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[2012] ZASCA 72
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Stellenbosch Farmers' Winery Ltd v Commissioner for the South African Revenue Service, Commissioner for the South African Revenue Service v Stellenbosch Farmers' Winery Ltd (511/2011, 504/2011) [2012] ZASCA 72; 2012 (5) SA 363 (SCA); 74 SATC 235 (25 May 2012)
Links to summary
THE SUPREME COURT OF APPEAL OF SOUTH AFRICA
JUDGMENT
Case no
: 511/2011
REPORTABLE
In the
matter between:
Stellenbosch
Farmers’ Winery Limited
…......................................................
Appellant
and
Commissioner for the South African Revenue Service
….......................
Respondent
Case no:
504/2011
In the
matter between
Commissioner
for the South African Revenue Service
…...........................
Appellant
and
Stellenbosch
Farmers’ Winery Limited
….................................................
Respondent
Neutral
citation:
Stellenbosch Farmers’ Winery v Commissioner
for SA Revenue Service
(511/2011 and 504/2011)
[2012] ZASCA 72
(25 May 2012)
Coram:
Brand, Van Heerden and Tshiqi JJA and Kroon and Boruchowitz AJJA
Heard:
2 May 2012
Delivered:
25 May 2012
Summary: Revenue – whether receipt by taxpayer of a sum of
money of a capital or a revenue nature - whether interest on alleged
underpayment of provisional tax in respect of the receipt should have
been levied in terms of s 89quat(3) of the Income Tax Act
58 of 1962
– whether receipt attracted value added tax in terms of s 7 of
the Valued-Added Tax Act 89 of 1991 or zero rate
applicable in terms
of s 11(2)(
l
)(ii).
____________________________________________________________________
ORDER
On appeal from: Tax Court, Cape Town (Louw J with Messrs P Ranchod
and B Nduna as assessors, sitting as a court of first instance).
Case no. 511/2011:
The main appeal is upheld with costs, including the costs of two
counsel.
The additional assessment of the taxpayer in respect of the 1999 tax
year is set
aside.
The cross-appeal is dismissed with costs, including the costs of two
counsel.
Case no. 504/2011:
The appeal is dismissed with costs, including the costs of two
counsel.
__________________________________________________________________
JUDGMENT
__________________________________________________________________
KROON AJA (BRAND, VAN HEERDEN et TSHIQI JJA and BORUCHOWITZ AJA
concurring):
[1] Before us are two matters that emanated from, and were heard
simultaneously in, the Tax Court sitting at Cape Town (Louw J
with
Messrs P Ranchod and B Nduna as assessors). Leave to appeal to this
court was granted by Louw J.
[2] In the main appeal in case no. 511/2011,
,
Stellenbosch Farmers’ Winery Limited (the taxpayer) seeks to
attack the finding of the court a quo that the receipt by the
taxpayer of the sum of R67 million during the 1999 tax year had
correctly been included by the Commissioner for the South African
Revenue Service (the Commissioner) in the taxpayer’s gross
income in the assessment for that tax year, and had accordingly
correctly been assessed to tax. The taxpayer’s contention is
that the receipt was of a capital nature and had therefore attracted
no tax liability.
[3] In the cross-appeal the Commissioner seeks to assail the order of
the court a quo setting aside the refusal by the Commissioner
to
direct, in terms of s 89quat(3) of the Income Tax Act 58 of 1962,
that interest not be paid by the taxpayer on the unpaid provisional
tax assessed to have been payable in respect of the sum of R67
million (as part of the taxpayer’s gross income), and the
direction of the court a quo that such interest not be paid.
[4] In case no. 504/2011 the Commissioner appeals against the order
of the court a quo setting aside the assessment by the Commissioner
that the taxpayer’s receipt of the sum of R67 million was
subject to value-added tax (VAT) at the rate of 14 per cent in
terms
of s 7 of the Value-Added Tax Act 89 of 1991, ie in the sum of R9 380
000 (and that in addition the taxpayer was liable to
pay a penalty of
R938 000 and interest in the sum of R7 804 274,09), and the court a
quo’s declarator that the receipt by
the taxpayer of the sum of
R67 million was subject to VAT at the rate of zero per cent in terms
of s 11(2)
(l)
(ii) of the Act. The dispute between the parties
centres around the issue whether the receipt of R67 million related
to ‘services’,
as defined in s 1, supplied by the
taxpayer to a non-resident and not ‘directly in connection with
movable property situated
inside the Republic of South Africa’,
as envisaged in s 11(2)
(l)
(ii).
