A company in financial distress may have a variety of outstanding tax debts at the commencement of business rescue. Besides capital amounts of tax due, there could also be tax returns for VAT, PAYE and income tax which are due and have not been submitted resulting in tax liabilities which are due and payable, but do not yet appear on the relevant statements of account. The late submission of returns will also result in 10% late payment penalties for VAT, PAYE and provisional taxes, and potentially 20% underestimation penalties for income tax, plus interest. There could also be administrative penalties imposed for non-submission of income tax returns.
This article considers where these tax debts should rank in business rescue proceedings and also practical issues which arise on the section 22(3) VAT liabilities which are triggered.
All references to "section" in this article are to sections of the Companies Act 71 of 2008 (Companies Act) unless otherwise provided.
Where do tax debts rank?
In CSARS v Beginsel NO and Others (2013), the High Court held that no statutory preferences are created in Chapter 6 of the Companies Act dealing with business rescues, such as those in sections 96 to 102 of the Insolvency Act 24 of 1936 which granted SARS a preferent creditor status. Accordingly, SARS is not a preferent creditor but a concurrent creditor in terms of section 145(4)(b) of the Companies Act with voting interests equal to the value that the creditor can expect to receive if the debtor was liquidated.
The Beginsel case dealt with outstanding VAT, PAYE, SDL, UIF, penalties and interest which existed prior to commencement of business rescue. What about tax debts which arise after commencement of business rescue? Are tax debts which arise after commencement of business rescue "post commencement finance" or "costs of business rescue" and should they be given priority in ranking to other unsecured concurrent creditors?
In South African Property Owners Association v Minister of Trade and Industry and others (2018 (2) SA 523 (GP)), the court was requested by way of a declaratory order to interpret "post-commencement financing" and "costs arising out of the costs of the business rescue proceedings" in sections 135(2) and 135(3). The applicant, SAPOA, acts as an umbrella body of homeowners' associations and represents approximately 1,300 companies and organisations.
The applicant applied for a declaratory order that the rent for immovable property occupied, rates, taxes, electricity, water, sanitation and sewerage charges payable by a company in business rescue after commencement of business rescue constitutes post-commencement financing or alternatively, costs of business rescue proceedings.
The court held that the financing intended in section 135(2) (ie post-commencement financing) relates to the obtaining of actual financing in order to assist in managing the company out of its financial distress, hence the provision that any asset of the company may be used to secure that financing to the extent that the asset is not otherwise encumbered.
The costs referred to in the application are costs incidental to the leased property, and are subject to the terms of the particular lease agreement. These costs arise out of the terms of the lease agreement. These costs do not constitute, by any interpretation, costs arising out of the business rescue proceedings. Furthermore, the liability of such costs arises out of the relevant lease agreement, despite being continually incurred, even after commencement of the business proceedings. To hold that such costs constitute post-commencement financing would elevate an obligation prior to commencement of business rescue proceedings to a preference over other creditors not provided or contemplated by section 135.
Income tax liabilities arise from taxable income derived from trading activities of the company. Similarly, VAT liabilities arise from the supply of goods or services by the company under business rescue and PAYE liabilities arise from remuneration paid to employees. Based on the Beginsel and SAPOA cases, it would be difficult to argue that these tax liabilities are post-commencement finance or costs of business rescue proceedings. These tax liabilities are thus unsecured concurrent claims.
This would be the position even if these tax debts arise on a continuous basis after commencement of business rescue. Costs of business rescue proceedings in section 135(3) contemplate costs similar to the remuneration of practitioners, not tax debts arising from the trade carried on by the debtor after commencement of business rescue. Examples of fees for other professional advisers include fees for legal advisers, accountants, auditors and valuers assisting in the business rescue process. This view is supported by the ranking of claims set out in two unreported cases in the Johannesburg High Court.
Kgomo J held in Merchant West Capital Solutions (Pty) Ltd v Advance Technologies & Engineering Company (Pty) Ltd & Another 2013 JDR 1019 (GSJ) and Redpath Mining South Africa (Pty) Ltd v Marsden N.O. & Others 2013 JDR 1410 (GSJ) that the effect of section 135 was to provide a ranking of claims as follows:
- the practitioner, for remuneration and expenses, and other persons (including legal and other professionals) for costs of business rescue proceedings (section 135(3));
- employees for any remuneration which became due and payable after business rescue proceedings began (section 135(1) and 135(3)(a));
- secured lenders or other creditors for any loan or supply made after business rescue proceedings began, ie post-commencement finance (section 135(3)(a)(i) and section 135(3)(b));
- unsecured lenders or other creditors for any loan or supply made after business rescue proceedings began, ie post-commencement finance (section 135(3)(a)(ii));
- secured lenders or other creditors for any loan or supply made before business rescue proceedings began;
- employees for any remuneration which became due and payable before business rescue proceedings began;
- unsecured lenders or other creditors for any loan or supply made before business rescue proceedings began (ie the concurrent creditors) (section 135(3) generally).
The ranking above gives rise to the issue of secured creditors for pre-commencement debt (number 5) ranking lower than unsecured creditors for post-commencement debt (number 4). However, the above ranking has not been overturned by a decision of a higher court and remains sound authority. Notably, this ranking issue does not affect the discussion in this article of where tax debts should rank, given that tax debts are usually unsecured.
There is also the use of "post-commencement finance" in these two judgements in 2013, which are later clarified in the SAPOA judgement in 2018. Read in context, the phrase "post-commencement finance" in these 2013 judgements should be taken to mean debts which arise after commencement and should include tax debts owed to SARS, ie not only the narrow meaning of actual financing provided to manage the debtor out of financial distress as determined in the later 2018 SAPOA judgement.
