MAY 2010 ISSUE 129 CONTENTS Directors and PAYE PAYE on tips

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1 MAY 2010 ISSUE 129 CONTENTS ANTI-AVOIDANCE The ambit of sections 80A to 80L DEDUCTIONS Assets acquired by way of share issue EMPLOYEES TAX Directors and PAYE PAYE on tips SARS NEWS Interpretation notes, media releases and other documents ANTI-AVOIDANCE The ambit of sections 80A and 80L It recently came to our attention that the South African Revenue Service ( SARS ) had purportedly acted in terms of section 80A of the Income Tax Act, No 58 of 1962, as amended (the Act), to disallow an estate duty deduction claimed by the executors of a deceased estate. This action raises the question whether the general anti-avoidance provisions of the Act can be used to vary the tax consequences that would otherwise apply under other fiscal statutes, in casu the Estate Duty Act, No 45 of 1955, as amended. Section 80A provides inter alia that an avoidance arrangement is an impermissible avoidance arrangement if its sole or main purpose was to obtain a tax benefit and.... A tax benefit is defined in section 80L to include any avoidance, postponement or reduction of any liability for tax ; and the word tax is defined to include any tax, levy or duty imposed by this Act or any other Act administered by the Commissioner (emphasis supplied). If one has regard to these provisions, as SARS no doubt did in the estate duty matter alluded to above, there would seem to be nothing to indicate that the provisions of section 80A are limited in their application to the tax consequences to be determined under the Act. However, section 80B(1) of the Act provides that: The Commissioner may determine the tax consequences under this Act of any impermissible avoidance arrangement for any party by disregarding, combining, or re-characterising any steps in or parts of the impermissible avoidance arrangement; disregarding any accommodating or tax-indifferent party or treating any accommodating or taxindifferent party and any other party as one and the same person; Integritax Issue 129 May 2010 SAICA, 2010 page 1

2 deeming persons who are connected persons in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount; reallocating any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties; re-characterising any gross income, receipt or accrual of a capital nature or expenditure; or treating the impermissible avoidance arrangement as if it had not been entered into or carried out, or in such other manner as in the circumstances of the case the Commissioner deems appropriate for the prevention or diminution of the relevant tax benefit. (Emphasis added) It is clear from the opening words of section 80B(1) that where an arrangement is an impermissible avoidance arrangement, the Commissioner is empowered to determine the tax consequences under the Income Tax Act in the ways mentioned. It follows that the Commissioner does not have the power to determine the tax consequences of an impermissible avoidance arrangement under any other fiscal statute such as the Estate Duty Act. This conclusion is moreover in keeping with the now repealed section 103(1), in terms of which the purpose of avoiding any tax administered by the Commissioner could be taken into account, but the effèct thereof nevertheless had to be to avoid a tax levied under the Income Tax Act. It is considered, then, that the ambit of section 80A, which must be read together with section 80B, is limited to the taxes levied under the Income Tax Act. The Taxpayer, February 2010 Issue, p21 IT Act: s 80A - s 80L Integritax Issue 129 May 2010 SAICA, 2010 page 2

