SARS loses bat­tle over MTN au­dit fees claim

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - Beric Croome

Case pro­vides some clar­ity on the de­ductibil­ity of au­dit fees and pro­fes­sional ser­vices ren­dered

IN MO­BILE Tele­phone Net­works Hold­ings (Pty) Lim­ited v the Com­mis­sioner for the South African Rev­enue Ser­vice, the South Gaut­eng High Court was re­quired to de­ter­mine whether the Com­mis­sioner was cor­rect in dis­al­low­ing MTN’s de­duc­tion of au­dit fees for the 2001 to 2004 years of as­sess­ment, and the ex­pen­di­ture in­curred by the com­pany in re­spect of pro­fes­sional fees charged for train­ing staff on a new ac­count­ing pack­age.

The com­pany ini­tially ap­pealed the Com­mis­sioner’s find­ing to the Tax Court and suc­ceeded par­tially on the de­ductibil­ity of au­dit fees by se­cur­ing a de­duc­tion of 50% on the au­dit fees claimed for the 2001 to 2004 years of as­sess­ment. The tax court agreed with the Com­mis­sioner that the costs in­curred on the train­ing of staff for the new ac­count­ing pack­age was not de­ductible for tax pur­poses.

The South African Rev­enue Ser­vice (SARS) was dis­sat­is­fied with the court’s de­ci­sion and cross­ap­pealed in re­spect of the de­ci­sion on the au­dit fees, con­tend­ing that the de­duc­tion of 50% of the au­dit fees was in­cor­rect. In de­cid­ing whether the au­dit fees, or the fees paid for pro­fes­sional ser­vices, were de­ductible, the tax court was re­quired to con­sider the pro­vi­sions of sec­tion 11(a) of the In­come Tax Act, 1962, the so-called “gen­eral de­duc­tion for­mula”, and also to take ac­count of sec­tions 23(f) and (g), which pre­clude the de­duc­tion of ex­penses in­curred in re­la­tion to amounts that do not con­sti­tute in­come or which are not ex­pended for the pur­poses of the tax­payer’s trade.

MTN is a wholly owned sub­sidiary of the MTN Group Lim­ited (“MTN Group) and has five wholly owned sub­sidiaries. MTN Group con­ducts busi­ness by pro­vid­ing mo­bile telecom­mu­ni­ca­tion net­works and re­lated ser­vices. Judge Vic­tor pointed out that it was agreed in a pre­trial meet­ing that MTN car­ries on a trade.

SARS dis­al­lowed the au­dit fees in­curred for pur­poses of com­ply­ing with the com­pany’s statu­tory obli­ga­tion to have its ac­counts au­dited, as well as for the pur­pose of trad­ing. Pro­fes­sional fees re­lat­ing to the sec­ond is­sue, which SARS dis­al­lowed in full, con­sisted of ser­vices pro­vided in or­der to train the com­pany’s staff on a com­puter ac­count­ing sys­tem.

The judg­ment points out that it was com­mon cause be­tween the par­ties that the com­pany traded dur­ing the tax years in dis­pute. The au­dit re­quired the in­put and con­sid­er­a­tion of an au­di­tor re­gard­ing the div­i­dends re­ceived by the com­pany and in­come in the form of in­ter­est. The court pointed out that the div­i­dend in­come rep­re­sented the largest por­tion of MTN’s in­come, rang­ing be­tween 89% and 99%, dur­ing the tax years in dis­pute.

The tax court de­cided that the au­dit fees were in­curred for a dual pur­pose and reached the con­clu­sion that it was ap­pro­pri­ate to ap­por­tion the ex­pen­di­ture and de­cided that 50% was de­ductible and the bal­ance was not. The high court pointed out that the tax­payer con­tended that, on av­er­age, only 6% of the en­tries in its books of ac­count re­lated to div­i­dends, which was not dis­puted by SARS. SARS con­tended that the au­dit fees did not ad­vance the trade of the com­pany and were not di­rectly re­lated to the pro­duc­tion of its in­come and there­fore all au­dit fees claimed by the com­pany should be dis­al­lowed.

SARS ar­gued that the au­dit fees were in­curred by the com­pany to com­ply with its statu­tory obli­ga­tions and re­lied on Aus­tralian tax au­thor­ity where ex­pen­di­ture was dis­al­lowed for un­der­tak­ing a statu­tory task — FCT v The Swan Brew­ery Co. Lim­ited (1991) 22 ATR 295.

