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[2015] ZASCA 138
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Commissioner for the South African Revenue Service v Stepney Investments (20192/14) [2015] ZASCA 138; [2016] 1 All SA 1 (SCA); 2016 (2) SA 608 (SCA); 78 SATC 86 (30 September 2015)
Links to summary
THE SUPREME COURT OF
APPEAL OF SOUTH AFRICA
JUDGMENT
Case
No: 20192/14
Reportable
In
the matter between
THE
COMMISSIONER FOR THE
SOUTH
AFRICAN REVENUE SERVICE
FIRST APPELLANT
and
STEPNEY
INVESTMENTS (PTY)
LIMITED
RESPONDENT
Neutral
citation:
Commissioner
for the South African Revenue Service v Stepney Investments
(20192/14)
[2015]
ZASCA 138
(30 September 2015)
Coram
:
Navsa, Shongwe,
Majiedt and Mbha JJA and Van der Merwe AJA
Heard:
8
SEPTEMBER 2015
Delivered:
30 SEPTEMBER 2015
Summary:
Tax – determination of base cost of shares in terms of Eighth
Schedule to the Income Tax Act 58 of 1962 for capital
gains tax
purposes – 4.37% of shares in company disposed of –
market value of shares on valuation date to be determined
–
whether discount cash flow valuation method appropriately applied by
taxpayer.
ORDER
On
appeal from:
Tax
Court of South Africa, Cape Town (Yekiso J sitting as President of
the Tax Court):
1.
The appeal is upheld
with costs, including those of two counsel.
2.
The order of the Tax
Court is substituted with the following:
‘
(a)
The appeal is upheld.
(b)
The additional assessments in respect of the 2002 and 2003 tax years
of assessments are hereby set aside.
(c)
The matter is remitted to the Commissioner for the South African
Revenue Service for further investigation and assessment.
(d)
The Commissioner is ordered to pay the costs, including those of two
counsel where so employed’.
JUDGMENT
MAJIEDT
JA (Navsa, Shongwe and Mbha JJA and Van der Merwe AJA concurring):
[1]
Capital gains tax was introduced on 1 October 2001 through the
insertion of s 26A and the addition of the Eighth Schedule (the
Schedule) to the Income Tax Act 58 of 1962 (the Act). Where a capital
gain accrues on the disposal of assets in the seller’s
possession on, or acquired after, 1 October 2001, capital gains tax
is payable. The tax payable is determined by a calculation
of the
difference between the proceeds of the sale and the base cost of the
asset disposed of. At issue in this appeal is whether
the Tax Court
of South Africa, Cape Town, (Yekiso J sitting as President of the Tax
Court), was correct in setting aside the additional
assessments
raised by the appellant, the Commissioner for the South African
Revenue Service (the Commissioner) against the respondent,
Stepney
Investments (Pty) Ltd (Stepney), in respect of the 2002 and 2003
years of assessment for capital gains tax. This requires
a
determination whether Stepney had proved the base cost of the asset
disposed of during those years of assessment, namely 4.37%
of the
shares it had held in Emanzini Leisure Resorts (Pty) Ltd (ELR). This
appeal is with the leave of the Tax Court in terms
of s 86A(2) of the
Act.
The
legislative context
[2]
The shares disposed of were a pre-valuation date asset as defined in
paragraph 1 of the Schedule, ie an asset acquired prior
to 1 October
2001 and not sold prior to that date. Paragraph 25 of the Schedule
provides that ‘[t]he base cost of a pre-valuation
date asset .
. . is the sum of the valuation date value of that asset, as
determined in terms of paragraph 26, 27 or 28 and [certain
other
expenditure]’ Stepney elected in terms of paragraph 26(1)(a) to
utilise ‘the market value of the asset on the
valuation date,
as contemplated in paragraph 29, of the Schedule’ as the method
of determining the value of the shares as
at 1 October 2001
[1]
.
Paragraph 29(1)(c) provides that the market value on the valuation
date of the shares would be ‘the market value determined
in
terms of paragraph 31 on valuation date’ (the paragraph 29
market value). Such market value would, in terms of paragraph
31(1)(g), be ‘the price which could have been obtained upon a
sale of the asset between a willing buyer and a willing seller
dealing at arm’s length in an open market’.
[3]
The contention advanced by Stepney was that it had sustained a loss
in respect of the disposal of the shares because the aggregate
base
cost of the shares had exceeded the amount of the disposal proceeds.
