No tax deduction for damages paid for deliberate breach of supply contract

No tax deduction for damages paid for deliberate breach of supply contract

• 19 December 2019
• Corporate Tax
• Ben Strauss and Jerome Brink

Tuesday, 25 September 2018

Important:

This article is based on tax law for the tax year ending 28 February 2019.

Authors: Ben Strauss and Jerome Brink 

South African courts have held, on a number of occasions, that taxpayers are entitled to deduct damages or compensation paid to third parties. However, this principle does not apply in all cases.

The case of Kangra Group (Pty) Ltd v Commissioner for SARS (Case number A20/18) was recently heard by the full bench of the Western Cape division of the High Court.

Facts and background

The salient facts were relatively simple: The taxpayer, Kangra Group (Pty) Ltd (Taxpayer) was a coal mining company linked to the well-known entrepreneur and philanthropist, Mr Graham Beck. It supplied coal to AMCI under a set of agreements. The price of the coal was fixed under the contract at about US$25 per ton. During the term of the contract, the price of coal in the international market increased considerably to about US$40 per ton.

The Taxpayer unilaterally decided to stop supplying coal to AMCI at the fixed price, and to start supplying coal to third parties at the higher price. AMCI instituted arbitration proceedings against the Taxpayer and the parties eventually settled. The Taxpayer conceded AMCI’s claim and agreed that it would pay AMCI an amount of R90 million. It is important to appreciate that during the relevant period, Kangra Group’s coal business was spun off from the Kangra Group to another entity, namely Kangra Coal (Pty) Ltd (Kangra Coal) for the purpose of facilitating a black economic empowerment transaction with a chosen partner.

One of the key facts before the court was that Mr Beck concluded the settlement agreement on behalf of the Kangra Group (ie the Taxpayer) and the representative from AMCI relating to the Kangra Group’s (and/or Kangra Coal) obligations of supplying coal to AMCI. On that basis, the Taxpayer sought to deduct the settlement amount for income tax purposes in terms of the general deduction provision in s11(a) of the Income Tax Act, No 58 of 1962 (Act).

That provision reads as follows:

11. General deductions allowed in determination of taxable income

For the purpose of determining the taxable income derived by any person from carrying on any trade, there shall be allowed as deductions from the income of such person so derived:

(a) expenditure and losses actually incurred in the production of the income, provided such expenditure and losses are not of a capital nature…”

Historically, taxpayers have inevitably succeeded and failed in claiming expenses akin to damages and compensation pursuant to three issues, including:

1. whether the expenses were incurred for the purposes of conducting the taxpayer’s trade;

2. if so, whether such expenses were incurred in the production of income; and

3. thirdly, whether such expenses incurred were of a revenue or capital nature (if the answers to the above two queries were in the affirmative).

Please click here to read more.

This article first appeared on cliffedekkerhofmeyr.com.

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