Enviroserv Waste Management (Pty) Ltd v CSARS: A win for taxpayers in the SCA
Introduction
All is fair in tax and law, at least this is what all taxpayers hope when going up against the revenue service in a court of law. On the 18th of December 2023, the Supreme Court of Appeal ("the SCA") handed down judgement in what was a scarce win for taxpayers against the South African Revenue Service ("SARS") in the SCA.
This article explains the issues in the case and points out the significance of the decision in the broader context of disputes against SARS.
The facts
Enviroserv ("the Appellant") carries on the business of waste management services, and to carry out these services, the Appellant uses landfill cells ("cells") which are constructed by a process of excavation on a landfill site, and installation in the cells of a subsoil and a drainage system. The Appellant uses these cells to treat waste, thus reducing or eliminating the waste's hazardous effect on the environment.
A dispute arose between the Appellant and SARS. At the centre of the dispute was that the Appellant argued that the cells were "plant" as envisaged in s 12C(1)(a) of the Income Tax Act 58 of 1962 ("the Act") which provides for the favourable accelerated depreciation allowance for plant and machinery at the rate of 40% in the year in which the plant was brought into use and 20% for the subsequent three years. On the other hand, SARS argued that the cells were "environmental waste disposal assets" as contemplated in s 37B(2)(b) of the Act which provides for a less favourable or protracted depreciation dispensation of 5% in each year of assessment.
Furthermore, the Appellant and SARS were at odds on another point, and that is the imposition of an understatement penalty on the Appellant's failure to declare interest income of R25 910 000 due to it in respect of a loan advanced to its Ugandan subsidiary. The loan had not been repaid by the Ugandan subsidiary because of financial constraints and to account for this in its books the Appellant entered the amount in its books as ‘not fully recoverable, but still due’.
The law and arguments in relation to the appropriate depreciation dispensation
The section that the Appellant relied on in the tax court was s 12C(1)(a) read with s 12C(1)(c) which says that machinery or plant used by the taxpayer directly in a process of a manufacture carried on by the taxpayer or any other process carried on by the taxpayer which is of similar nature would enjoy a tax write off of 40% in the year in which the plant was brought into use and 20% for the subsequent three years.
The Appellant argued that the cells should be considered plant as envisaged in s 12C(1)(a) because the cells are used directly in the process of its manufacturing activities or a process similar thereto.
What follows is the Appellant's explanation of the process that takes place during its waste management operations. These are direct extracts from the tax court decision:
At paragraph 16 the Appellant testified:
"The liquid waste is stabilised and blended at the micro-encapsulation plant (or pug mill) resulting in “a final product generated… and that final product will then be land filled in the cell for final disposal”. The sludge is treated in a concrete bunker(s) by blending it with chemicals and “…again this blended material would be the final product that will go to the landfill site for final disposal”.
At paragraph 17 the Appellant testified:
"For solid waste, the processing does not involve treatment at the micro-encapsulation plant or bunker(s)… it is blended with chemicals in a specially designated area on the site itself, and then that blended material will be loaded into a tipper and… be taken to the cell… for the final disposal... treatment of that waste will happen within the waste body and in the cell, and all of that final product will then be disposed of in that cell”.
At paragraph 19 the court explained the evidence given by the Appellant's witness and held:
"the taxpayer is required to “manage” certain by-products as part of its operation: “one of them is the leachate that gets produced, another one is landfill gas and... contaminated water. These are activities related to the disposal of the waste within the cell” and as she put it “…if you haven’t disposed of waste in your cell you wouldn’t be generating leachate or contaminated water”. It is clear from her evidence that these by-products are generated by the waste body itself due to rainfall and biodegradation of the waste"
In summary the Appellant described the process that takes place in the cells as follows: Toxic waste is collected from clients and through a treatment process involving chemicals, which include lime, cement, caustic soda, ferrous sulphate, hydrogen peroxide, sulphur, and sodium metabisulphite, the hazardous components of the waste are removed and placed in the cells. A toxic liquid byproduct of this process, known as leachate or contaminated water, is generated by the waste body itself inside the cell due to rainfall and biodegradation of the waste. The leachate forms at the bottom of the cells and is then extracted and pumped away to a storage dam or tank. At the storage dam or tank the leachate is further treated to remove any other toxins so that it is disposed of as required by the legislation. The remaining waste in the cells remains there for 30 years and is monitored to ensure that leakage does not occur.
