This article examines the tax implications of transactions between branches, the consequences of individuals claiming the value of their labour as a deduction, and the implications of debtors acquiring their own debt. References to ‘para’ are to paragraphs of the Eighth Schedule to the Income Tax Act 58 of 1962 (Act) and references to ‘s’ are to sections of that Act unless the context otherwise indicates.
Dealings between branches
In ITC 1031 the appellant carried on the business of a general shipper in London and as a draper and outfitter in South Africa. The businesses in South Africa were operated under various trading names but were the sole property of the appellant. The London office shipped goods to the branches in South Africa and invoiced the branches with the cost of the goods plus a 5% commission and debited this amount against the branch. In addition, the branch was debited with interest on the amount outstanding. The effect of these accounting entries was to decrease the South African branch profits and increase the profits of the London office. The Commissioner included in the South African branch’s income the commission and interest as amounts derived from a South African source. On appeal, the court held that as the London and South African branches were carried on as activities of a single entity, the buying commission and interest were not admissible deductions attributable to the South African branches. It stated that under the well-established principles of income tax law
‘a man cannot lend to himself, or trade with himself, or make profit out of himself’.
The court referred the matter back to the Commissioner to determine how much of the expenses actually incurred in London were allocable to the South African branches.
The case is a reminder of the principle established in
Joffe & Co (Pty) Ltd v CIR, namely, that2
‘the Court is not concerned with deductions which may be considered proper from an accountant’s point of view or from the point of view of a prudent trader, but merely with the deductions which are permissible according to the language of the statute’.
In
Afrikaanse Verbond Begrafnis Onderneming Beperk v CIR3 the appellant company had carried on two businesses, a funeral insurance business and a funeral undertaker’s business. The appellant’s insurance business was assessable under the First Schedule read with s 18 of the Income Tax Act 31 of 1941, while its undertaker’s business was assessable under the general provisions of that Act. For the 1945 and 1946 years of assessment, the appellant had claimed a deduction for interest of £9 306 and £11 559 respectively in its undertaker’s business while its insurance business reflected corresponding credits. The appellant contended that the charging of interest on the capital invested in the undertaker’s business by the insurance business was necessary to maintain actuarial solvency of the insurance business. The Commissioner disallowed the claim on the basis that the company could not incur a liability for interest to itself. The court held that the profits of the company had to be assessed as the profits of a single taxpayer even though the profits from the two businesses had to be computed separately under different provisions of the Act. The profits derived from the non-insurance business could not be diminished by the deduction of theoretical payments between one side of the business and the other.
An interesting application of the above principles arises in the present-day insurance industry. The Insurance Act 18 of 2017 has formalised the use of cell structures within a licensed insurer.4 A cell structure enables persons who wish to carry on a particular type of insurance business to create a cell within a licensed insurance company without the considerable expense of applying for a separate license. The licensed insurer is responsible for ensuring that the cell complies with all regulatory and administrative requirements.
The cell owners hold a specific class or classes of shares in the cell enabling them to participate only in the profits derived by the cell. They can also be called on to recapitalise the cell should it make losses. The licensed insurer is, however, ultimately responsible for the cell debts on winding up of the company.
The cell is not a separate legal entity but the equivalent of a branch of a company. For income tax purposes, the licensed insurer submits a tax return including the results of the cell but for accounting purposes a separate tax computation must be completed for the cell so that its share of the tax liability can be debited against its profits. If a cell were to sell its business to the core (the activities carried on by the licensed insurer outside the cell), this will not have any actual tax implications as it would be a case of the insurer trading with itself. To give effect to such a disposal, the proceeds from the sale would be deposited into the cell’s bank account by transferring the amount from the core bank account. The amount so transferred would be reduced by the notional tax liability that the cell would have incurred in the form of income tax on recoupments and CGT on the capital realised had it disposed of the business to a third party. The net proceeds would be credited to the cell’s distributable reserves. The core would need to respond by debiting its reserves and crediting its bank account. These journal entries are necessary to maintain the rights and entitlements of the various classes of shareholders.
