SYNOPSIS. March In this issue. Regional offices. Purpose, intention, object and motive Can interest be of a capital nature?...

Transcription

1 SYNOPSIS In this issue Purpose, intention, object and motive Can interest be of a capital nature? SARS s statutory preference on insolvency Physical presence test for residence Africa desk - Mauritius.. 11 Regional offices Bloemfontein (051) Cape Town (021) Durban (031) East London (043) Johannesburg (011) Port Elizabeth (041) Pretoria (012)

2 Purpose, intention, object and motive No judgment of the South African courts has yet clarified the meaning of (and difference between) purpose and intention or the distinction between these terms and the taxpayer s motive or object. The words purpose and intention crop up often in tax legislation and tax judgments. For example section 103(1) applies to a scheme that was entered into for the purpose of obtaining a tax benefit ; a scheme of profit-making in its most straightforward form connotes the acquisition of an asset for the purpose of reselling it at a profit ; (per Corbett JA in Elandsheuwel Farming (Edms) Bpk v SBI (1978 (1) SA 101 (A), 39 SATC 163 at 180 1); the most important factor in determining whether a profit is of a capital or revenue nature is your intention at the time you bought or sold your shares ; (SARS s Tax Brochure for Share Owners, February 2006, page 3). No judgment of the South African courts has yet put under a strong lens the meaning of (and the difference between) purpose and intention in this regard, or the distinction between these terms and the taxpayer s motive or object. It is, therefore, interesting to see what the High Court of New Zealand had to say in this regard in Wellington Regional Stadium Trust v Attorney General [2005] 1 NZLR 250. The distinction between a person s purpose, intention and object In Plimmer v CIR [1958] NZLR 147 it was held that A man s purpose is usually, and more naturally, understood as the object which he has in view or in mind but in ordinary language purpose connotes something added to intention and the two words are not ordinarily regarded as synonymous. In this case, the taxpayer wished to acquire all the ordinary shares of a certain company. The present holder of the shares also held a number of preference shares, and was not willing to sell the ordinary shares unless the purchaser also bought the preference shares. Reluctantly, therefore, the taxpayer bought not only the ordinary shares but also the preference shares, intending to sell the latter as soon as possible. The issue before the court was whether the taxpayer had purchased the preference shares for the purpose of selling them. The court held that the answer was in the negative the sale of the preference shares was not the object which the taxpayer had in mind when he purchased them; he acquired them only because he could not acquire the ordinary shares unless he simultaneously bought the preference shares. The court referred to the decision in CIR v National Distributors Ltd [1989] 3 NZLR 661 where it was said (at 666) that It is well settled that the test of purpose is subjective, requiring consideration of the state of mind of the purchaser at the time of acquisition of the property. in some factual situations it may be necessary to draw a careful distinction between motives and intentions and purposes, even though 2

