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[2010] ZASCA 168
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Commissioner for South African Revenue Service v NWK Ltd (27/10) [2010] ZASCA 168; 2011 (2) SA 67 (SCA) ; [2011] 2 All SA 347 (SCA); 73 SATC 55 (1 December 2010)
Links to summary
THE SUPREME COURT OF APPEAL OF SOUTH AFRICA
JUDGMENT
Case no
: 27/10
In the
matter between:
COMMISSIONER
FOR THE SOUTH AFRICAN
REVENUE
SERVICE
...................................................................................
Appellant
and
NWK LIMITED
........................................................................................
Respondent
Neutral citation:
CSARS v NWK
(27/10)
[2010]
ZASCA 168
(1 December 2010)
Coram:
HARMS DP, LEWIS, CACHALIA and SHONGWE JJA and BERTELSMANN AJA
Heard:
11 NOVEMBER 2010
Delivered
1 December 2010
Summary:
Simulated transaction: tests for simulation: taxpayer
not entitled to claim deduction in respect of interest paid on amount
not
actually borrowed. Section 103(1) can be invoked where it is not
shown that transaction is simulated.
ORDER
On appeal from the Tax Court sitting at Johannesburg (per Boruchowitz
J and assessors sitting as a court of appeal):
1 The appeal against the order of the Tax Court is upheld with costs
including those of two counsel.
2 The order of the Tax Court is replaced with:
‘
(a) The objection to the assessments is
dismissed and the additional assessments are upheld.
(b) The objection to the imposition of additional tax of 200 per cent
is upheld.
(c) Additional tax of 100 per cent of the total amount of the
additional assessments is imposed in terms of s 76 of the Income
Tax
Act 58 of 1962.’
JUDGMENT
LEWIS JA (HARMS DP, CACHALIA AND SHONGWE JJA and BERTELSMANN AJA
concurring)
[1] Over a period of five years, from 1999 to 2003, the respondent,
NWK Ltd, claimed deductions from income tax in respect of interest
paid on a loan to it by Slab Trading Company (Pty) Ltd (Slab), a
subsidiary of First National Bank (FNB), in the sum of R96 415
776.
NWK is a public company which formerly operated as a co-operative
society trading in maize. The deductions were allowed. But
in 2003
the appellant, the Commissioner for the South African Revenue
Service, issued new assessments disallowing the deductions
and
refusing to remit any part of the interest on the amounts assessed.
He also imposed additional tax and interest in terms of
ss 76 and
89quat of the Income Tax Act 58 of 1962. The amount claimed pursuant
to the additional assessments, including additional
tax, was R47 360
583.
[2] The basis of the revised assessments by the Commissioner was that
the loan was not a genuine contract: it was part of a series
of
transactions entered into between NWK and FNB and its subsidiaries,
all designed to disguise the true nature of the transaction
between
NWK and FNB, with the intention of NWK avoiding or reducing its
liability for tax.
[3] NWK appealed against the assessments and the imposition of
additional interest and penalties. Boruchowitz J and two assessors
in
the Tax Court held at Johannesburg upheld the appeal. It is against
the order of the Tax Court that the Commissioner appeals.
The basis
of the Commissioner’s argument on appeal is that the loan was
simulated: that it had to be viewed in the light
of several other
agreements concluded between NWK and FNB, and FNB and its
subsidiaries, which together showed that a sum of only
R50m was lent
by FNB to NWK, and that the transactions were devised to increase the
ostensible amount lent so that deductions of
interest on a greater
amount could be claimed. NWK argued, on the other hand, that there
was an honest intention on the part of
NWK, represented by Mr E
Barnard, its financial director, to execute the contracts in
accordance with their tenor, and the claims
for deductions were
valid. The Tax Court accepted this contention and upheld the appeal
to the Tax Court on this basis.
