An interesting case (Mobile Telephone Networks Holdings (Pty) Ltd v Commissioner for the South African Revenue Service, case no A5033/10, delivered 1 July 2011) recently came before the South Gauteng High Court (the High Court).
The taxpayer sought to deduct expenditure incurred in respect of auditing fees and training fees but SARS only allowed a small portion of the auditing fees and disallowed the training fees. The taxpayer appealed to the Tax Court and was only partially successful.
The taxpayer then appealed to a full bench of the High Court.
The facts were common cause. The taxpayer was part of a group of companies and carried on a trade. It lent money to its subsidiaries and earned interest income. It also earned exempt dividend income from its shareholding in its subsidiaries.
The exempt dividend income far outweighed the interest income and made up between 89% and 99% of the total income in respect of the relevant years of assessment.
The taxpayer had its accounts audited inter alia for the purposes of complying with statutory obligations. However, only 6% of the time spent on the audit related to the exempt dividend income.
SARS disallowed the bulk of the auditing fees based on the fact that the greater part of the taxpayer's income was exempt. On appeal, the Tax Court ruled that the auditing fees were laid out for a dual purpose and that 50% should be allowed. It arrived at this conclusion by weighing up the importance of the exempt dividend income against the interest income.
As to whether expenditure incurred for the purposes of statutory compliance, such as auditing fees, necessarily equates to expenditure incurred in the production of income the Tax Court did not make a finding as such. However, it did find that, in this case, the audit was necessarily attached to the income earning operation because without the audit the taxpayer could not comply with the JSE requirements and so give confidence to creditors and access loans.
On appeal in the High Court it was stated that the legal principles relating to the deductibility of expenditure are clear:
- the expenditure must be incurred in the bona fide performance of the operation;
- the expenditure must have been incurred in the production of income;
- the expenditure need not be causally related to the income - a closeness of connection is sufficient; and
- in considering the connection regard must be had to the purpose of the expenditure and what it affects.
Two facts stood out - the taxpayer's business constituted a trade (it earned interest income), and only 6% of the work done in respect of the audit related to the exempt dividend income.
The High Court ruled that, applying the principles outlined above, the expenditure is deductible as it properly relates to and is closely connected to the operation and the income earning activities of the taxpayer. The High Court also ruled that the appropriate yard stick for apportionment is the amount of work done in respect of the interest income. Accordingly, the High Court allowed a deduction of 94% of the auditing fees.
What was striking about this case is that SARS initially argued in the High Court that auditing fees should never be allowed as a deduction, even though a small portion of the auditing fees was allowed by the Commissioner. Its argument was based on the view that the role of an auditor does not relate to the generation of income, but is a verification of financial information in an ex post facto manner for the benefit of investors and creditors. The argument was dismissed based on the facts before the High Court, but it gives some insight into the aggressive view that SARS currently holds.
A further issue in this case was the deductibility of training fees in respect of a computerised accounting system. The taxpayer had paid fees to a third party in respect of training its staff in respect of operating the system.
SARS initially disallowed the deduction on the grounds that the expenditure was capital in nature. The Tax Court also disallowed the deduction.
The facts were that the system was only used in respect of interest income and not exempt dividend income. The system enabled the taxpayer to consolidate its financial statements and it was also used to prepare budgets, forecasts and monthly reports. The system aided the taxpayer in fulfilling its duties under loan agreements and group business arrangements in respect of producing financial statements, as well as fulfilling its statutory duties. The group also benefitted from the system.
The High Court found that there was a direct relation between using the system and the taxpayer's trading activities. The court also found that the system allowed the taxpayer to trade more effectively, but that fact does not make the expense capital in nature.
The High Court applied the principle that cost is deductible if it is a necessary concomitant of the income-earning operation. In this case the training fees were a necessary concomitant. The fact that there was also a non-income earning benefit to the taxpayer was irrelevant.
The High Court allowed the deduction of the training fees.