My recent article on CSARS v Mobile Telephone Network Holdings (Pty) Ltd Case No (966/12) [2014] ZASCA 4 (7 March 2014) discussed the Supreme Court of Appeal’s decision on the deductibility of audit fees. This article addresses the second aspect of the case, where the taxpayer sought to deduct as a revenue expense the costs associated with the installation of a software system.
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.