[4] The Commissioner contended, in the alternative, both before the
Tax Court and this court, that s 103(1) of the Act, in operation
at
the relevant time, was applicable: the Commissioner was satisfied
that the transactions in question had been entered into for
the
purpose of avoiding tax. The Tax Court held that once the
Commissioner had concluded that the transactions were simulated he
could not be ‘satisfied’ that they been entered into for
the purpose of avoiding or reducing liability for tax. Section
103(1)
thus had no application.
Background to the transactions and their conclusion
[5] Before discussing the transactions that the Commissioner sought
to impugn it is helpful to look at the events leading to their
conclusion. As I have said, the main business of NWK was trading in
maize. In 1998, according to Barnard, it had an annual turnover
of
R1.5b. Its net operating profit was R103m. It had over the years
borrowed money from the Land Bank and had banking facilities
with a
number of commercial banks, including FNB, but had not used the
latter. In January of that year, two representatives of
FNB, Mr Louw
and Mr McGrath visited Barnard and offered a structured finance loan
facility to NWK.
[6] Neither Louw nor McGrath testified. Indeed no witness from FNB
was called by NWK. I shall revert to this briefly, since there
was
criticism of the Commissioner for not calling any witnesses from FNB.
It is of course NWK which bore the onus of proving that
the
transactions were not simulated, an issue to which I shall also
return. The history and context of the impugned transactions
emerge
from Barnard’s evidence, the written agreements and from other
documents.
[7] Barnard questioned aspects of the proposal, in particular the tax
implications. FNB sent him an opinion written by senior counsel
who
had commented on similar transactions. There is nothing to indicate,
however, what instructions were given to counsel, and
whether the
transactions on which he commented were identical or even similar to
those proposed to NWK by FNB. And while counsel
indicated that his
view was that the transactions described were tax-efficient, he did
caution, in spite of having been advised
that the transactions were
normal, that there was always the possibility that the Commissioner
might apply s 103(1) to them. The
transactions, he suggested, might
not be regarded as having bona fide business purposes.
[8] On 13 February 1998 Louw and Mr J van Emmenes, also from FNB,
wrote an internal memorandum to the General Manager, Group Credit
within FNB on the proposal to offer a ‘structured finance
facility’ of R50m to NWK, ‘repayable in 5 equal annual
capital and interest payments over 5 years’. The facility would
be used, they said, to reduce existing liabilities. They
recommended
the grant of the facility. Barnard did not see this internal
memorandum at the time, but he did confirm when testifying
that it
correctly reflected what had been discussed.
[9] The proposal was made formally in a letter FNB sent to NWK on 28
February 1998, offering to update its existing banking facilities
by
the addition of a term finance facility of R50m, subject to what it
called a term finance agreement. The formal proposal attached
was
said to be confidential and ‘proprietary’ to FNB and
required NWK to sign a confidentiality undertaking to preserve
FNB’s
trade secrets and highly confidential and sensitive information.
[10] A diagram reflected the suite of transactions that would
constitute the finance facility. It used indicative amounts rather
than the actual sums that would ultimately be paid and repaid. The
diagram also appeared to indicate the sequence in which all
contracts
and performance would occur, though it did not specify that this was
so and in fact the transactions were not all concluded
entirely as
envisaged nor did they follow the apparent sequence.
[11] The contracts envisaged were these. (I shall not use the sums
referred to in the proposals but rather the actual amounts reflected
in the transactions concluded later).
A subsidiary of FNB that dealt in financial instruments, Slab, would
lend a sum of R96 415 776 to NWK, to be repaid over five
years.
The capital amount would be repaid by NWK delivering to Slab at the
end of the five year period 109 315 tons of maize.
Interest would be payable on the capital sum at a fixed rate of
15.41 per cent per annum payable every six months. To this end
NWK
would issue ten promissory notes with a total value of R74 686 861.
To fund the loan Slab would discount the notes (sell them for an
amount less than their face value) to FNB. NWK, on due date,
would
pay FNB.
Slab would sell its rights to take delivery of the maize at the end
of the five year period to First Derivatives, a division
of FNB.
This ‘forward sale’, for the sum of R45 815 776, would
enable FNB to pay the full amount of the loan to NWK.