It placed a value of R8 686 162 on the aggregate
base cost,
calculated as 4.37% of the paragraph 29 market value of the total ELR
shares, namely R198 768 000. This valuation
of the total
ELR shares emanated from a valuation conducted by Bridge Capital
Services (Pty) Ltd in respect of all the ELR shares
(the Bridge
valuation), undertaken for all companies in the Tusk group (which
included ELR) in order to determine the base cost
of the various
assets of the group as at 1 October 2001 for capital gains tax
purposes. Purportedly acting in terms of paragraph
29(7)(b) of the
Schedule
[2]
,
the Commissioner adjusted this valuation to nil. In additional
assessments raised on 10 April 2007 as a consequence of this
adjustment, Stepney was assessed for a capital gain of R2 million in
its 2002 year of assessment and for a capital gain of R2.2
million in
its 2003 year of assessment in respect of its disposal of the shares
during those years. The Commissioner disallowed
Stepney’s
objection to these additional assessments, but the Tax Court set
aside this disallowance
[3]
.
The
factual context
[4]
Stepney originally held 23.73% of the shares in ELR. The latter was
mainly engaged in developing, owning and operating casinos,
hotels
and related leisure activities. The Kwazulu Natal Gambling Board (the
Gambling Board) awarded a casino licence to ELR on
21 August 2000 for
a period of 15 years in respect of a defined area, namely Richards
Bay. Complications arose subsequently when
members of a religious
grouping, known as the Richards Bay Ministers’ Fraternal,
litigated against ELR in respect of the
site where the casino was to
be erected. The awarding of the casino licence itself was, however,
not in issue. The litigation,
which ultimately reached this court and
in which the Richards Bay Ministers’ Fraternal was
unsuccessful, caused considerable
delays in the establishment of the
casino at Richards Bay. Consequently, ELR acquired an alternative
site at Empangeni under a
temporary licence issued by the Gambling
Board on 4 October 2001. At the time of the valuation for capital
gains tax purposes,
ELR was in possession of a permanent casino
licence which it was unable to utilise and was in the process of
acquiring a temporary
licence.
[5]
The Bridge valuation lies at the heart of the dispute whether the
value placed on ELR (and
a
fortiori
the
determination of the aggregate base cost of the shares disposed of)
was reasonable. In this regard Stepney bore the onus of
proving that
its valuation of the shares disposed of is correct
[4]
.
In the Tax Court it called a number of witnesses to discharge this
onus, the main one being an expert, Mr Pieter Veldtman of Bridge
Capital Services, a chartered accountant and an accredited sponsor
and designated advisor in respect of JSE matters and listed
companies. One of his specialities is the valuation of unlisted
shares. The Commissioner, in turn, adduced the evidence of several
witnesses to meet this case, the most important of whom were
Professor Harvey Wainer and Mr David Costa who, like Mr Veldtman,
are
chartered accountants. Prof Wainer is also an expert valuer of
companies and businesses, having lectured on the subject for
more
than 20 years and having done several hundred such valuations. Mr
Costa is a SARS employee based in Port Elizabeth, responsible
for
large and complex audits.
The
evidence
[6]
Before setting out the evidence adduced by the various witnesses, it
is necessary to mention certain significant features of
the case as
it unfolded in the Tax Court. These were emphasized by Stepney’s
counsel during argument. Firstly, the Bridge
valuation was done by
utilising the discount cash flow (DCF) valuation method. This was
contended to be the most appropriate method
in respect of the
valuation of an asset such as shares. It entails valuing the business
of an entity on its future forecast free
cash flows, discounted back
to present value through the application of a discount factor. The
Commissioner, on the other hand,
in adjusting the base cost valuation
to nil, utilised the net asset value (NAV) valuation method. It was
implicitly conceded in
the court below that this valuation method was
inappropriate and that the DCF method should have been used. The
concession was
properly made. It has the consequence that Mr Costa’s
evidence on behalf of the Commissioner became largely irrelevant, as
is the case with that of Mr Christiaan Vorster for Stepney, which
evidence was led solely for the purpose of justifying the adoption
of
the DCF, as opposed to the NAV, methodology. And it has a direct
bearing on the second striking feature of the case, namely
the nature
of the evidence of Prof Wainer.
[7]
Not only did the Commissioner concede that the wrong methodology was
utilised by his official, Mr Costa, but Prof Wainer’s
mandate
was also narrowly circumscribed, namely to analyse the Bridge
valuation and to subject it to criticism. No separate independent
valuation was done by Prof Wainer or anyone else on behalf of the
Commissioner. Prof Wainer compiled his report in 2013, some nine
years after the Bridge valuation. He listed numerous shortcomings in
the Bridge valuation, an aspect to which I shall revert presently.
