that year
at a substantial profit, purchases
large quantities of stock just
prior to the close of his tax and trading year. If he were permitted
to deduct the cost of purchasing
that stock from the income
generated by his sales, without acknowledging the benefit of the
stock acquired, he would be escaping
taxation in that year on income
which otherwise would have been taxable by the simple expedient of
converting it into trading
stock of the same value. That process
could be repeated every year ad infinitum. It is true that there
would ultimately have
to be a day of reckoning when trading finally
ceases, but the fact remains that the taxpayer will have been
enabled to avoid
liability for tax until that point is reached.
Where the trader is an individual who is subject to rising marginal
tax rates
as his trading profit increases, he would be enabled to so
regulate his apparent profit that he immunised himself from them
indefinitely.’
[2]
NRV is defined in IAS2 as the estimated selling price of inventory
in the ordinary course of business, less the estimated costs
of
completion and the estimated costs necessary to make the sale.
[3]
In Commissioner for the South African Revenue Services v Volkswagen
South Africa (Pty) Ltd
[2018] ZASCA 116
;
[2018] 4 All SA 289
(SCA);
2019 (2) SA 362
(SCA) (CSARS v Volkswagen) para 28, Wallis JA
explained: ‘The International Financial Report Standards
(IFRS) are internationally
accepted standards issued by the
International Accounting Standards Board (IASB). International
Accounting Standard 2 (IAS 2)
was originally issued in 1993 with
revisions being issued in 2003 and 2006. The version with which we
are concerned was updated
on 2 January 2008. The Accounting
Practices Board reissued it in South Africa as AC 108 without
alteration and it forms part
of the statement of Generally Accepted
Accounting Practice (GAAP)’.
[4]
Volkswagen South Africa (Pty) Ltd v Commissioner for South African
Revenue Service 80 SATC 58 (PE).
[5]
CSARS v Volkswagen fn 3 above para 54.
[6]
Ibid para 18.
[7]
Ibid para 22.
[8]
Ibid para 26.
[9]
Ibid para 31.
[10]
Ibid para 36.
[11]
Ibid paras 52 and 53.
[12]
Ibid para 32.
[13]
Ibid para 46. Wallis JA explained: ‘Writing down the value of
part of the stock to NRV ignores the fact that the NRV of
the
remaining stock is higher than cost price. The overall position with
a company that is a going concern will probably be that
the NRV of
the trading stock, taken as a whole, will be greater than cost
price. In a solvent and profitable trading company
it would be
surprising if it were not. Companies do not usually acquire, or
manufacture, trading stock that they think will realise
less than it
cost. To pursue that course for any length of time would lead to
insolvency. Using NRV is a legitimate approach
from an accounting
perspective. However, I can see no reason for the Commissioner to
accept that Volkswagen’s trading stock
had diminished in value
on the basis of a calculation where Volkswagen took advantage of the
‘swings’, where the
NRV was lower than cost price, but
disregarded the ‘roundabouts’, where the reverse was
true.’
[14]
Ibid para 46.