[5] Both matters find their origin in related sets of facts (as set
out in the paragraphs that follow), many of which were common
cause
or not in dispute.
Background
[6] The taxpayer was a wholly owned subsidiary of Stellenbosch
Farmers’ Winery Holdings Limited. The latter was in turn wholly
owned by Stellenbosch Farmers’ Winery Group Limited. In the
judgments of the court a quo the last mentioned entity was referred
to as ‘SFW Group’, and the present judgment will follow
suit.
[7] At all material times the taxpayer carried on business as a
producer and importer of liquor products, and as a wholesaler of
a
range of spirits, wine and other liquor products to retailers. In
contradistinction, SFW Group was exclusively a holding company,
and
did not conduct other operational business activities. Since the
1970s the taxpayer had inter alia imported and distributed
Bells
whisky (together with Dimple and Haig whiskies – hereinafter
collectively referred to as Bells).
[8] On 1 February 1991 United Distillers plc (UD), a subsidiary of
Guinness plc, both based in the United Kingdom, concluded a
joint
venture agreement (the JV agreement) with SFW Group and Distillers
Corporation (SA) Ltd (Distillers). This agreement led
to the
formation of United Distillers Imports (Pty) Limited (UDI) in which
SFW Group and Distillers each held a 25 per cent shareholding
and UD
the remaining 50 per cent.
[9] Clause 3.1 of the JV agreement provided that UD would enter into
distribution agreements with the entities in South Africa
appointed
by UDI as distributors of UD’s products (which included Bells).
It was further recorded, in respect of SFW Group
and Distillers, that
the intention was that as far as possible the only distributors would
be the marketing companies/divisions
of those two entities. Clause
3.4 reflected that the envisaged distributor of Dimple/Haig would be
Monis while Sedgwick Taylor
would distribute Bells. As a fact both
these entities were divisions of the taxpayer.
[10] As foreshadowed in the JV agreement, a further written agreement
relating to the distribution of Bells in South Africa (the
distribution agreement) was concluded on 12 May 1992 between UD and
an entity styled simply ‘Stellenbosch Farmers’
Winery’.
In terms of the agreement this entity was appointed as the exclusive
distributor of Bells in South Africa and surrounding
territories. On
the other hand, the entity undertook not to sell competing products
in the area in question. The period of the
distribution agreement was
ten years, with effect from 1 February 1991, whereafter the agreement
was terminable on 12 months’
notice. Accordingly, and
notwithstanding that extensions of the agreement was contemplated, it
would, depending on when notice
of termination was given, terminate
on 31 January 2002 or on a date subsequent thereto.
[11] The Tax Court accepted, for purposes of its judgment, but
without so finding, that the taxpayer was the entity which was a
party to the distribution agreement. I will later return to this
issue.
[12] It may be recorded at this stage however that the taxpayer did
in fact undertake the role of exclusive distributor of Bells
in terms
of the agreement, and continued therewith until, as set out later,
the distribution agreement was terminated on 28 August
1998. The
venture proved to be extremely profitable for the taxpayer. Over the
decades the taxpayer built up the Bells brand to
the position of a
pre-eminent asset in South Africa, which it did not occupy anywhere
else in the world. Bells sales contributed
between 18 per cent and 25
per cent of the taxpayer’s profit or ‘bottom line’.
This was significant for the taxpayer
as the sale of spirits
delivered the real profit margins (as opposed to other products). As
the volumes of spirit sales was small
compared to those of other
products ,a significant reduction in spirit sales would not bring
about a significant reduction in costs,
but only affect the ‘bottom
line’. In South Africa Bells acquired the reputation of a
‘Known Value Item’,
which the taxpayer’s other
international spirit brands did not achieve. As it was put, the Bells
brand ‘brought feet
into the retail stores’ and was a
valued asset to the retailer. This in turn gave the taxpayer
substantial leverage and bargaining
power in its dealings with
retailers, and enabled it to induce them to stock, and give ‘forward
space’ to, other products
of the taxpayer (at the expense of
products of competitors). After the loss of the distribution rights
for Bells (as to which,
see below) the taxpayer’s trading
income dropped very significantly, by many millions of rand, during
the ensuing two financial
years (whereafter the taxpayer was forced
to merge with another entity to avoid bankruptcy).
[13] During 1997 certain corporate structural changes in the form of
company mergers took place in the United Kingdom and Europe,
involving inter alia Guinness plc and UD. One result was the
formation of an entity styled Diageo Nederland BV (Diageo). The
changes
effected the union of the spirit and wine businesses of inter
alia UD and UDI, and the distribution network of another distributor
in South Africa, Gilbeys, also accrued to Diageo. The above changes
entailed consequences for the liquor market in South Africa.
