30 September 2011 by

The issue of shares does not constitute an expense for tax purposes

The Supreme Court of Appeal (the SCA) in the judgment of CSARS v Labat Africa Limited (Labat) in Case Number 669/10 once again caused consternation by indicating on 28 September 2011 that the issue of shares would not constitute expenditure for tax purposes.

Even though the issue has to some extent subsequently been addressed in section 24B of the Income Tax Act (the Act) to the effect that a company is deemed to have actually incurred an amount of expenditure in the case where shares are issued in return for the acquisition of assets equal to the lesser of the market value of the asset or the market value of the shares immediately after the acquisition, the issue is still relevant in circumstances where shares are issued in return for the settlement of a liability or in satisfaction of services that have been rendered to the company.

In the Labat case, the taxpayer purchased the entire business operations of Labat-Anderson (South Africa) (Proprietary) Limited. The business operations were defined to include all of the tangible and intangible assets of Labat-Anderson, including a trademark. The business was acquired for a purchase consideration of R120 million, discharged by the issue of the Labat shares at an issue price of 90 cents per share.

Previously it was indicated that the taxpayer did actually incur expenditure in obtaining assignment of the trademark as it incurred an unconditional legal obligation in respect of the amount concerned. However, the SCA indicated that the true question should have been whether the issuing of the shares by a company amounts to expenditure and not whether the undertaking to issue the shares amounts to an obligation (which it does). It was indicated that the concept of an "obligation" and "expenditure" are not synonymous. The concept of expenditure actually incurred was interpreted to mean all expenditure for which a liability has been incurred during a year, whether or not the liability has been discharged.

It was also indicated that the English cases relied on by the taxpayer were not applicable. It was indicated that expenditure means the action of spending funds. It was indicated that the allotment or issuing of shares does not reduce the assets of a company even though it may reduce the value of the shares held by its shareholders. Ironically, the Court indicated that there could have been a different conclusion had the seller purchased the shares at an agreed price and the proceeds of the sale would have been applied to the purchase price of the business. In such an instance, set-off could have applied.

Once again taxpayers seem to have been prejudiced in the sense that, it was indicated that tax laws contain anomalies and inconsistencies. Taxpayers should thus accept these anomalies and inconsistencies. However, it seems that, if the inconsistency and anomaly is on the other foot and it may prejudice SARS, a different approach is adopted by the Courts.

Even though section 24B of the Act to some extent assists taxpayers if shares are issued in return for the acquisition of assets, the judgment by the SCA is still disappointing given the fact that, from a commercial perspective, the issuing of shares in settlement of obligations is a common commercial practice in circumstances where the shares have real value in the commercial world.

Emil Brincker

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