These agreements all have substantially similar provisions. The tax authorities must provide information to each other that is foreseeably relevant to the administration and enforcement of domestic tax laws, the collection of taxes and the prosecution of criminal tax matters. The significance of the “foreseeably relevant” requirement is that tax information exchange agreements should not be used for information fishing expeditions. The requesting authority must exhaust its own means of obtaining the requested information before resorting to the agreement. The parties must ensure that they have the authority under their domestic law to obtain the kind of information likely to be requested.

Sometimes a party may request permission to visit the other party to interview individuals and examine records.

South Africa has concluded and ratified tax information exchange agreements with Barbados, Belize, Costa Rica, Dominica, Lichtenstein, Samoa and Monaco, but to date only those with Barbados and Liechtenstein have been ratified by both parties.

Given the global push towards tax base erosion and profit shifting, which invariably involves tax havens, we can expect a continuing increase in the number of these arrangements.

Peter Surtees

January 2015

Chronology:

DS Rens (the testator) owned the remaining extent of Portion 2 of the farm Hammanskraal No 112.

July 2008:         the Minister consents to sub-division into:

(1)           Rem Ext of Portion 2 (which I will refer to as Portion 112); and

(2)           Portion 76 of Rem Ext of Portion 2 (which I will refer to as Portion 76).

Feb 2009:         the Surveyor General approves the sub-division.

March 2009:      deed of sale of Portion 76 to D de Klerk on behalf of a company to be formed:

(3)           subject to a suspensive condition that township rights would be granted within 18 months; and

(4)           DSR would acquire 20% of the share capital of the company which would hold the property (Hammanskraal Residential Properties (Pty) Ltd).

Sept 2009:        Edelstein instructs a valuer to value the properties; not Portion 76 but of another Portion.  And see 17.2.

11 March 2010:  DSR executes his will:

(5)           Daughter Rene Zerf to get R250 000;

(6)           Daughter Natalie de Klerk to get a farm valued at R18 million (is D de Klerk Natalie’s husband?  Not clear from the judgment);

(7)           Son TA Rens (TAR) to get Rem Ext Portion 2.  (As will appear later, the issue in the case was whether this referred to the entire farm or only Portion 112).  He records his intention during his lifetime to transfer the property to TAR and insofar as he achieves this it must be seen as an advance on TAR’s inheritance.

1 June 2010:     deed of sale (the “second deed”) signed but nothing came of it.  D de Klerk signs on behalf of DSR (how?)

25 June 2010:    DSR dies.  Executors appointed: TAR, Edelstein & D de Klerk.

26 Sept 2010:    suspensive condition not met; contract null and void.

2 Dec 2010:      the deed of sale drafted and finalised.

25 Nov 2011:     registration of title and servitudes in favour of Eskom.

25 Nov 2011:     subdivision registered and certificate of registered title registered.

6 Jul 2012:        first and final liquidation and distribution in the estate filed and D De Klerk resigns.  Had he not resigned, Edelstein would have been compelled to take action against him.  The judgment does not explain the reason for this statement.

6 Jul 2012         Edelstein gets an opinion from Fine SC.  He does not tell Fine about the second contract or that the subdivision had not been finalised at time of the will.

Arguments

TAR contended that Portions 112 and 76 (ie the whole of Rem Ext of Portion 2) were bequeathed to him, whereas Edelstein contended that Portion 76 should fall in the family trust (presumably the residual heir)

The court identified what it called a factual matrix summarising the inferences that the protagonists urged upon the court, based on the facts and circumstances.  Based on these:

Edelstein contended that, at the date of execution of the will, Portion 76 was already sold.  The time for fulfilment of the suspensive condition had not yet lapsed and the deed of sale was in force.  He contended that the testator would have seen it this way, especially since he would receive a 20% shareholding;

Edelstein contended further that in September 2009 DSR had instructed him to transfer Portion 112 (ie excluding Portion 76) to TAR as an advance on his inheritance.  The transfer was delayed by the Eskom servitude registration.  The inference he placed before the court was that the legacy (see 6(3)) was to cover the eventuality that the donation had not been concluded by DSR’s death ie the donation related to the same property as in the will;

TAR contended that DSR would not have wanted him to inherit only R4 million (Portion 112) as opposed to R9 million (both Portions).  However, Rene and Natalie disputed this and pointed to the disparity of their inheritances.