But ultimately the Tax Court had before it only the Bridge valuation,
which was subjected to extensive criticism by Prof Wainer.
[8]
The evidence of the lay witnesses on behalf of Stepney was largely
common cause. The narrative advanced by Mr Thabo Mokoena,
a former
executive director in the Tusk group of companies, Mr David
Hirschowitz, Stepney’s general manager and Mr Jeremy
Franklin,
the former chief executive of the Tusk group, which was later taken
over by Peermont Global, can be summarized as follows.
With the
advent of democracy and following the abolition of the former
homelands, Sun International, a major international leisure
group,
had to dispose of some of its casino businesses, in line with the new
casino licences regime. Mr Franklin and some of his
fellow Sun
international employees at that time established the Tusk group to
explore new casino opportunities flowing from Sun
International’s
disposal of some of its casinos. The Tusk group became one of the
major shareholders in ELR, together with
Stepney and an empowerment
consortium. One of the entities in the Tusk group, Tusk Casino Hotel
Management, was contracted by ELR
to manage the Richards Bay casino.
As stated, ELR had acquired a casino licence for Richards Bay for a
period of 15 years, which
it was unable to utilise until the
litigation with the Ministers’ Fraternal was concluded. In the
interim it acquired a temporary
licence on 4 October 2001 and
operated a temporary casino at Empangeni. A valuation of the assets
of all the corporate entities
in the Tusk group (including ELR) was
undertaken by Bridge Capital on 25 August 2004 for capital gains tax
purposes. This valuation
was done utilising the DCF method and having
regard to financial projections prepared by Deloitte Consulting Group
(Deloittes)
and information provided by Tusk management for ELR’s
submission to the Kwazulu Natal Gambling Board for a temporary casino
licence at Empangeni. That application was dated 10 July 2001.
Ancillary information was given to Bridge Capital by Messrs Mokoena
and Franklin and the rest of the Tusk group’s management to
compile the valuation report.
The
Bridge valuation
[9]
Mr Veldtman, who was responsible for the Bridge valuation, testified
about it. He confirmed having used the DCF methodology
and that he
had relied on information from Tusk management, including the
financial projections prepared by Deloittes. The market
value of the
assets of all the entities in the Tusk group, including ELR, was
determined in accordance with the relevant provisions
of the Schedule
for capital gains tax purposes. These assets were unlisted shares. He
explained and motivated his determination
of the future forecast cash
flows and the discount factor that he had applied. On behalf of the
Commissioner Mr Costa issued a
letter of audit findings to explain
why the Bridge valuation was not accepted. He advanced two main
reasons for the rejection of
the Bridge valuation and for the raising
of additional assessments. The first was that the DCF valuation
method was wrongly utilised
for the determination of the market value
of the shares and, second, that the forecasts used by Mr Veldtman for
purposes of the
valuation were not reliable. The Tax Court found that
the Commissioner did not advance the unreliability of the financial
projections
and assumptions made in the Bridge valuation as one of
the factors that had been taken into account in raising the
additional assessments.
The Commissioner’s primary contention
before us was that Stepney had failed to discharge its onus to
establish the validity
or reliability of the projected revenue
utilised by Mr Veldtman in compiling his valuation. Stepney also
contended that the Commissioner
impermissibly sought to change the
grounds of assessment which it sought to have upheld in this court.
[10]
Mr Costa’s criticism of the Bridge valuation was along the
following broad grounds:
(a) the
financial projections were made in perpetuity, and not for the
limited 15 year period of the casino licence;
(b) the
estimates were not based on a trading history as ELR was a
‘greenfields operation’ at the valuation date, 1
October
2001;
(c) the
estimates utilised by Bridge Capital was made in 2000 before the
temporary casino was erected; and
(d) it
failed to factor in the effects of the September 11 terrorist attacks
in the USA.
[11]
Prof Wainer’s main criticisms of the Bridge valuation were as
follows:
(a) in valuing
the shares Mr Veldtman failed to apply a discount based on the fact
that they were ‘minority’ shares;
(b) the
validity or reliability of the information collated in the valuation
spreadsheet containing the financial projections was
fundamentally
flawed in several respects, namely the projected tax, projected
revenue, projected working capital and the terminal
value; and
(c)
an incorrect date was used.
Before
I discuss these criticisms, a brief consideration of the applicable
legal principles is apposite. First, I consider two legal
principles
which Stepney vigorously advanced as preliminary aspects and, second,
consideration will be given to the nature of expert
evidence.
