In terms of the Statistical Release on liquidations and insolvencies published by Statistics South Africa in July 2021, there has been a 21.5% increase in the number of liquidations in the first seven months of 2021 compared to the first seven months of 2020. This has not deterred SARS from collecting outstanding tax debts from defaulting taxpayers.
Generally, when a business is in financial distress, it is not uncommon that the first financial obligations that fall by the wayside are the business’ tax obligations. This is unsurprising as business owners likely prioritise payments to employees, suppliers and other creditors in order to keep their operations afloat. However, this is not an advisable strategy, as debts to SARS accumulate interest, and where applicable, administrative non-compliance penalties that accumulate monthly. In addition, where a taxpayer understates its tax liabilities, SARS may impose understatement penalties, that range from 10% of the tax debt in a standard case, and up to 200% where there is intentional tax evasion on the part of the taxpayer.
There are several tax considerations which need to be kept in mind by taxpayers where the business is in financial distress and is no longer able to operate, or once liquidation proceedings have commenced and compromises are entered into with creditors.
cessation of trade
In the case of a taxpayer whose business is in distress and is no longer able to operate, and where such a taxpayer has an accumulated assessed loss which would otherwise be available to be carried forward to subsequent years of assessment and be offset against any taxable income in such subsequent years of assessment, the accumulated assessed loss would be forfeited in the event that the business does not trade for a tax year. Should a taxpayer fall upon hard times and be unable to carry on its trade for a tax year, the taxpayer would forfeit its accumulated tax losses and should the taxpayer resume its trade at a later date, any profits would be fully taxable.
SARS’ rights in a liquidation
Once a taxpayer undergoes compulsory liquidation or a voluntary liquidation, SARS would be a concurrent creditor in the liquidation proceedings and would be entitled to receive distributions equivalent to other concurrent creditors.
tax implications of debt compromise
The process of liquidation itself may trigger adverse tax implications for the taxpayer undergoing liquidation. It is highly likely that most, if not all, of the debts of the taxpayer undergoing liquidation would be compromised, and creditors would only receive a portion of the amounts owing to them by the taxpayer. The compromise of the debts would trigger the debt concession or compromise provisions set out in section 19 and paragraph 12A of the Eighth Schedule of the Income Tax Act, 1962 (“Income Tax Act”). Section 19 of the Income Tax Act provides for the tax implications which would arise for a taxpayer where a debt owed by such taxpayer is cancelled, waived, extinguished or capitalised as envisaged in that section, and such debt funding was utilised by the taxpayer to fund tax deductible expenditure (ie operational expenditure). Where a taxpayer is released from the obligation to make payment of a debt (or part of such debt) that was utilised to fund tax deductible expenditure, the amount of the debt, in respect of which the taxpayer has been relieved of the obligation to make payment, would constitute a recoupment in the taxpayer’s hands. This would give rise to a tax obligation in the taxpayer’s hands where the taxpayer does not have an accumulated assessed loss.
Similarly, paragraph 12A of the Eighth Schedule to the Income Tax Act provides for the tax implications in the instance where a taxpayer is relieved of the obligation to make payment of a debt or part of a debt, and the debt funding was utilised to acquire capital assets. Paragraph 12A of the Eight Schedule to the Income Tax Act makes provision for any amount of debt utilised to fund capital or allowance assets, which is reduced or forgiven, to be applied first to reduce the base cost of the capital asset or allowance asset, and provides for the triggering of Capital Gains Tax once such base cost has been reduced to ZARnil.
There are several exemptions to the application of section 19 and paragraph 12A of the Eighth Schedule to the Income Tax Act, that are set out in section 19(8) and paragraph 12A(6) of the Eighth Schedule. The exemptions provided by section 19(8) and paragraph 12A(6) of the Eighth Schedule to the Income Tax Act should be kept in mind by a taxpayer who embarks on liquidation proceedings, whether voluntarily or compulsorily.
Where the debt concession or compromise provisions set out in section 19 and paragraph 12A of the Eighth Schedule to the Income Tax Act are applicable to debts that are compromised as part of the liquidation process, any additional tax obligations that arise as a result of such liquidations would be triggered on the date of confirmation of the final liquidation and distribution account. It must be taken into account in the final liquidation and distribution account, per Interpretation Note 91 published by SARS.
SARS’ rights in terms of the TAA
Recently, SARS has exercised its powers in terms of section 177 of the Tax Administration Act, 2011 (“TAA”), which provides that a senior SARS official may authorise the institution of proceedings for the sequestration, liquidation or winding up of a person for an outstanding tax debt. The provisions of section 177 of the TAA were invoked by SARS against a taxpayer in the case of Commissioner for the South African Revenue Service v Zikhulise Cleaning Maintenance and Transport Services. In this case, the taxpayer was indebted to SARS in an amount in excess of ZAR122-million, and had repeatedly failed to honour its commitments to make payment of its outstanding tax debts, despite submitting returns reflecting its tax obligations and undertaking to make payment. SARS was granted leave to institute liquidation proceedings against the taxpayer in terms of section 177 of the TAA. In a media release dated 16 October 2020, SARS commented that the judgement is precedent-setting and empowers SARS to act decisively against taxpayers who attempt to circumvent their fiscal obligations by using court processes to restrict SARS’ ability to collect outstanding debt. SARS Commissioner Edward Kieswetter commented that “SARS will act within the law and will pursue without fear or favour any taxpayer who is bent on evading their legal obligations”.
SARS is committed to collecting outstanding tax debts, and will not be deterred from collecting such tax debts by instituting liquidation proceedings against defaulting taxpayers. Taxpayers should keep in mind the applicable tax considerations upon experiencing financial constraints, and upon embarking on liquidation proceedings.