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ANALYSIS: A bad settlement is better than a good judgement

Two court judgements illustrate why it’s almost always best to settle out of court.

As a member of the tax court, I have learnt to accept that there is wisdom in the proverb “a bad settlement is better than a good judgement”. A number of tax disputes are decided by the courts of law because each of the parties involved believe they have a strong case, which naturally implies that the other party has a weak case.

This is not confined to tax matters. I am reminded of a fable that was shared many years back. This narrative is about two cats with some bread to share. Instead of enjoying the bread they argued that the bread was not divided equally. Cat one believed that cat two unjustifiably received a bigger share. Cat two, on the other hand, was of the view that cat one received a bigger portion.

The two cats agreed to approach a judge (Judge Sokhetye) to help them solve their problem. Apparently Judge Sokhetye was delighted to see that these two cats had the wisdom to approach him.

He asked his subjects to bring the scale so that he could weigh the bread and see if there were any merits to the argument that the shares were not equal. The scale proved that one share of bread was indeed bigger than the other. As a solution Judge Sokhetye decided to take a bite of the bigger share and gobbled quickly. This was seen as a step in the right direction as the bigger bread was going to be approximately the same size as the smaller one.

Unfortunately, after the bite, what was previously the bigger bread was now the smaller. Judge Sokhetye applied the same approach by biting the bigger bread as a way of balancing the scales. The scale did not balance until the bread was finished. Judge Sokhetye then stood up, adjourned the court proceeding (mayichithekeinkundla) and declared that the problem was solved (umcimbindiwugqibile).

Once a matter goes to court you are guaranteed that at least one party is going to lose. It is not a negotiated settlement, it is a judgement. There has to be a loser, whether deserved or not. Sometimes losers are determined by technical arguments, rather than the merits of the case. Sometimes a party loses because a particular angle was not argued by the legal representatives.

Sometimes the court views the matter from a completely different angle. Consider the following recently decided cases:

Commissioner, SARS v Brummeria Renaissance (Pty) Ltd 2007 (6) SA 601 (SCA), 69 SATC 205
The Supreme Court of Appeal had to adjudicate on the issues as defined in the statement of the grounds of assessment, read with the statement of the grounds of appeal. Issues that were not raised in the statement of grounds of appeal could not be pursued before the court. The court had to consider the taxpayers’ contention that the interest-free loans did not result in any ‘amount’ being “received by” them which could be, and was, wrongly included in their gross income. The Supreme Court of Appeal (SCA) held that the right to use the loan capital interest free has an ascertainable money value that should be included in the gross income of the taxpayers.

Clearly the taxpayer lost in this case. One wonders how this case would be decided had the taxpayer argued (as an alternative) that even if there is an ‘amount’ as envisaged in gross income definition, such amount was of a capital nature.

This is extracted from a judgement released by the Supreme Court of Appeal.
In 1993 AECI formed Founders Hill as a ‘realization company’ with the express purpose of realizing the land which AECI sold to it to “best advantage”. It commenced doing so and engaged the services of another AECI subsidiary, Heartland Properties, to further develop and market the land.

The Commissioner initially did not regard profits on sales of the Modderfontein land as taxable income. But for the tax years 2000 and 2001, he issued a revised assessment on the basis that the profits were taxable income. He also levied penalty and interest. Both the Commissioner and Founders Hill approached the question whether the erven sold were capital assets or stockin- trade on the basis that Founders Hill had acquired capital assets: the Commissioner contended that the company had changed its intention and had become a trader in land.

On appeal, the Supreme Court of Appeal took a different approach. It held that once an entity acquires assets for the purpose of selling them, it trades in those assets. There are exceptional cases where a realization company or trust is required in order to facilitate the sale of assets (for example, where different people owned them, but to sell to best advantage the interposition of another entity is required). But this case was not exceptional and Founders Hill had traded in the land it had acquired from AECI for that purpose.

This judgement was criticised for being based on an argument that was not contended by any of the parties involved. There are a number of other cases where losing parties thought they had strong cases, which were decided otherwise. These include Commissioner for South African Revenue Service v NWK Ltd (27/10) [2010] ZASCA 168, Computek v The Commissioner, SARS (830/2011) [2012] ZASCA 178 and VAT Case number: 759.

Taxpayers should remember that in tax cases the playing fields are not levelled because:

  • Section 102 of the Tax Administration Act No 28 0f 2011 requires the taxpayer to discharge the onus of proof that they should not be taxed or they are entitled to a deduction. This replaces section 82 of the Income Tax Act No 58 of 1962. I have heard certain taxpayers in court arguing that SARS has not proven their case. SARS is only required to discharge the onus of proof under very limited circumstances
  • Tax authorities sometimes can resolve to change the law when they lose certain cases. This is what happened after the Tradehold case decided in 2012.

I believe that settlement is the way to go.

Author: Zweli Mabhoza CA(SA) is Gead of Tax Services, SizweNtsalubaGobodo.