TAX4863-Advanced Case Law Question & Answers.
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TAX4863-Advanced Case Law prev Q & A 2018-22
TAX4863-Advanced Case Law prev Q & A 2018-22
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TAX4863/101
QUESTION (50 Marks)
Mr Green Tick, a resident of the Republic, is the accountant of a local company operating in the
field of information technology. He had over a period of some eight months falling within the
current year of assessment embezzled a staggering amount of R1,6 million from the company
before the internal audit department discovered where the funds of the company were leaking.
The amounts embezzled took the form of payments by clients to the company for services
rendered that were illegally routed to and deposited into an account created in his personal name.
Mr Tick utilised about one-half of these monies (R750 000) to supplement his salary earned from
the company (covering living expenses) while the remainder (R850 000) was moved to an off-
shore bank account that he also operated in his personal name. He has earned interest to the
value of the equivalent of R12 000 over this period from this investment.
The company’s discovery of the embezzlement and the threat of legal action against him, forced
Mr Tick to offer to withdraw these funds from overseas and pay the amount back to the company.
The shortfall of some R738 000, however, will still have to be settled and the offer made by Mr
Tick provides that he will pay this shortfall back in monthly instalments of R15 000 in return for
the undertaking by the company that it will not press for any charges to be brought against him.
As part of the deal, he has agreed to voluntarily relinquish his employment with the company.
The company, being eager to recover this “loss” without incurring any legal costs, will in the
process only collect the initial R1,6 million embezzled, without any compensation for lost interest.
The directors of the company, who do not have any expertise in the field of Taxation, are not sure
about the normal tax implications that will flow from the offer on the table for either the company
or Mr Tick.
REQUIRED:
Write a report to the directors of the company to explain the “gross income” implications of the
information provided above (on the assumption that the offer is accepted) as far as it relates to
the company and Mr Tick respectively. Motivate the points covered in your report by reference
to relevant legislation and case law. Ignore any value-added tax consequences.
22
, 5 TAX4863/201
SPECIFIC COMMENTARY AND SHORT SOLUTION TO ASSIGNMENT 2
Introduction
The question requires you to deal with the aspect of “gross income” only. Reference to and discussing
the deduction side (in calculating taxable income) in the circumstances will thus be unnecessary and irre-
levant. Your answer should, however, cover “gross income” in so far as both Mr Tick and the company
are concerned. It is stated specifically that Mr Tick is a resident of the Republic, while the company is said
to be a local company. This (in the absence of information to the contrary) means that it has either been
registered in South Africa, or that all of its activities are carried out in the Republic (its place of effective
management is in the Republic). If that is the case, it will also meet the definition of a resident. No party
will thus be non-resident and the aspect of source will not be relevant.
Definition of gross income
Seeing that the question relates to “gross income”, the definition thereof is of vital importance. This defi-
nition can be divided into two parts. The first is the general definition thereof, while the second part relates
to amounts specifically listed to form part of gross income. In the circumstances, the general definition
seems to be the one that deserves our attention to commence with the discussion.
The general definition of gross income contains certain requirements that all need to be met before an
amount of “gross income” can arise. If any one of these requirements are absent, there can be no “gross
income” arising, unless such amount is covered by a special inclusion. The requirements to be met are
as follows:
Total amount in cash or otherwise
Received by or accrued to or in favour of
Non-capital in nature
There can be little doubt that an amount of money is at stake for both the taxpayers involved. No property
other than money is mentioned and the whole aspect of valuing property earned in a form other than
money, need not be discussed. The focus will thus be directed towards the last two requirements of the
definition.
Received by or accrued to or in favour of
In the Geldenhuys case, the words “received by” were held to mean “received by the taxpayer on his own
behalf and for his own benefit”. In this case, a widow held a usufructuary right over a flock of sheep and,
due to drought in the area, the flock was disposed of at a time when their numbers had dropped to below
that which existed at the time of gaining her right therein. The resultant proceeds was deposited into her
personal bank account and SARS was keen to tax her on this. Seeing that there was no fructus due to
the drop in the number of sheep forming part of the flock, she had no right to any portion of the proceeds.