If the cell were to dispose of its business to a third party, the proceeds would be deposited into its bank account and its distributable reserves credited. The cell would be debited with its share of any actual tax liability arising when the insurer submits its consolidated tax return, and the cell bank account would be reduced accordingly.
Any administration fees charged to the cell by the licensed insurer will reduce the cell reserves and increase the core reserves but from a tax perspective they will cancel out and have no impact on the insurer’s overall tax liability.
In a Rhodesian case (now Zimbabwe),
Anglo American Corporation of SA Ltd v COT5 the appellant company had its head office in Johannesburg and a branch office in Salisbury (now Harare). The company had shares in various companies in South Africa and Rhodesia. In December 1971 the Johannesburg office had collected dividends of R1 137 581 on behalf of the appellant’s companies in Rhodesia. The exchange rate between the Rhodesian dollar and the rand was at par at the time. The Salisbury office paid the Rhodesian companies R$1 137 581, and the Johannesburg office credited the Salisbury office with R1 137 581. The total amount standing to the credit of the Salisbury office in Johannesburg was R1 467 683. On 21 December 1971 the rand was devalued with the result that the amount standing to the credit of the Salisbury office was now worth R$1 287 441, a difference of R$ 180 242. In submitting its tax return in Rhodesia, the company claimed the R$ 180 242 as a loss in the production of its Rhodesian income. The appeal was dismissed on the basis that the Salisbury office and the Johannesburg office were in law one persona and, in law, one individual taxpayer. How the two offices adjusted their accounts in relation to each other was simply a matter of internal bookkeeping, and the reality of a transaction must always be looked to. That reality, it is submitted, was that the company had received dividends in rand and deposited them into its South African bank account. It then paid those dividends out of its Rhodesian bank account in an equivalent amount in Rhodesian dollars. Any attempt to create a liability between the branches was simply a bookkeeping fiction.
Under the then tax treaty between South Africa and Rhodesia, a single enterprise which carries on business in both countries was in effect regarded as a separate
persona in each country when taxing the profits which have their source in either country. In that regard, the court noted that the company’s internal bookkeeping did not affect whether a particular receipt was taxable or a loss deductible.
Individuals claiming the cost of their labour
In ITC 1106 a builder sought to claim a deduction for a salary he paid himself. The court stated:
‘But appellant had raised another interesting point, viz.: that he was entitled, as he himself worked on the building, to give himself a salary and charge it against the cost of the building. For that proposition he had advanced no authority, and, speaking for himself the President was not prepared to accept it as a legitimate charge. It would mean that every farmer who worked and took a turn at ploughing and sowing mealies would be able to charge against his business his personal wages, and the Court did not consider that the Act ever contemplated expenditure of that nature, if indeed it could be called legitimate expenditure.’
In ITC 7807 the appellant had constructed plant and machinery and sought to claim a wear-and-tear allowance under the equivalent of s 11(e) on the value of his skill and labour. The court dismissed the appeal on the grounds that the taxpayer had failed to discharge the onus of proving the value of his labour and the fact that the deduction was at the Commissioner’s discretion.
In the United Kingdom case of
Oram (Inspector of Taxes) v Johnson, under a provision equivalent to para 20(1)(e), the appellant had sought to add to the base cost of a dwelling house the value of his skill and labour in improving it. In dismissing the appeal, Walton J stated the following:8
‘It is perhaps a matter of first impression based on the impression that the word “expenditure” makes on one, but I think that the whole group of words, “expenditure”, “expended”, “expenses” and so on and so forth, in a revenue context, mean primarily money expenditure and, secondly, expenditure in money’s worth, something which diminishes the total assets of the person making the expenditure, and I do not think that one can bring one’s own work, however skilful it may be and however much sweat one may expend on it, within the scope of para 4(1)(b).’
