Did the SCA get this right?

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Did the SCA get this right?

• 06 July 2020
• Deductions Pre-trade and prepaid expenses
• PWC

In the matter of Telkom SA SOC Ltd v Commissioner for the South African Revenue Service [2020] ZASCA 19 (25 March 2020), on which we have reported in relation to the foreign exchange dispute, a second dispute concerned the right of Telkom to deduct commissions paid to selling agents who signed up subscribers.

Telkom offered a special incentive bonus to agents for the introduction of new subscribers, which was paid on connection of the subscriber to Telkom’s mobile network. It paid an incentive bonus of approximately R179m in the year of assessment in question, which it claimed as a deduction. SARS asserted that the subscribers had signed up for 24-month contracts and that the expenditure should be spread over the term of each contract. It disallowed approximately R137m, which would only be allowed as a deduction in subsequent years of assessment.

The decision of the Tax Court is summarised in paragraph [46] of the SCA judgment:

‘The Tax Court, in upholding the appeal, made the following findings:

a. The benefit that was attached to the expenditure was the conclusion of the contract with the customer in question.

b. Velociti rendered all the services which it was obliged to do in terms of the incentive letters and for which the payment of R178 788 421 was made.

c. As a result, there was no basis to add back and disallow R136 531 542 of the cash incentive bonus expenditure by the application of s 23H in the 2012 year of assessment.’

SARS had been dissatisfied with this decision and had noted an appeal to the SCA.

The judgment

In his judgment, Swain JA paraphrased section 23H(1) by referring only to the parts that he considered pertinent:

‘Where any person has during any year of assessment actually incurred any expenditure (other than expenditure incurred in respect of the acquisition of any trading stock) –

d. (a) which is allowable as a deduction in terms of the provisions of section 11 (a). . .; and

e. (b) . . . in respect of –

. . .

(ii) any other benefit, the period to which the expenditure relates extends beyond such year of assessment, the amount of the expenditure which shall be allowable as a deduction in terms of such section in the said year and any subsequent year of assessment, shall be limited to, in the case of expenditure incurred in respect of –

. . .

(iii) any other benefit to which such expenditure relates, an amount which bears to the total amount of such expenditure the same ratio as the number of months in such year during which such person will enjoy such benefit bears to the total number of months during which such person will enjoy such benefit or where the period of such benefit is not determinable, such period over which the benefit is likely to be enjoyed:

Provided that the provisions of this section shall not apply –

(aa) Where all the goods or services are to be supplied or rendered within six months after the end of the year of assessment during which the expenditure was incurred, or such person will have the full enjoyment of such benefit in respect of which the expenditure was incurred within such period, unless the expenditure is allowable as a deduction in terms of section 11D (2); …’

Telkom argued that the agent had provided a customer, which Telkom had accepted and connected to its network, and that no further benefit was expected to accrue to Telkom from the agent, whose services had been fully rendered and paid for. Telkom was thereafter under an obligation to supply the services to the subscriber in terms of the subscription agreement, for which a fee was payable by the subscriber. The agent, in addition to the introductory commission, would be entitled to receive a commission monthly in respect of subscription revenues.

The argument of SARS was set out in paragraph [50] of the judgment:

‘The Commissioner, however, submitted that the key question was when and how the benefit, in respect of which the expenditure was incurred, was enjoyed. This was because the pleaded dispute turned on, when and how Telkom enjoyed the benefit, received from the cash incentive bonus payment. The Commissioner pleaded that it was the subscription agreement with the client that was the source of the direct benefit to Telkom. The Commissioner also pleaded that the benefit to Telkom, flowed primarily and directly from the service contract, in terms of which the individual customer paid monthly subscription fees. The dealer was a mere facilitator, who brought about the source of the benefits, and the benefits ie the fees, were direct and central to Telkom’s business. It was the agreement concluded between Telkom and the respective dealers which was the indirect source of the benefit.’