3 DEDUCTIONS Assets acquired by way of share issue In the past seven years, there have been conflicting judgments in the Income Tax Court concerning the question of whether a company has incurred expenditure where it has issued shares in consideration for the acquisition of an asset. The conflict in the Income Tax Court The debate was sparked by a challenge made by SARS against a taxpayer in ITC 1783 [2004] (66 SATC 373). In that matter, a company had entered into an agreement for the purchase of part of a seller s business. A method for fixing the value of the assets was specified in the agreement and the purchaser company undertook to allot and issue to the seller, in discharge of the value of such assets ( the purchase price ), such number of ordinary shares in its capital, to be issued at par plus a premium, as would result in the seller holding that proportion of the entire issued share capital of the purchaser as the purchase price had to the total value of the purchaser s assets inclusive of the acquired assets. Portion of the value of the business acquired related to a licensing agreement, and the purchaser sought to deduct such expenditure in the determination of its taxable income. SARS argued that the purchaser had not incurred expenditure in acquiring the licence. The court (Goldblatt J.) found in favour of the SARS argument, stating that the word expenditure had to be given its ordinary meaning and summarising its views thus (paragraph 7.2 of the judgment): expenditure in its ordinary dictionary meaning is the spending of money or its equivalent eg time or labour and a resultant diminution of the assets of the person incurring such expenditure. An allotment or issuing of shares by a company 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 these circumstances such issue or allotment of shares does not, in our view, constitute expenditure by the company. The issue again came before the court in ITC 1801 [2005]68 SATC 57. The facts are not dissimilar to those of ITC Here a purchaser company had purchased a business from a seller as a going concern. Portion of the purchase price was ascribed to a trademark owned by the seller. In consideration for the purchase of the trademark, the purchaser company issued shares to the seller and thereafter claimed deductions in terms of section 11(gA) of the Income Tax Act, No 58 of 1962 (the Act) in respect of expenditure actually incurred in acquiring the trademark. SARS disallowed the deduction, one of the grounds of disallowance being that no expenditure was actually incurred by the [purchaser] in acquiring the trademark. In this case, the court rejected the earlier decision. It cited with approval the dictum of Nicholas AJA in Edgars Stores Ltd v CIR [1988] 50 SATC 81 at 95 that: Actually incurred does not mean actually paid, but means all expenditure actually incurred during the year, whether the liability has been discharged during that year or not. It was found further that the Court in the earlier matter had not considered precedent from the highest court in the United Kingdom, which had rejected similar assertions that the issue of shares was not the giving of a consideration for the acquisition of assets. Accordingly, the Court held that the purchaser had actually incurred expenditure in acquiring the trademark. Integritax Issue 129 May 2010 SAICA, 2010 page 3

4 The Legislative response Section 24B of the Act was inserted in 2004 and provided that where a company has acquired an asset in exchange for an issue of shares it is deemed to have actually incurred an amount of expenditure equal to the market value of the asset. This section had retrospective effect for capital gains tax purposes to 1 October 2001 and prospective effect from the date of promulgation of the amendment act 32 of 2004 (24 January 2005) for all other purposes of the Act. Paradoxically, the application of section 24B is limited to the acquisition of assets in exchange for shares, and does not extend to the payment for services by way of an issue of shares. While the services of employees and directors are effectively covered by the provisions relating to share incentive schemes, there is still a legislative gap in relation to services by independent third parties. The High Court decision In a judgment handed down on 11 December 2009, in the matter of Commissioner for South African Revenue Service v Labat Africa Ltd (Not yet reported), the North Gauteng High Court dismissed the appeal of SARS against the decision in ITC One of the interesting submissions made on the Commissioner s behalf in this matter was the inference to be drawn from the insertion of section 24B in the Act. It was urged that the use of the word deemed in section 24B indicates that, but for this provision, the issue of shares would not constitute expenditure actually incurred. The Court found this argument unconvincing and unhelpful. The court considered the conflict between the judgment of Goldblatt J and the judgment before it on appeal and unanimously upheld the judgment of the ITC 1801, concluding that: the correctness of the view taken by the judge a quo is confirmed, on analysis made even on the criteria of Goldblatt J that the word expenditure must be given its ordinary meaning. If the agreement for the acquisition of the asset had been that the seller would purchase an agreed number of the unissued shares of the purchaser at an agreed price, and that the proceeds of such sale would be applied to payment of the purchase consideration of the asset, there could be no doubt that the transaction would constitute or involve an expenditure by the company of a portion of its share capital. Do we have finality? Unless SARS successfully appeals against this decision, it is considered that this latest decision provides strong support for the view that, even as regards transactions entered into before 24 January 2005, a purchaser who discharges the consideration for the acquisition of an asset by issuing shares to the seller actually incurs expenditure on the acquisition of the asset for the purposes of the Act. In addition, it is submitted that there is no reason why the implications of this decision should be limited to the acquisition of assets, and that they apply equally to the acquisition of services, for which section 24B of the income tax act makes no provision. PricewaterhouseCoopers IT Act: s 11(a), s 11(gA), s 24B Integritax Issue 129 May 2010 SAICA, 2010 page 4