First Derivatives would sell to NWK the right to take delivery of
the same quantity of maize for the sum of R46 415 776, payable
immediately on the conclusion of the contract, but delivery to take
place only five years hence. This contract would neutralize
the
risks associated with delivery in the future.
Slab would cede its rights to a trust company to relieve Slab of the
‘administrative burden’ of the transaction.
(This
transaction did not eventuate.)
[12] The proposal indicated that the series of transactions would
enable NWK to deduct the interest paid on the capital sum in
the year
it was payable under s 11(a) of the Act. Barnard submitted the
proposal to NWK’s board of directors for approval
which was
granted on 30 March 1998. Contracts envisaged in the proposal were
signed by Barnard on behalf of NWK on 1 April 1998
and by Slab and
FNB on 2 April. I shall, for convenience, refer to the date of the
contract as 1 April 1998.
The contracts between NWK and FNB and its subsidiary or division
The loan
[13] The contract provided that Slab would lend R96 415 776 to NWK.
‘Repayment’, to take place on 28 February 2003,
would be
effected by the delivery to Slab of 109 315 tons of ‘dried
white maize intended for human consumption’. (Although
the
transaction was, in my view, a sale and not a loan, I shall refer to
it for convenience as a loan.) The delivery was to be
effected by
representatives of the parties meeting in the presence of a notary
when appropriate certificates would be signed –
a recognized
means of constructive delivery in the industry.
[14] The parties agreed that Slab would be entitled to cede its right
to delivery of the maize or to delegate any of its obligations
under
the contract, to a company within the FNB group, without the consent
of NWK. NWK, on the other hand, was not permitted to
cede any right
or delegate any obligation, but it undertook to effect delivery to
any cessionary.
[15] The capital amount of the loan was subject to interest at a
fixed rate of 15.27 per cent per annum, compounded monthly in
arrear.
The interest was payable every six months. In respect of each payment
NWK was to (and did) issue promissory notes, the
face value of the
total being R74 686 861. This is the amount that NWK claimed as a
deduction over the five year period in terms
of s 11(a) of the Act.
The forward purchase agreement: First Derivatives to NWK
[16] The second contract concluded on 1 April 1998 was labelled a
‘forward purchase agreement’. First Derivatives,
a
division of FNB, sold to NWK the same quantity of maize (109 315
tons) as was supposed to be delivered in discharge of the loan
for
R46 415 776. The price was payable in cash on 1 April 1998 and
delivery was to be effected on 28 February 2003, the same day
on
which NWK was to discharge its obligation under the loan. And
delivery was to be constructive. The purpose of this transaction
was
to ensure that NWK would have possession of the requisite quantity of
maize when it was required to effect delivery to Slab.
NWK in fact
paid the sum of R46 415 776 to First Derivatives on 1 April 1998.
The forward purchase agreement: Slab to First Derivatives
[17] On the same day, Slab sold to First Derivatives the same
quantity of maize for R45 815 776. Again, the price was payable on
1
April 1998, and delivery of the maize would be effected, in the same
manner, on 28 February 2003. NWK was not party to this contract,
but
was aware that it would be concluded: a similar transaction (that
Slab would sell its claim against NWK to First Derivatives)
was an
integral part of the proposal by FNB.
The cession of the rights in the promissory notes to FNB
[18] On 1 April 1998 a fourth transaction was concluded. Slab sold
its rights (ceding them) to the promissory notes to FNB for
R50 697
518. It will be recalled that the face value of the notes was R74 686
861. The discount was thus substantial. Again, although
NWK was not a
party to the transaction, it was envisaged in the proposal and
Barnard was aware that the cession at a substantially
discounted rate
would be effected.
The June 1998 cessions
[19] On 29 June 1998 NWK and Slab ceded their respective rights to
the delivery of maize to FNB. Barnard for NWK signed both deeds
of
cession at FNB’s request. The NWK right to delivery arose from
the forward sale between it and Slab. The Slab right to
delivery
arose from the loan agreement. In the proposal it was envisaged that
Slab would cede its right to the maize to a trust
company. Instead
FNB was substituted as the cessionary. The Tax Court regarded the
cession by NWK to FNB as one in securitatem
debiti.