These arguments prevailed and the judgment concluded at paragraph [53]:

‘The Commissioner therefore correctly submitted, that the period to which the expenditure “relates”, must be the period during which the benefit is enjoyed. Telkom does not incur the incentive bonus expenditure solely to establish a new connection with a customer. The benefit lies in having a customer who pays subscription fees over the fixed term of the contract. Telkom does not enjoy any benefit immediately upon the conclusion of a new contract. It has nothing to show for it until such time as the connection turns into fee income. That is when Telkom begins to enjoy the true benefits of the cash incentive payments.’

Judgment was given in favour of SARS and it was held that the commissions could only be deducted evenly over the period of the contract.

Commentary

From the discussion in the judgment of the respective arguments, it appears that the arguments on both sides addressed only the ‘benefit’ derived from a contract of agency and that the Court concerned itself only with the benefit of the arrangement. That said, it is submitted that a thorough analysis of section 23H(1) should have been made. The second finding in the Tax Court (that the services in respect of which the commission was paid had been fully rendered by the agent in the year of assessment) was not addressed in the judgment. It is submitted that the finding that the services had been rendered by the agent in the year of assessment was the ratio decidendi of the Tax Court decision.

In paragraphs 8 to 21 of the judgment, Swain JA had gone to lengths to specify the approach to interpretation of words used in a statute and the importance of the correct application of context in so doing. He had also confirmed that the contra fiscum rule, which entails an interpretation more favourable to the taxpayer, should be applied in cases of irresoluble ambiguity.

Based on the discussion on interpretation in the judgment, it is pertinent to identify whether the principles were put into practice in interpreting section 23H(1)(b).

Words used in a statute should be interpreted by considering ‘… the language used in the light of the ordinary rules of grammar and syntax …’

The judgment considered only a part of section 23H(1)(b) (which was referred to in the judgment as ‘the relevant portions of section 23H(1)’).

Section 23H(1)(b) applies to expenditure actually incurred by a taxpayer:

‘(b) in respect of—

(i) goods or services, all of which will not be supplied or rendered to such person, during such year of assessment; or

(ii) any other benefit, the period to which the expenditure relates extends beyond such year of assessment.’ (Emphasis added)

It is submitted that, based on the ordinary rules of grammar and syntax, the relevant inquiry was to establish first whether the payment had been made for goods or for services or for another benefit and not whether the taxpayer enjoyed a commercial benefit flowing from a person other than the person to whom the expenditure was paid. This was the basis for the finding in the Tax Court, to which no reference is made in the judgment, other than to state the Tax Court’s findings.

By simply assigning no relevance to paragraph (b)(i), Swain JA appeared to ignore a part of the subsection that was critical to the dispute.

Even in the modern age of purposive interpretation, consideration still needs to be given to the words used in the statutory provision, as suggested in Rex v Standard Tea & Coffee Co. (Pty.) Ltd. and Another, 1951(4) S.A. 412 (A.D.) at 416:

‘It is a cardinal rule of interpretation of legislative enactments that they “should be so construed that, if it can be prevented, no clause, sentence or word shall be superfluous, void or insignificant”.’

It is submitted that Swain JA failed to take account of the necessity to identify the cause for the payment, as opposed to the indirect outcome. It is submitted that the words used in section 23H(1), applying the ordinary rules of grammar and syntax indicate that the expenditure must have been incurred either for goods or for services or for some other benefit.

The determination appears to hinge on the interpretation of the words ‘in respect of’. In this regard, Rumpff ACJ stated in Buglers Post (Pty) Ltd v Secretary for Inland Revenue 1974 (3) SA 28 (A) at 33:

‘I have quoted the whole of this sub-paragraph because it illustrates the possibility of the words ‘in respect of’ having a narrow or a wide meaning depending on the context in which the words are used. See, for instance, Sekretaris van Binnelandse Inkomste v Raubenheimer, 1969 (4) SA 314 (AD), where, in considering the meaning of these words in relation to sec. 11 (1) of the then Act, this Court referred to the case Commissioner for Inland Revenue v Crown Mines Ltd., 1923 AD 121, and more specifically to what SOLOMON, J.A., said at p. 128, namely:

“Now the words in respect of may be used in various senses, and in each case it is essential to examine the context in order to ascertain the sense in which it is used.”’

