Judgment summary
The appeal concerned two procedural orders made by the Tax Court, Johannesburg in the course of a transfer pricing dispute relating to the 2011 year of assessment. The first order granted SARS leave to amend its Rule 31 statement of grounds of assessment. The second order refused BASF leave to make two amendments to its Rule 32 statement of grounds of appeal [1].
The High Court first considered whether the Tax Court's orders were appealable. It held that they were, because the orders concerned the competence of the Tax Court to grant the amendments, and questions of competence always have a final effect [21].
On the merits, the High Court held that the amendments SARS sought to introduce constituted a novation of the whole of the factual and legal basis of the original assessment, contrary to Rule 31(3) of the Tax Court Rules. The Tax Court therefore erred in granting SARS leave to amend [58].
The High Court further held that the Tax Court erred in refusing BASF leave to introduce the two amendments to its Rule 32 statement. The amendments related to amounts forming part of the assessment already placed in dispute in full, and were therefore permissible under Rule 32(3) [82].
The appeal was upheld in its entirety with costs on Scale C, including the costs of two counsel [83].
Background
BASF South Africa Pty (Ltd) (BASF) is a manufacturer and distributor of catalysts. It purchases Platinum Group Metals (PGMs) from a connected company, BASF Metals GmbH incorporated in Switzerland (BASF Zug). The PGMs are liquified, mixed with other chemicals and applied as a coating to substrates to form catalysts, which are sold to South African original equipment manufacturers (OEMs) [2].
SARS conducted an audit and found that BASF's purchases of PGMs from BASF Zug were not at arm's length. SARS applied the Transactional Net Margin Method (TNMM) with a full cost mark-up (FCMU) profit level indicator. SARS's comparison of BASF's FCMU against a benchmarking study of comparable independent companies showed that BASF's three-year weighted average FCMU of (0.60%) for the 2009 financial year fell below the minimum of the comparable range, and its FCMU of (1.00%) for the 2011 financial year fell between the minimum and lower quartile of the comparable range [29].
On 11 January 2016, SARS issued an additional assessment adjusting BASF's taxable income for the 2011 year of assessment [31]. BASF objected on 5 May 2016, arguing that the prices paid to BASF Zug were at arm's length and that SARS had not factored the use of high-value input material in BASF's cost base [32]. SARS disallowed the objection on 29 July 2016 and adjusted BASF's taxable income to the median of the arm's length inter-quartile range achieved by the comparable companies [32].
BASF filed a notice of appeal. SARS delivered a Rule 31 statement on 24 July 2018 [33]. During preparation for the appeal, SARS obtained an independent benchmarking study from Dr Fügemann, which produced three new benchmarking studies and also considered the effect of MNE Group Synergies [36].
Core dispute
The appeal turned on two issues [1].
First, whether the Tax Court was correct to grant SARS leave to amend its Rule 31 statement to introduce three new benchmarking studies and a separate MNE Group Synergies adjustment. BASF argued that these amendments constituted a novation of the whole of the factual and legal basis of the original assessment, which is prohibited by Rule 31(3) of the Tax Court Rules [37, 38].
Second, whether the Tax Court was correct to refuse BASF leave to amend its Rule 32 statement to introduce: (a) amounts of R27,342,842.00 and R49,231,289.00 (totalling approximately R77 million) which BASF alleged SARS had failed to include in calculating its EBIT, and which BASF contended would have materially reduced the transfer pricing adjustment to the assessment of R114,157,077.00; and (b) compensation received by BASF for holding PGMs on behalf of OEMs in the form of surcharge levies [59, 60].
A preliminary question arose as to whether the Tax Court's orders were appealable, given SARS's argument that they were purely interlocutory [5, 6].
Court findings
On appealability, the court held that the orders were appealable. The orders concerned the competence of the Tax Court to grant the amendments, and questions of competence are always treated as having a final effect. Furthermore, procedural matters relating to a dispute are appealable decisions of the Tax Court under section 129(2)(d) of the Tax Administration Act [15, 18, 21].
On the SARS amendment, the court held that the MNE Group Synergies adjustment was legally incompetent. Section 31(2) of the Income Tax Act 58 of 1962, as it read in 2011, confined any adjustment to the "consideration" in respect of the affected transaction. The statute did not permit a separate or additional adjustment for synergies or other economic concepts not directly reflected in the price or consideration for the transaction. The introduction of such an adjustment novated the legal basis of the original assessment [48, 52, 53, 58].