TAR contended further that DSR was an astute businessman who would have well understood the tenuous nature of the suspensive condition.

Given the competing interpretations of the will, Edelstein contended for rectification on the grounds that the provision in the will was ambiguous and that the factual matrix pointed to his interpretation.

The finding

As to rectification, the court stated that rectification is an equitable remedy, the purpose being to give effect to the true intention of the testator in the case of a will.  The onus is on the applicant for rectification to establish, on the balance of probabilities, firstly that the alleged discrepancy between expression and intention was a mistake; and secondly what the testator really meant to provide.  In the present matter there was no ambiguity, and therefore no room for rectification.

Edelstein contended that the will must be interpreted according to Natal Joint Municipal Pension Fund v Endumeni Municipality [2012] (4) SA 593 (SCA).  The court rejected this contention on the grounds of the difference between a contract and a will.  A contract offers the parties the opportunity to explain clauses.  A testator is beyond reach, and so the correct approach in the case of a will where, as here, the testator’s words are clear from the plain grammatical wording is to have regard to the material facts and circumstances known to the testator when he drafted the will.  The court cannot interpret the language of the will to give effect to what the testator may have intended but has not expressed at all.  The court must put itself in the position of the testator – the armchair rule.  Had DSR not wanted TAR to inherit Portion 76 if the sale fell through, he could have stated as much.

The “second deed” (see 7), had “popped up” as a desperate attempt by D de Klerk to keep the original deed of sale alive and thus Portion 76 out of the picture.  The court noted that D De Klerk had drafted and signed the “deed” on behalf of DSR and he, of course, was the person who stood to benefit from it.

Edelstein stated on affidavit that DSR had instructed him to exclude Portion 76 in the will but that he had omitted to do so.  TAR denied this and provided evidence in support of his contention.

In the event the court found for TAR and indicated some displeasure with Edelstein’s conduct.

The general principle in issue is how to treat expenses, audit fees in this case, that relate to both taxable income such as interest and to exempt income such as dividends.  Expenditure incurred in respect of exempt income is not deductible, for obvious reasons.  The question arose as to the appropriate method by which to apportion these expenses.

The facts

The taxpayer was the holding company of a number of subsidiaries in the group and earned by far the majority of its income from dividends from these companies.  It also made interest-free loans to its subsidiaries, and interest-bearing loans to other group companies.  It thus had two sources of income: dividends from its subsidiaries and interest from loans to members of the group.  The taxpayer had no employees, but used the resources of the group instead.

SARS apportioned the audit fees based on the relationship between the taxable portion of the revenue, the interest, and the exempt portion, the dividends.  The result was that most of the audit fees were not deductible.  In the years in question, 2001 to 2004, the disallowed percentage of the fee varied between 94% and 98%.  The taxpayer appealed to the tax court, contending that the entire audit fee was deductible, basing its argument on the respective numbers of entries in the records.  The tax court rejected both parties’ arguments and held that a 50/50 apportionment was appropriate.

Both parties appealed to the High Court; the taxpayer persisting with its view that a full deduction was justified, alternatively that 94% of the fee was deductible based on an alleged time basis.  The court accepted the alternative submission, thus finding against SARS, and SARS duly appealed to the SCA.

The principles

The SCA considered the well-settled principle that, in deciding whether expenditure has been incurred in the production of income, as required by the Income Tax Act, 1962, “important, sometimes overriding factors are the purpose of the expenditure and what the expenditure actually effects”.  The court has to assess the closeness of the connection between the expenditure and the income earning operations.  Accordingly, the audit fees were a part of the general overhead expenditure enabling it to carry out all its activities.  Thus the audit of financial records is “necessarily attached” to the performance of the income-earning operations.