5 EMPLOYEES TAX Directors and PAYE The debate Historically, directors of private companies were excluded from employees tax as they did not receive regular remuneration throughout the year. This gave them a distinct advantage over normal salaried employees who had PAYE deducted from their salaries on a monthly basis. The current definition of employee specifically includes directors of private companies. The question remains whether all directors of private companies would fall into the employees tax net by being included in the definition of an employee. There is also an argument that certain types of directors can be excluded from the employees tax net by meeting the requirements of trading independently. The rules Where an employer pays remuneration to an employee, the employer is required to deduct employees tax (commonly known as PAYE) from the remuneration and pay the tax deducted to SARS on a monthly basis. The withholding of PAYE is only necessary where remuneration is paid by an employer or representative employer to an employee. All three elements need to be present simultaneously before employees tax must be deducted. Remuneration is very widely defined in tax legislation and includes almost any type of payment for services rendered. However, any amount paid or payable in respect of services rendered by any person in the course of carrying on a trade independently from the employer would be excluded. The tax legislation contains a number of statutory tests that if met, would immediately classify a person as not being independent. Even if the statutory tests are not met, the dominant impression of the relationship still needs to be formed in order to determine if a person is independent or not. SARS have provided guidelines on the dominant impression tests in their Interpretation Note 17. The contention By trading independently, one of the three critical requirements for deducting employees tax is missing, as there would be no remuneration. Consider the three types of directors that can be appointed by a company, and understand the differences in their broad roles, responsibilities and basis of payment for their services. Executive directors usually involved in the day to day management of the company full-time salaried employees of the company. Non-executive directors not an employee, but rather a person external to the company not involved with the day to day management of the company no specific management responsibility usually involved on a part time basis ultimate responsibility for the management of the company is shared with the executive directors share the legal duties and responsibilities of the executive directors. Integritax Issue 129 May 2010 SAICA, 2010 page 5

6 Independent non-executive directors not employed by the company, present or past not a retained professional advisor that is influenced by his / her fee not a supplier or customer of the company no family connections with someone in the company or group no significant dependence on his director s fee from the company the ability to resign is a test of independence. It is clear from the normal roles and responsibilities attributable to executive directors in relation to the company that they would not qualify as being independent. However, once the tests (statutory and dominant impression) of independent contractors is applied to the roles and responsibilities of non-executive directors and independent non-executive directors, there exists a legitimate argument that these types of directors could indeed qualify as being independent and fall outside the employees tax net. It is evident from the Explanatory Memorandum issued by SARS, when the definition of employee was amended to include directors of companies, that the intention of the legislature was to include into the employees tax net the director that operates exactly on the same basis as a salaried employee save for the fact that they are also a director of the company. These directors would no longer receive the benefit of delaying the payment of taxes based on the provisional tax system, but employees tax would be deducted on a monthly basis. Based on the specific relationship and duties of a non-executive director in relation to the company, the intention of the legislature could not have been to include these directors in the employees tax net as with normal salaried employees. The litmus test Independence cannot be applied carte blanche to all non-executive directors. To determine whether a non-executive director could possibly qualify as being independent in terms of the tax legislation in relation to a company, consider the role and responsibilities that each of the non-executive directors have in relation to that company, tested against the statutory and non-statutory tests in terms of the legislation. Grant Thornton IT Act: 4 th Schedule Interpretation Note No.17 Integritax Issue 129 May 2010 SAICA, 2010 page 6