The
law
[12]
Stepney submitted that on appeal against a decision of the Tax Court
this court has limited, narrowly circumscribed powers.
It placed
reliance on the following dictum in
Commissioner
of Inland Revenue v Da Costa
[5]
:
‘
[I]f
a decision of a Special Court is based on the exercise of a
discretion, this Court will interfere only if the Special Court
did
not bring an unbiased judgment to bear on the question, or did not
act for substantial reasons, or exercised its discretion
capriciously
or upon a wrong principle:
Ex
parte Neethling and others
1951
(4) SA 331
(A) at 335
’
.
The
submission is misconceived and the passage from
Da
Costa
is quoted out
of context.
[13]
In
Da Costa,
Van
Heerden JA in fact held that there is ‘a full right of appeal
against any decision of a Special Court on issues of fact
or law’.
[6]
In this regard the learned Judge referred to s 86A of the Act, as
inserted by Act 103 of 1976, where this full right of appeal
had been
enacted. Reference was also made to
Hicklin
v Secretary for Inland Revenue
[7]
where Trollip JA held that under s 86A:
‘
The
appeal is . . . a re-hearing of the case in the ordinary, well-known
way in which this Court, while paying due regard to the
findings of
the Special Court on the facts and credibility of witnesses, is not
necessarily bound by them.
’
The
excerpt from
Da
Costa
and the
reference to
Ex
parte Neethling
[8]
must be understood in the proper factual context.
Neethling
concerned the sale
of immovable property which was subject to a fideicommissum in favour
of certain minor children. As upper guardian
the Provincial Division
was called upon to consider, in the exercise of its discretion,
whether the proposed deed of sale was in
the interests of the minor
children. It is in this context that this court considered whether
the Provincial Division had exercised
its discretion capriciously or
upon a wrong principle, or whether it has not brought its unbiased
judgment to bear on the question
or had not acted for substantial
reasons. And it is in this context that the passage from
Da
Costa
above, relied
upon by Stepney, must be understood. Stepney incorrectly categorized
the matter before us as a ‘review’.
It is not, as
outlined above it is a full appeal.
[14]
The second preliminary aspect concerns Stepney’s contention
that the Commissioner impermissibly sought to change the
grounds of
assessment. In this regard reliance was placed on
Commissioner,
South African Revenue Service v Brummeria Renaissance (Pty) Ltd &
others.
[9]
Stepney’s argument proceeded along these lines that the
original grounds of assessment was limited to those enumerated in
SARS’ statement of the grounds of assessment in terms of Tax
Court Rule 10(3). SARS could not subsequently alter those grounds
by,
for instance, conceding that the DCF method was the correct valuation
method and in then seeking to assail this method on various
grounds.
The contention cannot be upheld. Rule 12 of the Tax Court Rules
provides that the issues before the Tax Court are those
adumbrated in
SARS’ statement of grounds of assessment under Rule 10,
together with those outlined in the taxpayer’s
statement of
grounds of appeal in terms of Rule 11. In paragraphs 4, 9, 20 and 23,
in particular, of the statement of grounds of
assessment SARS
pertinently raised the issue that Stepney’s market value of the
relevant ELR shares had been ‘overstated/inflated’
for
purposes of determining the base cost of the shares. SARS set out a
summary of the reasons why it took this view. It had therefore
not
merely confined itself to the methodology utilised, DCF versus NAV,
but it had pertinently challenged the premise underlying
Stepney’s
valuation in several respects.
Brummeria
is entirely distinguishable on the facts. There the Commissioner had
issued original assessments in March 2000 and revised assessments
in
March 2002. Consequent to an objection in April 2002 by the taxpayer
(
Brummeria
)
to the revised assessments, the Commissioner issued further revised
assessments in July 2004. Like the first revised assessment,
the
further revised assessment had an entirely different basis than the
original assessment. Brummeria’s contentions that
the further
revised assessments were out of time (s 79(1)(c)(i) of the Income Tax
Act 58 of 1962, as it read at that time, precluded
the Commissioner
from raising a further assessment after the expiration of three years
from the date of the first assessment (unless
he was satisfied that
there was fraud, misrepresentation or non-disclosure of material
facts) were upheld on appeal. Cloete JA
said that:
‘
.
. .
once
the Commissioner changed the entire basis of the assessment in the
further revised assessments, he allowed Brummeria’s
objection
to the revised assessments in full as contemplated in s 81(5) and, as
no fraud, misrepresentation or non-disclosure is
relied upon, that is
the end of the matter. I therefore consider that the Commissioner was
precluded by the provisions of s 79(1)
read with s 81(5) of the Act
from raising the assessments against Brummeria . . . .