Application of the principles

The question was the extent to which those income-earning operations generated taxable revenue.  The court acknowledged the principle of apportionment where expenditure meets the “necessarily incurred” test but relates to both taxable and exempt income.  The problem is to establish an acceptable basis of apportionment.  Previously the courts have applied formulae, as in CIR v Nemojim (Pty) Ltd [1983] 45 SATC 291 AD and CIR v Rand Selections Corporation Ltd [1956] 20 SATC 390 AD, or a basis that the court deemed to be fair in the circumstances, as in Tuck v CIR [1988] 50 SATC 98 AD.  In the present case, the court recoiled from basing the apportionment on a formula which might not reflect the actual situation, or on the respective number of entries, or even on a narrow comparison of the sources of revenue.  It was not possible to lay down general rules as to how to apply apportionment.  The court acknowledged that “an auditor has to undertake a wide range of general tasks which do not relate to specific income items”.

The MTN audit function involved far more than the time spent on the book entries, which may well have made up a relatively small component of the overall audit time.  For example, the group consolidation would necessarily have taken considerable time.  It was clear that the interest-earning operations made up a modest part of the operations, and the apportionment would have to reflect this reality.  SARS’s approach was too narrow, and that of the taxpayer was too generous.  In all the circumstances, the court considered it fair and reasonable to allow 10% of the audit fees.

Where does this leave taxpayers in relation to audit fees and similar expenses?  In their favour is the fact that the court has confirmed that audit fees are “necessarily attached” to operations.  At least once in the recent past, SARS has argued, unsuccessfully, that audit fees should be disallowed altogether.  In SARS’s favour is the finding that audit fees are subject to apportionment.  And both parties are on notice that consideration of the specific circumstances and not formulaic approaches is necessary in apportioning expenditure.

The case also dealt with a capital/revenue argument in relation to the costs associated with the installation of a software system, but that is a topic for another article.

In February 2014 the Cape High Court found that, in the legal context at least, “pending” means “proceedings having begun but not yet concluded”, as opposed to the applicants’ claim that it means “about to happen”.  The court also found, in response to the applicants’ alternative challenge, that Part C of Chapter 5 of the Tax Administration Act 2011 (TAA) is not unconstitutional.  Part C enables a judge to order an inquiry into a person’s tax affairs, and section 58 provides that, once a judge has ordered such an inquiry, it is not suspended despite the fact that civil or criminal proceedings are pending or contemplated against a person.  Not for the first time, this decision indicates how difficult it is to impugn the constitutionality of tax legislation.

Two of the 13 applicants were the main protagonists.  One was presently arraigned on fraud charges, several of which were income tax or VAT related charges; and he and another applicant were the respondents in an asset preservation order brought by SARS in terms of section 163(4) of TAA.  Acting on an application by SARS in terms of Part C, Judge Davis of the Cape High Court had granted an order for an inquiry into the affairs of the two main applicants.

Because the fraud and preservation processes had already commenced, the applicants contended that the court was not at large to order an inquiry.  Their reason lay in the wording of section 58 of TAA, which provides that, unless a court orders otherwise, an inquiry relating to a person “must proceed despite the fact that a civil or criminal proceeding is pending or contemplated against or involves the person…”  The applicant contended that “pending” means “about to happen” and, because the fraud and preservation proceedings were already under way, a court was precluded from ordering an inquiry under Part C.

The court considered the meaning of “pending” with reference to the Shorter Oxford Dictionary and legal parlance, and concluded that it means “proceedings having begun but not yet concluded”.  Thus “pending” in section 58 means that an inquiry must continue even during civil or criminal proceedings, unless a court orders otherwise.  The order was thus valid.

The applicants then attacked the constitutionality of Part C of the TAA as a whole.  They had been denied untrammelled access to the court file relating to the inquiry application and this, according to them, inhibited their ability to impugn the constitutionality of Part C.  The court’s response was twofold: that their attack lay in the relevant sections themselves and not in the contents of the file; and that their interpretation had no prospect of being upheld.  Their access to the file was thus refused along with the Constitutional attack.

The Cape High Court was required to decide this question in Gary Walter van der Merwe & others v CSARS & others, Case No 1984/14.  Judgment was delivered on 17 February 2014.

Peter Surtees