The facts of the case:
In 1998, NWK borrowed R96 million from a subsidiary of FNB.
But NWK claimed it was only R50 million, and from FNB itself, not a subsidiary. The deal was that NWK would repay the loan after a period of five years, via the delivery of a specified quantity of maize.
But, as with any loan, interest was piling up on the R96 million. So, NWK deducted the interest from its income tax on the basis that this was expenditure in the production of income.
NWK then entered into a number of other agreements that cancelled out the need for it to deliver the maize.
SARS saw what was going on and took NWK to the Johannesburg Tax Court. But the Court found in favour of NWK, when it defended its position. The Tax Court found that it was NWK's intention to repay the loan via delivery of maize, so it let the deal slide.
Read on to find out what the SARS Commissioner had to say...
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The SARS Commissioner wasn't happy with the decision
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The SARS Commissioner wasn't happy with this decision; he believed the transaction was a sham and he wanted to apply anti-avoidance provisions to the transactions. SARS took the case to the Supreme Court of Appeal (SCA).
The SCA upheld the Commissioner's appeal against the Tax Court's decision. It agreed with the Commissioner that the transaction was a sham and NWK never intended to deliver the maize as repayment of the loan.
This was bad news for NWK – the financial blow would be in the millions! The Court reduced the penalties for NWK, but stressed that it's not enough to test for simulation by asking the parties if they intended to obey the contract. It argued that the test should go further, to examine the commercial sense of the transaction.
If the purpose of the transaction is simply to create the opportunity for one party to evade tax, then the transaction is a sham.
What can you learn from this case?
It's simple really. Don't try to pull a fast one on SARS. It will
catch you out.
And now for the good news
structure your affairs in a tax efficient way and claim the legitimate tax breaks available to your businesses. But you have to qualify for them. And as long as you can justify your claims to SARS, it usually won't find fault with your tax affairs.
When it comes to business deals and contracts, it's vital the contracts and agreements reflect your true intentions. If they don't, you can be sure SARS can and will successfully challenge the arrangement.
My last bit of advice for you
In this particular case, the Court said that even if you really do carry out the terms of the various contracts, if you look like you're doing what the contract said you'd do – but there's no real and sensible commercial purpose in the transaction besides scoring you a tax benefit, then the contract is probably a sham. SARS will see it as a way for you to avoid the business arrangement and you'll end up paying for it.
So, before you enter into any agreement, make sure it makes commercial sense and that SARS would approve of it.
You can write to SARS, ask it for a non-binding ruling. If you do this, you'll get an opinion out of SARS. It saves you having to learn the hard way! You'll send the agreement to SARS and ask it to issue a private non-binding ruling on it so the parties to the agreement will know how SARS will treat it for tax purposes.
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