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The lawfulness of retrospective amendments in tax law

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The lawfulness of retrospective amendments in tax law

19th July 2017

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On 29 May 2017, Judge Fabricius delivered judgment in the Gauteng High Court in the case of Pienaar Brothers (Pty) Ltd vs Commissioner for the South African Revenue Service and the Minister of Finance, in a case dealing with the Taxation Laws Amendment Act, 2007 (the “Amending Act”) which inserted section 44(9A) into the Income Tax Act, 1962 (the “Act”).

The taxpayer sought an order declaring that section 34(2) of the Amending Act is inconsistent with the Constitution, and invalid to the extent that it provides that section 44 (9A) of the Act shall be deemed to have come into operation on 21 February 2007 and to be applicable to any reduction or redemption of the share capital or share premium of a resultant in company, including the acquisition by that company of its shares in terms of section 85 of the Companies Act, on or after that date.

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Pienaar Brothers approached the court seeking a declaration that the amendment to section 44, the so-called amalgamation section in the Act, was unconstitutional and invalid on the basis that the amendment was retrospective. The company had concluded an amalgamation transaction in terms of section 44 of the Act, in which it acquired all of the assets of the company then known as Pienaar Brothers (Pty) Ltd on 16 March 2007 with effect from 1 March 2007 in terms of the sale of business agreement. Later, on 3 May 2007, the board of directors of the Company resolved, under the Companies Act, to make a distribution to its shareholder’s pro-rata to their shareholding of an amount of ZAR29.5-million out of the taxpayers’ share premium account. On the date of the resolution, the tax law excluded from the definition of “dividend” any amount distributed out of a company’s share premium account. The company therefore argued that on 3 May 2007, when the distribution was made, it did not constitute a dividend as defined in the Act and thus, no secondary tax on companies (“STC”) was due and payable on the distribution on the basis that it was made out of the share premium account. The Commissioner, however, assessed the amount of ZAR29.5-million to STC on the basis that the amount fell within the amendments introduced to section 44 by way of the Amending Act, which was only promulgated on 8 August 2007.

The court examined the process whereby section 44 of the Act was amended. It was pointed out that in the 2007 Budget Speech presented on 20 February 2007, the then Minister of Finance indicated the intention to pass retrospective legislation to deal with anti-avoidance arrangements relating to STC. Subsequently, on 21 February 2007, the Commissioner issued a press release stating that the STC exemption for amalgamation transactions contained in section 44(9) of the Tax Act was to be withdrawn with immediate effect, that is, from 21 February 2007. On 27 February 2007, the South African Revenue Service (“SARS”) and National Treasury released for public comment the Draft Taxation Laws Amendment Bill, 2007. That Bill proposed the amendment of section 44 addressing the concerns raised by the Minister in his Budget Speech. As pointed out above, the amalgamation transaction, the distribution as well as the introduction of the B-BBEE partner in the company was completed in early May 2007. Thereafter, on 7 June 2007, the 2007 Taxation Laws Amendment Bill was published, but instead of proposing the deletion of sections 44(9) and (10) of the Act, it proposed the insertion of a new subsection (9A). The Bill also indicated that the amendment would be retrospective to 21 February 2007. The company contended that it concluded the amalgamation transaction in May and only later in June 2007 did it become aware that the transaction concluded by it could be covered by the amendment.

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On 8 August 2007, the Taxation Laws Amendment Act, 2007 was promulgated, giving effect to the amendments announced in the February 2007 Budget Speech. The company argued that the amendment was invalid under the Constitution because it was retrospective and offended against the principle of legality of the rule of law. The company contended that when it completed the transaction in May, it was not possible to know that the amount would be subject to STC by virtue of the fact that there was no law in place and that it could not be held liable for interest for this reason and similarly could not be subject to penalties or criminal prosecution for not having submitted an STC return reflecting the reduction of share premium as a dividend liable to STC. The judgment deals with both the legal arguments of the company and the Commissioner at length, and refers to the position in South African law as well as a number of other countries.

The case is a very useful summary of the legal position regarding retroactive amendments, not only in the tax arena.

The Commissioner’s counsel contended that the taxpayer was given notice of a proposal to amend the law and that it was not correct to argue that there was no prior notification of the proposed amendment to plug the perceived loophole in the STC legislation. The Commissioner’s counsel referred to the process whereby the amendment was given effect to and the court made it clear that the history of the amendment made it clear that the Minster, SARS and Parliament were determined to close the STC loophole with effect from 21 February 2007. The court analysed the rule of law in the Constitution and various academic writings dealing with that topic. The court referred to the general principle that an amendment to a law should only apply prospectively, that is from a future date unless the amendment makes it clear that it applies from an earlier date. The court reviewed the position of retroactive amendments in the United States, United Kingdom, Canada and other countries and came to the view that those constitutional democracies do not specifically prohibit retroactive amendments to tax laws. The court indicated that it is also necessary to weigh up the public interest and the needs of the Treasury when considering retroactive amendments to legislation even though such amendments may adversely affect particular taxpayers. At paragraph 63, the judge stated as follows:

“I am not aware of any authority or legislative provision that provides that a fairly precise warning needs to be given before the legislature can pass retrospective legislation, whether in general, or in the case of a tax statute. In the latter instance, economic demands must be considered in the context of the purpose and effect of an intended statute. If the tax statute is rationally connected to a legitimate purpose, no precise warning is required, if one at all.”

The court pointed out that the Constitution itself does not contain a provision prohibiting retrospective legislation. The court accepted that Parliament may not legislate with retrospective effect as it pleases, but to do so must meet the standard required for the constitutional validity of retrospective amendments. It indicated that reference must be made to the rationality test and the second standard relating to reasonableness or proportionality.

The court referred to various judicial decisions and came to the conclusion that, in the particular instance, the standards set by the court had not been violated and therefore decided that the amendment to section 44 was lawful and the taxpayer was liable to the STC as assessed by the Commissioner.

The taxpayer also argued that its right to property had been violated as a result to the manner in which the amendment was enacted and the court dismissed this contention on the basis that the amendment did not constitute the unlawful deprivation of property.

The court came to the conclusion that it is not necessary that exceptional circumstances must exist for Parliament to pass retrospective legislation. The court decided that there was no overriding duty to give notice of intended legislation. It was decided, in the present case, that there was sufficient notice of general impact and that there is no overriding duty to give notice that indicates precisely what the intended legislation will encompass.

As a result, the court dismissed the company’s application to find that the amendment was unlawful under the Constitution. By virtue of the fact that the case related to constitutional issues, it made no orders as to costs. It remains to be seen if the case will proceed on appeal to a higher court. The judgment is important in that it sets out clearly, for the first time, the consequences of retrospective amendments to legislation in the tax arena and taxpayers and advisors are well advised to study the comprehensive judgment which is a good summary of the law in South Africa and around the world.

Written by Beric Croome, Executive, Tax, ENSafrica

This article was first published by ENSafrica.

No information provided herein may in any way be construed as legal advice from ENSafrica and/or any of its personnel. Professional advice must be sought from ENSafrica before any action is taken based on the information provided herein, and consent must be obtained from ENSafrica before the information provided herein is reproduced in any way. ENSafrica disclaims any responsibility for positions taken without due consultation and/or information reproduced without due consent, and no person shall have any claim of any nature whatsoever arising out of, or in connection with, the information provided herein against ENSafrica and/or any of its personnel. Any values, such as currency (and their indicators), and/or dates provided herein are indicative and for information purposes only, and ENSafrica does not warrant the correctness, completeness or accuracy of the information provided herein in any way.

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