The court said it was com­mon cause that the amount of work un­der­taken by the au­di­tors ex­tended be­yond the ver­i­fi­ca­tion of in­ter­est in­come and re­ceipt of div­i­dends, but that those additional tasks did not de­tract from the ap­pel­lant’s con­tention that the au­dit fees re­lated to its in­come-earn­ing ac­tiv­i­ties.

It would ap­pear that only 6% of the au­dit time was spent on the div­i­dend sec­tion of the au­dit. The court de­cided that the ex­pen­di­ture in­curred by the com­pany on the au­dit fees, was in­curred to di­rectly fa­cil­i­tate the car­ry­ing on of its trade, not only in a legally com­pli­ant man­ner, but also to gen­er­ate in­come.

The court de­cided that the only fair ba­sis on which the au­dit fees should be ap­por­tioned was that 94% of those costs should be al­lowed as a de­duc­tion for tax pur­poses. The court de­cided that it was ap­pro­pri­ate to take ac­count of the time spent on au­dit­ing the in­ter­est in­come, as op­posed to the fact that a sub­stan­tial part of the in­come de­rived by the com­pany con­sisted of div­i­dends.

When deal­ing with SARS’ cross­ap­peal, the court in­di­cated that SARS sought to ar­gue that the au­dit fees did not at­tach to the com­pany’s op­er­a­tions and even where trad­ing is con­ducted through the com­pany, the tax­payer should ac­cept that there are additional ex­penses for au­dit fees and the le­gal obli­ga­tion re­lat­ing thereto is un­re­lated to the earn­ing of the tax­payer’s in­come. The court pointed out that SARS ap­proach would pro­vide an enor­mous ob­sta­cle to the world of com­merce and trade if the de­duc­tion of au­dit fees was to be de­nied on this ba­sis.

In reach­ing its ap­por­tion­ment ra­tio, SARS took ac­count of the val­ues of in­come de­rived and did not take ac­count of the amount of work in­volved in the au­dit process. The court re­jected SARS’ method of ap­por­tion­ment as be­ing fac­tu­ally and legally in­cor­rect. The court held that the bulk of the au­dit fees re­lated to the earn­ing of in­ter­est and not div­i­dends based on the time spent by the au­di­tors on the dif­fer­ent tasks re­quired to com­plete their au­dit.

In ad­di­tion, SARS dis­al­lowed the pro­fes­sional fees paid for ser­vices ren­dered re­gard­ing the im­ple­men­ta­tion of the com­put­erised ac­count­ing sys­tem. The court pointed out that the ma­jor­ity of trans­ac­tions in MTN’s fi­nan­cial records re­lated to the in­ter­est in­come de­rived, and that the ac­count­ing sys­tem was not used in re­la­tion to the div­i­dend in­come re­ceived by the com­pany. The ex­pen­di­ture claimed by MTN re­lated to its busi­ness only and was not used for the ben­e­fit of its sub­sidiary com­pa­nies. The court ex­pressed the view that the pro­fes­sional fees were closely con­nected to the earn­ing of the in­ter­est-in­come re­ceived by the com­pany and that the pro­fes­sional fees were di­rectly re­lated to the com­pany’s trad­ing ac­tiv­i­ties.

SARS ar­gued that MTN had not pro­vided suf­fi­cient in­for­ma­tion and de­cided that the com­pany had not dis­charged the onus placed in re­la­tion to the ac­count­ing sys­tem. The court was crit­i­cal of SARS and pointed out that SARS had failed to con­sider the rel­e­vant in­for­ma­tion, be­fore dis­al­low­ing the pro­fes­sional fees re­lat­ing to the ac­count­ing sys­tem.

The unan­i­mous de­ci­sion of the court was that 94% of the au­dit fees were de­ductible and that the ex­pen­di­ture re­lat­ing to the train­ing on the ac­count­ing sys­tem must be al­lowed. SARS was there­fore or­dered to pay the costs of the com­pany’s ap­peal.

The case pro­vides some clar­ity on the de­ductibil­ity of au­dit fees and pro­fes­sional ser­vices ren­dered re­gard­ing the im­ple­men­ta­tion of an ac­count­ing sys­tem.

Dr Beric Croome is a tax ex­ec­u­tive at ENS.

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