Income tax liabilities only arise on issue of assessments
Income tax liabilities are assessed annually after submission of ITR 14 tax returns when SARS issues the ITA 34 assessments. Income tax liabilities thus only arise when the assessments are issued.
Income tax liabilities which are due and payable, and which appear on the relevant statements of account at commencement, would rank as unsecured creditors before business rescue proceedings began (number 7).
If income tax returns are late and not submitted at the commencement of business rescue, income tax due for the periods before commencement would not have arisen and cannot be dealt with in the business rescue plan until the returns are submitted and those years assessed.
Income tax liabilities (including late payment and underestimation penalties and interest) in assessments issued after commencement which relate to years pre commencement would be unsecured claims which arise after commencement of business rescue (number 4). This is on the basis that income tax liabilities only arise when assessments are issued.
Income tax liabilities in assessments relating to post commencement business would similarly be unsecured claims ranking at number 4. These tax debts arise as a result of taxable income earned by the debtor during the business rescue process. SARS was not a lender that provided actual financing, and the tax debts were not costs of remuneration or fees of advisers to facilitate the business rescue of the debtor.
Similar to income tax liabilities, administrative penalties for non-submission of income tax returns only arise on the issue of the related penalty assessments. If the penalty assessments were issued by SARS after commencement relating to years before or after commencement, the amounts owed would be unsecured claims which rank at number 4. If they were issued before commencement, they would rank at number 7.
VAT liabilities are triggered by supply and PAYE liabilities by payment of remuneration
VAT and PAYE returns are self-assessments submitted by the taxpayers. VAT and PAYE liabilities arise on a continual periodic basis as and when they occur in the relevant months. VAT and PAYE due in the months before commencement would already have arisen in those months regardless whether returns were submitted by the taxpayers. The submission of the returns forming the self-assessment does not trigger the tax due. For VAT, the taxable supplies, and for PAYE, the payment of remuneration in the relevant months, are the appropriate triggers for these tax liabilities. The debtor's submissions of the returns or self-assessments merely facilitate the payments of these taxes to SARS.
These VAT and PAYE liabilities relating to years before commencement would not be post-commencement finance and costs of business rescue proceedings for the same reasons discussed above for income tax liabilities. Where returns are late, the business rescue practitioner would need to estimate these tax liabilities or submit the outstanding returns to have these tax liabilities reflected in the relevant statements of accounts. These tax liabilities, including late payment penalties and interest, would then need to be listed as part of the list of creditors in the business rescue plan and be dealt with as pre-commencement unsecured claims ranking at number 7.
Similarly, VAT and PAYE liabilities arising after commencement and which relate to post-commencement business would be unsecured claims after commencement ranking at number 4.
Deemed output VAT in business rescues (section 22(3) of the VAT Act)
Expiry of 12 months
Section 22(3) of the Value-Added Tax Act (VAT Act) applies when a vendor had claimed an input VAT deduction on an invoice and had then not paid the full consideration on this invoice (which was due and payable) within 12 months after the tax period in which the deduction was made. (The contract does not provide for a payment period longer than 12 months.) There would then be a deemed output VAT on the tax fraction of the remaining outstanding amount to be accounted for by the vendor in the next tax period after the 12 months (usually in the 13th month if monthly returns are submitted).
For example, if the supply and invoice in January 2020 had been for R115, the vendor would have claimed the input VAT of R15 in the January 2020 tax period, with the January VAT 201 submitted by the end of February 2020. If the vendor had not paid the invoice of R115 by January 2021 (ie within 12 months after expiry of January 2020), there would be a deemed supply of the R115 and a deemed output VAT of R15 in the February 2021 tax period, to be declared and paid in the VAT 201 due by the end of March 2021.
If the 12 months after the end of the tax period in which the input VAT was claimed expire before commencement of business rescue, then any deemed output VAT liability which is not paid or declared would be an unsecured claim ranking at number 7.
If the 12 months expire after the commencement of business rescue, then the deemed output VAT amounts on the outstanding invoices are unsecured claims ranking at number 4.
Practical issues with penalties and interest
In practice, the business rescue plan will usually also deal with the anticipated section 22(3) deemed output VAT in the list of creditors. SARS will receive the same cents to the Rand as all other concurrent creditors.
The deemed output VAT triggered however, should also be reduced by the distribution to other concurrent creditors which outstanding amounts after 12 months have triggered the liability. If an outstanding invoice is R115 VAT inclusive and the creditor would receive a distribution of R1 for every R100 in the business rescue plan, the creditor would then receive R11.50 from the invoice outstanding of R115. R1.50 would be the VAT on the R11.50 distributed. Therefore, the deemed output VAT triggered should only be R15 less R1.50 = R13.50. SARS should then be entitled to the distribution as a concurrent creditor on R13.50, not on the full R15 initially claimed as input VAT.
The practical issue of penalties and interest on VAT statement of accounts when the deemed output VAT is triggered after expiry of the 12 months remains. There is no clarity on how to deal with the ongoing penalties and interest once the deemed output VAT is declared.
SARS would have ongoing post-commencement concurrent claims for the penalties and interest at number 4 which rank higher than pre-commencement unsecured trade creditors. This is an unfair outcome which results in SARS receiving a preference in ranking for tax debts relative to the other unsecured pre-commencement trade creditors whose debts continue to be unpaid with no penalties and interest. The debtor under business rescue would have ongoing tax debts which are not anticipated during the business rescue process. This would defeat the purpose of maximising the likelihood of the company continuing in existence on a solvent basis.