SARS demands a slice from fraudsters too

Thousands of South Africans fall victim to 'get-rich-quick' investment schemes each year. One of the most common is the so-called pyramid scheme. Such schemes compensate investors from the funds that these investors bring into the scheme through actively

'Investors' are usually rewarded with nothing more than a hole in their finances. Meanwhile, the individuals and companies that operate the schemes disappear with millions of rand. In the event a pyramid company is spotted in time, the liquidators move in. Investors then have to join creditors in a long queue to see if they will receive any compensation from the unbundling of assets that remain in the failed company.

But creditors and investors are not the only ones fighting for the morsels left in these insolvent companies. SARS is also keen to get in on the act.

SARS versus the liquidators of MP Finance Group

A real life example of is found in the case of SARS versus the liquidators of MP Finance Group CC. MP Finance Group was created by court order, and houses a number of insolvent corporations which once operated as illegal pyramid schemes. The mastermind behind these operations was Marietjie Prinsloo.

SARS was keen to recover taxes on income earned by these organisations in the 2000, 2001 and 2002 tax years. In 2005 the Durban Tax Court ruled that SARS had an income tax claim against the company. The liquidators were keen to keep SARS's hands off the funds. They challenged the initial decision made by the Durban Tax Court, and when this appeal was rejected in the Court, were quick to take the case to the Supreme Court of Appeal in Bloemfontein.

The Supreme Court rules in favour of SARS

The Supreme Court had to determine whether the initial SARS income assessment was fair. In doing so, the court considered whether the various corporations now gathered under the MP Finance Group were liable for income tax. "What matters is that what they took in was income received and duly taxable. The assessments were correctly raised," said Justice Craig Howie.

The ruling identified two relationships the first between SARS and the illegal organisation, and the second between SARS and investors in the scheme. The Court pointed out that the argument contained in the liquidator's appeal could not be applied to the first relationship. The Supreme Court believed that the amounts received by the scheme constituted gross income. Even though the group generated money by illegal means, the court still viewed this money as income, and tax was due on it.

This ruling establishes SARS as a creditor of the insolvent estate. SARS will now be added to the list of creditors with a claim against the remaining funds in MP Finance Group.

Not the first or last case of this kind

A quick Internet search reveals that this is not the first case fought by SARS relating to 'income' generated from pyramid schemes. In March 2006, the Port Elizabeth Tax Court ruled against SARS in a case where SARS attempted to assess a taxpayer on interest 'earned' from a pyramid scheme.

The taxpayer in question had kept records of all the monies he forwarded to the pyramid scheme. When the scheme collapsed, the taxpayer "submitted and proved a claim against the insolvent estate, including interest in the amount of R449 036 which was due to him but which had never been received by him."

With typical SARS sensitivity, the commissioner assessed the taxpayer on this interest amount. "The Commissioner argued that despite the illegality of the agreement between appellant and the scheme, this did not preclude the application of the provisions of the Income Tax Act to the interest which the appellant had become entitled to on investing in the scheme."

In this case, common sense prevailed. The court upheld the taxpayers appeal, concluding that: "it could never have been the legislature's intention to have a person taxed on income that he never received or if he received it, he would forfeit it in terms of other legislation."

Editor's thoughts:
The results in the above cases seem to contradict each other. In one, SARS is granted the right to demand income tax from an insolvent company that operated an 'illegal' pyramid scheme. In the other, SARS was unsuccessful in an attempt to recover income tax on interest payments which had accrued (but not been paid) to an investor in a pyramid scheme. Is SARS correct in demanding tax from companies operating such schemes, particularly where SARS is competing for funds with individuals who have suffered losses at the hand of such schemes? Send your comments to gareth@fanews.co.za