In this first newsletter for 2023 we consider the following:
Practice Note (PN) 31 of 1994 to be possibly withdrawn
Corporate assessed loss limitations time-aligned to corporate tax rate reduction
Foreign Pension trust (FPT) continued: Donations tax and the Welch case
Thistle judgment revisited – Remission of Penalties
SARS Interpretation Notes (INs), Draft INs, Guides, BCRs, BPRs Noter-Up
(We shall publish a same-day 2023/4 Budget Speech newsletter likely Wednesday, 22 February but date still to be confirmed by Treasury).
Tony Davey – Editor
Duncan McAllister – Co-Editor
SARS has announced its intention to withdraw PN31 effective for years of assessment commencing 1 March 2023. However, SARS invited submissions on the proposed withdrawal for a period which is now closed. This PN allows the deduction of interest incurred on borrowed funds where such funds are on-lent for the purpose of earning interest, notwithstanding that the borrower is not a moneylender. Thus, for example if taxpayer Company A (a non-money lender) borrows from Bank B at rate X + 1 and on-lends to Company B at rate X + 3, Company A is allowed to claim a tax deduction of the interest incurred of X + 1 and thus effectively includes in taxable income, only the net interest of 2, notwithstanding Company A is not carrying on a trade of moneylending but merely providing ad hoc finance to assist another company. We await SARS’s response to the submissions, likely in the Budget Speech, February 2023.
CORPORATE ASSESSED LOSS LIMITATIONS TIME-ALIGNED TO CORPORATE TAX RATE REDUCTION
This limitation on the carrying forward of a full assessed loss, is effective for years of assessment ending on or after 31 March 2023, or, put another way, for years of assessment commencing 1 April 2022. This date is aligned to the date of reduction of the corporate rate from 28%to 27% as announced by the Minister of Finance in his 2022 Budget Speech being, as stated above, years of assessment commencing on or after 1 April 2022.
Thus companies with years of assessment commencing 1 March 2022 and ending end February 2023 are not affected by the assessed loss limitations until the following tax year commencing 1 March 2023 and ending end February 2024. (Bear in mind, however, the rate remains at 28% for such companies). As another example, for companies with years of assessment commencing after 1 April 2022, say 1 July 2022 ending June 2023, the reduced corporate rate of 27% applies, but with an assessed loss carried forward, limited to the higher of R1 million and 80% of taxable income.
[Source: GG 45787 of 19 January 2022 – Taxation Laws Amendment Act 20 of 2021, section 18, which amends section 20 of the Income Tax Act].
FOREIGN PENSION TRUST (FPT) CONTINUED:
DONATIONS TAX AND THE WELCH CASE
In essence, Estate R.F. Welch v C: SARS – SCA Case 2004 is the most relatively recent decided SCA Court case on the criteria to constitute a donation. The facts were that in terms of a consent paper, made an order of Court, maintenance was payable to an ex-spouse. In discharge of this legal obligation, certain assets were settled upon a trust under which, inter alia, the ex-spouse was a beneficiary. SARS sought to impose donations tax on the settlement.
The SCA (in reversing the Cape High Court decision by a majority of 3 to 2), held that:
– Only settlements which were motivated by pure liberality or disinterested benevolence;
– For no quid pro quo (for example, not discharging a legal obligation);
could constitute a donation and be liable to donations tax.
Put another way, settlement of assets for the express purpose of discharging legal obligations to a third party is not a donation either at RSA common law or within the definition of “donation” in the Income Tax Act.
This particular scenario of the Welch case, cannot be equated with the funding of an inter-vivos trust (whether onshore or offshore) under which assets are voluntarily settled upon such a trust as an estate-planning arrangement, including the purchase by such trust of a foreign Retirement Annuity or pension.
To quote from Judge Zulman –
“……….  The question which falls to be answered in this particular case cannot be solved by adopting a priori a point of departure which purports to answer in advance the very question which remains to be considered. That point of departure is that all disposals of property to a trust are donations unless they are loans to the trust or pursuant to purchases by the trust. (Our underlining).
