In the Supreme Court of Appeal (SCA) matter, Commissioner SARS v Megs Investments (Pty) Ltd & Another 2005(4) SA 328 SCA, the rules relating to the retention of assessed losses were fleshed out to serve as a guideline for other businesses. The taxpayer in the case arranged discounts for bulk purchases made on behalf of clients. Income consisted of the difference in the discount passed on and the purchase consideration prior to the discount.
The taxpayer traded successfully for a number of years before selling the business as a going concern to a big retail group.
Part of the sale agreement was that the taxpayer would continue to collect payments from its clients and pay suppliers during a transition phase. The taxpayer did not receive the income owed it during this transition phase. Instead, it invested the purchase consideration it had received in order to establish similar businesses in neighbouring countries.
In other words, during the years of assessment in which the dispute regarding the assessed loss use arose, the taxpayer received no trade income, but expended energy and money trying to establish contracts with potential clients elsewhere in Africa.
The taxpayer had successfully appealed to the Tax Court. In turn, SARS had appealed this decision at the High Court in Bloemfontein – unsuccessfully. SARS then took the case to the SCA, which held as follows:
- Taxpayers must show a connection between their interest income and their trade.
- The taxpayer in question could not be treated as an investment company for two reasons: firstly, although it had derived investment income in previous years, this did not of itself show that it had carried on the business of an investment company, and secondly, the investments had been made with the aim of expediting expansion of the business rather than maximising returns.
- Investment from income is not normally income derived from the carrying on of a trade within the meaning of the act.
In short, the taxpayer had not proved that trade had been carried on in the year in question, an essential requirement for the offset of assessed losses against taxable income in a subsequent year of assessment. As a result, the appeal was decided in favour of SARS.
Other taxpayers can learn from this. I believe that when a business is sold – as in this instance – the income that is still gathered from clients of the business by the sellers should be retained by them as taxable income and an adjustment made to the purchase consideration. Doing so might have made a difference to the outcome of the case in question.
This would be better than simply selling the business for a capital amount, as a continuous thread of trade is maintained and all assessed losses can be used until the company begins to trade in another field or in another area.
Peter O’Halloran is head of tax at BDO, Gaborone. Contact him on 00267 390 2779.