’
The
reliance on
Brummeria
is therefore misplaced.
[15]
In April 2006 the Commissioner challenged the Bridge valuation. By
letter dated 5 July 2007 Stepney lodged detailed objections
to the
letter of assessment of 10 April 2007. It pointedly addressed various
aspects raised in the letter of assessment, namely
the unresolved
litigation against the Ministers’ Fraternal and the delay in
trading operations as at 1 October 2001. Stepney
also motivated fully
why the Bridge valuation is correct. The dispute was thus clearly
understood by all concerned to go beyond
the mere valuation
methodology. And on 30 April 2013 the Commissioner amended the
statement of grounds of appeal as follows:
‘
Even
if the Net Asset Value method were to be considered less appropriate
or not appropriate at all, and the Discounted Cash Flow
Model
considered more appropriate, the valuation of the shares remains
overstated / inflated for the reasons mentioned in paragraphs
20 and
23 [of the statement of grounds of assessment].
’
All
the issues were in any event fully ventilated in the Tax Court. There
was no objection from Stepney in the Tax Court that the
Commissioner
had changed the grounds of assessment. Stepney cannot now, on appeal,
complain about the widening of the issues, assuming
in its favour
that there had been any.
[10]
In the premises Stepney’s contention that the Commissioner
impermissibly sought to change the grounds of assessment cannot
be
sustained. The next aspect for consideration is the nature of expert
evidence.
[16]
The nature of expert evidence and a court’s approach to it is
well established. In
Coopers
(SA) (Pty) Ltd v Deutsche Gesellschaft Für Schädlingsbekämfung
MBH
[11]
,
Wessels JA described it thus:
‘
As
I see it, an expert’s opinion represents his reasoned
conclusion based on certain facts [or] on
data
,
which are either common cause, or established by his own evidence or
that of some other competent witness. Except possibly where
it is not
controverted, an expert’s bald statement of his opinion is not
of any real assistance. Proper evaluation of the
opinion can only be
undertaken if the process of reasoning which led to the conclusion,
including the premises from which the reasoning
proceeds, are
disclosed by the expert’
[12]
.
More
importantly, as Addleson J said in
Menday
v Protea Assurance Co Ltd
:
[13]
‘
It
is not the mere opinion of the witness which is decisive but his
ability to satisfy the Court that, because of his special skill,
training or experience,
the
reasons for the opinion which he expresses are acceptable
. . . the Court, while exercising due caution, must be guided by the
views of an expert when it is satisfied of his qualification
to speak
with authority and
with
the reasons given for his opinion
’
(My
emphasis).
It
was contended on behalf of the Commissioner that Mr Veldtman’s
evidence did not meet the criteria laid down in
Coopers
and in
Menday.
It
was submitted that he failed to give reasons for some of his
conclusions and that much of the data upon which he based his
conclusions
was shown to be fatally flawed. Further that he gave a
bald statement of his opinions without providing the underlying
reasoning.
It was contended that the information on which Mr Veldtman
based the valuation was not sound. I discuss those aspects next.
The
future forecast free cash flows
[17]
As stated, Mr Veldtman testified that he received information from
Tusk management, upon which he relied to compile his valuation
report. But at the time of the valuation there was other information
available which would have had a material effect on the figures.
The
DCF calculation in the Bridge valuation was not based on the
management accounts of 2004, but on the forecast amounts calculated
by Deloittes in 2001 as part of the figures submitted to the Gambling
Board in respect of the application for a temporary licence.
Stepney
sought to justify the use of the 2001 Deloittes figures on the basis
of them being closer to the time of the valuation
date, 1 October
2001. But this approach is fatally flawed inasmuch as the actual
figures which were available in 2004 (when the
Bridge valuation was
done) showed that the figures forecasted by Deloittes in 2001 were
unreasonable. As Prof Wainer illustrated
in his expert report and in
oral evidence, the forecast for 2003 was R49 million, whereas the
actual figure was a R61 million negative,
ie a variance of R110
million. The actual figures for 2004 constituted only 10% of the 2005
projected figures and only 20% of the
projections for 2006 and 2007.
[18]
Mr Veldtman also consciously disregarded ELR’s letter to the
Gambling Board dated 20 March 2003. In the letter, signed
by Mr
Mokoena on behalf of ELR, the challenges and travails facing the
temporary casino at Empangeni was tabulated. Revenue during
the nine
months of trade was a mere 43% to 46% of budget and this, together
with the ongoing litigation by the Ministers’
Fraternal, was
said to have ‘precipated a major crisis for Emanzini’
(ELR). As a result ELR submitted a revised project
proposal to the
Gambling Board in respect of the permanent casino at Richards Bay in
order to ‘obviate disastrous consequences’.
