The Supreme Court of Appeal (SCA) has drawn a clear line in the sand on the vexing issue of pre- and post-commencement debt when it comes to the tax liability of companies in business rescue.
The court found that the “re-quantification” of a tax debt in an additional assessment (post-commencement of business rescue) does not create a new (post-commencement) liability. The date on which the debt becomes payable is irrelevant.
The matter between Henque and the South African Revenue Service is important because it creates legal precedent on how the courts consider the payment of tax debt to SARS when a company is in business rescue, says ENSafrica tax executive Charles de Wet.
Simply issuing an additional assessment of a tax liability after the start of business rescue proceedings does not change the nature of the liability and thus the amount that SARS is entitled to recover, says De Wet.
Tax debts
Henque, a clothing and beauty product retailer, approached the SCA after the High Court in Johannesburg dismissed its application for declaratory relief regarding its tax debt payable to SARS.
It did not ask relief relating to an assessment, or a decision by SARS, but it wanted clarity on how the amounts owed to SARS should be paid.
Henque claimed its debt related to periods before the business rescue proceedings started, and it was subject to the payment agreement set out in the business rescue plan.
SARS argued the debt related to the period after the start of the proceedings and therefore SARS was entitled to the full amount and not only what was included in the plan. It argued it was also entitled to set off the debt against a value-added tax refund owed to Henque.
A critical part of business rescue is how to deal with debt accumulated before the company is placed in business rescue and the payment to suppliers after the proceedings started. In business rescue, SARS is treated like all other concurrent creditors and is paid in accordance with the terms of the agreed business rescue plan. This is unlike liquidation, where SARS is considered a preferential creditor, explains De Wet.
The timeline
SARS issued an original assessment of the company’s tax return for 2017 on 29 November 2017 but gave notice of an audit. The company claimed a loss of R46 000. It went into business rescue and proceedings started on 31 January 2018.
On 1 May 2018, SARS raised an additional assessment for the 2017 tax period.
The creditors only met in June to consider and approve the business rescue plan. The court noted that on 2 August SARS recorded the 2017 additional assessment as a “pre-business” rescue debt.
The company had a VAT refund owed to it of more than R1 million for the January 2018 period that was initially verified and approved by SARS but later revoked. On 14 February 2019, SARS informed the business rescue practitioner that it had set-off the VAT refund against the 2017 additional income tax assessment debt and the VAT liability for January 2018.
SARS argued it was entitled to do this because the 2017 additional assessment (raised after the commencement of the business rescue proceedings) and the January VAT generated in the month leading up to the business rescue proceedings were “post business rescue debts”.
The dispute
Henque disputed how SARS dealt with its VAT refund. It brought an application in November 2020 asking the High Court for a declarator that its income tax for 2017 and its VAT liability for January 2018 arose before it started with business rescue proceedings. It asked the court to declare that these pre-commencement debts could not be offset against any liability that arose after business rescue started.
The High Court rejected Henque’s submissions.
In its application before the SCA, Henque submitted that the re-quantification of the debt in the additional assessment did not create a new liability. The tax owed to SARS for the 2017 financial year was owed at the end of the 2017 financial year. The VAT owed for January 2018 was generated before the business rescue process started on 31 January 2018.
It argued both were pre-business rescue commencement liabilities, payable in terms of the approved business rescue plan.
SARS submitted that its claim for income tax related to the 2017 additional assessment only became due on 31 May 2018, and the VAT liability for January 2018 only became due and payable on 23 February 2018. So, both were post-commencement debts and should be paid in full.
The decision
The SCA found that the tax debt exists, with or without an assessment, and the assessment merely determines the debt. The court found that both the 2017 income tax and the January 2018 VAT liability were pre-commencement debt.
It further noted that the Companies Act prohibits the application of set-off to any claim against a company while in business rescue. Although the Tax Administration Act (TAA) entitles SARS to apply for set-off of outstanding debt against a refund, the Act also recognises that tax debt is “irrecoverable at law” if it is subject to a business rescue plan.
“SARS’s attempt to rely on its right in terms of the common law to set-off refunds owed to Henque against tax debts it claims are due to it would circumvent the legislative scheme regulating the payment and recovery of tax debts in the TAA and the statutory provisions relating to business rescue in the Companies Act,” the court found.
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.