[20] In effect each cession cancelled the other. NWK transferred its
right to FNB to claim delivery of the maize. And FNB acquired
from
Slab the right to claim delivery of the same maize from NWK. (The
‘cancellation’ of the delivery would have been
by the
process of
confusio
: where a right and corresponding
obligation inhere in the same person, the obligation ceases to
exist.) Slab ceased to be a party
to any of the agreements in June
1998. Its participation in the transaction as a whole was ephemeral.
The implementation of the contracts
[21] The promissory notes issued by NWK in respect of its interest
obligations were presented and paid on their due dates. And
on 28
February 2003 FNB and NWK representatives met in the presence of a
notary in Lichtenberg. FNB delivered negotiable silo certificates
to
NWK in performance of its obligation to deliver the maize under the
NWK forward purchase agreement. The same silo certificates
were
handed over to FNB in performance of NWK’s obligation to
deliver maize to FNB (as cessionary of Slab’s right)
five
minutes later, according to the notary’s certificate. The
reader might well say ‘What a charade’. But I
shall
revert to that.
A bank facility afforded by FNB to NWK on 23 February 1998
[22] Before turning to the issues before the Tax Court it should be
noted that there was another agreement between FNB and NWK,
concluded
before the series of transactions concluded in April and June of
1998. On 23 February 1998 Louw and Van Emmenes of FNB
wrote to NWK,
following discussions with Barnard, and offered two bank facilities:
a direct bank facility of R150m and ‘termynfinansiering’
in the sum of R50m. The latter was for a period of five years, and
was subject to various terms, including that NWK would not borrow
from any other financial institution (excluding the Land Bank) over
the five-year period without the written consent of FNB.
[23] The offer by FNB was accepted by NWK on 1 April 1998, the same
day as it signed the other loan agreement for R96 415 776.
In an
internal memorandum written to the General Manager, Group Credit, by
Louw and Van Emmenes, it was pointed out that NWK was
interested in a
‘medium term structured finance proposal’ and that FNB
had been requested to consider a ‘loan
facility of R50m
repayable in 5 equal annual capital and interest payments over 5
years’. This memorandum culminated in the
letter of 23 February
offering the short term facility of R50m.
Claims by NWK for deductions from Income Tax
[24] In each of the years of assessment for income
tax from 1999 to 2003 NWK claimed and was granted a deduction from
income in
terms of s 11(a)
1
of the Act in respect of the interest paid to FNB.
The amount claimed was equal to the face value of the promissory
notes paid in
the year, which NWK had issued to Slab and which Slab
sold to FNB.
[25] In June 2003 (and in March 2004 in respect of the 2003 year of
assessment) the Commissioner issued additional assessments
in terms
of s 79 of the Act, disallowing the deductions previously made. He
also, in terms of s 76, imposed additional tax of 200
per cent (the
maximum permissible) and interest (s 89quat – interest on
underpayment). NWK objected to the additional assessments.
The
Commissioner disallowed the objections, and NWK duly appealed against
the respective assessments and the imposition of the
additional tax
and interest.
Grounds of assessment
[26] The basis of the additional assessments was the Commissioner’s
view that the agreements concluded between NWK and FNB
and its
subsidiary Slab did not reflect the substance of the real
transaction. Slab, it contended, was interposed as a party solely
for
the purpose of reducing or evading liability for income tax. The loan
by Slab to NWK, although ostensibly of R96 415 776, was
in reality
one for R50m. And the effect of the forward sales and the cessions
was that the same maize that NWK would use to discharge
its
obligation to repay Slab (the right to performance having been ceded
to FNB), was sold by FNB to NWK.
