A clogged loss is a loss which, in terms of the Eighth Schedule to the Income Tax Act, No 58 of 1962 (‘the Act’), must be disregarded in the determination of the disposer’s aggregate capital gain or aggregate capital loss Thus, such a loss is ring-fenced and is deductible only from a capital gain arising from the disposal of assets to that same “connected person”.
The Johannesburg Tax Court in A (Pty) Ltd v Commissioner for the South African Revenue Service, decided on 13 February 2012 (Case No. 12644; not yet reported), recently had to consider, inter alia, the proper interpretation of paragraph 39(1) and, in particular, whether that provision applied to the redemption of redeemable preference shares, thereby rendering the taxpayer’s capital loss a “clogged loss” because of the connection between the taxpayer and the company which had issued those shares, for it was common cause that they were part of the same group of companies and were under common control.
In this case SARS had disallowed the capital loss claimed by the taxpayer company which had been incurred as a result of the redemption of redeemable preference shares held by it in a second company in the same group on the basis that the loss was a “clogged loss”, as envisaged in paragraph 39(1) of the Eighth Schedule to the Act.
The Commissioner expressed the view that paragraph11 39(1) is applicable and that the redemption of the preference shares constituted a disposal. The Taxpayer, on the other hand, was of the view that paragraph 39(1) was not applicable because the redemption of the shares was not a disposal by the Taxpayer to any other person. The Taxpayer placed emphasis on the preposition “to” which is used in addition to the term “disposal” in paragraph 39(1) and submitted, that the kinds of disposal that are contemplated in paragraph 39(1) are those where the asset, or the rights in the asset, are transferred from the disposer to any other person. The Taxpayer’s contention was that even though, in terms of paragraph 11(1), the term “disposal” includes “redemption” the language of paragraph 39(1), in particular the phrase in that paragraph “the disposal … to”, delineates and confines the kind of disposals to those envisaged in paragraph 11(a) such as sales, etc., where there is a transfer of the asset, or the rights in the asset, from the disposer to any other person.
The Taxpayer further submitted that in the case of the redemption of shares there is no transfer of the shares (or the bundle of rights represented by the shares) from the holder of the shares to the redeeming company. The Taxpayer’s argument was that on redemption, the shares (or rights represented by the shares) were extinguished and ceased to exist. The Commissioner’s counter-argument was, in essence, that the redemption was a kind of “buy back”, and was a disposal to the redeeming company (in this case B Ltd) as contemplated in paragraph 39(1) and that the appellant’s loss was, accordingly, a “clogged loss”.
In determining the meaning of paragraph 39(1) and in particular whether the term “disposal” in that paragraph had to be given a restricted meaning in the light of its context in that paragraph and, in particular, because it is used in that paragraph in conjunction with the preposition “to”. The court considered the principles of interpreting fiscal and tax legislation.
The court stated that in interpreting fiscal or tax legislation one commences with a literal interpretation because such legislation ought to be certain. The court referred o the case Van Heerden and Another v Joubert NO and Others where the court explained what is meant by the golden rule of statutory interpretation in terms of which words in a statute had to be given their ordinary literal meaning within their context in the statute. In terms of this rule the ordinary grammatical meaning of the words must be adhered to if the language of the statute is unambiguous and its meaning is clear. The court may only depart from the ordinary meaning if it leads to an absurdity so glaring that it could never have been contemplated by the Legislature. In Cape Brandy Syndicate v England Revenue Commissioners the rule which applied in interpreting fiscal legislation was stated as follows:
“.....one has to look at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied. One can only look fairly at the language used.”
The court stated that it is also a fundamental principle that when interpreting legislation literally every word used by the legislature must be taken into account. However it must also be borne in mind that in interpreting anti-avoidance provisions, such as paragraph 39(1)9, a wider interpretation is required so as to suppress the mischief at which the provision is aimed at and to advance the remedy. It is very important to bear in mind in this regard that interpreting “widely” does not mean that the meaning of the provision being interpreted must be stretched beyond what its language permits.
The court further stated that the mischief at which paragraph 39(1) is aimed is clearly to prevent a taxpayer from avoiding or reducing its tax liability by creating a capital loss through the disposal of an asset to a person (including a company) that it is connected to. The court was of the view that to allow such losses, that is, as a result of disposals to connected persons to be deducted generally, would provide fertile ground for the creation of fictitious losses. Tax liability would be reduced while the asset, or the benefit thereof, would still be retained by the disposer, albeit through the connected person.
The court said that according to the canons of construction referred to above the preposition “to” in paragraph 39(1) cannot be ignored unless its inclusion would result in an absurdity so glaring that it could never have been contemplated by the legislature.
The court expressed the view that the wording of paragraph 39(1) is clear and the Commissioner has not submitted that the proposition, “to”, was mere surplusage, nor did the Commissioner make out a case for the deletion of that word from the paragraph. The court further sated that it was not shown that the ordinary literal meaning of the paragraph (inclusive of the preposition “to”) leads to an absurdity, or that it would permit the mischief which the legislature intended to prevent by means of that paragraph and that while the redemption of shares constitutes a “disposal” as defined in paragraph 11, it is not a “disposal to any other person” as envisaged in paragraph 39(1). The redemption of shares results in the extinction and not in a transfer of the rights embodied in the shares to the company redeeming them, or to any other person.
The court held that paragraph 39(1) does not apply to the redemption of shares in the present case and that the loss incurred was accordingly not a “clogged loss” as envisaged in that paragraph.