The South African Supreme Court of Appeal (SCA) handed down judgment on 15 October in a long-running dispute over whether a capital contribution made by an employer taxpayer to a trust established for purposes of an employee share incentive scheme was deductible for income tax purposes.
In CSARS v Spur Group (Pty) Ltd (Case no 320/20)  ZASCA 145, the Spur Group (Pty) Ltd, a wholly owned subsidiary of the Spur Corporation, and the South African Revenue Service (SARS) had been involved in a legal dispute since the group’s 2015 financial year regarding the tax deductibility of a ZAR48 million (USD3 million) payment related to the Spur Group Management Incentive Share Scheme 2004.
The sum was paid to a share trust that facilitated the funding of another company, owned by employees, to acquire shares in Spur Corporation as part of the Share Scheme. This contribution was claimed by Spur Group as a tax deduction in accordance with the general deduction formula of the Income Tax Act 58 of 1962 (ITA).
Expenditure is generally deductible by a taxpayer where it is incurred in the production of the income of that taxpayer. The cost of incentivising employees is generally considered to be a cost incurred in the production of the employing company’s income. On this basis, it was submitted, by Spur Group, that the contribution was incurred in the production of Spur Group’s income and was therefore legitimately deductible. The contribution was not paid, either directly or indirectly, to Spur Group’s employees.
During the 2015 financial year, SARS issued additional income tax assessments to Spur Group in respect of the 2005 to 2012 years of assessment totalling ZAR22.034 million (comprising ZAR13.996 million in additional income tax and ZAR8.038 million in interest). The additional assessments were issued following the disallowance of a deduction claimed in respect of the group’s Share Scheme. The additional income tax assessments were paid in full during the 2015 and 2016 financial years.
Following failed dispute resolution proceedings, Spur Group appealed the additional assessments, and the matter was first heard in the Income Tax Court (ITC) in February 2018. The ITC found in favour of Spur Group. SARS appealed the ruling. The appeal was heard by a full bench of the Western Cape High Court on 29 July 2019 with the majority judgment issued on 26 November 2019 in favour of Spur Group, dismissing SARS’ appeal with costs awarded to Spur Group.
SARS subsequently appealed the matter to the SCA, with the appeal heard on 17 August 2021. The legal question before the SCA was whether there was a sufficiently close connection between Spur Group’s expenditure of the contribution to the trust and Spur Group’s income-producing activities, for the expenditure to be claimed as a deduction.
The SCA found that the contribution by Spur Group to the trust was used only to finance the purchase of Spur Corporation’s shares in a separate company owned by employees. The funding provided by the trust was repaid to the trust on conclusion of the Share Scheme, with Spur Corporation being the only capital beneficiary of the trust.
The SCA therefore held that the contribution itself did not benefit the employees, despite it being used to facilitate the benefits that accrued to the participants of the Share Scheme. On this basis, it concluded that there was an insufficient link between the expenditure incurred by Spur Group and the benefits arising from the incentivisation of Spur Group’s key staff.
The SCA also addressed the issue of prescription because, at the time of SARS issuing the additional income tax assessments relating to this matter, the original income tax assessments for the 2005 to 2009 years of assessment had prescribed. As a result of an administrative error made by the management of the group at the time, the SCA ruled that, in terms of the Tax Administration Act 28 of 2011, prescription does not apply, and the assessments from 2005 to 2009 remain valid.
“[A]s a matter of policy, a court would be loath to come to the assistance of a taxpayer that has made improper or untruthful disclosures in a return,” it said. “Clearly, this would offend against the statutory imperative of having to make a full and proper disclosure in a tax return.”
The Spur Group is considering its rights in consultation with legal counsel and will determine the appropriate course of action, which it believes, at best, could only include making application to challenge the SCA ruling at the Constitutional Court. The disputed income tax assessments were settled in cash in earlier financial years but it will be required to settle SARS’ legal costs, which are not yet determined.
Although SARS previously issued several rulings that confirmed the principle that a capital contribution pursuant to a share incentive scheme may be tax deductible in the hands of the employer companies, it was announced in the 2013 National Budget Speech that government was reviewing the deductibility of expenditure in relation to share incentive schemes.
In this case, the SCA focused on specific distinguished features, notably that the contribution remained within the Spur Group and that the participant employees only benefited from it indirectly, if at all. Taxpayers would be well advised to review their current arrangements in light of this ruling and any employers embarking on share incentive schemes should take account of this judgment.