The proceeds solely belonged to the holders of the bare dominium in the flock (her children). They held
ownership in the flock, subject to her right only to the fruit (if any) produced by the flock. The court thus
held that she was not to be taxed on such proceeds as she merely received this amount on behalf of the
holders of the bare dominium.
Not every physical receipt of an amount will thus constitute a “receipt” for the purposes of the Income Tax
Act. Where an amount is received on behalf of another person or where it is to be held in trust for the
benefit of another person, the recipient cannot be taxed thereon. A normal tax liability can only arise where
an amount is received for the personal benefit of the taxpayer. Amounts received in the form of a loan (or
its repayment) will further not constitute gross income either, due to the immediate and unconditional
obligation to repay it (Genn & Co). While the use of a loan may over a period of time provide a benefit to
the recipient, the funds advanced cannot in itself constitute a “receipt” for the lack of personally being able
to claim ownership thereof. Such funds must be refunded to the lender once the period for which it may
be used, has elapsed.
, 6
Amounts obtained in an illegal fashion (for example, stolen) may raise doubt as to whether it will meet this
requirement of obtaining a personal benefit in order to be “received by” for the purposes of “gross income”.
The amounts physically received by Mr Tick had not been received on behalf of the company. Neither
were they initially held in trust for the benefit of the company. Could Mr Tick have received these amounts
on his own behalf and for his own benefit? He did utilise it to supplement his salary and make an invest-
ment in his own name, but later offered to repay it to the company who was the rightful owner thereof.
The fact that an amount arises due to an illegal activity, that there is immorality involved or that an act is
ultra vires, does not impact upon the question whether the resultant amount has been “received” for the
purposes of “gross income”. In Delagoa Bay Cigarette Co the company advertised packets of cigarettes
worth sixpence for sale at ten shillings, with each packet containing a numbered coupon. The company
then set aside two-thirds of its revenue to a fund from which monthly prizes were to be awarded to the
holders of the winning numbers. In the process, the company was found to be running an illegal lottery
(apart from the selling of cigarettes), but this did not save it from being taxed as the legality of the business
was held to be irrelevant in deciding whether the amounts received or accrued constituted “gross income”.
This situation of operating a business containing an illegal element may possibly be distinguished from
that where the business as a whole relates to illegal activities (for example, human trafficking or drug
dealing) or where stolen goods are sold, but it seems as if the end result from a tax point of view will be
the same. Receipts and accruals remain taxable. In ITC 1545, the taxpayer bought and sold diamonds,
which he knew were stolen. The proceeds from the sale thereof, was still held to be part of his “gross
income”. A taxpayer cannot “hide” behind the fact that the business producing the income has some form
of illegality.
How would this situation then compare to a situation where cash is stolen, or fraud or corruption is the
cause of the receipt thereof? In COT v G (a Zimbabwean case containing persuasive powers) the taxpayer
took advantage of his position to obtain from the Government more money than was legitimately required
for official purposes. This excess was used to buy goods for himself and, if, not, put into his personal bank
account. He was later convicted and sentenced to prison, part of which was suspended on condition of
repayment of these amounts. On being assessed, the respondent argued that the monies he took never
became his (despite his intention to treat it as his own) and that it, therefore, was never “received” by him.
The court held that this was a unilateral taking and that it conferred no right upon the taker to the things
taken. He “took” rather than to “receive”. It was said that not only his intention, but the intention of the
person who passed the money on to him, must in the process be taken into account. These monies were
held not to be taxable in his hands.
This may create a perception that stolen amounts will not be taxable. However, the decision in the case
of MP Finance Group may have changed this view. The operators of a pyramid scheme in this case, were
held liable for normal tax on deposits received from investors. The court held that, at some stage, the
perpetrators realised that the scheme was insolvent and that it would be impossible to pay these deposits
back to investors. The court was thus of the opinion that, from that stage onwards, they made their money
by swindling the public by accepting new investments with the intention of retaining them for their own
benefit. The operators thus treated these deposits received as “income” and as their own property. This
court effectively held that “stolen” money can in fact be taxable where treated by the taxpayer as his
“income” and as the taxpayer’s own property.
