One of the issues dealt with in a recent Tax Court decision was the deductibility of certain marketing and management fees paid by the taxpayer, to its local holding company. The Commissioner for the South African Revenue Service disallowed both deductions when assessing the taxpayer on the grounds that they were excessive. The Tax Court found in favour of the taxpayer and allowed the deduction of the full amount of both fees. The decision is, however, a reminder to taxpayers to ensure that when calculating the costs of intra-group company services they are able to demonstrate that such costs were incurred in the production of income and not inspired by some other motive.
The taxpayer, being a company that conducts mining operations and exports fluorspar, concluded a marketing agreement with its holding company in terms of which the latter was appointed the sole marketing agent. The marketing agreement provided that:
- the taxpayer would pay R3 million to its holding company to conduct a study into global demand and supply priorities of the product and to expand the taxpayer's customer base;
- a fee of R200 000 was payable monthly, which amount would escalate at 10 per cent annually;
- the holding company would use all reasonable endeavours to increase the taxpayer's customer base and sales and provide accurate and proper records of all transactions concluded by it pertaining to the taxpayer's product;
- the holding company would pay over sales proceeds received by it monthly in arrears;
- the holding company would render all reasonable assistance to the taxpayer as required by it including legal proceedings, marketing and product queries; and
- the holding company would be entitled to appoint sub-agents to assist with the marketing of the product and the taxpayer was liable for the costs of sub-agents.
An independent geologist testified that the marketing fees were reasonable by prevailing standards. The court accepted that the benefits of entering into the marketing agreement were such that the taxpayer was able to secure large sales at higher prices and penetrate the European market, a market with which they had not had much success previously. These were, in the words of the court, "...legitimate purposes for claiming this expense of marketing fees". The fact that the holding company used sub-agents overseas did not derogate from this intention.
The holding company was paid out under the marketing agreement less than 3% of the taxpayer's turnover and the sub-agents were paid about 2.5%. The court held that such fees were not excessive in the generally accepted sense of such matters. For these reasons the tax court stated that it could not be said that the marketing fees were so devoid of commercial rationality or substance that a motive other than the production of income motivated them.
The principle that can be derived from this decision is that it is not for the courts or the Commissioner, with the benefit of hindsight, to say that a particular expense was not strictly necessary or that it was not effective. Nevertheless, in our analysis, the Commissioner failed to succeed because he could not validly challenge the commercial necessity for marketing in these particular circumstances nor the reasonableness of the fees incurred.
However, we caution that there may very well be cases where expenditure incurred is not in the production of income because of their excessive nature. The courts have held that the Commissioner may validly challenge deductibility of expenditure where the expenditure is unreasonable and hence not in the production of in
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