 In my view the point that requires special emphasis in this case is that this trust is not typical of the many inter vivos trusts which exist in South Africa. Typically, the latter trusts give expression to a unilateral desire by the settlor to sequester funds for the benefit of named beneficiaries to whom no legal obligation to do so is owing. Here the position is quite different.
 The creation of this trust had its genesis in arms’ length negotiations in a litigatory setting. Its creation was part of a compromise reached between the parties and was made mandatory by the court order………..  To equate this trust with trusts created in circumstances where no antecedent obligations are owed by the settlor to the named beneficiaries is neither possible nor appropriate. (Our underlining).
Further to this, the Commissioner for SARS did not raise the argument under s 58 of the Income Tax Act that Donations tax may be levied upon the part of a settlement which exceeds the value of the consideration received. Thus, if a Founder has no vested rights to the foreign trust monies as is claimed by FPT providers seeking to distinguish their structures from that considered by SARS in BCR 080, this would surely trigger donations tax on the basis of an inadequate consideration.
It follows that any carte blanche reliance on the Welch case in the context of FPTs is misplaced.
THISTLE JUDGMENT REVISITED – REMISSION OF PENALTIES
In our previous newsletter 7.2022 dated 15 November 2022, we commented on the SCA judgment that the conduit principle does not apply to pyramid trust structures. Another interesting aspect of the judgment pertained to the remission of Understatement Penalties (USP).
SARS had imposed a penalty of 50% under the table in s 223(1) of the Tax Administration Act 28 of 2011 (TAA) on the basis that there was ‘No reasonable grounds for “tax position” taken’. Section 223(3)(b) of the Tax Administration act (TAA) provides that SARS must remit a penalty imposed for a substantial understatement if the taxpayer obtained an opinion from an independent registered tax practitioner, before the tax return was due, with full disclosure of the facts, which confirmed that the taxpayer’s position is more likely than not to be upheld in court.
Another situation when an USP is not imposed by SARS is under Section 222(1) of the TAA, being ‘a bona fide inadvertent error’. SARS Guide to Understatement Penalties adopts a strict and narrow approach to a bona fide inadvertent error as meaning an involuntary mistake, as distinct from a deliberate cause of action.
The Thistle Trust had relied on a legal opinion which had been obtained by another member of the Zenprop Group.
In the judgment the court stated the following:
‘ SARS initially adopted the position that, in the light of the legal opinion, it should be concluded that the Thistle Trust had consciously and deliberately adopted the position it took when it elected to distribute the amounts of the capital gains as it did. However, during the argument before us, counsel for SARS conceded, correctly, that the understatement by the Thistle Trust was a bona fide and inadvertent error as it had believed that s 25B was applicable to its case. Though the Thistle Trust erred, it did so in good faith and acted unintentionally. In the circumstances, it was conceded that SARS was not entitled to levy the understatement penalty.’
It might be accepted that the taxpayer acted in good faith and made an error of interpretation. But the court’s conclusion that reliance on the legal opinion was ‘inadvertent’ is going to be a hard pill for SARS to swallow. The SARS position on distributions through multiple discretionary trusts was clearly set out in the Comprehensive Guide to Capital Gains Tax, and the taxpayer must have taken a conscious decision to take a different view. It would have made more sense for the court to consider the opinion under s 223(3), assuming it was obtained from an independent registered tax practitioner before the returns were submitted. Alternatively, the court should have considered whether the taxpayer had reasonable grounds for the tax position taken. Given that the taxpayer had succeeded in the tax court, this may well have been the case. It would have been helpful if the court had explained why it considered the error in interpretation to be inadvertent. In the result, it is going to be difficult in future for SARS to impose understatement penalties when taxpayers have relied on professional advice, including from senior counsel who are not registered tax practitioners.