In the 30 September 2011 edition of Tax Alert, (see The issue of shares does not constitute an expense for tax purposes), we discussed the recent judgment delivered in the case of CSARS v Labat Africa Limited (669/10). The Supreme Court of Appeal (SCA) overturned a High Court decision and held that the issue of shares does not constitute 'expenditure' for tax purposes.
Although the Labat case dealt specifically with the issuing of shares in exchange for the acquisition of an asset, which to a large extent is now in any way governed by section 24B of the Income Tax Act, No 58 of 1962 (the Act), the judgment may have wider consequences especially in the context of issuing shares in relation to services rendered. In essence, section 24B of the Act provides for a base cost to the extent that shares are issued in return for the acquisition of assets, but has its shortcomings in that it does not deal with the rendering of services or payment of a debt.
Certain commentators argue that discharging the consideration for the rendering of services by the issue of shares should also constitute expenditure actually incurred for purposes of the Act and that there is no reason to limit the application of this principle only to the acquisition of assets. The reality though is that a legislative gap still remains in dealing with the payment of services by way of issuing of shares and it appears that the Labat case may curtail any further arguments in support of deductibility.
The lower courts dealt with the issue as to whether any expenditure had actually been incurred and concluded that the success of the enquiry is dependent on whether the taxpayer incurred an unconditional legal obligation in respect of the amount concerned. In relying on the well-known cases of Edgars Stores Ltd v CIR and Nasionale Pers Bpk v KBI, the lower courts held that it is not a requirement that the obligation be discharged - once the obligation has been incurred, the expenditure becomes deductible. Instead of dealing with whether an obligation arose, the SCA stated that the lower courts should have dealt with the question as to whether the issuing of shares by a company amounts to 'expenditure', as the concepts of 'obligation', 'liability' and 'expenditure' are not synonyms.
The SCA held that the term 'expenditure', although not defined in the Act, should carry its ordinary English meaning. The SCA stated that expenditure "... refers to the action of spending funds; disbursement or consumption; and hence the amount of money spent." The SCA went on further to state that "... Expenditure, accordingly, requires a diminution of assets (even if only temporary) or at the very least movement of assets of the person who expends". In ITC 1783, which the SCA accepted as partially correct, it was held that the allotment or issuing of shares does not in any way reduce the assets of the company although it may reduce the value of the shares held by its shareholders. In summary, the issue of shares does not constitute 'expenditure' for purposes of the Act.
Even though the Labat case dealt with the acquisition of assets, it follows that similar principles would likely apply in denying a deduction for the issue of shares in the case of services rendered. Unless a similar provision to section 24B of the Act is introduced, dealing specifically with the issue of shares in relation to services rendered, taxpayers are best advised to transact on a pure cash basis in these circumstances.
Ruaan van Eeden