UD
accordingly sought to extract itself prematurely from the
distribution agreement, and negotiations towards that end were set
in
train.
[14] In the result, a written agreement (the termination agreement)
was concluded on 27 August 1998. Reflected as a party to the
agreement was SFW Group (referred to in the body of the agreement as
‘SFW’). The effective date of the agreement was
28 August
1998, ie some three years and five months before the earliest date on
which the distribution agreement could have been
terminated by UD
giving notice as envisaged therein.
[15] Clause 4.1 of the termination agreement provided inter alia that
in consideration of payment by Indivined BV (another party
to the
agreement) of the sum of R67 million to ‘SFW’, the latter
and UD agreed that certain agreements would terminate.
These included
the JV agreement and what was referred to as the ‘SFW
Distribution Agreement’, defined in clause 2.1
as:
‘
an
agreement dated 12
th
May
1992 between UD and SFW relating to distribution by SFW of the
Products in terms of which SFW was granted sole and exclusive
rights
to distribute the Products in the Territory’.
Also included were any other arrangements relating to the
distribution of the products between UD or its affiliates and SFW or
its affiliates. In terms of clause 2.1 the term ‘affiliate’
included a subsidiary of any party to the agreement.
[16] Clause 4.5 of the termination agreement read as follows:
‘
For
the avoidance of doubt:-
Neither SFW nor UDI will have
any claim against UD or Indivined; and
SFW will have no claim against
UDI
for compensation for loss of
distribution rights, loss of goodwill or any other loss of any kind
arising from the terminations provided
in this agreement and SFW
acknowledges that the payments to be made to it under this Agreement
represent full compensation for
the closure of SFW’s business
relating to the Products as a consequence of the termination of the
distribution rights relating
to the Products.’
[17] The amount of R67 million was in due course paid to the taxpayer
and its receipt was reflected in its financial statements
for the
1999 tax year. It is this receipt that is the subject of the issue in
the main appeal in case no. 511/2011.
Onus
[18] In terms of s 82 of the Income Tax Act, the onus (in the Tax
Court and on appeal to this court) was on the taxpayer to establish
that the receipt of the R67 million was of a capital nature and that
it should not have been assessed to tax as part of the taxpayer’s
gross income, as was directed by the Commissioner.
Did the taxpayer acquire distribution rights and did it surrender
them against payment of the sum of R67 million?
[19] A stance adopted by the Commissioner was the following. The
taxpayer was not a party to the distribution agreement; it therefore
acquired no rights under that agreement to distribute any products.
It was therefore similarly not a party to the termination agreement
and it was not paid anything in respect of the termination of the
distribution rights provided for in the termination agreement.
Its
receipt of the sum of R67 million must accordingly have been in terms
of a further agreement. What that agreement was, was
not disclosed.
Accordingly, there could not be any talk of the taxpayer having
discharged the onus of proving that the Commissioner
had erred in
including the sum of R67 million as part of the taxpayer’s
gross income for the 1999 tax year. I did not understand
Mr Emslie
(who, with Mr Sholto-Douglas, appeared for the Commissioner) to press
this contention. That attitude of counsel was correct.
[20] I do not think that it is necessary, as regards the distribution
agreement, to consider the argument of Mr Cilliers (who,
with Mr
Louw, appeared for the taxpayer) that the reference to ‘Stellenbosch
Farmers’ Winery’ in the agreement
was ambiguous, and
therefore that evidence of identification of the entity intended was
admissible, and that the evidence disclosed
that the intention was to
refer to the taxpayer.
[21] The following considerations dictate a finding that the taxpayer
did acquire the exclusive rights of distribution provided
for in the
distribution agreement:
(a) SFW Group was solely a holding company, and did not carry on any
operational business activities.
(b) The taxpayer was an operational company that was capable of
implementing the distribution provisions of the agreement; indeed,
it
had been conducting activities of the nature in question for decades.
(c) The JV agreement envisaged that marketing companies/divisions of
SFW be appointed as distributors of the products in question.
The
taxpayer was such an entity.
(d) The taxpayer did in fact assume the role of exclusive distributor
of certain products as envisaged in the agreement and that
regime
governed the relationship between all the role players in question
until the termination agreement came into effect.
[22] The judgment of the Tax Court proceeded on the premise that it
was the taxpayer that surrended the distribution rights in
question,
and in consideration thereof received payment of the sum of R67
million. It could suffice to comment that the premise
was the
corollary of the finding referred to in the previous paragraph. It
may be added however that the evidence disclosed that
the party with
which negotiations were held in respect of the termination of the
distribution rights was in fact the taxpayer.