Words used in a statute should be interpreted after considering ‘… the context in which the provision appears; the apparent purpose to which it is directed and the material known to those responsible for its production.’

The provisions of section 23H were enacted in 2000. The Explanatory Memorandum to the Taxation Laws Amendment Bill, 2000, stated that the provision is an anti-avoidance provision to address certain tax-avoidance schemes. It stated, at page 35:

‘In this regard, a new section 23H is proposed, which provides that where any person has incurred any expenditure, which is or was allowable as a deduction in terms of the provisions of section 11(a), (b), (c) or (d) of the Income Tax Act 1962, the amount allowed to be deducted in any year of assessment shall be limited to the expenditure relating to goods supplied, services rendered or benefits the person will become entitled to during the relevant year of assessment.’ (Emphasis added)

Subsection (b) read as follows when originally enacted:

‘in respect of goods, services or any other benefit, all of which will not be supplied or rendered to such person, or the full benefit of which such person will not become entitled to during such year of assessment,’​​​​​​​

In 2001, the wording of section 23H(1) (b) was amended and split into two paragraphs, as recorded earlier. Paragraph (i) dealt with goods or services that had not been fully supplied or rendered and subparagraph (ii) with other benefits yet to be fully ‘enjoyed’.

At the same time, subparagraph (iii) to subsection 1 was amended as follows (Note: bold text indicates deletions and underlined text indicates insertions):

‘(iii) any other benefit to which such [person will become entitled] expenditure relates, an amount which bears to the total amount of such expenditure the same ratio as the number of months in such year during which such person will [be entitled to] enjoy such benefit bears to the total number of months during which such person will [be entitled to] enjoy such benefit or where the period of such benefit is not determinable, such period over which the benefit is likely to be enjoyed:’

The Explanatory Memorandum to the Second Revenue Laws Amendment Bill, 2001, explained the amendment thus:

‘Certain commentators have suggested that this provision is not effective in spreading the amount incurred in respect of a benefit over the period over which that benefit will be enjoyed. It is, therefore, proposed that this section be amended to make it clear that this is the intention.’ (Emphasis added)​​​​​​​

The purpose of the amendment was therefore to give effect to the spread of the expenditure and not to extend the original purpose that the taxpayer must be entitled to a benefit in respect of the payment.

The mischief at which the provision was directed was the deduction of prepayments for services yet to be rendered or prepayment of contractual consideration or statutory charges for benefits which would only commence or be finally received after the end of the year of assessment and claiming deduction of the expenditure as actually incurred. At the same time, recipients of the payments could potentially invoke section 24C and claim a deduction for expenditure yet to be incurred by them under the contracts. The purpose was to match the deduction of expenditure incurred with the goods or services or benefits that were supplied or to be provided or to which the taxpayer might be entitled.

The reference to ‘other benefits’ was included to bring within the ambit of the provision expenditure such as:

• premiums for short-term policies of insurance paid annually in advance,
• statutory charges, which may be imposed or paid annually, such as municipal rates, vehicle licensing charges, television licences and business licences, and
• prepaid rental.

Payment of these amounts does not result in the supply of goods or services, but provides the security of insurance cover in respect of insurable risks, the ongoing enjoyment of maintained municipal or national infrastructure, such as roads, parks, public beaches, public television broadcasts, and the like, and undisturbed possession of leased premises. This is the context in which the term ‘other benefit’ was used. The payment resulted in entitlement and demanded no obligation of the taxpayer other than to make payment.

It was clear from the words ‘goods or services … supplied or rendered’ that the expenditure in question related to consumption. Similar principles apply to a benefit, which is enjoyed for the period referred to in the contract or statute giving rise to the payment. That is, the goods or services would be consumed or the entitlement to the benefit of insurance cover, enjoyment of public amenities orundisturbed possession of leased premises would be extended to the taxpayer in the future period. In all instances the payment must have secured a future entitlement.

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This article first appeared on pwc.co.za.

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