The admissibility of external evidence in the face of a clearly written contract received significant attention during a recent High Court appeal brought by the South African Revenue Service against a Tax Court judgment.
The Court’s willingness to consider evidence beyond the written terms shows how readily it will look past “contractual labels” to examine the commercial reality of an employment relationship.
This principle has far-reaching implications for hundreds of businesses that rely on outsourced payroll services, says Joon Chong, a tax partner at Webber Wentzel.
HR Focus, a payroll administrator with more than 90 clients in the Eastern Cape, objected to additional assessments raised in respect of Skills Development Levies (SDLs) and value-added tax.
SARS contended that HR Focus was the employer of the 4 500 individuals registered on its payroll but deployed at its retail clients’ businesses. It raised SDL assessments, and following a 2018 VAT audit, issued additional VAT assessments. The Tax Court upheld HR Focus’s appeal against all the additional assessments.
Parol evidence rule
In its automatic appeal to the High Court, SARS filed an extensive notice setting out four distinct grounds of appeal in its heads of argument. One of them related to the parol evidence rule.
The rule stipulates that when parties put their agreement into a final written contract, no outside evidence may be used to contradict, change, or add to the terms of that written agreement.
SARS said HR Focus impermissibly attempted to show that the employment contracts were not what they purported to be by presenting inadmissible evidence in violation of the parol evidence rule.
SARS also argued that HR Focus failed to discharge the burden of proof that it was not liable for SDL or VAT because it was not the employer of the 4 500 employees.
The contracts
The employment contracts designated HR Focus as the employer, the relevant business as the client, and the relevant individual as the employee.
In 2010, the owner of HR Focus, Bruce Butler, changed the business model from labour broking to concentrate on the payroll administration and labour-related services provided by HR Focus.
The High Court noted that the later contracts reflected this change in that they did not provide for temporary employment but were notice-period contracts involving permanent employment for an indefinite period, terminable on notice.
After the change, the retail clients of HR Focus were the employers. This fact was reflected in the wording of the contracts and in what happened in the workplace.
HR Focus had no control over the day-to-day duties of the employees, whether they had to work overtime, or whether they were entitled to receive a bonus. The retail clients provided the necessary instructions to HR Focus and notified HR Focus when employees were on annual or sick leave and when employees had to be disciplined.
SARS argued this evidence should have been ruled inadmissible by the Tax Court on the strength of the parol evidence rule because it was “extrinsic and tendered to contradict, add to, or modify” the employment contracts, which designated HR Focus as the employer.
HR Focus said this argument was misguided, given that the employment contracts were not the “sole memorial” of the agreement relating to the employees’ employment.
The company further submitted that the extrinsic evidence, which dealt with the true nature of the transactions and the relationship between the parties, was in any event admissible in line with the “contextual, purposive approach” to interpretation.
It argued that the evidence was relevant to determine the meaning of the employment contract, which, in turn, demonstrated that HR Focus was not endeavouring to contradict, add to, or modify the contract.
Chong said the courts’ approach to outside evidence reflects the modern position that contractual interpretation requires considering text, context, and purpose together.
“Courts no longer need to find ambiguity before examining surrounding circumstances,” she notes.
Tax avoidance
SARS pulled out all the stops and further argued that HR Focus was involved in an impermissible tax avoidance scheme. The wages paid by the retail clients were paid into an account in the name of Butler.
This, together with the “deliberate and significant” understatement of VAT in the invoices rendered to the retail clients, supported the conclusion that Butler was siphoning money from HR Focus, which, according to SARS, constituted an impermissible form of tax avoidance.
The High Court found this contention unfounded.
The only amounts that accrued to HR Focus were in respect of the fees that were due to it.
“It is furthermore trite that VAT is not payable on wages. There was thus no obligation on HR Focus to account for VAT in respect of the wages of the disputed personnel, and there was accordingly no understatement of VAT, deliberate or otherwise, or any question of a tax avoidance scheme as contended.”
The High Court dismissed SARS’s appeal with costs, including the costs of two counsel to be determined on Scale C in respect of senior counsel and Scale B in respect of junior counsel.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies.
