We have previously written on the recent controversial decision of ITC 1839 [2010] 72 SATC 61. This case gave rise to a denial of certain deductions in context of a business sale with a seemingly inequitable result.

To recap, in ITC 1839 the court held that, where a seller sold its business as a going concern and, pursuant to that sale agreement, the purchaser assumed contingent liabilities of the seller, the seller was not allowed to claim those liabilities as a deduction for the reason that, despite the fact that it had foregone a portion of the purchase price of the assets equal to the value of the contingent liabilities, it could not be accepted that it actually incurred expenditure in respect of those liabilities (as contemplated in the general deduction formula envisaged by section 11(a) of the Income Tax Act, 58 of 1962 ("the Act")).

It seems commercially improbable that this difficulty could be overcome by the seller actually paying (and "incurring") the contingent liabilities at the time of the sale – since these are legally and economically not yet due.

If the seller may not deduct the contingent liabilities at the time of sale, perhaps the purchaser would be entitled to claim a deduction. The Court in ITC 1839 seemed to hold that this was possible but did not formally decide the point. In a South African unreported case (Case No. 11107, 29-4-2005) the taxpayer had acquired the business of the seller. At the time of the sale the seller had a conditional liability to pay bonuses to its employees (i.e. it had not yet been incurred for tax purposes). Subsequent to the acquisition of the business, the purchaser paid these bonuses. In that case it was held that the purchaser could deduct the bonuses paid to employees taken over from the seller. However, it is still not clear whether the same conclusion would be reached in all cases where provisions are transferred to and subsequently discharged by the purchaser, especially when further taking into account that a Privy Council decision (Commissioner of Inland Revenue v New Zealand Forest Research Institute Ltd [2000] STC 522 (PC)) held that expenditure incurred in respect of provisions taken over was incurred as part of the purchase price which was capital in nature and therefore not deductible.

Accordingly, it appeared that a situation could arise that neither the seller nor the purchaser would be entitled to a deduction in respect of expenditure incurred in respect of contingent liabilities or provisions transferred in terms of a sale of business. When taking into consideration the frequency at which sale of business transactions occur, this uncertainty is an unacceptable result as there would have been no doubt around the deductibility of the expenditure in the original business owner's hands, had the sale of business not taken place.

During the course of 2010, our firm made submissions to National Treasury in which we set out this problem and proposed legislative intervention to provide certainty of the tax treatment in this regard. Accordingly, we welcome the attention of National Treasury to this issue. The 2011 Budget proposes to establish rules to ensure that contingent liabilities are completely transferred to the purchaser, which suggests that the purchaser would be allowed a deduction. There may well be other means to achieve a satisfactory tax outcome. This is an unfolding tax issue which merits close attention from both commercial lawyers and their clients.