I refer specifically to
the evidence of Mr Stroebel, the managing director of the taxpayer
(and of SFW Group as well), Mr van der
Watt, the corporate strategy
and planning manager of the taxpayer, and Mr Cardwell, the managing
director of UDI. The evidence
was not challenged.
Was the receipt of the sum of R67 million of a capital or a
revenue nature?
[23] While the Act, in s 1, contains a definition of ‘gross
income’, which excludes receipts or accruals of a capital
nature (save for certain exceptions which are not relevant for
present purposes), there is no definition of ‘receipt or
accrual of a capital nature’. There is no single criterion for
determining whether a receipt or accrual is to be categorised
as
capital or income. The question falls to be decided on the facts of
each particular case: see
Bourke’s Estate v Commissioner for
Inland Revenue.
1
In
Commissioner for Inland Revenue v Pick ’n Pay Employee
Share Purchase Trust
2
Smalberger JA expressed himself as follows:
‘
There
are a variety of tests for determining whether or not a particular
receipt is one of a revenue or capital nature. They are
laid down as
guidelines only – there being no single infallible test of
invariable application. In this regard I agreed with
the following
remarks of Friedman J in
ITC
1450
(at
76):
“
But
when all is said and done, whatever guideline one chooses to follow,
one should not be led to a result in one’s classification
of a
receipt as income or capital which is, as I have had occasion
previously to remark, contrary to sound commercial and good
sense”
’.
[24] The judgment of the Tax Court sets out a tabulation of a number
of the guidelines which have been recorded in previous decisions
of
the courts. It is not necessary in the present judgment to repeat the
tabulation, and I will content myself in the discussion
that follows
with a reference only to those guidelines that appear to be
appropriate for a resolution of the issue on hand.
[25] The starting point in my view is the finding of the court a quo
that the exclusive distribution rights held by the taxpayer
in terms
of the distribution agreement, was a capital asset. That was the
argument of Mr Cilliers in the Tax Court and the correctness
thereof
was conceded by Mr Emslie. In this court that common approach was
persisted in. It was clearly correct and nothing more
requires to be
said on that score. It follows that, consequent upon the termination
agreement, the taxpayer lost an asset.
[26]
Non constat
however, so the court a quo approached the
matter, that the R67 million payment was of a capital nature. The
approach was in keeping
with the approval by Franklin J in
ITC
1259
3
of the following dictum in the English case of
Inland Revenue v
Fleming & Co (Machinery) Ltd (3)
:
4
‘
The
sum received by a commercial firm as compensation for the loss
sustained by the cancellation of a trading contract or the premature
cancellation of an agency agreement may in the recipient’s
hands be regarded either as a capital receipt or a trading receipt
forming part of the trading profit. It may be difficult to formulate
a general principle by reference to which in all cases the
correct
decision will be arrived at since in each case the question comes to
be one of circumstance and degree.’
[27] The Tax Court held that the question to be answered was whether
the tax- payer was compensated for the capital value of the
exclusive
distribution right, ie whether the compensation of R67 million paid
for the early termination of the distribution right
was paid as
compensation for the loss of the value of the capital asset, the
distribution right, and therefore destined to fill
a hole in the
taxpayer’s assets, or whether it was paid as compensation for a
loss of profits in the sales of Bells, which
would be the result of
the early termination of the distribution right.
[28] The first comment that falls to be made on the ruling of the Tax
Court against the taxpayer on this score is that it implies
that the
receipt of the R67 million by the taxpayer was ‘a gain made by
an operation of business
carrying out a scheme for profit-making’,
a well established guideline test considered by Smalberger JA to be
the appropriate one in
Pick ’n Pay.
5
That would mean however that in the present matter the taxpayer,
admittedly in possession of a capital asset and treating it as
such,
changed its intention in respect thereof, and decided to convert its
use of the capital asset (part of its income-producing
structure) to
use thereof as trading stock (part of its income-producing
activities). For the reasons that follow I am unable to
align myself
with that proposition.
[29] It was held in the court a quo that in order to determine the
nature of the amount paid to the taxpayer for the early termination
of the exclusive distribution right, it was important to look at the
bargaining position of the taxpayer and what the amount was
paid for.
It was pointed out that come what may there was no prospect of UD’s
agreeing to the extension of the agreement
beyond the remaining 41
months. The parties therefore negotiated, and ultimately reached
agreement, upon the compensation for a
wasting asset with a finite
lifespan. It is not clear to me however how this consideration bears
on the nature of a payment admittedly
made in respect of an asset.
