In Mr Z v CSARS, case number 13472, heard in the Johannesburg tax court in November 2014 and recently reported, the taxpayer sought, unsuccessfully, to claim a deduction for damages he had paid in settlement of a dispute with a former client. In arriving at its judgment, the court dealt with the application of the eiusdem generis rule of interpretation and how SARS should apply the understatement penalties in the Tax Administration Act, 2011 (TAA).
Facts
In November 2003 A Investments Ltd (A), using the taxpayer as its agent, had disposed of its 47,3% shareholding in B (Pty) Ltd, trading as BCD. In June 2006 A informed the taxpayer that it had discovered that the taxpayer had withheld material information from A when it sold its shares in BCD. This information, which was about minority shareholder protection, would have had a bearing on whether or not A sold its entire shareholding in BCD.
In August 2007 the taxpayer sold his shares in BCD for about R842 million, and in October A claimed damages from the taxpayer for its failure to represent A properly. The claim was based on the value of the shares and claims A would have enjoyed had it not sold its shares and claims in BCD. After negotiations, the parties agreed on an amount of R695 million, which the taxpayer duly paid to A.
The taxpayer then sought to link the 2003 sale by A to the taxpayer’s 2007 sale, so that it could deduct the settlement amount from the proceeds. The taxpayer’s aim was to satisfy the court that, whereas the proceeds of his disposal was R842 million, it was subject to his obligation to pay the settlement amount to A. In making this submission the taxpayer relied on paragraph 35(3) of the Eighth Schedule to the Income Tax Act, 1962, which provides that the proceeds from the disposal of an asset must be reduced by any reduction of an accrued amount forming part of the proceeds as the result of, inter alia, “the cancellation, termination or variation of an agreement or due to the prescription or waiver of a claim or release from an obligation or any other event” (emphasis added). Put differently, when the taxpayer sold his shares in 2007 he was aware that he would have to pay a settlement amount to A, and his argument was that the sale of his shares was therefore linked to his obligation to pay A the settlement amount. According to him, the obligation was “any other event” contemplated in paragraph 35(3).
Court decision
The court rejected this contention, stating that the fact that he had decided to pay the damages claim out of the proceeds did not affect the fact that he had disposed of his shares and received R842 million for the disposal.
Eiusdem generis rule
As to the taxpayer’s reliance on the phrase “any other event”, in support of which his counsel contended that the phrase was so wide that it included the settlement amount, the court found that one could not read the words in isolation. The court agreed with SARS’ submission that the phrase had to be interpreted according to the eiusdem generis or noscitur a sociis rule, in terms of which a word derives its meaning from that of its associates. In paragraph 35(3) these were cancellation, termination, variation, prescription, waiver, and release. The phrase therefore contemplated an event of a similar nature to its predecessors. Where general words follow particular and specific words, the meanings of the general words must be confined to things of the same kind as the specified ones. In addition, it was settled law that the word “any” did not extend the meaning beyond the confines of the word’s neighbours. In short, the two transactions were separate and distinct.
Penalties
Regarding the imposition of a 75% penalty for understatement by SARS, this meant that, in terms of the understatement penalty matrix in the TAA, SARS concluded that there were no reasonable grounds for the taxpayer’s treatment of the settlement amount. The taxpayer’s unchallenged evidence was that he believed that his interpretation was correct in terms of the Eighth Schedule. He had taken professional advice as well. On that basis the court found that there were reasonable grounds for the position the taxpayer had adopted. Further, in consulting the experts, he had taken reasonable care, so that his conduct was not caught by the next category in the matrix, which provides for a 50% penalty if the taxpayer has failed to take reasonable care in compiling his return. This left only the category of substantial understatement, carrying a 10% penalty, and it was clear that the taxpayer’s return had included a substantial understatement. Therefore a 10% penalty was appropriate, not the 75% imposed by SARS.
Finally, given the process by which the taxpayer had arrived at his decision, the court directed that the interest imposed by SARS should be waived.