Therefore, the Appellant's argument was that the cells are plant because the process that takes place inside the cells is one that is directly part of its manufacturing activities (of waste management) and the product of this process is leachate, which it disposes of as required by law, thereby executing on its mandate of waste management services.
The Commissioner on the other hand argued that the cells were used to store waste and not for a process similar to manufacture. Furthermore, the Commissioner put it to the Appellant that the leachate was not manufactured but was instead an unwanted product that happens when water enters the landfill.
The Commissioner also argued that the cells are more akin to buildings than plant. In this respect, the Commissioner asserted that the cells are:
"‘. . . immovable property that has been structured to fulfil the purpose of waste disposal. The various layers constructed cannot be viewed as plant as these are not fixtures, implements, machinery or apparatus used in carrying on any industrial/manufacturing process but permanent structures. The landfill is an asset used to handle resultant pollutants outside the ongoing process. Thus the landfill will be classified as an environmental waste disposal asset that is more akin to the longer useful life of a manufacturing building and is similar to the examples provided in the EM [Explanatory Memorandum], namely dams, reservoirs, evaporation ponds, etc.’ "
An "environmental waste disposal asset" is defined in s37B as
"any...solid wate disposal site, dam, dump, reservoir, or other structure of a similar nature, or any other improvement thereto, if the structure is -
(a) of a permanent structure;
(b) utilised in the course of a taxpayer's trade in a process that is ancillary to any process of manufacture or any other process which, in the opinion of the Commissioner, is of a similar nature; and
(c) required by any law of the Republic for purposes of complying with measures that protect the environment."
The tax court correctly summarised the parties' positions as follows:
"SARS contends that the “treatment” of the waste once it has reached the cells (in which, it is common cause, the waste is stored in perpetuity) is not a process of manufacture. Put differently, it is SARS’ case that the storage of the waste is ancillary to the treatment of the leachate process; the taxpayer does not manufacture leachate (which is an unwanted by-product); and the cells are, in fact, designed to minimise the forming of leachate."
"On the other hand it is the taxpayer’s case that the process of waste treatment involves an end-product, namely material safe for the environment, that differs substantially from the material received by the taxpayer from its customers, which is unsafe for the environment. This principal activity is the process of manufacture carried out by the taxpayer and differs significantly from “mere storage”. The taxpayer’s case is further that part of the leachate “process” of its waste treatment also occurs in the cells constructed by it for use in its business."
In deciding whether the cells are a direct, integral component of the Appellant's “manufacturing” process the tax court found that "the cells are used by the taxpayer to store the already “manufactured” products, as opposed, for example, to any deductions claimed in respect of its micro-encapsulation plant or bunkers". Furthermore, the court held that "the cells do not drastically change the waste body and by-products once they are stored, whether in terms of utility or value, but rather the contrary".
In essence the tax court was of the view that there was no process of manufacture that took place in the cells and that "the principal activity of the constructed cells is the final disposal of the waste streams managed by Enviroserve [the Appellant] and therefore, the cells were not plants but rather manufacturing buildings."
In the SCA the court decided that the cells are plant that are directly used in the process of the Appellant's manufacturing activities (waste management). The reason for this decision is found in paragraph 18 of the judgement where the court found that the "Commissioner ignored the process of separation of the leachate from solid waste in the cells prior to the draining of the leachate from 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."