3 the ideas conveyed by the respective words merge into each other without a clear line of differentiation. In CIR v Hunter [1970] NZLR 116 the taxpayer had wanted to remit funds from the United Kingdom to New Zealand. To obtain a better exchange rate than the official rate, the taxpayer purchased New Zealand securities with sterling and immediately sold the securities for New Zealand currency, making a profit in the process. The Commissioner sought to tax the profit in terms of a statutory provision which applied where property was acquired for the purpose of selling. The taxpayer argued that, in purchasing the stock, she did not have the purpose of selling it, and that her purpose was to convert the sterling funds into New Zealand currency. In Holden v CIR [1974] 2 NZLR 52, which involved similar facts, the Privy Council held that The appellants argued that this purpose [of selling the stock] was only incidental to the wider and more essential purpose to remit funds from the United Kingdom to New Zealand but that, in their Lordships' opinion, is irrelevant. There can be only one answer to the question for what purpose the securities were bought and the fact that the purchase and sale were part of a wider objective cannot affect that answer. In Union Shipping New Zealand Ltd v Port Nelson Ltd [1990] 2 NZLR 662 it was said (at 707) that purpose implies objects or aim. In CIR v BNZ Investment Advisory Services Ltd (1994) 16 NZTC 11,111 it was said (at 11,115) that purpose is the object which the taxpayer has in mind or in view. It is not synonymous with intention or motive.... purpose implies objects or aim... purpose is the object which the taxpayer has in mind or in view. It is not synonymous with intention or motive. The court rejected the argument, with North P drawing a distinction between immediate purpose and ultimate object, saying that the issue was whether the stock was acquired by the taxpayer for the purpose of selling, and that Her ultimate object, it is true, was to transfer her English funds to New Zealand but her purpose in acquiring the English stock was to sell it immediately In the same case, McCarthy J said Purpose must, naturally, be distinguished from motive or expectations. In the present case, the long-range aim of [the taxpayer] was to move her money from London to New Zealand. But as I view her actions, the dominant purpose of the purchase of the conversion stock was not that. To the same effect, it was held in Wairakei Court Ltd v CIR (1999) 19 NZTC 15,202 (at 15,206) that Purpose is a reference to the object that the taxpayer had in mind or in view. This is not synonymous with intention or motive. Moreover, care must be taken to avoid confusing the means by which the taxpayer achieves his purpose with the purpose itself. In Wellington v Regional Stadium Trust v Attorney-General [2005] 1 NZLR 267 the central issue was whether a particular charitable trust had the intention or purpose of making a profit. If the answer were affirmative, then in terms of New Zealand s Local Government Act of 2002 the trust would not be exempt from income tax. 3

4 Schemes of profit-making The meaning of purpose is of central importance in the context of a scheme of profit-making in South African income tax. The facts were that the Wellington region in New Zealand needed a new sports stadium. Through an initiative by the city council, a charitable trust was formed with the council as settlor. The trust raised loans to finance the building of the stadium, and it was duly built. To raise further money for the maintenance of the stadium, the trust sold membership, corporate boxes, naming rights, signage and sponsorship. The court said (at para 50) that it could not be said that an organisation has the purpose of making a profit where its profit objective is limited to making sufficient profits to meet its financial commitments, with the profits being retained and not distributed. The profits (said the court at para 56) were a means to an end, namely to enable the stadium to operate as a going concern, not an end in themselves. The court held, accordingly, that the trust did not operate its trading undertaking for the purpose of making a profit, and that it therefore qualified for exemption from tax. In Elandsheuwel Farming (Edms) Bpk v SBI (1978 (1) SA 101 (A), 39 SATC 163 at Corbett JA said, apropos the meaning of a scheme of profit-making, that (italics added) In its normal and most straightforward form, the latter connotes the acquisition of an asset for the purpose of reselling it at a profit. It has also been said by the Appellate Division that intention is not to be confused with mere contemplation ; in tax cases one is not concerned with possibilities which the taxpayer foresaw and with which he reconciled himself, but solely with his object, his aim, his actual purpose.. The latter dictum suggests that a taxpayer s intention is synonymous with his object, his aim and his actual purpose. The New Zealand authorities cited above, in particular Wairakei Court Ltd v CIR, suggest that it is an error to treat such terms as synonymous. It is to be hoped that the South African courts will take the first opportunity to examine and clarify the meaning of these terms. 4