The letter
undoubtedly casts a long shadow over ELR’s optimistic forecasts
of 2001, and yet no regard was given to it.
[19]
Counsel for Stepney argued strenuously that the factors outlined
above could not have been taken into account, since to do
so would
amount to applying hindsight. Taking into account the actual figures
which were available in 2004 and having regard to
the letter above,
would have been eminently reasonable in the circumstances. In doing
so Mr Veldtman would have tested the reasonableness
and correctness
of the projections provided by management. A valuer cannot just
blindly accept at face value figures presented
to him or her –
there is a duty to assess their reasonableness and correctness. The
necessity of assessing the reasonableness
of the forecasts was
acknowledged in the Bridge valuation. The information available at
the time of the Bridge valuation pointed
clearly to a significant
overstatement of revenue projected in 2001. But, as stated, no regard
was given to it. The information
was available at the time that the
valuation was conducted and the proper perspective is that the valuer
was duty bound to have
regard to it to interrogate the soundness of
management’s projections. It was wrong not to take the later
information into
account. And it resulted in a gross overstatement of
the projected revenue forecast which in turn led to a material
inflation of
value in the Bridge valuation.
[20]
The next aspect to be considered is the fact that the wrong date was
utilised in the valuation. As this had become common cause
in the Tax
Court, it can be disposed of briefly. Instead of utilising the
valuation date set out in the Schedule (1 October 2001),
the relevant
figures were calculated in the Bridge valuation with reference to 31
March 2002. The experts (Mr Veldtman and Prof
Wainer) had agreed in
their joint minute that this mistake had a 10% adverse impact on the
valuation, ie approximately R19.8 million
on ELR’s total
valuation and about R860 000 on the valuation of the relevant
ELR shares. Whilst relatively small, the
adverse impact on the
aggregate base cost is self-evident.
[21]
In respect of the tax calculations, it is uncontroverted that an
understatement of the tax amount would have led to an overstatement
of value in the Bridge valuation. The tax calculations emanated from
ELR management and was, on his own version, not verified for
reasonableness by Mr Veldtman, because he ‘felt comfortable’
that a ‘detailed and rigorous calculation’
had been done
by management. There was no evidence of this, save for vague
assertions by Mr Mokoena that the calculation had been
done as ‘part
of the budgetary process’ and ‘by applying the norms in
terms of tax factors’. The problem
is that the tax calculation
does not accord with an application of the relevant statutory rates.
The matter is exacerbated further
by the fact that the tax
calculations in the Bridge valuation, which according to Mr Franklin
were made by Deloittes as part of
the submission to the Gambling
Board, differ from the tax amounts submitted to the Gambling Board as
a schedule to ELR’s
letter of 10 July 2001. Thus, while the
Bridge valuation utilised the revenue figures contained in this
letter, it strangely and
inexplicably did not use the tax amounts it
contained. The Bridge valuation thus falls short in respect of the
tax calculations
as well insofar as there has been an understatement
of the tax.
[22]
There are material shortcomings in the reliability of the projected
capital expenditure as well. The amounts of projected capital
expenditure underlying the Bridge valuation were strikingly low –
R5 0000 for 2003 and 2006 and nil for 2002 and 2004. The
only
substantial amount is the approximately R181 million forecast for
2005. This amount was, according to Mr Veldtman, provided
for in
respect of the permanent casino. No additional capital expenditure
for the construction of the temporary casino was taken
into account
in the Bridge valuation. That amount would have been R71 million
according to ELR’s letter of 10 July 2001 to
the Gambling
Board. Mr Veldtman testified that the expectation was for little or
no capital expenditure to have been invested in
the temporary site.
Not only was this in direct conflict with the aforementioned letter,
but it was also out of kilter with the
facts available at the time of
the Bridge valuation. The temporary casino was to be housed in a
building previously owned and operated
by Clover Dairies as a
distributing warehouse. It is self-evident, and in any event plain
from Mr Mokoena’s testimony, that
substantial construction had
to be undertaken to convert this site into a temporary casino which
was planned to operate for a period
of three years. Apart from the
failure to include the sum of R71 million for the temporary casino in
the capital expenditure forecasts,
the Bridge valuation also did not
include any substantial amounts for ongoing capital expenditure for
the maintenance of buildings,
furniture and fittings.
