Tax cases review from SOUTH AFRICA

Simulated transactionsThe SCA decision in CSARS v NWK Ltd [2011] (73 SATC 55) (the NWK case) almost a year agoput the (judicial) cat amongst the (tax) pigeons.The NWK decision related to a structured finance transaction. What really caught the eye,however, was the SCA's introduction of a so-called "commerciality" requirement. The SCA heldthat in determining the existence of a simulation, one should go further than merely askingwhether the parties intended to give effect to a contract in accordance with its tenor. The SCApointed out that where parties devise a structure to achieve an objective other than the oneostensibly achieved, they usually do intend giving effect to the transaction on the terms agreed.Hence it was held [at 55]: "The test should thus go further, and require an examination of thecommercial sense of the transaction: of its real substance and purpose. If the purpose of thetransaction is only to achieve an object that allows the evasion
of tax, or of a peremptory law,then it will be regarded as simulated."Although the SCA acknowledged that a taxpayer could take advantage of a "tax-effectivestructure", it warned that "... there must be some substance – commercial reason - in thearrangement, not just an intention to achieve a tax benefit or to avoid the application of a law. Acourt should not look only to the outward trappings of a contract; it must consider, whensimulation is in issue, what the parties really sought to achieve." [at 80]The Tax Court (Western Cape) took up the SCA's invitation when it recently decided a series oftax appeals involving employee share incentive schemes (Cases No 12760, 12828 and 12756decided by Allie J on 14 September 2011).In brief, Judge Allie had to consider the tax consequences of so-called deferred delivery shareincentive schemes. In such schemes the employee would almost immediately after the grant ofan option to take up shares, exercise the option,
thereby eliminating any "gain" in the value of theshares for purposes of section 8A of the Income Tax Act, No. 58 of 1962. The assumption wasthat the tax event giving rise to the tax liability took place on the exercise of the option (or theconclusion of the agreement for the purchase of the shares), and not on the subsequent actualdelivery of the shares to the employee. Hence the notion of "deferred delivery".In deciding whether the employee had unconditionally purchased the shares at the time when theoption was exercised, the judge turned to the NWK case "...in which guidelines are set out toestablish the true substance of a transaction". Having considered various passages from theNWK case dealing with simulation, the judge held that there was still some "conditionality" whenthe employee exercised the option and, therefore, there was no "complete sale" at the time ofexercising the option. Accordingly it was held: "Section 8A is triggered when a gain
is made. Inthe case of deferred delivery schemes, the gain can only be quantified once delivery occurs asthat is when acquisition of the shares is complete." And further: "It is clear from the scheme andthe way appellants understood its purpose, that it is the right to take delivery against payment at3a later date at a price less than the market value of the shares at that later date that created thesubstantial financial gain which serves as an incentive to employees."Judge Allie's reference to simulation and the NWK case indicates that he viewed the terms of thedeferred delivery share incentive scheme in question as not reflecting the true substance of theagreement. The true substance of the agreement was that the exercise by the employee of theshare option amounted to a "conditional" purchase of the shares - thus there was no "completesale" as yet. The Judge consequently regarded delivery to indicate that "...acquisition of theshares is complete" that
is when section 8A is triggered.As is evident, the NWK shadow looms large.The NWK case makes it clear that there must be some substance, that is a "commercial reason",for a transaction and not just an intention to achieve a tax benefit or to avoid the application of alaw. The SCA's NWK approach in relation to simulation and its requirement of "commercialreason" shows remarkable overlap with the "business purpose" test found in the USA.Gregory v Helvering [1934] (69F 2d 809); affd [1935] 293 U.S. 465 US SC essentially held thatthe taxpayer's corporate "re-organisation" completely lacked any business purpose. The tax reliefin respect of same was bluntly denied. In CIR v Transport Trading & Terminal Corp. 176 F2nd570 (2nd Cir. 1949) Judge Hand described the "business purpose" requirement as follows: "Thedoctrine of Gregory v Helvering ...has a much wider scope: it means that in constructing wordsof a tax statute which describe commercial or industrial
transactions we are to understand themto refer to transactions entered upon for commercial or industrial purposes and not to includetransactions entered upon for no other motive but to escape taxation."Interestingly, the US Gregory v Helvering and the UK IRC v Duke of Westminster [1936] AC 1,[1935] All ER Rep 259, HL, cases were decided almost simultaneously on different sides of theAtlantic.Lord Tomlin's statement from Duke of Westminster is oft-quoted:"Every man is entitled if he canto order his affairs so that the tax attaching under the appropriate Acts is less than it otherwisewould be."Whereas almost 80 years ago Gregory v Helvering dashed taxpayer hopes in the USA, the Dukeof Westminster in the UK (and locally) became the cornerstone for many tax planning strategies.The NWK case and the apparent enthusiasm with which it is being applied locally could beindicative that the newly introduced "commercial reason" requirement might be taking SAtowards
some convergence with the "business purpose" test as applied in the USA.To be on the safe side requires that there should always be a demonstrable non-fiscal financial,business or economic driver for any transaction.Cliffe Dekker Hofmeyr