5 Can interest be of a capital nature and thus not deductible? Recent Australian case sheds useful light The South African courts have suggested, on a few occasions, that an outlay of interest may in certain circumstances be of a capital nature and therefore not qualify as a deductible expense in terms of section 11(a) of the Income Tax Act. See for example the dissenting judgment of van Wyk AJA in CIR v Drakensberg Garden Hotel (Pty) Ltd 1960 (2) SA 475 (A), 23 SATC 251 at 260. Many business deals depend on interest being tax-deductible, and would be stillborn if it were not; and many businesspeople and their advisers blindly assume that anything they label interest in the documentation of a business deal will be deductible. In asking whether interest can in some circumstances be of a capital nature and hence non-deductible, we need to accept at the outset that We need to define our terms and ask what precisely is interest?; Just because the documentation of a business deal calls something interest does not mean that it is in fact interest; and In determining whether a particular outlay constituted interest and whether it was of a capital nature, we need to take into account not just the particular component of the business deal that gave rise to the interest, but the entire deal, for it may involve complex, inter-locking financing arrangements, such that the nature of the interest component cannot be considered in isolation. A recent decision of the Australian Federal Court in Macquarie Finance Ltd v Commissioner of Taxation [2004] 210 ALR 508 sheds useful light on these questions. What is interest and why is it usually deductible in terms of section 11(a)? Interest has been described as a payment made by a borrower for the use of the money borrowed (FCT v Century Yuasa Batteries Pty Ltd (1988) 82 FCR 288 at 291) or the price of money that is borrowed (Re Farm Security Act 1944 of the Province of Sasketchewan [1947] SCR 394) or a recompense to the lender for being kept out of his money (Lomax v Peter Dixon and Co Ltd [1943] 2 All ER 255). It follows, therefore, that there must be a borrowing before what is paid by the borrower can be said to be interest. And "borrowing" presupposes that the lender is entitled to a return of the money lent. It seems to be accepted, therefore, that the provision of funds which are not repayable does not constitute borrowing and that the consideration paid by the recipient of the funds will therefore not be interest. 5

6 Thus, in Emu Bay Railway Co Ltd v FCT (1944) 71 CLR 596 at 608 it was held by Rich J that, A borrowing involves the obligation to repay and it was held in the United States in Jewel Tea Co Inc v United States (1937) 90 F 2d 451 at 453 that in the absence of a provision [that a holder of a security may unconditionally demand repayment of his money at a fixed time] the security cannot be a debt. But where complex financial arrangements are concerned, it is important to revert to the proper inquiry and ask, not whether the outlay in question was interest, but whether it was of a capital nature. This leads to the question whether the expenditure was incurred for the purpose of producing a lasting advantage for the enduring benefit of the taxpayer s business. (British Insulated & Helsby Cables v Atherton (1925) 10 TC 155 at ) Ordinarily, interest does not secure a lasting advantage Where complex financial arrangements are concerned, it is important to revert to the proper inquiry: not whether the outlay in question was interest, but whether it was of a capital nature. In an irredeemable or perpetual debenture, the capital amount is not repayable unless and until the borrowing company goes into liquidation. (See Ford, Principles of Company Law, 2nd ed para 1208.) Even though that contingency may never be fulfilled, it seems (for there is no judicial authority directly in point) that the recurrent consideration paid by the company to the debenture-holders is indeed interest for tax purposes. Section 11(a) does not refer to interest The question whether the expenditure under scrutiny is interest is not definitive of its deductibility. There is nothing in section 11(a) of our Income Tax Act or the corresponding provision of the (Australian) Income Tax Assessment Act which requires that the expenditure in question be characterised as interest ; all that is required is that it was incurred in the production of income and that it was not of a capital nature. Nonetheless, we tend to take for granted that interest fulfils these requirements and hence that interest that it is incurred in the context of a business deal, whose object is the production of income, qualifies for deduction under section 11(a). In straightforward contractual arrangements involving the borrowing of money at interest, this is a safe assumption. of an enduring nature for the borrower, and therefore passes this test. Corporate finance via debt and capital Where a company seeks to raise capital which it requires for an extended period, it must choose between debt (borrowing) and capital (the issuing of shares). Debt tends to be a cheaper way of raising finance than capital because holders of debt do not have the capital and dividend rights of shareholders. Moreover, debt is usually more tax-effective in that interest is deductible whereas dividends are not. From the point of view of the company seeking the finance, debt is usually an ephemeral arrangement, in that the loan will be repaid at the end of the stipulated term, whilst the issuing of shares creates rights which endure for the life of the company. In Macquarie v FCT, supra, an unusual arrangement was reached. The company seeking finance offered investors the opportunity to subscribe for preference shares in itself, and also for notes issued by an outside finance company. The issue price of the shares was the same as the face value of the notes. The arrangement was that immediately after the subscription of the shares, an amount would be repaid to the investor equal to the 6

