Businesses frequently enter into arrangements under which one company assumes responsibility for expenses ordinarily incurred by another, particularly within corporate groups. While such arrangements may make commercial sense, their tax consequences are not necessarily straightforward.

In Taxpayer Olie Trading (Pty) Ltd v Commissioner for SARS (IT 76811), the Tax Court considered whether a company could deduct expenditure incurred in supporting an associated mining company, where that expenditure was intended to protect its future supply of raw materials.

The Court dismissed the taxpayer's appeal, illustrating the distinction between expenditure incurred for a legitimate commercial purpose and expenditure qualifying for deduction under the Income Tax Act.

Background to the dispute

Taxpayer Olie Trading (Pty) Ltd (‘Olie’) conducted the business of processing, marketing and selling foundry-grade chromite sand. It obtained chrome ore from an associated company, Clarisse Mining Limited (‘Clarisse’), under an offtake agreement concluded in 2009.

The agreement provided that Clarisse would supply chrome ore to Olie at production cost plus 6.5%. Importantly, it also stipulated that, should Clarisse enter a period of ‘care and maintenance’, Olie would become responsible for Clarisse's operational costs until mining operations resumed.

In August 2017, Clarisse suspended mining operations and entered care and maintenance, remaining in that position throughout the 2018, 2019 and 2020 years of assessment.

Two categories of expenditure subsequently became contentious.

The first comprised approximately R25.1 million in production costs previously advanced by Olie on Clarisse's behalf. These amounts were ordinarily recovered through subsequent purchases of chrome ore, but became irrecoverable when mining ceased. Olie wrote off the amount in its 2018 financial year.

The second comprised approximately R40.5 million in operational expenses paid during the care and maintenance period, principally relating to security, electricity and preservation of the mining operations.

SARS disallowed the deductions, prompting Olie to appeal.

The taxpayer's argument

Olie contended that the expenditure was incurred in the production of its income and for the purposes of its trade, as contemplated in section 11(a), read with section 23(g), of the Income Tax Act.

Its argument was commercially understandable.

Olie depended on Clarisse for chrome ore and had invested approximately R40 million in constructing a processing plant at Clarisse's mine. Preserving the mine, its mining rights and associated infrastructure was therefore important to Olie's future operations.

Moreover, the obligation to meet Clarisse's operational expenses was expressly provided for in the offtake agreement.

Olie accordingly maintained that the expenditure was incurred to protect its business and secure its future income-producing activities.

Why the Court disagreed

The Court identified three principal difficulties with Olie's position.

First, the expenditure was not incurred by Olie itself.

Although Olie paid the expenses, the underlying invoices were issued to Clarisse, which maintained the contractual relationships with the service providers.

The Court distinguished between paying another company's liabilities and actually incurring expenditure for purposes of section 11(a).

The contractual obligation under the offtake agreement did not, in the Court's view, transform Clarisse's expenses into deductible expenditure of Olie.

Second, the expenditure lacked the necessary connection with Olie's income-producing operations.

The care and maintenance expenses were directed at preserving Clarisse's mining operations and ensuring that production could potentially resume in future.

The Court considered these to be holding costs associated with preserving an income-producing structure, rather than expenditure incurred in producing Olie's income during the relevant years.

Although Olie continued trading, this did not establish the necessary connection between the expenses and its own trading activities.

Third, the expenditure was not incurred for the purposes of Olie's trade.

The Court emphasised the distinction between Olie's business of processing and selling chromite sand and Clarisse's business of mining chrome ore.

Protecting a future source of supply did not, without more, establish that Clarisse's operational expenditure was incurred for the purposes of Olie's trade.

The additional difficulty with the bad debt

The Court also rejected the deduction of the approximately R25.1 million written off in 2018.

The expenditure had been incurred over several preceding years and could not simply be claimed as a deduction in 2018.

Furthermore, the Court found that the requirements for a bad debt deduction under section 11(j), as addressed in the judgment, had not been satisfied.

Reclassifying the expenditure as a cost of sales did not alter its underlying character.

The outcome and practical implications

The Tax Court dismissed the appeal, confirmed SARS' additional assessments for all three years, together with interest, and ordered Olie to pay SARS' costs, including counsel's costs.

The judgment carries an important message for corporate groups.

Commercial arrangements involving shared expenses, financial support and the preservation of group operations require careful consideration from a tax perspective.

A contractual obligation to fund another company's expenses does not necessarily establish an entitlement to deduct those expenses. Equally, expenditure incurred to protect future business opportunities must still satisfy the statutory requirements for deductibility.

The central lesson is that commercial justification and tax deductibility are not synonymous

Each company must establish its own entitlement to a deduction, having regard to the nature, purpose and timing of the expenditure.

The fact that an arrangement benefits the wider corporate group is not, by itself, sufficient.