The ability to claim a deduction of contingent liabilities in the context of the disposal of a business or assets has recently been considered in a number of instances. In the case of Ackermans Limited / Pep Stores (SA) Limited v The Commissioner, the Supreme Court of Appeal examined what constituted expenditure actually incurred and if in assuming the contingent liabilities there factually had been expenditure actually incurred. In the February Budget it was further highlighted that the impact of the contingent liabilities is an issue that will be addressed and that further clarity will be provided regarding the applicable rules to be applied in relation to taxable asset acquisitions.
It is therefore noted with interest that SARS issued a Binding Class Ruling on 10 May 2011 specifically addressing the ability to claim a deduction of contingent liabilities in circumstances where assets and liabilities are disposed of within the same group of companies. The factual background, as indicated in the ruling, is that the two companies concerned form part of the same group of companies and the proposed transaction was to be implemented in accordance with the provisions of the amalgamation provisions as contained in s44 of the Income Tax Act. The rationale for the disposal of the assets and liabilities as a going concern was to streamline the operations of the two companies in that the client base of the companies was largely similar.
It is further highlighted in the ruling that:
- the nature of the contingent liabilities include both employment related obligations such as leave pay and bonuses, and sales related obligations such as warranty obligations and contract cost overruns;
- provisions for future costs eligible for allowances under s24C are specifically excluded from the transfer;
- if the contingent liabilities were to materialise, they would ordinarily have been deductible when incurred by the company had the contingent liabilities not been disposed of in terms of the amalgamation.
Against the backdrop of the above factual circumstances, the ruling confirmed that the purchaser will be entitled to deduct expenditure actually incurred in respect of the contingent liabilities transferred. Further, the seller of the assets and liabilities will not be entitled to a deduction of the contingent liabilities transferred to the purchaser despite any reduction in the purchase price of the business arising from the purchaser assuming the contingent liabilities.
It is interesting that in the ruling reference is made to the requirement of there being expenditure actually incurred by the purchaser in order to qualify for the deduction of the contingent liabilities. Such approach is in line with the Ackermans case and as such the necessity of considering whether there has been an "undertaking of an obligation to pay" or "actual incurring of a liability" will likely remain a requirement which will have to be satisfied in order to be able to claim any deduction of any contingent liabilities in terms of s11(a) read together with s23(g) of the Income Tax Act.
In addition, in relation to any contingent liability relating to leave pay, the ruling does confirm that there will have to be compliance with s23E of the Income Tax Act. The ruling, however, does not expand on any further requirements which will have to be satisfied in this regard.
A further question which arises is the extent to which the ruling will be applied in formulating any applicable rules regarding the acquisition of contingent liabilities in accordance with the February Budget. Specifically, the inability for a seller to claim a deduction of any contingent liabilities where there has been a reduction in the purchase price as stipulated in the ruling may be an indication of one of the matters which will be further clarified pursuant to the statutory amendments referred to in the February Budget.