A recent judgment in the Cape Town Tax Court embedded the legal principles set down in the anti-avoidance case against Absa, this time in a tax dispute regarding “dividend stripping”.
Tax specialists affirm that the judgment is useful because it confirms that the Constitutional Court’s ruling is legally binding, but it also reduces the wide net cast in that case.
Read: ConCourt ruling expands GAAR reach and raises investor risk
The dividend-stripping matter relates to a dispute between the South African Revenue Service and seven shareholders in RASS Investment, a company that built and leased self-storage units.
SARS attacked the transaction RASS entered with Ancient Limited for the disposal of its entire shareholding to a wholly owned subsidiary of Ancient. The transaction included the declaration of a pre-sale dividend to the seven shareholders, a subscription for new RASS shares by the Ancient subsidiary, the use of proceeds from the subscription as payment for the declared dividends, and the sale of the remainder of the shares at nominal value.
The tax consequence is no capital gains tax, or income and dividend withholding tax.
Ancient reported the transaction to SARS, and an investigation, audit, and additional assessments for CGT followed. The assessments went on appeal before the Tax Court, which found in favour of SARS.
Two issues that raised concerns were the Court’s approach to the Conhage or “choice” principle and the conflation of the General Anti-Avoidance Rules (GAAR) and the “simulation doctrine”.
Choice principle
Peter Dachs, executive in ENS’s tax practice, says there has been a robust debate over whether the choice principle was still alive after the Absa ruling.
Judge Matthew Francis acknowledged in his Tax Court judgment that the Absa case reaffirmed the Conhage principle. Within the bounds of the anti-avoidance provisions, a taxpayer may arrange his affairs to attract less tax, and where the same commercial result can be achieved in different ways, he may choose the way that attracts less tax.
“The principle is part of our law and was not weakened by Absa Bank,” Judge Francis noted.
Dachs says this is quite powerful. “On the facts, the Court said, the choice principle still applies, but it does not apply when there is another (unnecessary) step that is only done for tax purposes.”
In the context of the RASS case, the step was where RASS declared a dividend to the shareholders just before the remaining shares were sold at nominal value to the buyer. “In those circumstances, the choice principle does not offer protection,” Dachs adds.
The tax team of law firm Bowmans also notes the Tax Court’s finding that Conhage protects a choice between different means of achieving the same result.
However, the Court held that in the RASS/Ancient structure, the dividend-and-subscription mechanism was not an alternative means of effecting a sale. It was a step grafted onto the sale whose only distinguishing function was to alter the tax outcome.
“This is a significant departure from the Conhage ‘choice’ principle and is likely to cause substantial uncertainty regarding the ability of taxpayers to structure their affairs in a tax-efficient manner,” the Bowman’s team adds.
“While this is a Tax Court judgment and thus not legally binding on higher courts, it provides a clear indication that a subscription-and-buyback structure could (depending on the facts) be vulnerable to a GAAR attack.”
However, Dachs believes the Tax Court’s ruling on the Conhage principle is sound. Market concern relates to subscription-and-buyback transactions where – instead of a party selling its shares to a buyer – the buyer subscribes to shares in the target and the target buys back the shares from the seller.
“The share subscription-and-buyback falls nicely into that choice principle. The Tax Court did not attack that; it only said there must not be an unnecessary step that is only done for tax purposes. That is quite important.”
Conflating tests
The conflation of GAAR and the simulation doctrine tests is a concern. GAAR is a statutory provision, while simulation is part of common law where substance over form is tested.
GAAR tests the arrangement, tax benefit, sole and main purpose, and tainted elements (tax abnormalities). Taxpayers may choose tax‑efficient structures, but not ones that cross into impermissible avoidance. Simulation is about intent to deceive or to disguise (saying one thing but doing another).
Dachs explains that Tax Court’s judgment talks about the transaction being an economic disposal. It is irrelevant for GAAR purposes. “That is a simulation or substance question… It is not legally correct to look at the economic effect when you apply GAAR. One looks at the transaction as it was entered into and whether it was done for a tax or commercial purpose. That is the GAAR test.”
When considering the simulation doctrine, one considers whether there was something disguised or dishonest about the transaction. Then one can look at the economic substance of the transaction.
“If there has been a disguise, SARS can look through what was said and what was done. It is legally confusing to mix two different tests.”
Both Dachs and the Bowmans team believe the Tax Court judgment will go on appeal.
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. The information in this article is a general guide and should not be used as a substitute for professional tax advice.
