TAX ALERT. We have launched a new Tax website. Click here to visit the site. IN THIS ISSUE FAR REACHING DECISION BY THE TAX COURT 5 AUGUST 2011

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1 5 AUGUST 2011 TAX ALERT FAR REACHING DECISION BY THE TAX COURT On 1 August 2011, the Johannesburg Tax Court (the Court) handed down a significant judgment that is yet to be reported and that specifically addresses, in the words contained in the judgment, "novel and complex" issues relating to the interpretation of the provisions of sections 36(7E) and 36(7F) of the Income Tax Act, 58 of 1962 (the Act). By way of background, a taxpayer owned three gold mines, where two of the gold mines were in a profitable position and one of the gold mines made a loss during the relevant years. In addition, the taxpayer derived income from non-mining activities. The question was whether the loss of the one mine could be set off against the taxable income derived by the taxpayer from its non-mining activities or whether the loss had to be deducted on a pro rata basis from the income of the profitable mines. The taxpayer adopted the approach of deducting the loss from the taxable income derived from its non-mining activities as opposed to deducting the loss from the income of the profitable mines. Further, the capital expenditure of the profitable mines was redeemed up to the limit of the taxable income of the profitable mines. The South African Revenue Services (SARS) adopted the approach that the operating loss of the non-profitable mine should be deducted from the income of the profitable mines on a pro rata basis before redeeming any capital expenditure against the respective taxable income of the mines. IN THIS ISSUE A review of recent developments Far reaching decision by the Tax Court Contradictory approaches to statutory interpretation - uncertainty prevails? We have launched a new Tax website. Click here to visit the site. continued EVERYTHING MATTERS

2 It was argued on behalf of SARS that: operating expenses must be deducted from income while capital expenditure relating to a particular mine is to be redeemed against taxable income and that the deduction of capex is ring-fenced in terms of section 36; section 11(a) of the Act distinguishes between trades and requires that the operating loss of a trade firstly be deducted from the income derived from that trade, if any; the intention of the legislature in enacting sections 36(7E) and 36(7F) was to prevent the corrosion of the non-mining tax base and the taxpayer's approach would be to promote the mischief which the legislature intended to overcome; to allow the deduction of expenses from the trade of mining for gold from non-mining activities carried on by the taxpayer would distort and dilute the graduating tax rate applicable to the gold mining trade. It was argued on behalf of the taxpayer that on a correct interpretation of sections 36(7E) and 36(7F), it is necessary to draw a distinction between a current year loss or operating loss and an assessed loss. An assessed loss, being a loss incurred in a previous year, and carried over from a previous year was ring-fenced in terms of sections 36(7E) and 36(7F). It is noted that the focus of the judgment related to the application of section 11(a) of the Act as opposed to the interpretation of sections 36(7E) and 36(7F). Sections 36(7E) and 36(7F) Unfortunately, the Court did not address the interpretation of the provisions of sections 36(7E) and 36(7F) of the Act as raised in argument before the Court. The Court only concluded cursorily in relation to the application of sections 36(7E) and 36(7F) that: "The sequence of deductions of which the current operating loss of a mine is first deducted from mining income, before the deduction of the assessed losses contemplated ss 36(7E) and (7F) and thereafter the capex from the taxable income of the mine to which it relates is consistent with the Legislative intention. By reducing the income of the respective profitable mines through the deduction of the operating loss of one of its mines the amount of capex that may be redeemed against the respective incomes of such profitable mines is also reduced and a measure of preservation of the income from non mining activities is also achieved." The opportunity for addressing the "novel and complex" issues raised by the case was dismissed in favour of the focus switching to section 11(a) by the Court as opposed to specifically considering the arguments raised by either the taxpayer or SARS. Taxpayers that seek to apply the provisions of sections 36(7E) and 36(7F) of the Act are left in the position where there is no guidance provided by the Courts in circumstances where the provisions of sections 36(7E) and 36(7F) are unclear. Section 11(a) Importantly, in its focus on the interpretation of section 11(a), it is significant that the decision by the Court adopts a contrary approach to the interpretation of section 11(a) of the Act that will likely have far reaching implications. It was held by the Court that the wording of section 11(a) is clearly unambiguous and that: "While ss 36(7E) and (7F) ring-fence mining and individual mines, respectively, and in particular in respect of the redemption of capex and the deduction of the balance of the assessed losses from the previous year s11(a) distinguishes between trades and allows certain expenses and losses (current or operating) to be deducted from the income derived from the taxpayer from a particular trade." The Court drew a distinction between the different trades conducted by a taxpayer in its interpretation of section 11(a). In particular, each trade of a taxpayer must be separated for purposes of claiming any deduction. Effectively, if any taxpayer conducts more than one trade, then the losses incurred in respect of any trade may not be deducted from the income derived by the taxpayer from any other trade. continued 2 l Tax Alert 5 August 2011

