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Simulated transactions: welcome clarification from the Supreme Court of Appeal
During a recent court case (Roshcon (Pty) Ltd v Anchor Auto Body Builders CC), the Supreme Court of Appeal (SCA) clarified the issues caused by its decision relating to simulated transactions in a previous case - SARS v NWK Limited (NWK). Taxand South Africa provides an overview of how these cases help clarify the principles around simulated transactions.
The Roshcon (Pty) Ltd v Anchor Auto Body Builders CC case was not a tax case: it concerned supplier and floorplan agreements relating to the sale of trucks. On the assumption that NWK had transformed South African law in regard to simulated transactions, counsel contended that the agreements in question in the Roshcon case were a disguise or simulation, amounting in fact to a pledge of the trucks without delivery of possession as required by law. In rejecting this argument, the SCA took great care to reaffirm the well-established principles relating to simulations, and to explain its previous comments in NWK.
NWK was a tax case. It concerned a loan of R50 million but with a range of unrealistic and self-cancelling features added to make it look like a loan of nearly R100 million. These additional features served no real commercial purpose other than to inflate the deductions that NWK could make against its taxable income. The SCA had no hesitation in declaring the transaction to be a simulation, notwithstanding the fact that the parties intended to take all the unrealistic steps provided for in the contractual documents. Delivering the unanimous judgment of the Court, Lewis JA stated that the commercial sense of transactions need examination for their real substance and purpose. He went further to say that even if parties do deliver the terms of the contract, a performance charade should give credence to their stimulation.
This aroused concern amongst tax practitioners and others. It appeared to call into question the long-established principle that parties may genuinely arrange their transactions in such a way as to avoid the imposition of a tax, or to remain outside the provisions of a statute. It suggested that even an honest transaction might be deemed a simulation if it lacked a sound commercial purpose.
In income tax cases such as NWK, parties may seek to take advantage of income tax legislation in order to obtain a reduction in their overall liability for income tax. The various mechanisms for doing this involve taking straightforward commercial transactions and adding complex additional elements solely for the purpose of claiming increased or additional deductions from taxable income, or allowances provided for in the legislation. This was the case in NWK where a range of unrealistic and self-cancelling features had been included “solely to disguise” the true nature of the loan. The requirement of disguise was therefore met in the NWK case and therefore the simulation principle applied in these circumstances.
The problem the court faced in NWK was that despite the apparent futility in doing so, the parties intended to take all the steps provided for in the contractual documents. It was in this context that Lewis JA had said that it was not sufficient, when testing for a simulation, to enquire whether there was an intention to give effect to a contract in accordance with its terms, the test had to go further, and require an examination of the commercial sense of the transaction, of its real substance and purpose.
The simulation principle still requires an element of dishonesty, disguise or deception. In the absence thereof, the principle cannot apply. In applying this principle to genuine transactions it is therefore not necessary for a court to go further and test whether such transactions have commercial substance and purpose.