On 1 March 2004, Ackermans sold its retail business as a going concern to Pepkor Ltd. The purchase price was defined as R800m plus the rand amount of liabilities (totalling R1,129,440,402). The liabilities included three contingent liabilities totalling R17,174,777: (a) R9,880,666 for post-retirement medical aid benefits; (b) R6,394,111 for long-term bonus schemes; and (c) R900,000 for property lease repair obligations. In terms of the sale agreement, Pepkor assumed all of Ackermans' liabilities including the three contingent liabilities. The purchase price was discharged by Pepkor assuming the liabilities and creating an R800m loan account. Ackermans claimed a deduction under s 11(a) of the Income Tax Act 58 of 1962 for the amount of R17,174,777, arguing it incurred expenditure by accepting a reduced purchase price in exchange for Pepkor assuming the contingent liabilities. Pep Stores had a similar appeal on identical facts.
The appeals were dismissed with costs, including the costs of two counsel.
The binding legal principle is that 'expenditure actually incurred' within the meaning of s 11(a) of the Income Tax Act 58 of 1962 means the undertaking of an obligation to pay or the actual incurring of a liability. A taxpayer does not incur expenditure merely by accepting a reduced purchase price in exchange for a purchaser assuming the taxpayer's liabilities. For expenditure to be actually incurred, there must be a legal obligation or liability created, not merely an economic diminution of the taxpayer's patrimony. At the effective date of a transaction, if no legal obligation to pay is created by the taxpayer, no expenditure is actually incurred for purposes of s 11(a).
The court made several non-binding observations: (1) It was not necessary to consider whether lump sum expenditure incurred to free a taxpayer from anticipated or contingent revenue expenses is itself of a revenue nature, as this was not determinative of the appeal. (2) The court noted that there would be no anomaly in not allowing the deduction to Ackermans, as Pepkor would be entitled to deduct the liabilities when they became unconditional. (3) The court observed that the mechanism employed in the sale agreement was to facilitate the sale and that journal entries do not equate to expenditure actually incurred. (4) The court commented that in transactions of this nature, the net asset value (assets less liabilities) typically dictates the purchase price and liabilities are ordinarily discharged by the purchaser when purchasing a business as a going concern.
This case is important in South African tax law as it establishes the meaning of 'expenditure actually incurred' in s 11(a) of the Income Tax Act 58 of 1962. It clarifies that for a deduction to be allowed under s 11(a), there must be an actual undertaking of an obligation to pay or the incurring of a liability. The case confirms that accepting a reduced purchase price in exchange for a purchaser assuming liabilities does not constitute expenditure actually incurred by the seller. It provides guidance on the distinction between economic substance and legal form in tax deductions, emphasizing that the legal creation of a liability is required, not merely an economic diminution of patrimony. The judgment is significant for structuring business sale transactions and understanding what constitutes deductible expenditure in the context of assumption of liabilities.