The taxpayer owned immovable property consisting of six buildings configured into apartment style living units for students of TUT.  The taxpayer entered into a lease agreement with TUT for indefinitely renewable periods of five years.  TUT was permitted to use the premises only for accommodation for its students during term time and holiday groups during university vacations.

TUT would conclude lease agreements with the students and, during vacations, the holiday groups.  The taxpayer played no role in these agreements.  TUT took full responsibility for control, discipline, strict compliance with the house rules and ensuring that students vacated the premises on termination of the respective leases.

TUT paid the taxpayer a monthly rental based on the number of available beds, whether or not they were occupied, and undertook to restore the premises to good condition on termination of the lease with the taxpayer.  The taxpayer provided furnishings and amenities to the premises, and was responsible for routine maintenance, management services, security and repairs.

The court stated that the taxpayer’s performance under the lease agreement was a taxable supply, “unless one of the exemptions, exceptions, deductions or adjustments contained in the Act applied”.  The rest of the judgment consists of an examination of these provisions to see whether any of them applied.

The taxpayer contended that it was obliged to charge VAT on only 60% of the total consideration from TUT, in terms of section 10(10) of the Act.  This provided that “Where domestic goods and services are supplied at an all-inclusive charge in any enterprise supplying commercial accommodation for an unbroken period exceeding 28 days, the consideration in money is deemed to be 60% of the all-inclusive charge”.  So the question was whether or not the taxpayer was supplying commercial accommodation.

Section 10(10) defines “commercial accommodation”, to the extent here relevant, as lodging or board and lodging, together with domestic goods and services, in any house, flat, apartment, room, hotel, motel, inn, guest house, boarding house or residential establishment which is regularly and systematically supplied, but excluding a dwelling supplied in terms of an agreement for letting and hiring it.

The decisive question, then, was whether the taxpayer was providing lodging to TUT.  The dictionary meaning of this term is “a temporary place of residence” or a “temporary residence; sleeping accommodation”.  A lodger is “a person who pays rent in return for accommodation in someone’s house”.  Based on these definitions, the court made the point that a lodger must be a natural person.  It followed that the notion that the taxpayer was providing lodging to TUT was inconsistent with the ordinary meaning of the word.  The relationship between the taxpayer and TUT bore “little resemblance to conventional arrangements for the provision of board and lodging”.

However, the taxpayer contended that its supply to TUT met the definition of “commercial accommodation” because the accommodation supplied was used by the students, who were the lodgers.  The court rejected this contention because it conflated two distinct supplies: the longer one by the taxpayer to TUT; and the shorter ones by TUT to the students.  The latter supply, being incidental to the supply of educational services, was exempt under section 12(h)(ii) of the Act.  The taxpayer’s approach was contrary to the general principle that the VAT consequences of a supply must be assessed primarily by the contractual arrangements under which the supply is made.  The nomenclature used by the parties in a contract was not decisive; it was necessary to determine the true nature of the contract.  There was no contractual nexus between the taxpayer and the students.  The relevant contract was the one between the taxpayer and TUT and did not involve the supply of temporary accommodation to TUT.  The fact that TUT supplied temporary accommodation to the students was irrelevant in relation to the taxpayer.  Accordingly, the supply by the taxpayer did not meet the first requirement of the definition of “commercial accommodation” and it was not necessary to canvass the other requirements.

The taxpayer no doubt felt aggrieved by losing in the SCA after two victories in the lower courts.  However, a moment’s reflection suggests that the taxpayer was not too hard done by.  The alternative to the present arrangement, which would have brought the taxpayer within the definition of “commercial accommodation”, would have been for the taxpayer to let the units directly to the students, with all the administrative cost and stress that this would have entailed.  Instead, the taxpayer was able to place this whole burden into the hands of TUT.  In fact it might well be that the taxpayer was financially better off, if the 40% additional VAT paid was less than the cost of operating six apartment blocks filled with students.

SARS had taken the view that the taxpayer had misrepresented and failed to disclose material facts in regard to the true nature and substance of a series of agreements with other entities. These agreements, according to SARS, were simulated loans aimed at giving the taxpayer improper interest deductions. As a result, SARS issued additional assessments permitting deduction of interest on loans of R100 million instead of the R185 million claimed by the taxpayer.

The present case was not about the merits or demerits of the additional assessments but rather about the review and setting aside, or alternatively the constitutional legality, of SARS’s decision to issue them under section 79 of the Income tax Act, 1962 (since repealed and replaced by section 92 read with section 99 of the Tax Administration Act, 2011).

