By Doria Cucciolillo, Consultant, BDO Tax
In Pienaar Brothers (Pty) Ltd v Commissioner for SARS (GNP) handed down on 29 May 2017, the High Court ruled on the constitutionality of retrospective tax law amendments and whether tax law amendments could apply prior to promulgation.
The matter emerged from an amalgamation transaction (under section 44 of the Income Tax Act, 1962 (the ITA)) effected on 1 March 2007. Serurubele Trading 15 (Pty) Ltd (the taxpayer) acquired all the assets in a South African company (OLD Co), which led to the termination of OLD Co. As partial settlement of the purchase price of the business, the taxpayer issued shares to OLD Co, which resulted in a share premium being recognised by the taxpayer. Subsequently, on 3 May 2007, the taxpayer distributed a portion of this share premium to its shareholders. At the time of this distribution, companies generally had to declare secondary tax on companies (STC) on dividends declared to shareholders. This distribution did not attract STC as it was done from share premium, sourced from the amalgamation transaction and not the capitalisation of profits. Although the law at the time did not impose STC, it happened amid major developments that risked its STC-exempt status.
On 20 February 2007, the Minister of Finance announced (without any specifics) that retrospective legislation would be passed to address anti-avoidance relating to STC. The next day the Commissioner for SARS (the Commissioner) announced the immediate revocation of section 44(9) of the ITA as it inadvertently permitted a permanent loss of STC rather than a mere deferral of tax, which was the underlying purpose of the amalgamation provisions. On 27 February 2007, the draft Taxations Laws Amendment Bill of 2007 proposed the removal of section 44(9) of the ITA and its retrospective annulment with effect 21 February 2007. On 3 May 2007, the taxpayer distributed the share premium to its shareholders. On 7 June 2007, the Taxation Laws Amendment Bill of 2007 proposed a different strategy to address the STC “loophole”, namely to include section 44(9A) into the ITA instead of withdrawing section 44(9). Parliament realised that the mere removal of section 44(9) of the ITA (which exempted certain distributions from STC) would not entirely prevent STC avoidance in amalgamation transactions as the distributable income of an amalgamated company may change character and become a share premium in the other company. If the other company then distributes the share premium, it will not constitute a dividend as defined, which will result in a permanent STC loss. Finally, on 8 August 2007, section 44(9A) was promulgated in the Taxations Laws Amendment Act of 2007 (the Amendment Act), with retrospective effect 21 February 2007.
Following an audit of the taxpayer’s affairs in 2011, the Commissioner imposed STC on the share premium distribution made on 3 May 2007 through the retrospective application of section 44(9A) of the ITA. The taxpayer challenged this assessment on both interpretational and constitutional grounds. It was argued that the retrospective amendment was in conflict with the Rule of Law, which is underpinned by the principle of legality. The taxpayer also argued that in the absence of an explicit statement to this effect, the Amendment Act cannot apply (retrospectively) to completed transactions. The taxpayer also perceived the retrospective amendment as unfair, claiming that taxpayers have the right to be aware of legislation in force when structuring their affairs in a tax efficient manner. Other arguments against the retrospective amendment included potential administrative difficulties, taxpayers being in automatic default with certain STC provisions and the withdrawal of an exemption pertaining to completed transactions being in conflict with the Constitution, which prohibits the arbitrary deprivation of property.
The court pointed to two types of retrospective legislation, namely retrospectivity in the “weak” sense which changes the future tax consequences of pre-existing transactions, and retrospectivity in the “strong” sense where changes are deemed to have been in force from a date preceding its enactment (“retroactive” amendments). The present matter involves retrospectivity in the strong sense as an amendment made on 8 August 2007 influenced the tax consequences dating back from 21 February 2007. Judge Fabricius J dismissed the application based on the following major findings:
- The wording of the Amendment Act made it clear that the retrospective effect extended to all transactions falling within the scope of section 44(9A) of the Act, including completed transactions. History and the context of the amendment indicated that Parliament intended to address the statutory “loophole” with effect from 21 February 2007.
- In terms of the Constitution, a person cannot be convicted for an omission if it was not an offence at the time it occurred. And, courts will only follow a retrospective approach to the extent mandated by the wording of legislation. Therefore, the retrospective application did not extend to administrative duties, which will only take effect on promulgation.
- Taxpayers are not entitled to fairness in taxation. Nevertheless, the retrospectivity is not unfair as it served the best interest of the majority of taxpayers and the public to close the STC “loophole”.
- In evaluating the constitutional validity of the amendment, the court applied the so-called “rationality” test and considered whether the amendment method (the retrospective approach) could be rationally linked to the underlying purpose of the amendment. As a prospective amendment would have encouraged taxpayers to exploit the STC “loophole” in the period before it was closed, a retrospective approach could be justified as it protected the fiscus from a significant loss in STC revenue.
- The Commissioner and Minster of Finance gave adequate notice of retrospective amendment. Nevertheless, no legal authority requires a precise warning (or in fact any warning) of the intent to pass retrospective legislation. Moreover, it is impossible to provide an exact outline of future legislation as proposed amendments are subject to public consultation and a parliamentary process before final enactment.
- It was found that there was no unconstitutional deprivation of property under section 25(1) of the Constitution since the amendment created a civil obligation for tax instead of divesting a person from the use or enjoyment of property. The court reiterated that there was no arbitrary deprivation of property and that the legislature had adequate justification for the retrospective mechanism, namely to address an inadequacy without exposing the fiscus to further financial harm.
In conclusion, it is evident that retrospective tax law amendments are not automatically in conflict with the Constitution. A rational justification for adopting the retrospective approach must, however, be applied. A retrospective approach need not be the most appropriate method to achieve the desired outcome, but a logical link should exist between the method deployed and the intended purpose. Taxpayers are required to keep abreast of tax developments when structuring their affairs as retrospective legislation may potentially impact them. Retrospective legislation may be passed without further notice, apart from those that form part of the normal statutory amendment process. A taxpayer therefore does not have an unequivocal right to rely on current tax law, especially where the law can be applied to capitalise on “loopholes”.
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