Judgment summary
This is a statutory appeal under section 107 of the Tax Administration Act 28 of 2011, read with Rule 10 of the Tax Court Rules, by Taxpayer Boerdery against additional assessments raised by SARS for the 2018 and 2019 years of assessment (paras 1-2).
The dispute arose from two 'Multi-Peril Contingency Policy Contract' agreements between Taxpayer and Company XYZ Insurance Company Limited, for 2018 and 2019 respectively. Annual premiums were credited to a 'Special Experience Account', and Taxpayer submitted no claims during either period (para 2).
The 2018 premium was R35 000 037 (VAT inclusive), with a total annual aggregate limit of indemnity of R41.5 million. The 2019 premium was R35 391 732 (VAT inclusive), with a limit of indemnity of R49.5 million, though only R1 987 943 was actually paid, the balance being a 'roll-over premium' (para 4).
SARS disallowed the 2018 premium deduction of R30 434 815, allowing only a Company XYZ fee of R243 739. In 2019, SARS disallowed R1 987 943 of the R2 332 976 claimed, allowing the balance (para 5). SARS also imposed a 10% understatement penalty of R2 211 119.10 and interest under section 89quat(2) of the Income Tax Act of R1 950 355.74 (para 6).
The court held that the sole substantive issue was whether the Company XYZ deposits were deductible under section 11(a) of the Income Tax Act 58 of 1962 (para 7).
After interpreting the contracts holistically, the court found that the 'premium' operated as a deposit into an experience account which was refundable on demand or on termination, and which earned a determinable return described as 'notional interest' (paras 9-32). The court rejected the evidence of Taxpayer's witness, Mr One, as artificial and unconvincing on several points, including the characterisation of the 'investment management fee' and 'notional interest' (paras 18-24).
The court held that the amounts paid did constitute 'expenditure' under section 11(a), since there was a movement of assets from Taxpayer to Company XYZ in exchange for contractual rights (paras 37-39). However, the court held that this expenditure was of a capital nature, because the right to the experience account constituted an income-producing concern, being a capital asset, rather than a cost incidental to income-producing operations (paras 40-45).
The court found that Taxpayer had failed to discharge the onus of proving the payments were not of a capital nature, and the appeal against the additional assessments was dismissed (para 46).
On the understatement penalty, the court found SARS had discharged its onus under section 102(2) of the TAA to show substantial understatement, and confirmed the 10% penalty under section 223(1) of the TAA (paras 47-51). The court also confirmed the interest levied under section 89quat(2) of the Income Tax Act, finding the underpayment resulted from Taxpayer's aggressive tax position rather than circumstances beyond its control (paras 52-54).
Background
Taxpayer Boerdery conducted a farming trade, deriving income from the sale of fruit and vegetables (para 1). It entered into two annual insurance-styled contracts with Company XYZ Insurance Company Limited for 2018 and 2019, described as 'Multi-Peril Contingency Policy Contracts', which required payment of annual premiums for cover against defined events (para 2).
The premiums were credited to a 'Special Experience Account' maintained by Company XYZ, with debits for an 'insurer's margin' of 2.25%, an investment management fee of 65 basis points, reinsurance premiums, and claims paid (paras 12-13). No claims were made under either contract (para 2).
On termination or renewal, Company XYZ was contractually obliged to refund any positive balance in the experience account to Taxpayer, described as a 'Premium Refund and/or Performance Bonus' (para 14). The balances were in fact repaid: R30 million on 1 January 2019 and R32 million on 1 January 2020 (para 24).
Core dispute
The central issue was whether the amounts paid by Taxpayer to Company XYZ, described in the contracts as 'annual premiums', were deductible under section 11(a) of the Income Tax Act 58 of 1962, as expenditure actually incurred in the production of income and not of a capital nature (paras 3, 7, 33).
SARS's position was that the annual premium was not expenditure but simply another form of asset in Taxpayer's hands (para 5). Taxpayer contended the premiums constituted deductible insurance expenses (para 3).
Secondary issues concerned the correctness of the 10% understatement penalty imposed under sections 222 and 223 of the TAA, and the interest levied under section 89quat(2) of the Income Tax Act for underpayment of provisional tax (paras 6, 47, 52).
Court findings
The court held that the Company XYZ contracts had to be interpreted holistically, considering text, context and purpose together, applying the approach in University of Johannesburg v Auckland Park Theological Seminary and Another (paras 9, 15).
On that interpretation, the 'annual premium' was, in substance, a deposit credited to an experience account, refundable to Taxpayer on cancellation or at contract expiry, and generating a determinable return labelled 'notional interest' (paras 15-16, 20). The court rejected the evidence of Taxpayer's witness Mr One as artificial in several respects, including his explanations for the 'investment management fee', the 'notional interest' label, and the difference between the contract signing date and effective date (paras 18-32).
Applying the general deduction formula under section 11(a), as described in Armgold/Harmony Freegold Joint Venture v C:SARS, the court found that the payment did constitute 'expenditure' as understood in C:SARS v Labat Africa Ltd, since there was a movement of Taxpayer's assets in exchange for contractual rights (paras 35-39).
However, applying the capital/revenue distinction described in BP Southern Africa (Pty) Ltd v C:SARS and CIR v African Oxygen Ltd, the court found that the right to the experience account was an income-producing concern and therefore a capital asset, meaning the annual premium paid to acquire it was of a capital nature and thus excluded from deduction under section 11(a) (paras 40-45).
The court found that Taxpayer bore the onus under section 102(1) of the TAA and had failed to discharge it (paras 33, 46).
On penalties, the court found SARS had discharged its onus under section 102(2) of the TAA to prove the facts underlying the understatement penalty, namely that claiming a non-deductible amount resulted in substantial understatement, and confirmed the 10% rate under section 223(1) of the TAA (paras 49-51).
On interest, the court found the underpayment of provisional tax was not due to circumstances beyond Taxpayer's control but resulted from an aggressive tax position, and confirmed the interest under section 89quat(2) of the Income Tax Act (paras 52-54).
Outcome
The appeal was dismissed. The 2018 and 2019 additional assessments were confirmed. Taxpayer Boerdery was ordered to pay the costs of the appeal, including the costs of two counsel (para 55).
Major issues / areas of contention
- Whether payments described as 'annual premiums' under the Company XYZ contracts constituted deductible expenditure under section 11(a) of the Income Tax Act (para 33).
- Whether the payments, even if expenditure, were of a capital nature and therefore excluded from deduction under section 11(a) (paras 40-45).
- The correct interpretation of the Company XYZ contracts, including the Special Experience Account, insurer's margin, notional interest and premium refund clauses (paras 8-32).
- Whether the 10% understatement penalty imposed under sections 222 and 223 of the TAA was correctly imposed (paras 47-51).
- Whether interest levied under section 89quat(2) of the Income Tax Act on underpayment of provisional tax was justified (paras 52-54).