ENVIROSERV WASTE MANAGEMENT (PTY) LTD V THE COMMISSIONER FOR THE SOUTH AFRICAN REVENUE SERVICE

Key take aways

After considering the interpretation of section 12C(1)(a) of the Income Tax Act 58 of 1962 (the ITA), the court found that cells constructed by the appellant on its landfill sites constitute plant used directly in a process of manufacture or a process similar to manufacture.

When it comes to the imposition of understatement penalties by SARS, the court held that it is not sufficient for the Commissioner to merely show that a taxpayer’s conduct falls within the provisions of section 221 (read with s 223(1)) of Tax Administration Act 28 of 2011 (the TAA). The onus is on the Commissioner to show that the reprehensible conduct caused prejudice to SARS or the fiscus.

The facts

This matter was heard by the Supreme Court of Appeal (the SCA), following an appeal by the taxpayer from the Tax Court.

Enviroserv conducts a business of waste management services. It collects pre-classified solid waste from clients in return for fees, which is then taken to landfill sites, where the waste is treated, recycled and disposed of as defined in section 1 of the National Environment Management: Waste Act No 59 of 2008. The waste taken to the landfill sites contains organic or inorganic compounds that may have a detrimental impact on the environment because of inherent physical, chemical or toxicological characteristics. To remove these hazardous compounds, the waste is treated with various chemicals. It is then deposited into the cells, where it gets broken down and decomposes, producing a liquid substance known as leachate (a contaminated fluid). The leachate gathers at the bottom of the cell and is drained and pumped away to a storage dam or tank, where it is treated for further removal of toxins, after which it is disposed of in accordance with the prescribed legislation.

Separate from the facts discussed above, the Commissioner also levied an understatement penalty (USP) of 25% in respect of claims for future expenditure made under section 24C of the ITA against Enviroserv. According to the Commissioner, Enviroserv failed to declare interest income of R25 910 000 due to it in respect of a loan advanced to its Ugandan subsidiary. Because of financial constraints, the subsidiary had not been able to pay the interest and Enviroserv impaired it for accounting purposes as ‘not fully recoverable, but still due’.

The issues

Enviroserv contends that the process that takes place within the cells is ‘manufacturing’ or a process akin thereto. Consequently, the cells constitute plant used directly in the process of its manufacturing activities or a process similar thereto as provided in section 12C(1)(a) of the ITA. As such, it is entitled to depreciation allowances of 40% and 20% in the 2015 and 2016 years of assessment respectively.

The Commissioner argued that the cells do not constitute plant as envisaged in section 12C(1)(a) of the ITA, as they are not fixtures, implements, machinery or apparatus used in conducting or promoting Enviroserv’s business. Instead, they are rather structures, something akin to dumps or reservoirs as provided in section 37B of the ITA. The Commissioner, therefore, disallowed the claimed amounts, maintaining that the cells are waste disposal assets as defined in section 37B of the ITA, and that Enviroserv was only entitled to claim depreciation at 5% per year in respect thereof.

Regarding the imposition of the USP, the Commissioner contends that interest of R25 910 000 should have been included as accrued gross income in Enviroserv’s 2016 year of assessment, and that failure to include it resulted in an overstatement of Enviroserv’s losses.

Enviroserv argued that no USP should have been levied on the section 24C claims, as the understatement resulted from a ‘bona fide, inadvertent error’ as contemplated by sections 222(1) to 223 of the TAA.

Held by the court

The ITA contains no definition for ‘process’ or ‘manufacture’ or ‘process of manufacture’. The court therefore cited the following interpretation attributed to ‘process of manufacture’ in SIR v Hersamar:¹

Neither of the governing words in the phrase under consideration, viz “process” and “manufacture”, are words of any exact significance. Consequently, the whole phrase, “a process of manufacture”, is one to which it may be very difficult to assign a meaning expressed in terms which would properly distinguish between all cases which fall within the scope of the phrase and those which should fall outside its scope. The word “process” can cover an unlimited multiplicity of types of operations: “manufacture”, in its widest sense, can be said to mean the making of any sort of article by physical labour or mechanical power. DARLING J in McNicol v Finch (1906) 2 KB 352 at 361 stated that “the essence of making or manufacturing is that what is made shall be a different thing from that out of which it is made”.