7 1843. PAYE on tips A vast number of businesses in South Africa in industries such as hospitality, transport, gambling and tourism, employ persons who, in addition to their salaries, also benefit to a large extent from gratuities ( tips ) received from satisfied customers. These amounts upon first glance might seem insignificant, but the tax implications are substantial. This is largely because of banks does encouraging patrons to use credit cards, at no additional charges, coupled with the effect that crime has on the general public, with the result that when a tip is given by a customer rarely or ever does cash still exchange hands. Instead, it has become standard practice that the tip payable to the employee is part of the payment when the bill is settled, leaving the employer with the responsibility to transfer such tips to the employees bank accounts when it runs its weekly or monthly payroll. The question which arises is whether the tips which the employees receive from the customers during the performance of their duties will create a liability on the employer to withhold employees tax from such amounts in accordance with the provisions of the Fourth Schedule to the Income Tax Act, No 58 of 1962 (the Act). In addition and more significant is the question whether such amounts will result in an obligation on the employer to make additional contributions to the Skills Development Levy ( SDL ) and the Unemployment Insurance Fund ( UIF ), by including the tips in the calculation of its SDL and UIF liability. Liability of the employer to withhold employees tax on the tips Employees tax, also known as PAYE, is a withholding tax which is deducted from every employee s remuneration on a monthly basis. The deduction is made by the employer and is determined by using the tax rates issued annually by SARS. In terms of the Fourth Schedule to the Act, every employer who pays remuneration to an employee has an obligation to register with SARS and deduct employees tax. Failure to pay within the prescribed time period will result in penalties, equal to 10% of the amount of employees tax payable and an additional penalty not exceeding twice the amount that the employer failed to pay and/or interest being levied by SARS at the prescribed interest rate on the amounts that should have been paid. In accordance with paragraph 2(1) of the Fourth Schedule, the duty of the employer to withhold employees tax is dependent on whether or not the employer pays or is liable to pay remuneration, to an employee. Accordingly, if remuneration is paid or a liability to pay remunerations exists, there is a duty on the employer to calculate and withhold employees tax on such an amount. Remuneration is widely defined in paragraph 1 of the Fourth Schedule to include all payments and amounts payable, in cash or otherwise, whether or not for services rendered and includes salary and wages, leave pay, bonuses, gratuities, commissions, overtime pay and other amounts paid for services rendered as well as allowances and advances. The definition of remuneration expressly includes an amount referred to in paragraph (c) of the definition of the term gross income, as more fully discussed above. As a result the tips will constitute remuneration for purposes of the Fourth Schedule to the Act. However, the fact that the tips are included in the definition of remuneration does not automatically impose a liability on the employer to withhold employees tax in respect of such amounts. In order to establish if such an obligation exists, it is necessary to determine whether the employer will pay or is liable to pay the remuneration to the employees. The meaning of the phrase pay or liable to pay has not yet been evaluated by a South African court in the context of the Act, and for this purpose we consider the Dictionary of Legal Words and Phrases (Author: RD Claassen Judge of the High Court of South Africa) in terms of which the phrase Integritax Issue 129 May 2010 SAICA, 2010 page 7

8 payment is defined as the delivery of what is owned by a person competent to deliver to a person competent to receive, and when such a payment is made it operates to discharge the obligation of the debtor. The phrase liability to pay is equally defined as the state to be required to or accept legal responsibility to pay (Oxford Advanced Learner s Dictionary, AS Hornby). Therefore, even though the tips received by the employees constitute remuneration for purposes of the Fourth Schedule, in our view it could potentially be argued that the employer is not making a payment nor does the employer incur a liability to pay an amount to the employee. The above view is based on the fact that the amount that is distributed by the employer to the employee does not discharge a debt owed to the employees, and there is also no legal liability on the employer to pay the tips to the employees. As a result it is not the employer paying the tips but, in fact, it is the satisfied customers who are making a payment, in the legal sense, to the employee. The function of the employer is merely to receive and hold the amounts on behalf of the employees, as an agent, and to facilitate the transfer of the tips into the employees relevant bank accounts. Accordingly, as the employer has no legal obligation to pay the tips to the employees the subsequent distribution will not be a payment of remuneration, and for this reason the distribution of the tips will not create an obligation on the employer to withhold employees tax on the amounts of tips transferred into the bank account of the employee. Having said that, paragraph 2(2) of the Fourth Schedule enables the employer, at the written request of the employees, to deduct or withhold employees tax on the amount of tips received (as they are gross income for the employee), in order to ensure that their tax liability is not underpaid at the end of the year of assessment. In this regard, subject to the receipt of a written instruction by the employee, the employer can continue to calculate and deduct PAYE from the tips transferred into the employees bank accounts. Editorial Comment: Although the amount of the tips clearly forms part of the gross income of the employee, it must not be reflected as part of gross remuneration on the annual IRP5 certificate. SDL and UIF liability In terms of the Skills Development Levy Act, No. 9 of 1999, as well as the Unemployment Insurance Contributions Act, No.4 of 2000, every employer is liable to contribute an amount equal to one percent (1%) of the remuneration it pays to its employees. An employer for the purpose of these Acts is defined as having the same meaning as in paragraph 1 of the Fourth Schedule to the Act, which means it is any person who pays or is liable to pay to any person an amount of remuneration. As discussed above, even though the tips constitute remuneration, the employer has no legal obligation to pay the tips to the employees. As a result, it is our view that the employer also does not have to account for SDL and UIF contributions in respect of the tips paid over to the employees. Edward Nathan Sonnenbergs IT Act: s 1 par (c) of the definition of gross income, 4 th Schedule par 1 definition of employer and remuneration, par 2(1) and 2(2) Skills Development Levy Act Unemployment Insurance Contributions Act Integritax Issue 129 May 2010 SAICA, 2010 page 8