3 At paragraph 35 it was held that: "The section does not allow such expenses, or losses, incurred in respect of one trade to be deducted from the income derived by the taxpayer from another trade. In the case of a taxpayer who derived an income from mining and an income from another trade, the taxpayer is not allowed to deduct an operating loss incurred in the mining trade from the income derived from another trade and vice versa. The loss can only be deducted from the income derived from the same trade as the one in which the loss was incurred. The same would apply whether the taxpayer hasone or more mines and also derives and income from another trade." Therefore, applying the decision handed down by the Court, a taxpayer must separate each trade that it conducts for purposes of determining whether any deduction will be allowed under section 11(a). A deduction may only be claimed if the expense or loss of a particular trade relates to the income derived by that particular trade. There is no ability to claim any deduction from one trade against another trade despite the taxpayer conducting both trades. A strict interpretation of section 11(a) will be applied, leaving the taxpayer in the invidious position where the separate trades of a taxpayer are ring-fenced for purposes of claiming any deduction. Section 20 The Court further considered the interpretation of section 20 with specific reference to section 20(1)(b) regulating the set-off of an assessed loss. The Court agreed with the decision in ITC 1420 that "the assessed loss of the current year of assessment (ie a current year operating loss) incurred by the taxpayer in respect of non-mining activities, would not be deductible from income derived by it from gold mining despite the provision of section 20(1)(b)." The reasoning was that to allow such a position would be to undermine the Legislative intention to tax gold mining companies differentially. In this regard, the Court adopted an approach where the nature of the trade conducted by the taxpayer resulted in differential treatment. The Court further reasoned at paragraph 33 that: "But for what was held in ITC 1420, it is apparent that a loss incurred by a taxpayer in respect of one trade may, subject to exceptions, be written off against the income the taxpayer derived from another trade. However, it must be a loss incurred in respect of the trade and not only in respect of a unit or units in respect of that trade." Thus, the Court circumscribed the application of section 20(1)(b). Specifically, the set-off of a loss from one trade may not occur where the trade comprises a "unit" or "units". In the case before the Court, it was held that the separate mines of the taxpayer constituted such "units" and as such the loss suffered in relation to one "unit" could not be set-off against the profits of the other "units" as the loss was not in respect of the entire gold mining operation. If a taxpayer passes the hurdle of claiming a deduction of an expense or a loss in relation to a particular trade, the taxpayer will, if there is to be any set-off of any "assessed loss", have to demonstrate that such loss relates to the entire operations of the trade conducted by the taxpayer in question. The Court has thus elevated the importance of there being a single trade not only for purposes of claiming any deduction in terms of section 11(a) but also for purposes of being able to set-off any assessed losses incurred by a taxpayer. Section 36(7G) In addition, despite the taxpayer raising the argument that section 36(7G) of the Act should apply to the extent that the Court determined that sections 36(7E) and 36(7F) of the Act were not applicable, the Court chose to dismiss this argument as "hypothetical, or of academic interest" as there was no surplus taxable income after the redemption of capital expenditure in accordance with the provisions of sections 36(7E) and 36(7F). This unreasoned refusal to address such argument leaves the taxpayer without recourse and without any clarity regarding the circumstances when section 36(7G) may be applied by taxpayers. Natalie Napier 3 l Tax Alert 5 August 2011

4 CONTRADICTORY APPROACHES TO STATUTORY INTERPRETATION - UNCERTAINTY PREVAILS? In our Tax Alert of 8 July 2011, in the article entitled Purposive interpretation of tax statutes: back to the future?, we reviewed the judgment handed down on 15 June 2011 in the case of XYZ v CSARS (Case No 12895), in which case the Court considered the approach to be adopted when interpreting statutes. As indicated in our Tax Alert of 8 July 2011, although there is a role for purposive interpretation, Case No strongly indicates that it can only come into play where the intention of the legislature is not readily discernable from the wording of the applicable provision. The conclusion reached in Case No starkly contrasts with the approach to statutory interpretation adopted in the recent Court judgment in Case No The taxpayer argued in favour of a purposive approach to interpretation whereas the Commissioner contended that the plain wording used by the legislature is central to the interpretation of all statutes and that it applies equally to tax legislation. In summary, the Court held that the correct approach is to respect the language used: "Interpretation concerns the meaning of words used by the legislature and is therefore useful to approach the task by referring to the words used, and to leave extraneous considerations for later." Furthermore, it was held that the words chosen by Parliament cannot be subverted in favour of the spirit of the law, or undermined by referring to background policy considerations that are not reflected in the language of the particular statute. The use of the purposive approach to statutory interpretation may only, according to the Court, be used in limited circumstances. Specifically, only where there is ambiguity may the purposive approach provide a "reliable pointer to the intention of the legislature". Therefore, based on the decision in Case No a statute must be interpreted with reference to the words used and if the words are unambiguous, no reference may be made to any other aid to statutory interpretation. In its argument, the Commissioner made specific reference to the background material relating to the enactment of sections 36(7E) and (7F) of the Income Tax Act, 58 of 1962 (the Act), including the various explanatory memoranda, comments and opinions of the Margo Commission of Enquiry into the Tax Structure of the RSA 1986, press releases of the then Minister of Finance and commentary of academic writers in order to elucidate the mischief that the sections were intended to deal with and prevent. The Court held at paragraph 13 that: "Material that is not background material, such as the report of the Margo Commission and the views of commentators, are not admissible for the aforementioned purpose, but may be used in argument in an effort to persuade." The Court thus adopted a lenient approach to making reference to background materials and relied on the background material to ascertain the mischief that the legislative provisions are meant to address. In other words, the Court did not confine itself solely to the words of the Act as prescribed in Case No Rather, a more expansive approach was adopted where the Court elevated the importance of understanding the mischief that the statute sought to address. continued 4 l Tax Alert 5 August 2011

