The recent case of IT 13935 (M Family Trust v CSARS) concerned the tax consequences of a taxpayer’s broker receiving the proceeds, on the taxpayer’s behalf, from the sale of its shares and the subsequent misappropriation of those funds by the broker.

Facts

• On 10 August 2010, M sold its shareholding in D Ltd. The proceeds from the sale were paid in full by the purchaser into the bank account of M’s stockbrokers, as per the sale agreement.
• The funds held on M’s behalf were subsequently transferred to a foreign entity by the name of OP Jewellers in the UAE. This transfer appears to have been undertaken against M’s will.
• M argued that paragraph 35(3)(c) of the Eighth Schedule of the Income Tax Act No. 58 of 1962 should apply. This section provides that the proceeds from the disposal, during a year of assessment, of an asset by a person, must be reduced by any reduction, as the result of the cancellation, termination or variation of an agreement or due to the prescription or waiver of a claim or release from an obligation or any other event during that year, of an accrued amount forming part of the proceeds of that disposal.

Issue

The main issue before the court was the meaning of the words “or any other event,” as set out in section 35 (3)(c) of the Eighth Schedule, and whether it encompasses a case where funds are misappropriated.

Relevant law

The court referred to Natal Joint Municipal Pension Fund v Endumeni Municipality (2012) which dealt with the interpretation of legislation and held that the language of the provision itself must be read in context and having regard to the purpose of the provision. Most importantly, the court referred to ITC 1880 78 SATC 103 which held that a narrow interpretation should be given to the phrase to denote similar categories as those expressed by the preceding words in the paragraph.

Application

The purpose of paragraph 35(3) is to provide relief in the form of a deduction from the proceeds of a disposal of an asset in instances where the proceeds had as yet not been paid but had already accrued to the taxpayer and where provision for payment of the funds are varied, extinguished, waived or cancelled.

The relevant nexus is to the event that causes such extinguishing, not to a subsequent unrelated event caused by a third party who held no obligation to pay for the asset disposed of and who acted outside the agreement to dispose of the asset.

Conclusion

The court found that the alleged fraudulent activity that caused the funds to be removed from the control and beneficial use of M is an event that is not covered by paragraph 35(3)(c) of the Eighth Schedule because the event was committed by a party that was unrelated to the transaction of the disposal of the shares.

Remarks

Even though the taxpayer was no longer in possession of the proceeds from the sale of its shares, the taxpayer was still required to pay tax on the initial capital gain made thereon. It is, however, interesting to note that according to SARS’ interpretation note 80, a bank account is regarded as an asset for capital gains tax purposes.

Taxpayers should seek advice from a tax professional should they find themselves in the unfortunate predicament where proceeds from the sale of a capital asset are embezzled.