In support of the reason for its decision the court found that the Commissioner's interpretation of the word "manufacture" which required ‘manual labour or mechanical process’ found no support in the words used in s 12C(1)(a) and that the Mariam Webster definition of " 'the act or process of producing something’ is more consistent with the words used in the section, except that the end product must be different from the original material."
Further to the above, the court relied on its previous decisions of Secretary for Inland Revenue v Safranmark (Pty) Ltd 1982 (1) SA 113 (A) and Secretary for Inland Revenue v Cape Lime Company Ltd 1967 (4) SA 226 (A) at 234G-H finding that "nothing in the section 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... In the present case too, the fact that the decomposition and biodegradation resulted in the formation of unhazardous waste and leachate (raw material) does not detract from the fact that the leachate, produced from the process that occurred in the cells, is essentially different from the components that went into its production. In the same vein no words in s12C(1)(a) support the interpretation that the end product must be useful or wanted.
The court then summarised its views on the matter at paragraph 27 and 28 of the judgement where it held that the process that takes place in the cells is an indispensable part of the treatment of hazardous waste, more so because the cells and this process are mandated by the license under which the Appellant operates. Therefore, the Commissioner's contention that the cells are storage tanks for waste and by implication "environmental waste disposal assets" was incorrect.
The law and arguments in relation to the understatement penalty
The understatement penalty imposed by the Commissioner stems from the prejudice suffered by SARS or the fiscus for the non-declaration of the Appellant's interest income. However, in the Rule 31 statement the Commissioner did not give any details of the prejudice suffered by SARS or the fiscus. This omission by the Commissioner proved to be the only and fatal blow to the imposition of the understatement penalty because in Purlish Holdings (Pty) Ltd v The Commissioner for the South African Revenue Service [2019] ZASCA 4 para 20 the SCA held that "The Commissioner must show that the reprehensible conduct caused prejudice to SARS or the fiscus." This, in accordance with s 221 and 223(1) of the Tax Administration Act 28 of 2011.
The Commissioner, having failed to make any averments in the statements exchanged between the parties as to how SARS or the fiscus had suffered prejudice did not succeed on this ground too.
The appeal was accordingly upheld with costs.
Takeaways from the judgement
For a number of years, it seemed that SARS was unbeatable in the SCA, that once your dispute with the revenue authority had failed at the tax court (and the high court if you fancied) it was all but certain that the interpretation of the SCA would somehow land in SARS' favour. Noteworthy tax commentators such as Des Kruger had previously mentioned that this had to do with the judiciary taking the "policy position instead of literal interpretations".
However, this judgement, and the court's interpretation of the word "manufacture" in particular has reminded us that the SCA, as with all other courts in South Africa are bound by the principles that guide the interpretation of statutes and that is the approach that was formulated in Endumeni which is that:
"consideration must be given to the language used in the light of the ordinary rules of grammar and syntax; the context in which the provision appears; the apparent purpose to which it is directed and the material known to those responsible for its production. Where more than one meaning is possible, each possibility must be weighed in the light of all these factors. The process is objective not subjective. A sensible meaning is to be preferred to one that leads to insensible or unbusinesslike results or undermines the apparent purpose of the document.”
Clearly if the meaning of the word "manufacture" followed the Commissioner's view that manual labour or a mechanical process was required then what would become of plant that is focused on chemical processes requiring only the use of chemicals to complete its manufacturing process? Surely, such an interpretation would have led to an unbusinesslike result.
On the point of understatement penalties, it was a welcome reiteration on the part of the SCA that SARS is bound by the grounds that it puts to the taxpayer in its statements in preparation for the court proceedings. This, in particular is important because the development of the legislation governing tax disputes has gradually increased SARS' ability to bring in new grounds at the Rule 31 stage of the proceedings.
Indeed, all is fair in tax and law.
The full citation of the case is: Enviroserv Waste Management (Pty) Ltd v The Commissioner for the South African Revenue Service (154/2022) [2023] ZASCA 180 (18 December 2023)
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