The taxpayer contended that the decision stood to be reviewed and set aside on three grounds under PAJA:

1              that the proviso to section 79 did not apply. This permits SARS to raise an additional assessment after the expiry of three years from the date of the original assessment only if SARS is satisfied that the original assessment was due to fraud or misrepresentation or non-disclosure of material facts;

2              the raising of the assessments so long after the original assessments (from 1997 to 2012, although SARS had begun its investigation in 2003) was unreasonable and procedurally unfair; and

3              the SARS decision was materially influenced by an error of law, took into account irrelevant considerations and/or did not consider all relevant considerations, was not rationally connected to the information before SARS, and finally that SARS had failed to take a decision or that the decision it did take was so unreasonable that no reasonable person would have done so.

SARS contended that the High Court lacked jurisdiction to decide the matter because the issues in question were complex and required the expertise of the tax court. Alternatively, the taxpayer had not exhausted the remedies open to it before the tax court. Finally, there were disputes of fact that should be resolved by the tax court.

The court found that the tax court is a creature of statute whose powers are limited to those specified in the relevant fiscal Acts. There was adequate precedent to the effect that relief based on judicial review is available to litigants, and this applied to the present matter. The court thus found that it had the jurisdiction to hear the matter.

As for the delay, which was the main ground of review sought by the taxpayer, SARS submitted that the delay between 2005, when it commenced its investigation, and its letter of findings, issued in November 2011 and culminating in the additional assessments in 2012, was because SARS had to wait for the judgment in a case then before the Supreme Court of Appeal, CSARS v NWK 73 SATC 55 [2011] SCA.

The court acknowledged the constitutional imperative to deal with litigation promptly. At the same time, SARS had to be satisfied that the delay beyond three years was on account of Fraud, misrepresentation of a material fact or non-disclosure of a material fact. If SARS was so satisfied, the Act provided for additional assessments at any time after the original assessment. SARS contended that these elements had been present, while the taxpayer argued otherwise. The oral evidence necessary to adjudicate the review application was the same evidence that would be required to adjudicate the merits of the challenge to the additional assessments. The court therefor ordered that the matter be heard by the tax court by way of appeal by the taxpayer, where the conflicting evidence and arguments could be ventilated and judged.

During the 2004 year of assessment the taxpayer paid the consulting auditors, KPMG, R878 142 in respect of what was described as the “Hyperion” management system.  The taxpayer claimed this amount as an operating expense, but SARS disallowed it on two grounds: that it was not incurred in the production of income (but rather in creating an asset to be used as part of the income generating process); and was of a capital nature.

The taxpayer stated that the purpose of Hyperion was to effectively capture, record and index certain aspects related to the taxpayer’s financial affairs and to aid in the consolidation of its financial results and reporting within the Group.  The fees were “in relation to services rendered by the auditors in respect of the implementation, adjustment, fine tuning and user operation of the system.”  The system was also used for producing budgets, forecasts and management accounts, and it had the effect of reducing audit costs.  As stated in the evidence, the system’s main function was reporting and consolidation.  Its use in respect of the income earning activities was minimal.

KPMG were engaged to assist with the operation of the system and to teach staff how to understand and use it.  Based on an extract from the record of the replies of two witnesses who testified on behalf of the taxpayer, it would seem that their evidence was vague and not clear on exactly what the system did and what services KPMG rendered.

The tax court, in arriving at the decision that the fees were capital in nature, canvassed a number of the celebrated cases dealing with deductibility of expenditure.  A full description of the tax court’s discussion and analysis of these cases is beyond the scope of this article, but a quote from Nchanga Consolidated Copper Mines Ltd v Commissioner of Taxes 1962 (1) SA 381 (FC) distils the principles of deductibility.  The court stated that, as an initial approach and before reverting to other tests, it would be “proper first to try to determine whether, according to the true nature of the expenditure, it was made as part of the cost of performing the income earning operations or as part of the cost of the income earning machine or structure.”

On this basis the tax court found that the cost of acquiring Hyperion was capital in nature.  As for the fees, the tax court found that they were intended to add value to the income earning structure.  And this value remained intact from year to year.  Accordingly, they were capital in nature and not deductible.

In the appeal, the SCA noted that the taxpayer had no staff.  As indicated in my previous article, the taxpayer used the resources of other members of the group as it needed them; it did no more than hold shares in its subsidiaries, from which it received dividend income, and make loans, sometimes at interest and sometimes not, to members of the group.

The court observed that the taxpayer had offered no explanation for its failure to call as witnesses persons with personal knowledge of the implementation and workings of Hyperion instead of two employees who, despite holding senior positions, were able to offer only what the court described as “inadequate” evidence.  As a result, it was “well-nigh impossible to determine whether the KPMG fee fell legitimately to be deducted”, and the SCA confirmed the tax court’s finding.

It seems, therefore, that inadequate evidence from the taxpayer’s witnesses was fatal to the taxpayer’s case.  That said, it would be difficult to contend that the cost of equipping employees with the training necessary to operate the system could be anything but a capital expense.