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The principle of set-off is a common law principle that applies when two parties have reciprocal claims against each other and such claims are identical, each party may then set-off its claim against the other party’s claim provided that the party exercising its rights is legally entitled to demand performance from the other party under its claim (Siobhan Kearney and Conor Owens ‘Right to set-off: Contractual v equitable set off’ (www.irishlegal.com, accessed 18-1-2024)). The principle of set-off has long been accepted as part of the South African common law. Even though this is a common law principle, it can still apply between the parties by way of an agreement if both parties expressly agree that set-off will apply between the parties in the agreement.

Some conditions have to be satisfied for the set-off principle to be applicable. The conditions are as follows: The debts must be of the same kind, owed by the same parties in the same capacities, reciprocal debts must be due and enforceable, and both debts must be liquidated in the sense that they can be quickly and easily proven (SWVG Inc ‘South Africa: When can you set off a debt?’ (https://swvginc.co.za, accessed 18-1-2024).

Chapter 6 of the Companies Act 71 of 2008 (the Act) provides for a business rescue regime in the South African Law. In terms of s 128(1)(b) of the Act, business rescue refers to proceedings aimed at facilitating the rehabilitation of a company that is under financial distress by providing for:

‘(i) the temporary supervision of the company, and of the management of its affairs, business and property;

(ii) a temporary moratorium on the rights of claimants against the company or in respect of property in its possession; and

(iii) the development and implementation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and other liabilities, and equity in a manner that maximises the likelihood of the company continuing in existence on a solvent basis or, if it is not possible for the company to so continue in existence, results in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company.’

Legal moratorium in business rescue and set-off, how does it work?

In terms of s 133 of the Act, no legal action, including enforcement action, may be taken against the company, in respect to any property that the company owns or is lawfully in its possession while the company is under business rescue. This is only permitted with the practitioner’s written consent, the court’s permission, and in accordance with any terms the court deems appropriate. Furthermore, this section states that legal action may be taken as a set-off against any claims the company makes in any legal proceedings, whether those proceedings were filed before or after the business rescue proceedings only with the written consent of the practitioner.

The question that arises from s 133 is whether set-off qualifies as an enforcement action for purposes of business rescue. In Murray NO and Another v FirstRand Bank Ltd t/a Wesbank [2015] JOL 33382 (SCA) at para 32, Fourie AJA held that ‘the inclusion of the term “enforcement action” under the generic phrase “legal proceeding”, seems to me to indicate that “enforcement action” is a species of “legal proceeding” or, at least, is meant to have its origin in legal proceedings. This conclusion is strengthened by the fact that s 133(1) provides that no legal proceeding, including enforcement action, ‘may be commenced or proceeded with in any forum’. Furthermore, the court held that ‘s 133(1) conveys the notion that “enforcement action” relates to formal proceedings ancillary to legal proceedings, such as the enforcement or execution of court orders by means of writs of execution or attachment’. Therefore, one could argue that set-off does not meet the requirements for an enforcement action and that it can be used against any claim made by a financially troubled company in any court case, whether it is filed before or after business rescue procedures begin.

Section 154(2) of the Act provides that ‘if a business rescue plan has been approved and implemented … , a creditor is not entitled to enforce any debt owed by the company immediately before the beginning of the business rescue process, except to the extent provided for in the business rescue plan.’ Section 154 aims to make clear the position on the release of debts and claims against the company following the approval and execution of a business rescue plan. If a creditor has consented to the full or partial discharge of a debt as part of the approved plan, then the creditor will no longer be able to enforce the debt after the approved plan is approved and its terms and provisions are put into action.

Tax liability and set-off in business rescue proceedings

The question whether the Commissioner for the South African Revenue Service (Sars) is allowed to set-off a tax liability of a company against its value-added tax (VAT) refunds had never been considered before by the South African courts. However, this question had to be answered by the court recently in the case of Henque 3935 CC t/a PQ Clothing Outlet (In Business Rescue) v Commissioner for the SA Revenue Service [2023] JOL 58163 (GJ).

The applicant claimed in a 2017 tax return filed with Sars that it had lost
R 46 000 and was, therefore, exempt from paying income tax. Sars acknowledged that the applicant was entitled to a refund and further informed it that it was subjected to a further audit by Sars. Sars further found that the applicant was eligible for a refund because it had accrued tax credits for VAT.

The applicant commenced business rescue on 31 January 2018 through a resolution by its board. On 4 April 2018, Sars commenced with its audit. The audit revealed that the applicant had in fact a taxable income of R 16 793 724 in 2017. Sars conducted an additional assessment on the applicant on 1 May 2018. The additional assessment indicated the income tax liability for 2017 to be R 5 334 123.13, which included penalties and interest.