[23]
Stepney’s counsel conceded during argument that there were
flaws in the capital expenditure forecasts in the Bridge valuation,
but contended that these aspects had not been put to Mr Veldtman
during cross-examination. This contention loses sight of the fact
that the ELR letter of 10 July 2001 to the Gambling Board and the
accompanying schedules reflecting the figures came to the fore
only
when Mr Franklin testified, ie after Mr Veldtman’s testimony.
It appeared from Mr Franklin’s evidence that he
had found these
documents in a storeroom at his house long after discovery of
documents had been made by Stepney. The criticism
is therefore
unfounded. In conclusion on this aspect, the understatement of the
amounts for capital expenditure impacted materially
on the Bridge
valuation.
[24]
A further aspect for consideration in respect of the future forecast
free cash flows is the reliability of the terminal value
of
R527 218 000 which was used in the Bridge valuation. That
figure is based on revenue flows into perpetuity. It fails
to take
cognisance of the term of the casino licence, 15 years. The terminal
value was in effect calculated on the basis that there
was no risk of
the licence not being renewed upon expiry of the 15 year period. This
calculation was sought to be justified by
Messrs Mokoena and Franklin
on the basis that renewal of the licence after 15 years was a mere
formality and that only the exclusivity
period would expire. The only
circumstances imaginable under which the licence would not be
extended, Mr Franklin said, would be
non-compliance with the licence
conditions. This approach is far-fetched and out of touch with
reality. There was undeniably some
measure of risk attached, for
example, changes in attitudes to gambling and in policy and
legislation. Prof Wainer is correct,
in my view, that allowance
should have been made for the risk of non-renewal or, at the very
least, the costs associated with a
renewal application. In essence,
the loss of exclusivity after 15 years should have been taken into
account. This fact would of
necessity also have an impact on the
Bridge valuation.
The
discount factor
[25]
As stated, an appropriate discount rate must be applied to the
projected cash flows for a proper application of the DCF method.
The
discount factor represents the required return on investment but also
the risk inherent in the business. A discount rate of
20.86% had been
applied in the Bridge valuation. This discount factor, also known as
the weighted average cost of capital, comprises
the cost of equity
and the cost of debt. The cost of equity made up 19.92% and the cost
of debt 0.95% of the discount factor of
20.86%, ie a cost of equity:
cost of debt proportionality of 90:10. Mr Veldtman failed to furnish
adequate reasons for applying
a risk premium of 15%; he merely gave
vague assertions in this regard.
[26]
A serious shortcoming is the fact that the same discount rate was
applied to all the entities in the Tusk group. The group
owned and
operated casinos in Mmabatho, Venda, Klerksdorp, Taung and the one in
Richards Bay/Empangeni. Self-evidently, the risks
in respect of these
entities must vary, particularly having regard to the fact that the
others were established casinos, whereas
the one in the present
instance was a start-up or greenfields operation. There were many
uncertainties in respect of this new casino
– whether it would
attract sufficient clientele, the actual cost, when it would start
trading and so forth. Mr Veldtman conceded
the point that there were
varying risks for the various entities and sought justification in
the ‘swings and roundabouts’
principle. He however failed
to demonstrate how this principle operated in practice in respect of
the different casinos. The ELR
correspondence addressed to the
Gambling Board, referred to above, clearly showed that the temporary
casino at Empangeni faced
significant challenges, amongst others the
low revenues and ongoing litigation. On behalf of Stepney much was
made of the fact
that Richards Bay was at the time of the valuation
one of the fastest growing metropolitan areas in the country. That
may be so,
but the fact remains that the casino had been established
at Empangeni and, in terms of the concentric model of calculating
population
density and potential clientele, the location of the
casino would in the present instance have resulted in the dilution of
this
consideration. The ‘one size fits all’ approach of
Mr Veldtman was clearly inappropriate. The failure to assess the
ELR
casino separately and with due regard to its own particular risk
factors had an adverse impact on the discount factor that
was
applied.
[27]
A further problem is that certain obvious risk factors had been
disregarded. These were the unresolved litigation (which by
its very
nature is steeped in uncertainty) and the risk of increased
construction costs to erect a temporary casino. Whatever legal
advice
might have been received concerning the strength of Stepney’s
case in respect of the litigation, a purchaser of the
shares would
have considered it as an additional risk factor and a valuer would be
required to take that into account in applying
a discount factor.
