Small businesses looking for ways to protect themselves against operational risks and manage cash flow should carefully assess the tax implications of structured financial products, following a High Court ruling against an Eastern Cape citrus farming business.
The Western Cape High Court upheld the South African Revenue Service’s (SARS) additional tax assessment against Meiring Citrus, disallowing an almost R10 million expense claim linked to a structured self-insurance agreement with insurer Santam.
The case highlights the challenges SMEs face when using specialised financial arrangements designed to protect businesses against unexpected losses while also offering potential tax benefits.
Like many SMEs operating in high-risk industries, Meiring Citrus faced several business risks that could affect profitability and exports.
In testimony before the High Court, CEO Marina Meiring highlighted the risks facing the farming operation, including citrus black spot and false codling moth (FCM), which had previously affected exports and caused losses.
During discussions around the company’s 2017 provisional tax return, Meiring approached accountant Jeandre van Zyl from Moore Stephens WK Incorporated for ways to expense R10 million.
Van Zyl advised the company about a structured self-insurance product offered by Santam, which allowed Meiring Citrus to pay a R10 million premium over six months while receiving cover of R12 million, including VAT.
Under the arrangement, Santam deducted an underwriting fee of R400 000, while the remaining R9.6 million was placed into an “experience account” where insurance claims could be paid from the funds and the money could earn notional interest for the benefit of Meiring Citrus.
SARS questions major expense increase
The arrangement later attracted SARS’s attention after the farming business’s insurance expenses increased significantly from R220 527 in the 2016 tax year to R10 million in the 2017 tax year.
When SARS requested information about the expense, Van Zyl explained that the increase was due to the self-insurance arrangement with Santam and that the company was claiming the expense under the Income Tax Act.
SARS initially did not adjust the assessments after completing its verification process. However, after receiving the full Santam structured insurance contract, SARS raised additional assessments.
The revenue service argued that the arrangement operated more like an investment transaction rather than insurance.
Court ruling offers lessons for SMEs
The court found that the agreement between Santam and Meiring Citrus was “akin to an investment deposit in a bank account”.
“The Santam structured agreement was not a sham contract. The parties intended it to have effect in accordance with its tenor,” the court found.
However, the court ruled that simply labelling a contract as insurance and calling payments premiums did not automatically make the expense deductible.
The ruling confirmed SARS’s additional assessment, which disallowed the R10 million deduction and imposed a 10% understatement penalty.
What SMEs can learn
For SMEs, the case highlights the importance of understanding the financial and tax consequences of business protection strategies.
While insurance remains an important tool for businesses facing operational risks, complex arrangements require careful consideration to ensure they meet regulatory and tax requirements.
Small business owners should seek professional advice before entering agreements involving large financial commitments and ensure that products marketed as insurance provide genuine insurance benefits and comply with SARS requirements.