[30] The judgment of the court a quo sought to lay emphasis on what
was referred to as the taxpayer’s calculations in preparing
for
the negotiations. The reference was to the evidence of Van der Watt,
who stated during examination-in-chief that he was asked
to negotiate
on behalf of the taxpayer ‘an amount for the termination of the
contract as it had a period to run and we clearly
needed to be
compensated for that if it was terminated early’.
[31] That statement, so it was held, required to be seen in the
context of an ‘internal document’ of the taxpayer,
which
reflected that the starting point of the taxpayer at the envisaged
negotiations was to be its calculation of its loss of
profits over
the remaining 41 months in respect of Bells sales, plus the profits
from other products associated with the sales
of Bells. The judgment
continues as follows:
‘
The
final agreed compensation of R67 million mirrors this. It was made up
of R42 117 000 which compensated [the taxpayer] for
the
projected loss of profit for the remaining 41 months. The rest of the
R67 million was made up as compensation for the loss
of profit from
other products which [the taxpayer] would have been able to “bundle”
with or “piggy-back”
on
the sales of Bells and R7 million, which was expressly attributable
to the risk that income tax would be payable.’
[32] The above reasoning misinterpreted the evidence.
(a) While the figure reflected in the document in respect of Bells
sales (excluding VAT) was R42 117 000, the total figure
reflected for all sales including VAT (and inclusive of the addition
of a 35 per cent premium in respect of “piggy-back”
sales) was R64 818 000. Moreover, it was reflected in the
document that if, despite the manner in which the transaction (ie
the
compensation transaction) was structured, the tax authorities were to
seek to tax the proceeds, the tax liability would be
R14,5 million.
The amount of R67 million mirrors neither the total figure of R64
818 000 nor the tax figure of R14.5 million.
(b) In fact, the document in question, although drawn up by Van der
Watt, was not produced during the negotiations nor disclosed
to the
other side.
(c) On the contrary, the evidence of Stroebel was that his initial
offer to the other side was the sum of R100 million (the basis
of
this sum will be discussed below). The counter offer was R60 million.
To this figure R7 million was subsequently added as a
compromise sum
in respect of contingent tax liability.
[33] In any event, the judgment of the Tax Court recognised that in
the valuation of a capital asset it is not inappropriate to
have
regard to the profits anticipated from the use of the capital asset.
Para 32 of the judgment (which follows on the comments
about the
internal document) reads as follows:
‘
While
the method of calculation of the amount of compensation is an
important factor, it is not determinative of the nature of the
receipt. This is so because: “[I]t is a normal principle of
valuation of a capital asset, whether it be land or the goodwill
of a
business or otherwise, to use the profits expected to be earned from
the utilisation of the asset as a basis or starting point
for the
relevant calculations” per McEwan J in ITC
1341
(1980)
43 SATC 215
at 224; and see
Taeuber
and Corssen (Pty) v CIR
(1975)
37 SATC 129
at 140; and see
CIR
v Illovo Sugar Estates Ltd
(1950)
17 SATC 387
at 394.’
[34] The judgment of the court a quo then referred to what were
stated to be indicators of how the taxpayer, at the time, saw and
treated the amount of R67 million it received. The first were entries
in the taxpayer’s financial statements for the tax
year in
question. Two items were relevant. First, in the statement headed
‘CASH FLOW STATEMENT FOR THE YEAR ENDED 30 JUNE
1999’,
the R67 million was reflected as an ‘exceptional item’
under ‘cash flow from operating activities’
and not under
‘cash flow from investing activities’.
[35] In my judgment, counsel for the taxpayer validly argued that the
nature of a receipt (ie whether it is capital or revenue)
for income
tax purposes, is not determined by how it is subsequently treated for
accounting purposes. Reference (by analogy) was
made to the decision
in
Secretary for Inland Revenue v Eaton Hall (Pty) Ltd
6
where it was held that accounting practice cannot override the
correct interpretation of the provisions of the Act and their
application
to the facts of the matter. As appears from the present
judgment the facts favour a finding of a capital nature. Second, not
only
did the financial statement reflect that the receipt of the R67
million was an ‘exceptional item’, but note 4 to the
statement specifically recorded that the receipt was ‘compensation
for the cancellation of the exclusive distribution rights’,
which points rather to a receipt of a capital nature.
[36] The second item in the financial statements referred to by the
Tax Court was an entry reflecting that a dividend of some R88
million
was declared, notwithstanding that, although the taxpayer had the
reserves to declare the dividend it did not have the
cash on hand to
meet the dividend. The point (which had not featured in the
Commissioner’s pleadings) was however adequately
met by
counsel’s submission that the manner in which a taxpayer deals
with a receipt, after it has received it, cannot determine
the nature
of the receipt, eg the capital nature of the receipt of the proceeds
of the sale of a building is not affected by the
utilisation of the
proceeds to pay a dividend.