7 amount paid for the shares or the face value of the notes (these being the same amount). In effect, the investor was reimbursed the money it had paid for the shares or for the notes, but it was left ambiguous as to which was being reimbursed. Significantly, the preference shares and the notes were stapled securities, meaning that the holder was not permitted to transfer one without the other. In determining whether the interest paid on the notes was of a capital nature and thus not a deductible expense for the company, the court pointed out (at para 59) that in the United States, shares are in some instances treated as debt instruments, and that the converse can presumably also be true, in other words, that debt can be created by the issuing of shares. The court said that, in the present case, the argument that the interest paid on the notes was not of a capital nature ignored the inter-connection between the notes and the shares (which, as indicated above, were issued as stapled securities ) and also ignored the fact that no dividend was payable on the shares so long as interest was paid on the notes. a loan of an ephemeral character, but had incurred costs associated with a permanent injection of capital. In the result, the court held that (at para 73 and 120) that no part of the interest payable on the notes was a deductible expense. This judgment is not authority for the proposition that interest can be of a capital nature Although the headnote to the judgment says that this case decided that the interest was of a capital nature this is, with respect not a correct summation. The court referred throughout its judgment to the payment being so-called interest and said (at para 61) that to characterise the payment as interest ignored the composite nature of the rights of the investor. It would thus be more accurate (it is submitted) to summarise this judgment as holding that the payments made by the taxpayer to the The court held (at para 60) that the so-called interest in terms of this arrangement was not, in any practical sense, consideration paid to the holder of the note; the holder of the note might never get repaid, and might, in the future, have to rely only on his rights as a shareholder. In these circumstances, said the court (at para 61) the legal rights of the holders of the notes might seem to involve the payment of interest, but such a characterisation ignored the composite nature of their rights as holders of the notes and as holders of the shares. In effect, said the court (at para 63) the company had not incurred the cost of acquiring investors, though dressed up to look like payments of interest, were in fact not interest at all, but constituted expenditure of a capital nature in that the payments were intended to secure an advantage of an enduring nature, equivalent to a permanent injection of capital. 7

8 Statutory preference on insolvency cannot be subverted SARS has first shot at the spoils Central to the law of insolvency is the principle that, immediately upon the sequestration of an individual s estate or the liquidation of a company, there is a concursus creditorum (a coming together of creditors) the effect of which Innes CJ explained in Walker v Syfret 1911 AD 141 at 166 as follows: The sequestration order crystallises the insolvent s position; the hand of the law is laid upon the estate, and at once the rights of the general body of creditors have to be taken into consideration. No transaction can thereafter be entered into with regard to estate matters by a single creditor to the prejudice of the general body. Frequently, SARS is one of the unsecured creditors, and the Insolvency Act 24 of 1936 accords a preference to the payment of any tax on persons or the incomes or profits of persons for which the insolvent was liable (section 101(a)) and for VAT due by the insolvent immediately prior to sequestration (section 99(1)(cD)). In other words, SARS is entitled to be paid before the other concurrent creditors. SARS jealously defends its preferential claim to unpaid tax due by an insolvent taxpayer. The SCA strikes down an agreement which subverted the order of preference on insolvency In CSARS v Stand Two Nine Nought Wynberg (Pty) Ltd (2005) 67 SATC 275 the Supreme Court of Appeal affirmed the importance of preventing any subverting of the scheme, laid down in the Insolvency Act, for distributing the residue of an insolvent estate (after payment of the secured creditors) to the concurrent creditors in the order set out in sections of the Act. 8