5 At paragraph 21, the Court's purposive approach to interpretation is highlighted: "In my view s 36(7E), where it deals with the deduction of assessed losses carried over from preceding years of assessment, implies that such losses may only be deducted from the mine or mines that incurred them. I am fortified in this view that one of the main purposes of the subsection was to limit the amount of capex redeemed in any particular year. If the taxpayer was free to deduct the assessed loss from the preceding year from any other income it could undermine this purpose of the subsection. Subsection 36(7F) also provides that capex can only be redeemed against the taxable income of that mine after set-off of any assessed loss incurred by the taxpayer in relation to that mine in any previous year which has been carried forward from the preceding year of assessment." Further at paragraph 28, the Court held that: "In enacting ss 36(7E) and (7F) the Legislature did not regard the deduction of current operating losses as a mischief to be regulated by means of a ring-fencing provision in those subsections, in all probability because that was dealt with elsewhere in the Act." the Court did not identify any ambiguity in sections 36(7E) and (7F) of the Act, thereby justifying the use of the purposive approach to statutory interpretation. The contradictory approaches in the two cases highlighted above make the taxpayer's position all the more uncertain in that: there is no consistent approach that is applied when interpreting the provisions of the applicable tax statutes; it appears that either a strict literal approach may be adopted or an expansive purposive approach may be adopted; there is no indication of which interpretive approach may be used in any given circumstances, thereby compounding the uncertainty; the selection of the approach to statutory interpretation appears to be capricious and it seems that any one approach may be selected without sound reasons for doing so, thus prejudicing the taxpayer. Natalie Napier From the above extracts it is apparent that: the Court did not make reference to the actual words of the Act as the point of departure in accordance with the judgment in Case No 12895; no reference or reliance was placed on the decision in Case No 12895; the focus of the Court was on the mischief surrounding the enactment of sections 36(7E) and (7F) of the Act without first determining what is the "ordinary" meaning of the words contained in those sections; This information is published for general information purposes and is not intended to constitute legal advice. Specialist legal advice should always be sought in relation to any particular situation. Cliffe Dekker Hofmeyr will accept no responsibility for any actions taken or not taken on the basis of this publication. 5 l Tax Alert 5 August 2011

6 CONTACT US For more information about our Tax practice and services, please contact: Emil Brincker National Practice Head T +27 (0) E emil.brincker@dlacdh.com Alastair Morphet T +27 (0) E alastair.morphet@dlacdh.com Johan van der Walt T +27 (0) E johan.vanderwalt@dlacdh.com Natalie Napier T +27 (0) E natalie.napier@dlacdh.com Ruaan van Eeden T +27 (0) E ruaan.vaneeden@dlacdh.com Ben Strauss T +27 (0) E ben.strauss@dlacdh.com Andrew Lewis Associate T +27 (0) E andrew.lewis@dlacdh.com BBBEE STATUS: LEVEL THREE CONTRIBUTOR JOHANNESBURG 1 Protea Place Sandton Johannesburg 2196, Private Bag X40 Benmore 2010 South Africa Dx 154 Randburg and Dx 42 Johannesburg T +27 (0) F +27 (0) E jhb@dlacdh.com CAPE TOWN 11 Buitengracht Street Cape Town 8001, PO Box 695 Cape Town 8000 South Africa Dx 5 Cape Town T +27 (0) F +27 (0) E ctn@dlacdh.com 5th floor Protea Place Protea Road Claremont 7708, PO Box Claremont 7735 South Africa Dx 5 Cape Town T +27 (0) F +27 (0) E ctn@dlacdh.com EVERYTHING MATTERS Cliffe Dekker Hofmeyr is a member of DLA Piper Group, an alliance of legal practices