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South Africa’s New Benefit Tax

01 February 2012 Robert W Vivian, University of the Witwatersrand

In SARS v Brummeria 2007 the Supreme Court of Appeal (SCA) created a tax which we will name South Africa’s New Benefit Tax. It is a complicated tax based on the premise that ‘expenditure not incurred, is income’.

SARS has always wanted to tax people who receive interest free loans. Take for example the case of a child who has no car, no money and no job. The child needs a car to secure a job, but the bank won’t lend the child money without proof of income. A parent steps in to lend the child money to buy the car, interest free.

Alice in Wonderland English

Should the child who benefits from this interest free loan pay income tax on the interest not paid? If so, how should we interpret income tax to make this tax, income tax? And are we dealing with Alice in Wonderland English, where the words "income” and "expenditure” swap meaning? This is a form of English where words no longer have their normal everyday meanings.

To pay tax on ‘expenditure not incurred’ would violate a number of fundamental principles, other than English. Firstly, income tax is by definition a tax on income. Had the parent levied interest on the loan he would have received interest income which would legitimately be subject to income tax. The child in this event would not pay any tax because the payment of said interest would be an expense.

To levy income tax on the child (because the child has received a benefit hence the name benefit tax) we would have to argue that ‘expenditure not paid’ is income. It is difficult to understand how a person who does not pay interest finds this ‘expenditure not incurred’ re-appearing as taxable income. It would be easier to get to grips with this new benefit tax if the income tax was to be levied on the parent, because the income forfeited by the parent by not charging interest could be regarded as imputed income to the parent. In that way, at least, income remains income.

An income tax sans income

Secondly, income tax is the sharing of income between taxpayer and the state. If the taxpayer’s effective tax rate is 30 percent, SARS gets 30 percent of the income while the taxpayer retains 70 percent. It can be argued, structured correctly income tax can be paid. How does the taxpayer pay 30 percent tax on ‘expenditure not incurred’ benefit tax? The child has no income with which to pay the income tax on the ‘interest expenditure not incurred’. In this event the parent would have to lend the child an additional capital sum to cover the tax. But the tax obligation is the child’s. The child as taxpayer faces an unpayable tax.

Thirdly, to tax income not charged violates the fundamental principle of freedom of contract. The option to charge interest should lie exclusively with the parent, not the state. By taxing ‘interest expenditure not incurred’ SARS takes it upon itself to decide what transactions persons can or cannot enter into. If freedom of contract is to be violated, why limit it to loans?

A nonsensical notion

For example, if a successful doctor works one day a week free of charge to assist the poor, why not treat the benefit the poor people receive as ‘expenditure not incurred’? Assume a life-saving medical procedure costs R200 000 and the hospital and doctors agree to provide this free of charge. The patient has received a benefit of R200 000, so why not treat that as taxable income too? Well, currently income tax is not payable as neither the hospital nor the doctor charged the patient…

The question then arises: Where is the money going to come from to pay the new benefit taxes? Because the patient cannot afford the treatment – and therefore not the taxes – the doctor would have to not only agree to carry out the operation, free of charge, but pay the ‘income tax’ on the fees they never charged as well! Clearly the notion of ‘expenditure not incurred, is income’ is nonsense.

Fourthly, to tax, ‘expenditure not incurred’ as income would violate the taxpayer’s freedom of conscience. Many individuals would be offended were they compelled to levy interest, or pay interest on their own money, when assisting those in need. The charging of interest may be anathema due to religious teachings too.

Legislating through the courts

Despite these fundamental objections SARS remains determined to levy this New Benefit Tax. I pointed this out as far back as November 2001 in an article entitled Taxing Parents, IFA. But instead of taking the matter to Parliament to amend the tax legislation, SARS approached the courts to endorse it notion to tax a taxpayer who was not liable to pay tax!

Why the courts? Ever since the Magna Charta (1215) it is manifestly clear that only Parliament has taxing powers. The answer can be found from one of the most famous dissenting judgements in judicial history. In 1942 Britain (then at war) passed draconian security legislation to enable the government of the day to go even beyond the powers given to it by Parliament.

Distorting English

The matter ended up in the highest court of the land, the House of Lords, where despite government clearly acting beyond its powers the majority of judges allowed it. Lord Atkin, the judge who delivered the dissenting judgement, made two famous observations. Firstly, he noted that the judiciary was more executive-minded than the executive and could be relied upon to support government. And secondly he observed that courts to assist the government would do so even if it meant assigning new meanings to words in the English language to achieve something which could not otherwise be achieved.

He then famously quoted from a passage in Alice in Wonderland. To achieve what the judiciary wanted to achieve could only be done by distorting the English language, something he termed Alice in Wonderland English. The ordinary or everyday meaning of words in the legislation will not stop the courts from achieving their intended purpose. Thus ‘expenditure not incurred’ can through Alice in Wonderland English become ‘income’.

Back to basics

In the SCA case SARS targeted a company called Brummeria, which erected retirement villages. Brummeria offered to build retirement units for pensioners provided they advanced the capital for the unit. In return for the loan of the capital the pensioner acquired life rights to the unit. I discussed this case previously as Paying Income Tax on no Income, FA News, November 2007, but since that date SARS has issued its Interpretative Note 58, which opens the matter for further consideration.

Contrary to what SARS and the SCA believe this case is not about interest not being charged! Oddly neither SARS nor the SCA seemed to understand this point. When someone borrows money, two obligations arise. Firstly the obligation to return the capital and secondly, as long at the borrower has the capital, an ongoing obligation. This ongoing obligation is typically (but not always) to pay interest to the owner of the capital. SARS and the SCA seemed be believe that the only ongoing obligation could be the payment of interest.

Not obligation free

Brummeria proposed that the pensioner lend it a capital amount which would return to the pensioner’s estate upon death (the first obligation). It offered the pensioner rent free accommodation in a retirement unit for as long as it held the capital (the second ongoing obligation). In exchange for Brummeria holding his capital, the pensioner acquired a right of equal value occupy the unit, notionally an amount equal to the occupational rental. This case thus had nothing to do with an interest free loan because the loan by the pensioner to Brummeria was anything but obligation free. Neither SARS nor the SCA seemed to have understood this.

From the straight application of tax principles it can be argued that notionally Brummeria received an ongoing income in the form of occupational rental, but at the same time notionally paid the pensioner an amount as interest for the loan advanced. It was a barter transaction with a net tax outcome of these two notional transactions being turnover (rent) less expenditure (interest) – equals zero! As far a Brummeria is concerned applying basic tax principles it had no tax obligation.

A barter transaction

SARS and the SCA got lost in their ‘expenditure not incurred, is income’ argument and failed to approach the case from fundamental taxation principles. They concentrated on how ‘expenditure not incurred’ could be viewed as income, a taxable benefit. Had they isolated the income and expenditure as notional transactions in this barter transaction they would have arrived at the zero net tax conclusion already mentioned.

SARS Interpretative Note 58 seems to be an admission that the original case dealt with a zero tax situation. But its failure to rectify the situation means that the interpretative note is even more of a problem than the case itself. Since the Brummeria case and its Interpretative Note 58 has been subsequently applied in another case, the Interpretative Note deserves further consideration.

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