9 In this case, Stand Two Nine Nought Wynberg (Pty) Ltd had procured the winding up of Super Diamond Computers (Pty) Ltd (for brevity, the insolvent company ). At the time it went into liquidation, the insolvent company owed SARS some R in respect of unpaid tax, and owed various other amounts to other creditors. The insolvent company had no money at all in the kitty because a company called MMW Technologies (Pty) Ltd had taken over all of the insolvent company s assets without paying for them. Predictably, the liquidator convened an inquiry in terms of sections 417 and 418 of the Companies Act 61 of 1973 to determine what had happened to the insolvent company s assets. They day before the inquiry was due to begin, MMW entered into an agreement with the insolvent company in terms of which MMW undertook to pay the claims of every creditor of the insolvent company, including what was owed to SARS for the outstanding tax. In accordance with this undertaking, MMW paid R to the liquidator so that the latter could settle the claim of Stand Two Nine Nought Wynberg (Pty) Ltd against the insolvent company. It then transpired that MMW was unable to pay the insolvent company s debts, and it was in turn wound up. Stand Two Nine Nought Wynberg (Pty) Ltd claimed that the money paid by MMW to the liquidator had been earmarked for the payment of its claim and should be paid to it despite SARS s preferent claim in terms of the Insolvency Act for the tax due by the insolvent company. Did the liquidator act as the creditor s agent? The argument of Stand Two Nine Nought Wynberg (Pty) Ltd was that the liquidator had acted as its agent in receiving the sum of R from the insolvent company. The court did not accept this argument, holding that an arrangement whereby the liquidator was to pay the claim of a particular creditor of an insolvent ahead of the other creditors would subvert the scheme of distribution laid down by the Insolvency Act 24 of It was the liquidator s duty, said the court, to recover all the assets of the insolvent company, to realise them, and apply the proceeds firstly to the costs of the winding-up and then to distribute any residue to the concurrent creditors in the order of preference set out in sections of the Insolvency Act. Giving the judgment of the court, Conradie JA said As long as MMW honoured its obligations [to pay all the claims against the insolvent company] the agreement could be validly performed. As soon as it did not, however, performance of the agreement would offend against the Insolvency Act and for that reason be unlawful. In other words, the liquidator stepped into the shoes of the insolvent company in relation to the rights and obligations under its agreement with MMW. However, the effect of liquidation was to create a concursus creditorum and the provisions of the Insolvency Act, which dictate the order in which creditors must be paid, barred the liquidator from giving effect to that part of the agreement which said that the money paid in by MMW must be used to pay the claim of a particular creditor, namely Stand Two Nine Nought Wynberg (Pty) Ltd. Consequently, SARS s statutory preferential claim for tax due by the now-insolvent company remained intact, and the liquidator was obliged to draw the liquidation and distribution account in a manner that gave effect to that preference. It was the liquidator s duty to: recover all the assets of the insolvent company; realise them; apply the proceeds firstly to the costs of the winding-up and then to concurrent creditors in the prescribed order. 9

10 Applying the physical presence test for residence in the year of death or insolvency Anyone home? A person who is not ordinarily resident in the Republic in a given tax year will nonetheless be resident for income tax purposes if he or she fulfils a statutory physical presence test which involves the counting of the number of days of physical presence in the Republic over the previous five years. (Previously, the test was for physical presence in the past three years.) These criteria are laid down in the definition of resident in section 1 of the Income Tax Act 58 of Interpretation note 25 issued by SARS on 8 February 2006 provides welcome clarity on the application of the physical presence test in relation to a person who dies or becomes insolvent during the year of assessment. The Interpretation Note states, inter alia, that the 91-day period in the year of death is not scaled down to account for the fact that the year of assessment in the year of death or insolvency is less than 365 or 366 days. The day on which a person dies is regarded as a complete day. The position of a natural person who becomes insolvent during a year of assessment is that the period from the commencement of the year of assessment to the day prior to the person s becoming insolvent is regarded as a year of assessment. The result is that in a period from 1 March in one year to 28 February in the next, a natural person who becomes insolvent is regarded as having two years of assessment, each of which must be considered in applying the criteria of physical presence for the purpose of determining residence. 10

