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
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
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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