[27] The loan, the Commissioner contended, was a ‘mere paper
exercise and/or simulation’. The reasons for this were
that
none of Slab, NWK or FNB intended to trade in maize before or after
the transactions were entered into. The value of the maize
at the
time of delivery (in February 2003) was uncertain. The purchase price
for the maize was based on a fictitious value and
was determined
without reference to the value of the maize on the date of conclusion
of the contracts. On 1 April 1998 the price
of maize quoted on the
South African Futures Exchange (SAFEX) was R715 per ton, whereas the
price agreed was R419 per ton. The
total amount payable for the maize
under the forward sale agreement (R45 815 776) was determined by
discounting the loan amount
of R96 415 776 at the rate of 15.27 per
cent per annum – the same rate as that for interest payable on
the loan. To this
was added the sum of R97 518 which was payable to
Slab as a fee for its participation in the series of transactions.
[28] Further indiciae of simulation, the Commissioner considered,
were that the risks associated with delivery of maize five years
after the conclusion of the sales were great: the market is volatile.
Yet no account had been taken of volatility, of arrangements
for
storage after harvest, or the costs of storage or transport.
Moreover, the Commissioner asserted, the description of the maize
in
all the agreements was inadequate. The grade of the maize was not
stipulated although it would materially affect its market
value.
[29] NWK had no intention of repaying its loan with Slab through the
delivery of the maize; Slab had no intention of acquiring
the maize
or selling it, in turn, to FNB; and the cessions from Slab to FNB and
of NWK to FNB effectively cancelled the respective
obligations. (The
Commissioner contended that the respective obligations were
extinguished by set-off.) The obligations of NWK
and FNB respectively
to deliver the identical maize in February 2003 by the issue of silo
certificates by a notary were dependent
on each other: if one did not
perform the other could not.
[30] The Commissioner thus considered that the transactions ‘were
specifically designed to conceal the fact that in reality,
the actual
loan amount advanced’ to NWK was R50m. The additional amount
was simulated with a series of contracts purporting
to sell maize
which the parties never intended to have any effect. Slab had no real
role to play and its participation was ‘artificially
engineered
and specifically designed to conceal the fact that the true loan
amount was the sum of [R50m]. Slab’s sole purpose
was therefore
to facilitate the enhanced deduction claimed by [NWK] in terms of s
11(a) of the Act’. FNB made an immediate
profit of R600 000
when it bought the promissory notes for R50 697 518 from Slab.
Furthermore, FNB, in receiving the sum of R74
686 861 (the face value
of the promissory notes), in effect was paid interest on the real
loan of R50m.
[31] Thus having regard to the ‘substance and reality of the
transaction’ the face value of the promissory notes was
determined by combining the capital value of the loan (R50m) with
interest over the period of the loan of R23 989 343. The total
of
these two amounts, plus the fee of R697 518, was equal to the face
value of the promissory notes.
[32] The Commissioner considered that the actual transaction that was
contemplated by FNB and NWK was a loan for R50m: the promissory
notes
covered both the capital and interest. Thus the portion of the notes
that constituted repayment of capital was not deductible
as interest
in terms of s 11(a) of the Act and was also not expended in the
course of trade.
[33] In the alternative the Commissioner contended that the series of
transactions constituted a ‘transaction, operation
or scheme’
in terms of s 103(1) of the Act that had the effect of avoiding or
reducing NWK’s liability for tax in the
1999 to 2003 years of
assessment and that the transactions were abnormal and were entered
into solely or mainly for the purpose
of obtaining a tax benefit.
[34] The Commissioner imposed additional tax and interest, as I have
said. The grounds for this were that NWK represented in its
tax
returns in question that the payment of the promissory notes was in
respect of interest when in fact it was also in respect
of capital.
In so doing, NWK also represented that the transactions were normal
commercial transactions, in terms of which there
would be deliveries
of maize, when in reality no delivery was ever intended. The
deliberate attempt to disguise the true nature
of the transactions
warranted the imposition of the additional tax, he contended.
