SCA Rules: SARS can’t set off pre-rescue tax debts

Kylene Weyers Associate Director: Business Restructuring Services 

The long-awaited and highly anticipated judgment by the Supreme Court of Appeal (“SCA”) has just been published in the case of Henque 3935 CC t/a PQ Clothing Outlet v Commissioner for the South African Revenue Service (846/2023) [2025] ZASCA 56 (12 May 2025).

This groundbreaking and landmark judgment deals with 2 pertinent questions:

1. whether a tax liability arising from an additional assessment raised by the Commissioner for the South African Revenue Service (“SARS”) after commencement of business rescue is a pre- or post-commencement debt; and 

2. whether such liability may be set off against a VAT refund which became due to the company by SARS after the company was placed in business rescue.

Brief overview of the facts

The appellant is Henque 3935 CC t/a PQ Clothing Outlet (“Henque”), a South African tax resident close corporation.

In terms of section 5 of the Income Tax Act 58 of 1962 (“ITA”), Henque was required to pay tax on its income earned or accrued during each year of its financial years. It filed a tax return for 2017 with SARS (for the financial year ending 28 February 2017). On 29 November 2017, SARS issued a notice of an original assessment for the 2017 year of assessment.

On 31 January 2018, Henque commenced voluntary business rescue proceedings. On 1 May 2018, SARS raised an additional assessment for the 2017 income tax year of assessment. The business rescue plan of Henque was published on 31 May 2018 and was subsequently adopted by creditors on 13 June 2018.

On 2 August 2018, SARS lodged a claim with the business rescue practitioner (“BRP”) in relation to the 2017 additional assessment. The BRP also submitted Henque’s VAT returns. At that stage, Henque had accumulated a VAT credit.

On 14 February 2019, SARS informed the BRP that it had set off the VAT credit against the 2017 additional income tax assessment debt and the VAT liability for the period 01/2018. SARS’ view was that the liability for income tax arose when SARS raised an additional income tax assessment for the 2017 year of assessment on 31 May 2018 and on submission of the VAT return for the 01/2018 VAT period. As both the additional income tax assessment and VAT return were issued after commencement of business rescue, SARS argued that both constituted post business rescue obligations.

SARS accordingly asserted that it was entitled to apply the set-off, as both liabilities were post-business rescue debts which were not subject to the payment and enforcement terms under the business rescue plan.

Henque subsequently brought an application in the Gauteng Division of the High Court, Johannesburg (“High Court”) for declaratory relief that both sets of tax liabilities constitute pre-commencement debts and thus not capable of being set-off against a liability of SARS to Henque that arose after the commencement of business rescue.

Henque argued that it is the creation of the obligation that determines whether the debt is a pre- or post-commencement debt. It submitted that the re-quantification of the debt in the additional assessment does not create a new liability and, that being so, any income tax liability that it owed to SARS in respect of the 2017 financial year, was owed at the end of the 2017 financial year, prior to the commencement of business rescue on 31 January 2018. As such, it is a pre-commencement liability, payable and enforceable in terms of the approved business rescue plan.

Henque argued that the fact that the income tax debts became liquid and payable after business rescue does not alter their nature as pre-business rescue debts.

SARS however contended that a tax debt only comes into existence when it is quantified in the notice of assessment and when it becomes due and payable, which in this case was after the commencement of business rescue.

Core issues to be decided by the High Court, and subsequently the SCA

The first core issue to be considered was whether the income tax debt of a company in business rescue, arising from additional assessments raised by SARS after the company had commenced business rescue, in respect of income tax which was owed for a period prior to business rescue, is a pre- or post-commencement debt.

The second core issue to be decided was whether SARS is entitled to set-off such debt against the VAT refunds that became due to Henque by SARS after the company was placed in business rescue.

Judgment by the court a quo

The High Court, per Vally J, agreed with SARS’ contentions and ruled that the 2017 additional assessment (as well as the VAT liability) constitute post-commencement debt, which is not subject to the business rescue plan. The High Court further held that such debt could be set off against the VAT refund that became payable by SARS to Henque after it was placed in business rescue.

Henque then took the matter on appeal to the SCA.

The SCA’s findings 

Is the tax liability a pre- or post-commencement debt?

The SCA firstly considered the important question of whether the 2017 tax debt arising from additional assessment is a pre- or post-business rescue commencement debt.