[37] The court a quo also placed reliance on the fact that the R67
million was initially paid into a dividend account of SFW Group.
On
the evidence of Van der Watt this was done as a matter of convenience
as the taxpayer could then earn interest on the net amount
in the
account. The aspect is not of assistance to the Commissioner.
[38] A further ground for the finding of the Tax Court was founded on
a passage in the taxpayer’s statement of its grounds
of appeal
to the Tax Court. It read as follows:
‘
It was
commercially more sensible for the [taxpayer] to have the
[distribution] agreement terminated in 1998 upon compensation for
the
termination of its rights, than to have the agreement run its full
term and then not have it renewed. If it became apparent,
in 1998,
that the [taxpayer’s] right to distribute Bells . . . would not
have been renewed in January 2002, this would have
had a serious
detrimental effect on the motivation of sales staff, leading to a
reduction in income. Furthermore, the [taxpayer]
had to give itself
time to attempt to limit the damage that would have been caused by
the loss of its distribution rights by attempting
to garner other
business in place of the lost products.’
Suffice it to say that this passage speaks to an intention to receive
compensation for the loss of an asset, which would be used
in an
endeavour to replace that asset with another income-producing
structure.
[39] The above paragraph leads to a consideration of earlier
paragraphs in the judgment of the court a quo reading as follows:
‘
The
loss of the Bells distribution rights resulted in insignificant
changes to [the taxpayer’s] physical business
infrastructure.
But a few personnel (three to four out of 3200 employees) were laid
off. Bells was fully imported in bottled form
and the litreage of the
Bell’s products sold amounted to only 1,45 per cent of the
total litreage handled by [the taxpayer].
[The taxpayer’s]
infrastructure regarding production and distribution therefore
remained virtually intact . . . . [The taxpayer’s]
existing
income-earning structure was rendered less profitable, but it
remained virtually unchanged and was not removed.’
[40] However, one of the guideline tests adverted to in the court a
quo, borrowed from the decision in
ITC
1341
(1980) 43
SATC 215
, was whether a substantial part of the income-producing
structure of the taxpayer had been sterilised by the transaction in
question.
It was held in that case that the impairment of 20 per cent
of the taxpayer’s business was material, and compensation for
such impairment by the withdrawal of a party from a joint venture
agreement was held to be of a capital nature. See too the further
remarks following on the quotation from
Fleming
set out in
para 26 above, reading as follows:
‘
When
the rights and advantages surrendered on cancellation are such as to
destroy or
materially
to
cripple the
whole
structure
of the recipient’s profit-making apparatus, involving the
serious dislocation of the normal commercial organisation
and
resulting perhaps in the cutting down of the staff previously
required, the recipient of the compensation may properly affirm
that
the compensation represents the price paid for the loss or
sterilisation of the capital asset and is therefore a capital and
not
a revenue receipt.’
[41] In
Silke
on South African Income Tax, 2010 service 41,Vol
1 p 3-51, para 2.23 3.23 the following passages appear:
‘
An
amount received by way of damages or compensation for the loss,
surrender or sterilisation of a fixed capital asset or of a
taxpayer’s income-producing machine is a receipt of a capital
nature.
. . .
In order for compensation for
the cancellation of a trading contract to constitute a sum of a
capital nature, it is sufficient if
the contract constitutes a
substantial part of the business, and the cancellation need not have
the effect of destroying or materially
crippling the whole of the
taxpayer’s income producing structure.’
See too
Commissioner of Inland Revenue v Illovo Sugar Estates
Limited
1951 (1) SA 306
(N) at 310-311.
[42] Counsel therefore correctly submitted that the court a quo’s
reasoning reflected that it erroneously focussed on only
physical
assets, instead of the much more valuable incorporeal assets
constituted by the exclusive distribution rights (the loss
of which,
consequent upon the termination of the distribution agreement,
brought in its train the disastrous consequences referred
to earlier
in this judgment). The compensation for the impairment of the
taxpayer’s business constituted by that loss is
properly to be
viewed as a receipt of a capital nature.