Conclusion
[28]
It is clear that the Bridge valuation is fatally flawed in the
various respects outlined above. A court is entitled to reject
a
valuation if it is not satisfied with the investigations underpinning
it:
‘
For
instance, if the expert added up his figures wrongly, or took
something into account which he ought not to have taken into account,
or conversely, or interpreted the agreement wrongly, or proceeded on
some erroneous principle – in all these cases, the court
will
interfere
’
[14]
.
The
Tax Court was wrong in upholding that valuation. As a consequence,
Stepney has failed to discharge its onus of proving the paragraph
29
market value and thus also the aggregate base costs of the relevant
shares. But counsel for the Commissioner very properly conceded
that
the value of the shares cannot be nil. There was clearly considerable
value attached to ELR’s sole asset, the casino
licence. It was
not seriously disputed that a casino licence which grants the holder
exclusive rights in respect of the specified
area for a period of 15
years has considerable value and it is in the interests of justice
that a proper valuation be calculated.
The Tax Court should have
remitted the matter to the Commissioner for further investigation and
assessment in terms of s 83(13)(
a
)(iii)
of the Act. The grounds of assessment were unreasonable in two
respects, namely the incorrect utilisation of the Net Asset
Value
(NAV) methodology and the Commissioner’s valuation of the
shares as nil. The former was implicitly conceded in the
Tax Court
and the latter was conceded at the outset before us.
Stepney
is therefore entitled to its costs in the Tax Court in terms of s
130(1)(
a
)
of the
Tax Administration Act 28 of 2011
.
[15]
[29]
The following order is issued:
1.
The appeal is upheld
with costs, including those of two counsel.
2.
The order of the Tax
Court is substituted with the following:
‘
(a)
The appeal is upheld.
(b)
The additional assessments in respect of the 2002 and 2003 tax years
of assessments are hereby set aside.
(c)
The matter is remitted to the Commissioner for the South African
Revenue Service for further investigation and assessment.
(d)
The Commissioner is ordered to pay the costs, including those of two
counsel where so employed’.
________________________
S A MAJIEDT
JUDGE OF APPEAL
APPEARANCES
For Appellant:
P A Solomon SC and J Boltar
Instructed
by: Klagsbruin Edelstein
Bosman De Vries Inc, Pretoria
Symington
De Kok Attorneys, Bloemfontein
For Respondent: S F du Toit SC and D
Watson
Instructed
by: Faber Goertz
Ellis Austin Inc, Bryanston
McIntyre
& Van Der Post Attorneys, Bloemfontein
[1]
Paragraph 26(1) of the Schedule provides that a
taxpayer may elect one of three methods to determine the valuation
date value
of the asset, the first of which is the market value
(para
26(1)(a)).
[2]
Paragraph 29(7)(b) reads:
‘
(7) The
Commissioner may, notwithstanding any proof of valuation submitted
by a person to the Commissioner . . .
(a)
. . .
(b)
where the Commissioner is not satisfied
with any value at which an asset has been valued, the Commissioner
may adjust the value
accordingly’.
[3]
In terms of s 3(4)(g) of the Act.
[4]
Section 102(1)(e)
of the
Tax Administration Act
28 of 2011
.
[5]
Per Van Heerden JA in
Commissioner
of Inland Revenue v Da Costa
1985 (3)
SA 768
(A) at 775 F-G; (14/1984) [1985] ZASCA 32; [1985] 2 All SA
335 (A).
[6]
At 775C.
[7]
Hicklin v Secretary for Inland Revenue
1980
(1) SA 481
(A) at 485F; [1980] 1 All SA 301 (A).
[8]
Ex parte Neethling & others
1951
(4) SA 331
(A);
[1951] 4 All SA 231
(A).
[9]
Commissioner, South African Revenue Service v
Brummeria Renaissance (Pty) Ltd & others
2007
(6) SA 601
(SCA); (391/06) [2007] ZASCA 99; [2007] 4All SA 1338
(SCA).
[10]
Shill v Milner
1973
AD 101
at 105.
[11]
Coopers (SA) (Pty) Ltd v Deutsche Gesellschaft
Für Schädlingsbekämfung MBH
1976
(3) SA 352 (A).
[12]
At 371 F-H.
[13]
Menday v Protea Assurance Co Ltd
1976 (1) SA 565
(E) at 569B-E; [1976] 1 All SA
535 (E).
[14]
Per Denning LJ in
Dean
v Prince
1954 (1) All ER 749
at 758.
[15]
Section 130(1)(
a
)
reads as follows:
‘
The tax court
may, in dealing with an appeal under this Chapter and on application
by an aggrieved party, grant an order for costs
in favour of the
party, if –
(a)
the SARS grounds of assessment or
‘decision’ are held to be unreasonable . . . ;’