The introduction of three new benchmarking studies also novated the factual basis of the assessment. The original assessment was premised on a single benchmarking study. The new studies relied on different data sets and different comparables, constituting a material alteration of the factual foundation. The issue of comparability had already been raised in the notice of objection; SARS had chosen not to address it at that time and could not rely on its later absence from the Rule 32 statement to justify the amendment [54, 55, 56].
The Tax Court had erred by giving weight to Dr Fügemann's expert report without addressing the statutory basis for the adjustments, and had conflated expert opinion on economic theory with the legal question of what section 31(2) permitted [57].
On BASF's proposed amendments, the court held that the only restriction on a taxpayer raising new grounds in a Rule 32 statement is that those grounds must not constitute an objection against a part or amount of the assessment that was not objected to under Rule 7. Novelty of the ground is legally irrelevant [73, 79].
BASF had objected to the entire transfer pricing adjustment of R114,157,077.00. The proposed amendments concerned errors in the calculation of the quantum of that very adjustment. They did not seek to dispute any part or amount that had been acquiesced to. The Tax Court had erred by conflating the grounds of objection with the subject matter of the objection [72, 80].
Regarding the surcharge levies, the court found that the objection had already referred to BASF being compensated by OEMs for the use of its working capital, and there was a clear connection between that statement and the proposed amendment. The Tax Court had erred in treating the amendment as an entirely new case [66, 68].
Outcome
The appeal was upheld in its entirety with costs on Scale C, including the costs of two counsel [83].
The order of the Tax Court was substituted as follows: SARS was refused leave to amend its Rule 31 statement of grounds of assessment in respect of the proposed amendments served on BASF on 2 February 2023. BASF was granted leave to amend its Rule 32 statement as stated in paragraphs 3 and 6 of its notice in terms of Rule 35. SARS was ordered to pay costs on Scale C, including the costs of two counsel [Order, paragraphs 1 and 2].
Tp method highlighted
SARS applied the Transactional Net Margin Method (TNMM) with the full cost mark-up (FCMU) as the profit level indicator to determine whether BASF's purchase of PGMs from BASF Zug was at arm's length [27].
The TNMM analysis involved establishing a benchmarking range of profitability for comparable independent third parties and comparing BASF's actual profitability against that range. SARS adjusted BASF's taxable income for the 2011 year of assessment to the median of the arm's length inter-quartile range achieved by the comparable companies [27, 32].
BASF argued that the Comparable Uncontrolled Transaction (CUP) method was the appropriate method, because PGMs are widely traded commodities with market prices that can be readily ascertained and are not dependent on the negotiating positions of the parties. BASF contended that application of the CUP would have resulted in no adjustment being warranted [40].
Dr Fügemann, engaged by SARS during the appeal, conducted three new benchmarking studies identifying third-party companies that use high-value input materials such as PGMs in their manufacturing process. Dr Fügemann also considered the effect of MNE Group Synergies in determining an arm's length price [36].
Major issues / areas of contention
- Whether the Tax Court's orders granting and refusing amendments to Rule 31 and Rule 32 statements were appealable as decisions of the Tax Court on procedural matters, or were purely interlocutory orders with no final effect.
- Whether SARS's introduction of three new benchmarking studies in its amended Rule 31 statement constituted a novation of the whole factual basis of the original assessment, prohibited by Rule 31(3) of the Tax Court Rules.
- Whether SARS's introduction of an MNE Group Synergies adjustment in its amended Rule 31 statement constituted a novation of the legal basis of the original assessment, given that section 31(2) of the Income Tax Act 58 of 1962, as it read in 2011, confined any adjustment to the 'consideration' in respect of the affected transaction.
- Whether BASF was entitled under Rule 32(3) to introduce, as new grounds of appeal, amounts of approximately R77 million allegedly excluded from the calculation of its EBIT, where BASF had objected to the full transfer pricing adjustment of R114,157,077.00.
- Whether BASF was entitled under Rule 32(3) to introduce a new ground relating to surcharge levy compensation received from OEMs for holding PGMs, where the original objection had referred to compensation by OEMs for use of working capital.
- Whether the Tax Court erred by conflating the grounds of a taxpayer's objection with the subject matter of the objection, and by treating novelty of a ground as fatal to an amendment under Rule 32(3).
- Whether the appropriate transfer pricing method for the purchase of PGMs was the TNMM with FCMU or the CUP method.