On 2 August 2018, Sars sent a letter to the business rescue practitioner informing him that it was not kept up to date with rescue process. The business rescue practitioner requested Sars to send its claim against the applicant for consideration. Sars submitted its claim and claimed R 2 840 005; R 20 705,86; R 104 819,02; R 64 334,60; and R 5 101 361,14, which was for VAT, Unemployment Insurance Fund, Skills Development Levy and income tax respectively.

Sars accepted that the claim for income tax though raised on 4 April 2018 was a pre-commencement debt. Sars being a concurrent creditor, would have to recover this debt in terms of the plan. Sars adopted the view that the rest were post-commencement debts. Therefore, on SARS’ view, the applicant owed it R 3 029 894,53. At the same time, Sars owed the applicant a refund of R 1 018 820,80 for overpayment of VAT.

The applicant addressed correspondence to Sars seeking reimbursement of refunds. After some exchange of correspondence between Sars and the applicant’s attorneys, Sars acknowledged that its initial view that the refund could be set off against the R 3 029 894,53 was incorrect and that the refund was actually due and payable.

Further correspondence was exchanged between the parties and Sars later informed the applicant that its initial view was in fact correct. According to Sars this meant that the refund would not be paid to the applicant as it had been set-off against its income tax liability. Sars held a view that the income tax for the 2017 year only became due and payable on 31 May 2018 after the additional assessment was conducted. Therefore, because this liability was a post-commencement debt, it qualified for the VAT refund to be deducted from the amount owed to it under s 191 of the Tax Administration Act 28 of 2011 (TAA).

The applicant disagreed with the assertion and objected to the set-off of the refund from the amount owed on income taxes for the year 2017. The applicant claimed that the purported set-off was in contravention of s 198(1) of the TAA read with s 154 of the Act. The applicant believed that the completion of the income tax assessment after the commencement of business rescue did not change the more significant fact that the 2017 income tax liability emerged and was due on 28 February 2017. It is a pre-commencement debt and, therefore, it was not possible to apply set-off on same.

The court held that s 96(1)(f) of the TAA, provides that Sars must issue a notice of assessment and that such notice must have the date for paying the amount assessed. The court stated that the additional assessment was made on 4 April 2018 and issued to the applicant on 1 May 2018. The court held that the additional assessment identified the due date to be 1 May 2018 and the second date to be 31 May 2018. The court stated that the second date is the date by when the amount is due. As a result, the court held that the amount assessed, therefore, only became due and payable on 31 May 2018, therefore, it constitutes a post-commencement debt.

The applicant argued that, in accordance with s 5(1) of the Income Tax Act 58 of 1962 (Income Tax Act), the liability for the income tax occurred in February 2017, and that this fact does not change the fact that the additional assessment of income tax was only issued on 1 May 2018. A liability’s assessment, including any further assessments made after 28 February 2017, merely measured liability but did not create one.

The court disagreed with the submission and held at para 19 that s 5(1) of the Income Tax Act only creates the liability but it does so in accordance with the relevant provisions of the TAA. The court stated that the tax only became due and payable after Sars conducted the additional assessment. The court further held that the crucial event that turns a general liability into an actual one is the additional assessment. To put it another way, s 5(1) of the Income Tax Act must be read in light of the TAA and other pertinent laws.

The question laid before the court at the commencement of the proceedings whether the Commissioner for Sars can set-off a tax liability of a company against the VAT refunds due to the company was answered in the affirmative by the court.

Conclusion

It is trite law that a statute may not alter the common law more than is necessary, namely, statutes must not be presumed to change the common law. The common law and statutes must be read in harmony as far as possible. I submit that s 135(3) of the Act, and as held in the Henque case, does not restrict the right to set-off where Sars is a creditor in business rescue. Had the legislature intended to do so, it would have done so. In the circumstances, the provisions of
ss 166(1)(a) and 191(1) of the TAA do not conflict with the provisions of ch 6 of the Act, more particularly with ss 133, 134, and 135. This, therefore, means that Sars is permitted to set-off a refund owing to a taxpayer against any outstanding tax debts of the taxpayer during business rescue.

However, it must be noted that the operation of set-off during business rescue proceedings where a creditor is not Sars has not been considered by the South African courts as yet. It, therefore, remains to be seen at this stage how the courts will view the effect of business rescue proceedings on set-off in those circumstances.

Njabulo Kubheka BA LLB LLM (UKZN) is a Legal Counsel with Absa Group Legal in Johannesburg.

This article was first published in De Rebus in 2024 (May) DR 28.