In the recent case of Ackermans Limited ("Ackermans") v The Commissioner for the South African Revenue Service ("the Commissioner"), as yet unreported, Ackermans sold its retail business as a going concern to Pepkor Ltd ("Pepkor"). Ackermans claimed a deduction of approximatley R17 million in respect of three contingent liabilities which Pepkor assumed under the sale agreement. However, the Commissioner disallowed the deduction. The case, which was on appeal from the South Gauteng Tax Court was heard by the Supreme Court of Appeal ("SCA") which held that Ackermans had not incurred any expenditure in respect of these liabilities and was accordingly not entitled to any deduction therefor.

Background

In terms of the agreement, between Ackermans and Pepkor, Ackermans sold its 'business' to Pepkor as a going concern. The 'business' was defined as Ackermans' retail clothing business, including the 'business assets', the 'liabilities' and the 'contracts' as at the effective date which was, 1 March 2004. The 'liabilities' were defined in the sale agreement as 'all the liabilities arising in connection with the business, in respect of any period prior to the effective date, known to Ackermans as at the effective date'.

The purchase price in respect of the 'business' was the amount equal to the sum of R800,000,000 and the Rand amount of the liabilities of R329,440,402, totalling R1,129,440,402. In terms of the sale agreement, the purchase price was to be discharged as follows:

  • as consideration for inter-company and other loans owed to Ackermans, by an assumption by Pepkor of an equivalent amount of the amounts due by Ackermans to trade creditors as at and in respect of the period prior to 1 March 2004;
  • as consideration for the remaining business assets sold, the assumption by Pepkor of the remainder of the liabilities and the creation of an R800,000,000 loan account owed by Pepkor to Ackermans.

Therefore, Pepkor assumed all of Ackermans' liabilities. Included in the total amount of the liabilities, were the following three contingent liabilities totalling R17,174,777:

  • an amount of R9,880,666, in respect of Ackermans' contractual obligation to fund post-retirement medical aid benefits for its employees;
  • an amount of R6,394,111, in respect of Ackermans' obligations to employees under a long-term bonus scheme; and
  • R900,000, in respect of repair obligations undertaken by Ackermans under its property leases.

Ackermans submitted that, had it retained its business and continued to trade, the three contingent liabilities would have been deductible in its hands as and when they became unconditional, as each of the three contingent liabilities were incurred in the production of income.

Deduction claimed

Ackermans claimed a deduction in respect of the three contingent liabilities on the basis that under the sale agreement, Ackermans incurred expenditure equal to the contingent liabilities by foregoing a portion of the purchase price of the assets, to which it would otherwise have been entitled, equivalent to the value of the contingent liabilities.

Ackermans contended that as the economic effect of the sale agreement was that of the total amount of the purchase of R1,129,440,402, Ackermans received only R800,000,000. It was also submitted that the position would have been the same, if Ackermans had received R1,129,440,402 from Pepkor and paid the amount of R329,440,402 in respect of the liabilities back to Pepkor for Pepkor to assume the liabilities.

Ackermans argued that when lump sum expenditure is incurred by a taxpayer to free itself from anticipated or contingent revenue expenses, such expenditure is generally regarded as being of a revenue nature, and acccordingly this would apply to Ackermans' expenditure in respect of the contingent liabilities.

The Commissioner contended that the deduction claimed by Ackermans in respect of the contingent liabilities was not deductible under section 11(a) of the Act as it did not constitute 'expenditure' or 'expenditure actually incurred', such expenditure was not incurred in the production of income, it was of a capital nature and the expenditure was not incurred for the purposes of Ackermans' trade as required by section 23(g) of the Act.

The Commissioner submitted that Ackermans did not have any obligation to make a payment to Pepkor in terms of the sale agreement, and that the manner in which the purchase price was discharged did not involve any expenditure being incurred by Ackermans.

Ackermans responded that the phrase contained in section 11(a) of the Act referred to 'expenditure and losses actually incurred' and therefore a deductible 'loss' may exist independently of a legal liability and therefore there is no reason why 'expenditure' must necessarily have its source in a legal liability. Ackermans argued that whether the contract created an actual liability on Ackermans' part to pay R329,440,402 to Pepkor, which would be settled through set-off, was irrelevant. From Ackermans' perspective the commercial effect was precisely the same as if such a liability had been created.

The court held that this argument could not be accepted as 'expenditure incurred' means the undertaking of an obligation to pay or the actual incurring of a liability. No liability was incurred by Ackermans to Pepkor in terms of the sale agreement. The manner in which the purchase price was discharged by Pepkor did not result in the discharge of any obligation owed by Ackermans to Pepkor. Ackermans did not owe Pepkor anything in terms of the sale agreement.

It was submitted on behalf of Ackermans that unless the three contingent liabilities were allowed as a deduction in the hands of Ackermans, an anomaly would arise as they would never be deductible. However, the court held that this argument was without foundation as Pepkor would not be disallowed from deducting these liabilities as and when they became unconditional.

Conclusion

The court concluded that, it was clear on what occurred. The net asset value of the business was calculated and that this valuation determined the purchase price. In the ordinary course of purchasing the business as a going concern on this basis it would follow that the liabilities would be discharged by the purchaser. The fact that Ackermans rid itself of liabilities by accepting a lesser purchase price than it would have received had it retained the liabilities, does not mean in fact or in law that it incurred expenditure to the extent that the purchase price was reduced by the liabilities. However, at the effective date no expenditure was actually incurred by Ackermans.