The grounds of appeal
[35] NWK alleged in its grounds of appeal that the contracts
concluded between Slab, NWK and FNB were performed in accordance with
their terms: NWK received the amount of R96 415 776 in terms of the
loan agreement, and delivered the promissory notes to Slab.
NWK paid
the price of the maize – R46 415 776 – to First
Derivatives in terms of the forward sale agreement. NWK was
not party
to the agreements between Slab and FNB. The terms of the loan
reflected the intention of NWK and were implemented and
performed in
accordance with their tenor. And there was no tacit understanding or
unexpressed agreement on the part of NWK that
was not recorded in the
contracts to which it was party.
[36] NWK contended thus that the loan for the full capital amount was
correctly reflected and no portion of the payment made by
it was of a
capital nature. In so far as s 103(1) of the Act was concerned, NWK
denied that the contracts had the effect of avoiding
or postponing
liability for tax: they were concluded solely or mainly for the
purpose of securing loan finance. NWK also contended
that its tax
returns over the years of assessment contained full and accurate
information and that it was not liable for the additional
tax nor for
the additional interest.
The decision of the Tax Court
[37] The Tax Court found that NWK had acted in terms of the
agreements. It accepted that Barnard, representing NWK, had genuinely
intended to act in accordance with the terms of the loan agreement
and although aware of the agreements between Slab and FNB, was
not a
party to them. The Tax Court held that Barnard was a credible and
satisfactory witness. I shall deal with his evaluation
after
considering some of the evidence. It is important to note that the
Commissioner’s case in the Tax Court was that the
simulation of
the transactions was deliberate. There was no contention that the
parties had genuinely believed that the transactions
were bona fide
and would be performed in accordance with their terms. It was argued
in that court that NWK and FNB were acting
deliberately to conceal
the true nature of the transaction.
Onus of proof
[38] In this court the Commissioner maintained his
stance that NWK, represented by Barnard, had concluded the loan
agreement and
the forward sales and cessions to which it was party,
knowing that they were simulated transactions, and in order to gain a
tax
advantage rather than really to borrow the sum of R96 415 776. In
terms of s 82(b) of the Act NWK bore the onus of proving that
the
transactions were not simulated.
2
NWK argued that the agreements themselves provided
prima facie proof of the true transaction between the parties.
Accordingly, the
burden rested on the Commissioner to rebut the prima
facie inference.
[39] The Commissioner, on the other hand, contended that the
agreements had to be viewed in context and having regard to all other
evidence, and that NWK had not discharged the onus of proving that
the loan was not simulated. The mere production of the agreements
was
not enough to discharge the onus. NWK had to refute the assessment
that it had a dishonest intention to disguise a transaction.
And the
substance of the loan agreement, viewed in the light of other
transactions and negotiations preceding it, was such that
NWK had to
prove that it genuinely intended to borrow R96 415 776 from Slab, and
to repay it by delivering maize five years after
the money had been
lent.
[40] This court has previously held that the mere
production of agreements does not prove that the parties genuinely
intended them
to have the effect they appear to have. In
Erf
3183/1 Ladysmith (Pty) Ltd v CIR
3
Hefer JA, dealing with a contention that
agreements should be given effect in accordance with their tenor
(form), said:
‘
This
is plainly not so. That the parties did indeed deliberately cast
their arrangement in the form mentioned, must of course be
accepted;
that, after all, is what they had been advised to do. The real
question is, however, whether they actually intended that
each
agreement would
inter
partes
have
effect according to its tenor. If not, effect must be given to what
the transaction really is.’
After referring to s 82 of the Act Hefer JA continued:
‘
Therefore,
unless the appellants have shown on a preponderance of probability
that the agreements do indeed reflect the actual intention
of the
parties thereto, the Commissioner’s decision cannot be
disturbed.’
[41] This was the view also of Harms JA in
Relier
(Pty) Ltd v CIR
4
where he said that if the agreements in issue were
taken at face value the taxpayer would have to succeed: but the
agreement in
question had ‘unusual and unreal aspects to it’
which raised questions as to the real intention of the taxpayer. How
then does a court ascertain the real intention of a party to a
contract when the contract appears to be simulated? This is the
question to which I now turn before examining any of the evidence.