11 Africa Desk Mauritius Mauritius is a subtropical island of volcanic origin and is situated some 2,400 km off the south east coast of Africa. With its multicultural, bilingual population of around 1.3 million inhabitants, Mauritius is strategically located at the crossroads between Africa and Asia. Mauritius has realised a remarkable transformation in the last three decades from a mono crop economy (sugar) to a diversified economy resting on agriculture, manufacturing, tourism, financial and business services and on the emerging information and communication technology sector. Tax System, Rates and Incentives Mauritius has a global system of taxation as opposed to a schedular system. Under this system, income from all sources is added up and the appropriate tax rates are applied after reckoning all allowable deductions and exemptions. While corporate income is taxable at the applicable corporate rate (currently 25%), dividends paid by a corporation to its shareholders are exempt from tax. Companies operating in certain sectors such as manufacturing and tourism are taxed at the rate of 15% on their income. Furthermore, there are no capital gains tax or withholding tax payable in Mauritius. Corporate Residence A company incorporated in Mauritius is resident in Mauritius for tax purposes. A company not incorporated in Mauritius is resident in Mauritius only if it has its central management and control there. A Category 2 Global Business company is not considered as resident in Mauritius for the purposes of double taxation treaties. Foreign Tax Credits A corporation subject to tax on its foreign income is entitled to a tax credit in respect of any foreign tax paid on such income. The credit is, however, limited to Mauritian tax applicable to that income. Where the foreign income includes dividends, credit is allowed both for withholding tax and underlying tax, provided that the recipient company holds at least five percent of the share capital of the company paying the dividends. Credit for underlying tax is given on a multi-tier basis. Mauritian domestic law also provides for tax-sparing relief, whereby credit is allowed for foreign tax deemed to be paid though not actually paid. For the purpose of claiming and maximising foreign tax credit, a taxpayer may compute the amount of foreign tax by referring to all foreign source income together or to each item of such income separately, whichever is to his advantage. 11

12 Mauritius Global business companies, engaged in international business activity, are liable to tax at a rate of 15 percent, against which a credit for any foreign tax paid may be claimed. Where they are not able to show evidence that foreign tax has been charged on their foreign income, they will be presumed to have paid foreign tax amounting to 80 percent of the Mauritian tax chargeable with reference to that income. With the above provisions, actual tax payable by global business companies is in most cases marginal or zero and the effective rate does not in any case exceed 3%. Value Added Tax PricewaterhouseCoopers in Mauritius PricewaterhouseCoopers has its offices in Port-Louis, the capital city of the country. With over 120 professional staff members, PricewaterhouseCoopers serves a number of multinational companies doing business in Mauritius, a cross-section of the local business community as well as public institutions. Contact details 6th floor, Cerné House Chaussée Street Port Louis Mauritius Telephone Facsimile Value added tax (VAT) was introduced on 7 September 1998 to replace the sales tax. VAT is now chargeable at a standard rate of 15% on all goods and services. Editor: Ian Wilson Written by R C (Bob) Williams Sub-editor and lay out: Carol Penny Dis tri bu tion: Elizabeth Ndlangamandla Tel (011) Fax (011) This publication is provided by PricewaterhouseCoopers Inc. for information only, and does not constitute the provision of professional advice of any kind. The information provided herein should not be used as a substitute for consultation with professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all the pertinent facts relevant to your particular situation. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the author, copyright owner or publisher. Copyright 2006 PricewaterhouseCoopers Inc. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers Inc (a South African incorporated entity) or, as the context requires, the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.