[43] In amplification of the findings of the court a quo as to the
calculations that founded the settlement of the compensation
to be
paid, it was subsequently added that, as was admitted by Van der
Watt, a notional purchaser of the distribution rights (to
endure for
a further 41 months) would not have paid R67 million therefor, or
even R42 million. But, as against this feature is
a consideration of
what the negotiating parties wished to secure by settling the terms
of the termination agreement. A prospect
faced by UD was that during
the remaining 41 months that the distribution agreement had to run
the value of the Bells brand would
be seriously compromised as a
result of the manner in which the taxpayer, either of its own accord
or forced by circumstances,
exercised the distribution right. The
value of the distribution right, an asset, would be safeguarded in
UD’s hands. That
was something worth paying for.
[44] On the other hand, Stroebel, the managing director of the
taxpayer, and not Van der Watt, was the person who had finally to
determine and approve the settlement. As recorded earlier, he
conveyed to UD that he wanted a payment of R100 million (his main
purpose being to ensure that capital was available for the
acquisition of a new whiskey brand). In the result, he approved the
counter offer of R60 million as supplemented by the sum of R7
million, the compromise figure in respect of a contingent tax
liability.
The figures were cognisably less than the projected sales
profits and the contingent tax liability (if the Commissioner sought
to assess any such liability). The circumstance that in the result
Stroebel’s endeavours to acquire a substitute brand to
replace
Bells met with minimal financial success is neither here nor there.
[45] Finally, it should be emphasised that clause 4.5 of the
termination agreement
7
referred to payment of full compensation for the closure of the
taxpayer’s business relating to the exercise of the
distribution
rights (an asset). There was no reference in the
termination agreement to a payment for loss of profits. There is no
suggestion
that the termination agreement did not reflect the
intention of the parties or that it was in any way simulated. It need
hardly
be added that any suggestion that the taxpayer, faced with the
option of concluding a capital transaction with no tax implications
or an income transaction with such implications, would chose the
latter, is, to say the least, an unconvincing one.
[46] I find accordingly that the taxpayer, which did not carry on the
business of the purchase and sale of rights to purchase and
sell
liquor products, did not embark on a scheme of profit-making, and
that it did discharge the onus of establishing that the
receipt of
R67 million was of a capital nature. The Commissioner erred in
including the receipt in the taxpayer’s gross income
and
assessing same to tax. The taxpayer is accordingly entitled in the
main appeal to the relevant orders set out at the end of
this
judgment.
The Cross-Appeal
[47] The issue in the cross-appeal would only have remained alive had
the Commissioner been successful in resisting the main appeal.
The
Commissioner’s failure therein renders the issue in the
cross-appeal moot. The dismissal of the cross-appeal is accordingly
appropriate.
The appeal in case no. 504/2011
[48] As recorded in para 4 above, the Commissioner determined that
the receipt of R67 million by the taxpayer (a registered vendor
for
VAT purposes in terms of the Value-Added Tax Act 89 of 1991) was
subject to VAT at the rate of 14 per cent in terms of s 7(1)
of the
Act. The taxpayer’s appeal to the Tax Court against that
determination was successful. The present appeal by the Commissioner
is against the substituted order of the Tax Court that the receipt of
R67 million is subject to VAT at the rate of zero per cent
in terms
of s 11(2)(
l
) of the Act.
[49] Section 7(1) of the Act provides as follows:
‘
Subject
to the exemptions, exceptions, deductions and adjustments provided
for in this Act, there shall be levied and paid for the
benefit of
the National Revenue Fund, a tax, to be known as the value-added tax:
on the supply by the vendor of
goods or services supplied by him . . . in the course or furtherance
of any enterprise carried
on by him;
. . . .’
[50] It was correctly common cause both in the Tax Court and before
us that the matter concerned the issue of the supply of services
in
the course of an enterprise, and not the supply of goods. As will
appear below the issue was finally of narrow ambit.
[51] Relevant definitions in s 1 are the following:
(a) Enterprise includes:
‘
any
enterprise or activity which is carried on continuously or regularly
. . . and in the course or furtherance of which . . . services
are
supplied to any other person for a consideration . . . .’
A proviso to the definition of ‘enterprise’ provides
that
‘
anything
done in connection with the commencement or termination of any such
enterprise or activity shall be deemed to be done in
the course or
furtherance of that enterprise or activity.’
Supply includes:
‘
all .
. . forms of supply, whether voluntary, compulsory or by operation of
law, irrespective of where the supply is effected .
. . .’
Services include:
‘
anything
done or to be done, including the granting, assignment, cession or
surrender of any right or the making available of any
facility or
advantage . . . .’
[52] Section 11(2)
(l)
(ii) provides as follows:
‘
Where,
but for the section, a supply of services would be charged with tax
at the rate referred to in section 7(1), such supply
of services
shall, subject to compliance with subsection (3) of this section, be
charged with tax at the rate of zero per cent
where –
. . . .’