In reaching the conclusion that the cells are used for waste storage – a purpose that is ancillary to manufacture – the Commissioner ignored the process of separation of the leachate from solid waste in the cells. The omission of the process that occurs in the cells, and consideration only of the ultimate storage of treated waste in the cells, which is the final stage in the chain of waste management steps, is incorrect.

The court held that nothing in section 12C(1)(a) of the ITA can be interpreted to mean that raw material is ‘insufficient’ as an end product of the process of manufacture, as contended by the Commissioner. The test is whether that which is made is different from that out of which it is made.² In the same vein, no words in section 12C(1)(a) support the interpretation that the end product must be useful or wanted. The fact that the process conducted in the cells resulted in the formation of unhazardous waste and leachate (raw material), does not detract from the fact that the leachate is essentially different from the components that went into its production.

Furthermore, the court held that a sensible interpretation of the definition of ‘environmental waste deposit asset’ in section 37B(1) is that, where an asset is not an indispensable part of the process of manufacture but is utilised for the ancillary purpose of compliance with legal prescripts aimed at protecting the environment, then the provisions of this section are applicable. In other words, where the desired results can be achieved without utilisation of the asset, then the asset is ancillary to the process of manufacture. Where, as is the case in the current matter, the asset is an indispensable part of the manufacturing process, it cannot be ancillary to that process. The process conducted in the cells to extract the hazardous leachate is an indispensable part of the treatment of the hazardous solid waste. The fact that the cells are also used to permanently store the non-hazardous material, does not detract from their use directly in the process of manufacture.

Consequently, the cells constitute plant used directly in the process of its manufacturing activities or a process similar thereto as provided in section 12C(1)(a) of the ITA.

With regards to the USP, the court stated that the basis for the imposition of an understatement penalty is the prejudice suffered by the Commissioner as a result of the understatement of income by a taxpayer. It is therefore not sufficient for the Commissioner to merely show that a taxpayer’s conduct falls within the provisions of section 221 (read with section 223(1)) of the TAA, but the onus is also on the Commissioner to show that the reprehensible conduct caused prejudice to SARS or the fiscus.³

The Commissioner failed to make any averments of prejudice suffered by SARS or the fiscus in its statement prepared in terms of rule 31 of the Tax Court Rules. The Commissioner further contended that prejudice is not limited to financial prejudice, but includes the risk that the misstatement will hamper the ability of SARS to effectively administer tax legislation. However, no effort was made on the part of the Commissioner to prove the existence of such risk. The Commissioner therefore failed to discharge the onus of proving that Enviroserve’s conduct caused any prejudice to SARS or the fiscus.

The court upheld the appeal with costs.

This case provided a rare double-victory for taxpayers:

The SCA confirmed that issuing USP’s is conditional upon the Commissioner proving that a taxpayer’s conduct caused prejudice to SARS or the fiscus and that SARS is bound by the grounds that it puts to the taxpayer in its statements in preparation for court proceedings, such as the rule 31 statement.

The court also followed the rules of interpretation as laid down in Endumeni in preventing an overly stringent interpretation of the word ‘manufacture’ that would only allow manual labour or mechanical processes to satisfy ‘manufacture’ as provided in section 12C(1)(a) of the ITA.

1. Secretary for Inland Revenue v Hersamar (Pty) Ltd 1967 (3) SA 177 (A) at 186H-187A
2. Secretary for Inland Revenue v Safranmark (Pty) Ltd 1982 (1) SA 113 (A) para 18.
3. Purlish Holdings (Pty) Ltd v The Commissioner for the South African Revenue Service [2019] ZASCA 4 para 20.

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