Real intention and simulation: Substance and form
[42] It is trite that a taxpayer may organize his
financial affairs in such a way as to pay the least tax permissible.
There is,
in principle, nothing wrong with arrangements that are tax
effective.
5
But there is something wrong with dressing up or
disguising a transaction to make it appear to be something that it is
not, especially
if that has the purpose of tax evasion, or the
avoidance of a peremptory rule of law. However, as Hefer JA said in
Ladysmith,
6
one must distinguish between the principle that
one may arrange one’s affairs so as to ‘remain outside
the provisions
of a particular statute’, and the principle that
a court ‘will not be deceived by the form of a transaction: it
will
rend aside the veil in which the transaction is wrapped and
examine its true nature and substance’ (per Wessels ACJ in
Kilburn v Estate Kilburn
,
7
cited by Hefer JA in
Ladysmith
8
).
As the court said in
Ladysmith
9
the principles are not in conflict.
[43] I shall not traverse the long line of
authority in which these two principles have been invoked. They are
dealt with comprehensively
in
Ladysmith.
And they are expressed in classic statements in
Zandberg v Van Zyl
10
and
Commissioner of
Customs and Excise v Randles, Brothers & Hudson Ltd.
11
In
Zandberg
Innes JA said:
‘
Now,
as a general rule, the parties to a contract express themselves in
language calculated without subterfuge or concealment to
embody the
agreement at which they have arrived. They intend the contract to be
exactly what it purports; and the shape which it
assumes is what they
meant it should have. Not infrequently, however (either to secure
some advantage which otherwise the law would
not give, or to escape
some disability which otherwise the law would impose), the parties to
a transaction endeavour to conceal
its real character. They call it
by a name, or give it a shape, intended not to express but to
disguise its true nature. And when
a Court is asked to decide any
rights under such an agreement, it can only do so by giving effect to
what the transaction really
is: not what in form it purports to be.
The maxim then applies
plus
valet quod agitur quam quod simulate concipitur.
But
the words of the rule indicate its limitations. The Court must be
satisfied that there is a real intention, definitely ascertainable,
which differs from the simulated intention.
For
if the parties in fact mean that a contract shall have effect in
accordance with its tenor, the circumstances that the same
object
might have been attained in another way will not necessarily make the
arrangement other than it purports to be.
The
enquiry, therefore, is in each case one of fact, for the right
solution of which no general rule can be laid down’ (my
emphasis).
[44] In
Randles
Watermeyer JA, after quoting this statement said:
12
‘
I wish
to draw particular attention to the words “a real intention,
definitely ascertainable, which differs from the simulated
intention”, because they indicate clearly what the learned
Judge meant by a “disguised” transaction. A transaction
is not necessarily a disguised one because it is devised for the
purpose of evading the prohibition in the Act or avoiding liability
for the tax imposed by it. A transaction devised for that purpose, if
the parties honestly intend it to have effect according to
its tenor,
is interpreted by the Courts according to its tenor, and then the
only question is whether, so interpreted, it falls
within or without
the prohibition or tax.’
[45] While there may be no conflict between the
two principles referred to in
Ladysmith
there is a divergence in their application: the
cases do not consistently approach what is really meant by a party’s
intention
in concluding a contract –what purpose he or she
seeks to achieve – and this warrants some further
consideration. Indeed,
the best illustration of this divergence is to
be found in
Randles
,
13
where the different approaches are to be found in
the minority and majority judgments. The facts in that matter bear
repeating.
[46] Before 1936 Randles had imported fabric under rebate of customs
duty. Various manufacturers made up the fabric into shirts
and
pyjamas, and returned the items so made up to Randles for sale to
retailers. In 1936 the customs regulations changed. In order
for
Randles to get the rebate the manufacturers had to declare that the
material was their property. Randles thus changed its former
practice
and contracts with the manufacturers. They purported to transfer
ownership of the material to the manufacturers, so that
the
declarations could be made. But the ‘right’ that the
manufacturers acquired was severely restricted. They had to
make up
the garments in accordance with Randles’ instructions and to
resell the finished items to Randles at a price equal
to that which
Randles charged them, plus the cost of making up the garments.