(l) the services are supplied to
a person who is not a resident in the Republic; not being services
which are supplied directly
–
. . . .
(ii) in connection with movable
property . . . situated inside the Republic at the time the services
are rendered . . . .’
[53] The Tax Court found that, by agreeing to the early termination
of the distribution right, the taxpayer surrendered the remaining
portion of the right, and that such surrender constituted the supply
of services in the course of an enterprise by the taxpayer
to UD.
There can be no quarrel with the correctness of these findings.
.
[54] The argument of Mr Emslie was essentially the following.
Accepting that UD was a non-resident of the Republic, counsel
submitted
that the services supplied by the taxpayer were constituted
by the
act of surrender
and that the movable property in
connection with which those services were directly supplied by the
taxpayer was
the exclusive distribution right
provided for in
the distribution agreement, now coming to an end in terms of the
termination agreement, which right was situated
within the Republic
where it was being exercised.
[55] The argument cannot be upheld. In the first place, the
distinction sought to be drawn by counsel between the act of
surrender
and the right surrendered is not a valid one. The question
was dealt with by the Tax Court as follows:
‘
. . .
I do not agree with the submission that the exclusive distribution
right held by the [taxpayer] can constitute the movable
property as
contemplated in s
11(2)(
l
)
.
The
services supplied by the [taxpayer] consisted of the surrender of the
exclusive right. These services must be supplied
directly
in connection with movable property situated inside the Republic
at the
time the services are rendered. Logically there must be two separate
entities: the services being supplied and the movable
property which
stand in direct connection with the services being supplied. I fail
to see how the right which is being surrendered,
the surrender of
which constitutes the supply of the services, and is thus a
constituent part of the services being supplied, can
at the same time
constitute the movable property which is required by
section
11(2)
(l)
to
be in direct connection with the very services being supplied.’
(Emphasis in original)
I align myself with this reasoning and do not feel called upon to add
anything thereto.
[56] That conclusion renders it unnecessary to consider the second
leg of the inquiry. I will however make the following brief
comments.
I agree with the finding of the Tax Court that the exclusive
distribution right, which was incorporeal property, was
not situated
in the Republic. The
situs
of an incorporeal right is where
the debtor resides.
MV Snow Delta: Serva Ship Ltd v Discount
Tonnage Ltd
8
.
In this case the place of residence of the debtor, UD, was the
United Kingdom, where it was registered. The matter therefore fell
squarely within the purview of s 11(2)
(l)
(ii)
.
[57] The taxpayer accordingly discharged the onus resting on it in
terms of
s 37 of the Act to establish that the supply in question was subject
to value-added tax at the rate of zero per cent, and that
the
contrary decision of the Commissioner was wrong.
Orders
[58] The following orders will accordingly issue:
(a) Case no: 511/2011:
(1) The main appeal is upheld with costs, including the costs of two
counsel.
(2) The additional assessment of the taxpayer in respect of the 1999
tax year is set aside.
(3) The cross-appeal is dismissed with costs, including the costs of
two counsel.
Case no: 504/2011
The appeal is dismissed with costs, including the costs of two
counsel.
__________________
F Kroon
Acting Judge of Appeal
APPEARANCES:
Cases: 511/2011 and 504/2011
FOR APPELLANT: SA Cilliers SC (with him C Louw)
Instructed by Edward Nathan Sonnenbergs ,
Cape Town,
Symington & de Kok,
Bloemfontein.
FOR RESPONDENT: T S Emslie SC (with him A R Sholto-Douglas SC)
Instructed by The State Attorney,
Cape Town,
The State Attorney,
Bloemfontein.
1
Bourke’s
Estate v Commissioner for Inland Revenue
1991
(1) SA 661
(A) at 671I-J ;
53 SATC 86
at 93.
2
Commissioner
for Inland Revenue v Pick ’n Pay Employee Share Purchase Trust
1992 (4) SA 39
(A) at 56G-I.
3
ITC
1259
39 SATC 65
at 68-69.
4
Inland
Revenue v Fleming & Co (Machinery) Ltd (3)
33
TC 33
at 63.
5
Fn
2 above at 56I-G. See too
SIR v The
Trust Bank of Africa Limited
1975 (2)
SA 652
(A);
37 SATC 87
at 101-102.
6
Secretary
for Inland Revenue v Eaton Hall (Pty) Ltd
1975
(4) SA 953
(A) at 958 B-D.
7
Para
16 above.
8
MV
Snow Delta: Serva Ship Ltd v Discount Tonnage Ltd
2000 (4) SA
746
(SCA) paras 9-10.