In our Tax Alert of 16 March 2012 (Tax Alert), we discussed the first of the two main issues that arose for determination in a matter before the Johannesburg Tax Court in A (Pty) Limited v CSARS (Case No: 12644). The first issue concerned the applicability of the "clogged-loss" rule contained in paragraph 39(1) of the Eighth Schedule to the Income Tax Act, No 58 of 1962 (Act) to the redemption of preference shares. In essence, the court found that although the redemption of preference shares does constitute a disposal for the purposes of the Eighth Schedule, it is not a disposal "to" any other person as envisaged in paragraph 39(1) and therefore any capital loss that arises will not be ring-fenced.
The second issue concerned the extent of the taxpayer’s capital loss, more particularly, whether the preference dividend and redemption premium paid by the company as part of the redemption or purchase price of the preference shares constituted a "recovery" as contemplated in paragraph 20(3) of the Act. If it did, the base cost of the preference shares must be reduced by the extent of the recovery, effectively reducing the taxpayer’s capital loss.
Paragraph 20(1) of the Eighth Schedule provides that the base cost of an asset (the preference shares) is the sum of the expenditure actually incurred in respect of the cost of acquisition of that asset and other amounts referred to in paragraph 20(1). However, paragraph 20(3) of the Eighth Schedule prescribes circumstances when the "base cost" must be reduced by certain amounts. In particular, paragraph 20(3)(b) of the Eighth Schedule provides that the expenditure contemplated in subparagraph 20(1)(a) to (g) must be reduced by any amount that:
"has for any reason been reduced or recovered or become recoverable from or has been paid by any other person (whether prior to or after the accrual of the expense to which it relates)…"
In considering whether there was a recovery of expenditure contemplated in paragraph 20(1) of the Eighth Schedule, the court applied the ordinary dictionary meaning of the word "recovered", stating that, to constitute a recovery the taxpayer must have got back the cost (or part) expended in acquiring the asset. The court ruled that the preference dividend and redemption premium paid as part of the redemption price were not recoveries in this sense but rather "fruits" of the shares. The preference dividend or redemption premium being akin in nature to rent derived from a rental property. The court added that the fact that the preference dividend and redemption premium are benefits that might have been taken into account in determining the price paid for the preference shares does not convert them into recoveries envisaged in paragraph 20(3).
The taxpayer thus found himself in a favourable tax position in that it was permitted to take into account the full capital loss in determining its taxable income. The capital loss was therefore neither ring-fenced under paragraph 39(1) (as discussed in the Tax Alert) nor effectively reduced in terms of paragraph 20(3) of the Eighth Schedule to the Act.
As mentioned previously, it remains to be seen whether SARS intends appealing the court’s finding.