On 15 November 2019, the Cape Town Tax Court handed down judgement in ITC24614. It is yet another judgement concerned with the distinction between expenses of a capital nature or revenue nature – arguably the issue over which there has been the most litigation in South African tax history. The importance of the distinction lies in the deductibility of the amount for income tax purposes – while expenses which are revenue in nature are generally deductible, those of a capital nature, are not.
The expense (or loss, in this instance) which gave rise to the dispute, is a fellow subsidiary receivable amount (treated in the taxpayer’s books as a “loan”), which was written off by the taxpayer since it was clear that the fellow subsidiary was unable to repay the amount. SARS argued that the loss was of a capital (as opposed to revenue) nature, and along with denying the deduction, imposed a 50% understatement penalty on the taxpayer.
The origin of the loan was not from funds advanced by the taxpayer to the fellow subsidiary, but rather from trading activities between the parties (i.e. amounts which were included in the taxpayer’s income and the amount deducted therefrom).
The tax court argued as follows:
- A loss suffered by a taxpayer as a result of writing off indebtedness of another party can be categorised as either capital or revenue in nature and there is no single definitive yardstick for distinguishing between capital and revenue expenditure;
- Whether an amount lost or written off was advanced or treated as a loan is not in itself determinative of the capital or revenue nature of the loss or expenditure, since the accounting treatment applied by a party is not to be regarded as determinative of either the legal position or the correct tax position. The question is always one of substance rather than form, and is to be decided on all the facts of the case;
- It is not the treatment of an amount as a “loan” which is determinative, but whether the loss was incurred in the conduct of the taxpayers’ own revenue-earning trade or not; and
- This was not an investment concerned with supporting an extraneous business of the fellow subsidiary and the loss incurred did not amount to the deployment of the taxpayer’s fixed capital to equip its “income-earning machine”. It was rather an indebtedness that arose from its trading activities with the fellow subsidiary and as such is a clear example of the deployment of floating capital, insofar as it was not intended to remain outstanding but intended to be converted back into cash in the ordinary conduct of the taxpayer’s trade.
In the result, the tax court found in favour of the taxpayer and ordered that the additional assessment be set aside.
Respectfully, the tax court’s findings in this regard are sound, and it is unclear why the matter proceeded to litigation. Where the line between revenue and capital in nature is often blurred, this appeared on face value to be rather straightforward. The take-away from the judgement is that taxpayers should, especially where material amounts are involved, not merely accept additional assessments from SARS and should consult with experts where there are uncertainties.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)