It highlighted that section 5 of the ITA creates and imposes a liability for income tax in respect of the taxable income received or accrued during the relevant year. Immediately after the end of the year, the tax debt is owed, even though it may not yet have been quantified and is not yet due and payable. The process of quantification is by means of the submission of a return by the taxpayer for the assessment of tax in a further period allowed after the end of the year of assessment, and the making of an assessment by SARS on the basis of such return.

The SCA pointed out that SARS is empowered to make an additional assessment where the assessment does not reflect the correct application of the tax. The effect of this, is to permit SARS to re-quantify and correctly state the debt that was owed at the end of the relevant financial year. The SCA highlighted that the re-quantification of the debt in the additional assessment does not create a new liability.

The SCA stated that any income tax liability that Henque owed to SARS in respect of the 2017 financial year was owed at the end of the 2017 financial year, prior to the commencement of business rescue. As such, the SCA held that this liability is a pre-commencement liability.

The SCA emphasised that section 154(2) of the Companies Act 71 of 2008 (“Companies Act”) makes it clear that, where the business rescue plan has been adopted and implemented, a creditor is not entitled to enforce any debt owed by the rescued company immediately before the beginning of the business rescue process, except to the extent as provided for in the business rescue plan.

Notably, the SCA referred to the recent case of Christoffel Hendrik Wiese and Others v CSARS [2024] ZASCA 111; [2024] 4 All SA 108 (SCA); 2025 (1) SA 127 (SCA); 87 SATC 14, in which it was held that an assessment by SARS does not establish a new liability. The tax liability exists, by operation of law, whether or not there has been an assessment. An assessment merely determines the tax liability and renders it recoverable in accordance with the recovery mechanisms provided by Tax Administration Act 28 of 2011 (“TAA”).

The SCA concluded that the re-quantification of the debt in the additional assessment did not create a new liability and that the income tax liability that Henque owed to SARS was owed at the end of the 2017 financial year before the commencement of business rescue. That tax liability is therefore a pre-commencement debt, subject to payment under the approved business rescue plan.

The SCA similarly held that the obligation to account for VAT arises at the time of supply, not upon the submission of a VAT return. Given that the 01/2018 VAT period ended on the day that business rescue commenced, the VAT liability in respect of each and every supply made during January 2018 constituted a pre-commencement debt. 

Is SARS entitled to apply set-off?

The SCA then turned to consider the question of whether SARS is entitled to set-off VAT refunds against tax liabilities.

The court referred to section 191 of the TAA, which entitles SARS to apply set-off of an outstanding tax debt against an amount refundable to a taxpayer. However, the TAA recognises that tax debt is irrecoverable at law if it is subject to a business rescue plan.

The SCA held that tax debts subject to a business rescue plan are therefore excluded from the operation of a section 191 set-off. As a result, SARS cannot apply set-off for a pre-business rescue debt due to it by Henque, against a post-business rescue refund it owes Henque.

The VAT credits became payable by SARS to Henque after the commencement of business rescue. These credits are post-commencement credits. The SCA emphasised that SARS may not apply set-off of the pre-commencement debts against the post-commencement VAT refunds.

The SCA upheld the appeal by Henque and set aside the order of the High Court. The court ordered inter alia that the tax liabilities in question were pre-commencement debts, and that any claims that arose prior to commencement of business rescue proceedings are not capable of being set off against the liabilities of SARS to Henque during the existence of the business rescue process.

Conclusion 

This judgment is a great victory for the future of business rescue. The SCA provided much needed clarity on the treatment of tax liabilities in the context of business rescue.

Significantly, the SCA drew a clear distinction between the creation and quantification of tax liabilities. Any additional assessment by SARS merely quantifies an existing obligation, it does not create a new liability. The fact that SARS raised the assessment after business rescue had commenced, does not change the nature of this liability. The underlying tax obligations arose when the taxable income was earned or the supplies were made, not when the assessments were issued. Accordingly, the tax liabilities constitute pre-commencement debts.

The judgment also reinforces the critical statutory protections afforded to a financially distressed company in business rescue under section 154(2) of the Companies Act, which section explicitly precludes the enforcement of pre-commencement debts, except as provided for in a business rescue plan. Creditors of companies in business rescue need to take heed of this provision and the consequences it may have on how a particular creditor’s claim is treated in a business rescue.

We at BDO are equipped and ready to provide the necessary guidance to companies in business rescue and creditors alike regarding their respective rights and obligations pertaining to tax liabilities and tax refunds in business rescue.