9 SARS NEWS Interpretation notes, media releases and other documents 27 May 2010 Legal & Policy various Tariff Amendments published for 28 May May 2010 Legal & Policy The site has been updated to contain a full record of all Income Tax and other Practice Notes still in operation 21 May Legal & Policy - Draft Customs and Excise Schedule/Rules/Forms relating to Electricity Levy release for comment to be forwarded to sauthar@sars.gov.za by 4 June May Media Release - SARS Customs officials detain suspected counterfeit jerseys 14 May 2010 Legal & Policy Draft Customs and Excise Rules relating to wine-on-line released for comment - to be forwarded to sauthar@sars.gov.za by 28 May May Legal & Policy Government Notice R.381 of 14 May Tariff Amendment to Schedule No. 3 to insert tariff heading /01.00 for the manufacture of paintballs under rebate item May 2010 Legal & Policy Release of Draft Taxation Laws Amendment Bills, 2010 for comment by 11 June Also see Media Statements in this regard. 07 May Media Release - Two arrested in connection with R189m VAT refund fraud 06 May Legal & Policy-Capital Gains Guide: Comprehensive Guide to Capital Gains Tax (Issue 3) 06 May Legal & Policy - Tariff Amendment Gazette Notice R.357: Amendments to Schedule No. 4 to insert rebate item to implement provisions for the importation of goods for the construction of an agricultural technical demonstration centre with retrospective effect from 1 October May Legal & Policy - Tariff Amendment Gazette Notice R.358:Correction Notice to substitute subheading with subheading in subheading Note 3 to Chapter 48 with retrospective effect from 1 January April Media Release - South African Trade Statistics for March April Legal & Policy - Tariff Amendment: Amendments to Schedule No. 1 to increase the rate of duty of wheat and wheaten flour as recommended in ITAC Report No April Legal & Policy - Tariff Amendment: Amendments to Schedule No. 4 to delete rebate item /00.00/06 and substitute item /00.00/09.00 create rebate item /00.00/08 as a result of recommendations made in ITAC Minute No1/2010 in respect of the extension of the TCIDP 30 April Legal & Policy - Rule Amendment: Rules for section 6 and 120 in respect of King Shaka International Airport Integritax Issue 129 May 2010 SAICA, 2010 page 9

10 Readers are reminded that the latest developments at SARS can be accessed on their website Editor: Mr M E Hassan Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof KI Mitchell, Prof L Olivier, Prof JJ Roeleveld, Prof PG Surtees. The Integritax Newsletter is published as a service to members and associates of the South African Institute of Chartered Accountants (SAICA) and includes items selected from the newsletters of firms in public practice and commerce and industry, as well as other contributors. The information contained herein is for general guidance only and should not be used as a basis for action without further research or specialist advice. The views of the authors are not necessarily the views of SAICA. All rights reserved. No part of this Newsletter covered by copyright may be reproduced or copied in any form or by any means (including graphic, electronic or mechanical, photocopying, recording, recorded, taping or retrieval information systems) without written permission of the copyright holders. Integritax Issue 129 May 2010 SAICA, 2010 page 10