A similar view on the meaning of ‘expenditure’ was expressed in
C: SARS v Labat Africa Ltd in which Harms AP stated that expenditure9
‘requires a diminution (even if only temporary) or at the very least movement of assets of the person who expends’.
There is one situation, however, in which debtors who built or improved an asset through their own labour may be able to receive base cost for their efforts. This situation arises when the asset was erected or improved before 1 October 2001 (valuation date) and the market value method is adopted to determine the valuation date value of the asset.
Debtors acquiring their own debt
When debtors acquire their own debt, the amount owing is extinguished through a process known as merger or
confusio. The leading case on this topic is
Grootchwaing Salt Works Ltd v Van Tonder in which Innes CJ stated the following:
‘Now
confusio in the sense with which we are here concerned is the concurrence of two qualities or capacities in the same person, which mutually destroy one another. In regard to contractual obligations it is the concurrence of the debtor and creditor in the same person and in respect of the same obligation. (Pothier Verbintenissen, par 641; Opzomer, Vol. 7, para. 1472; Van der Linden (1.18, para. 5). The typical example of
confusio and the one mainly dealt with in the books is the case of a creditor becoming heir to his debtor or vice versa. But the same position is established whenever the creditor steps into the shoes of his debtor by any title which renders him subject to his debt (Pothier Verb, para. 642) and it is common cause that
confusio takes place as between lessor and lessee when the latter acquires the leased property. As to the consequences of
confusio there can be no doubt that speaking generally it destroys the obligations in respect of which it operates. Pothier (para. 643) is clear upon the point. A person, he says, can neither be his own creditor nor his own debtor. And if there is no other debtor then the debt is extinguished.
Non potest esse obligatio sine persona obligata. (See also Voet, 46.3.19; Cens. For, Pt. 1.4.38, para. 1; Van der Linden, 1.18, sec. 5, etc.), but the obligation is only destroyed to the extent to which the concurrence of the opposing capacities renders it impossible to exist.’
Merger can occur by cession. For example, a trust could distribute a debt to its beneficiary who owed that debt to the trust, or a subsidiary could distribute a debt to its holding company which owed the debt to the subsidiary. A company that issued a listed debenture could acquire its own debt on the open market. In all instances, the debtor will acquire the debt for an instant before it is extinguished through merger.
A debt acquired by cession must be distinguished from the waiver of a debt. This distinction is important because the different methods for extinguishing a debt can have profoundly different tax consequences. For example, assume a beneficiary owes a trust R100, which the beneficiary used to buy a capital asset which is still held and that the debt is fully recoverable. If the trust waives the debt, para 38 of the Eighth Schedule does not apply because no asset is disposed of to the debtor. The debtor’s liability is simply extinguished without the receipt of an asset. The trust will claim a capital loss under para 56(2) which will not be clogged under para 39, while the debtor must reduce the base cost of the asset under para 12A(3). By contrast, if the trust cedes the debt to the debtor, para 38 will apply since an asset is being disposed of to the debtor who acquires it for an instant before it is extinguished through merger. The debtor and the trust are connected persons,11 and the debt is being disposed of through donation. There will be no debt benefit under para 12A because the debt will have been extinguished because of the debtor having incurred expenditure of R100 under para 38. The trust will make neither a capital gain nor a capital loss on the disposal since it will have proceeds under para 38 of R100.12
A company that acquires its own shares does so for an instant before they are extinguished through merger. It is for this reason that para 11(2)(b) disregards the disposal of the share by the acquiring company to prevent a capital loss.
Conclusion
Generally,
- transactions between branches do not give rise to tax consequences;
- individuals do not incur expenditure for their own labour; and
- debtors acquiring their own debt by cession will acquire it for an instant before it is extinguished through merger. This extinction can result in a recoupment under s 19 or a base cost reduction or capital gain under para 12A for the debtor when the market value of the debt is less than its face value.
This article was first published by ASA in its
March 2025 issue.