There are some aspects, which cast some doubt as to the reliability of this view though. For example,
must the intention of both parties involved, not be taken into account? Surely, the investors would have
had a completely different intention in this regard? Investing in a scheme of this sort presupposes an
expectation of a refund of the amount(s) invested to the investor. Should the same principle applying in
the case of a loan not be relevant here? In Genn & Co, it was held that borrowed money is not received
nor does it accrue within the meaning of the definition of gross income. This is due to the immediate
obligation that will rest upon the borrower to return such funds to the lender. An investment by way of a
deposit should carry the same expectation and obligation for a refund. However, this ruling by the
Supreme Court of Appeal created a precedent that will have to be followed in future.
, 7 TAX4863/201
Some limited support for the decision in MP Finance Group can be found in ITC 1624 where the taxpayer
overcharged a customer for amounts supposedly paid on behalf of the customer to Portnet and which
were to be recovered from the customer. The taxpayer fraudulently increased the amounts actually paid
and subsequently rendered accounts to the customer for the recovery of these increased amounts. The
court in this case held that the taxpayer obviously had the intention to defraud the customer and in keeping
the excess. It was, thus, received as part of business income and, as a result, had to be included in “gross
income” for the taxpayer.
In turning to the issue of “accrued to”, the cases of Lategan and Peoples Stores held that these words
meant to become “entitled to” while this was later narrowed down in the case of Mooi to mean “uncon-
ditionally entitled to”. If there is an outstanding or unfulfilled condition attached to an amount, or its pay-
ment is contingent upon the happening of some event, it cannot be said that the creditor is unconditionally
entitled to such amount. Then, there can be no accrual of the amount until the outstanding condition has
been met. Only once all outstanding conditions have been met, can it be said that the amount accrued to
or in favour of the taxpayer. Normal credit terms do not give rise to an unfulfilled condition, but merely
represent an agreement between the parties that payment will be postponed to a future date. Amounts
due under such credit terms thus accrue normally once the other terms and conditions of the agreement
have been met.
In the Mooi case (decided before the introduction of sections 8A, 8B and 8C) the taxpayer was granted an
option to subscribe for shares in his employer company, subject thereto that he was still in the employment
of the company at its mine once this mine came into operation. The taxpayer accepted the option and
some three years later the mine came into operation. The option price paid by the taxpayer was far below
the market price of the shares and the Secretary for Inland Revenue included the difference in his gross
income. The question was whether the accrual took place at the time the option was granted, or only
when the conditions were fulfilled and the option exercised. The court held that the benefit only accrued
when the option became exercisable upon the conditions being fulfilled some three years after the granting
of the option.
The earlier of receipt or accrual will determine the date of inclusion of the amount in gross income
(Silverglen Investments). Double taxation of the same amount on receipt as well as accrual thereof should
not occur (Delfos). Once an amount has been received by or accrues to or in favour of the taxpayer, it will
form part of such person’s gross income (provided non-capital in nature) irrespective of its subsequent
payment to some other person (Witwatersrand Association of Racing Clubs). The only chance of having
the amount excluded from forming part of taxable income will then be where the taxpayer qualifies for relief
by way of exemption, or where an allowable deduction or allowance can be claimed against such inclusion.
Non-capital in nature
An amount can either be revenue or capital in nature – there are no other categories and there is no
halfway-house (Pyott Ltd). In the hands of Mr Tick, it may depend upon the way in which he treats the
stolen amounts (MP Finance Group). If treated as his income, then it will be revenue in nature. In the
hands of the company, there would be income arising as services rendered inherently will give rise to non-
capital receipts/accruals. This issue will be discussed further when dealing with the respective parties.
Mr Green Tick
There can be little doubt that any salary earned from the company will form part of his “gross income”.
This will normally accrue on a monthly basis. It will be earned in return for services that have been
rendered (inherently revenue in nature) and will be covered by either the general definition of “gross
income” or paragraph (c) thereof.
It is further clear that Mr Tick physically received an amount of R1,6 million during the current year of
assessment - an amount illegally routed to and deposited into an account created in his personal name.
While physically receiving the amount, it still needs to be established whether a “receipt” or an “accrual” of
the R1,6 million as required for the purposes of “gross income” has taken place. If so, its subsequent
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