Randles bore the risk of loss or damage to the material
at all times.
[47] Watermeyer JA for the majority ( Feetham JA concurred and
Centlivres JA delivered a separate concurring judgment) found that
Randles had so much wanted to transfer ownership of the materials,
albeit that the transfer was but a vehicle for achieving another
purpose, that they had intended to do so. There was no requirement,
he held, that the right transferred had to be untrammelled.
[48] De Wet CJ preferred to look at the substance
of what was done: the parties could not possibly have intended sales,
pursuant
to which ownership of the materials would pass, he
considered, since the manufacturers acquired a ‘right’
devoid of
content. Tindall JA too considered that the court should
have regard to what was done rather than what was said.
14
In cases that have followed, discussed below, the
minority approach has in fact been followed.
[49] In
Vasco Dry
Cleaners v Twycross
15
Hoexter JA examined all the peculiar features of a
contract, ostensibly for the transfer of ownership, to determine the
real intention
of the parties. And in
Skjelbreds
Rederi A/S v Hartless (Pty) Ltd
16
the court refused to recognize a cession of
rights, enabling litigation, where it was clear that the successful
litigant would have
to retransfer the rights to the cedent after the
litigation. Dishonesty was not in issue in any of these cases. But in
each a transaction
had been concluded to achieve a purpose other than
that for which it was ostensibly concluded.
[50] In other cases, such as
Hippo
Quarries (Tvl) (Pty) Ltd v Eardley
,
17
courts have looked at the form of a transaction
and concluded that the parties genuinely intended to give effect to
that which they
had apparently agreed. And in
CIR
v Conhage
18
Hefer JA found that sale and leaseback agreements,
which had unusual terms but which made good business sense, were
honestly intended
to have the effect contended for by the parties.
19
[51] In
Hippo
Quarries
the court drew a distinction
between motive and purpose, on the one hand, and intention on the
other, in trying to determine the
genuineness of a contract, and of
the underlying intention to transfer a right, where the transfer was
not an end in itself. Nienaber
JA said:
20
‘
Motive
and purpose differ from intention. If the purpose of the parties is
unlawful, immoral or against public policy, the transaction
will be
ineffectual even if the intention to cede is genuine. That is a
principle of law.
Conversely,
if their intention to cede is not genuine because the real purpose of
the parties is something other than cession, their
ostensible
transaction will likewise be ineffectual. That is because the law
disregards simulation.
But
where, as here, the purpose is legitimate and the intention is
genuine, such intention, all other things being equal, will be
implemented’ (my emphasis).
[52] NWK likened the transactions in this matter
to those featuring in
S v Friedman
Motors (Pty) Ltd
21
where the contracts in question were designed to
avoid legislation regulating money-lending transactions. In order to
obtain funds
to acquire a motor car, an individual would sell his car
to a bank. The bank would immediately resell the car to the
individual
for a higher price, but would reserve ownership in the car
until the full purchase price was paid – a hire-purchase
contract.
The individual would pay a cash deposit and monthly
instalments and on payment of the full purchase price ownership of
the car
would revert to him. The same object would usually be
achieved through a loan of the price by the bank to the individual,
repayable
with interest.
[53] Colman J considered that the transactions
might be loans, disguised as sales, or genuine sales, depending on
the parties’
intention. He said:
22
‘
If two
people, instead of making a contract for a loan of money by one of
them to the other, genuinely agree to achieve a similar
result
through the sale and repurchase of a chattel, there is no room for an
application of the maxim
plus
valet quod agitur quam quod simulate concipitur.
The
transaction is intended to be one of sale and repurchase, and that,
at common law, is what it is.’
[54] But in both
Friedman
and
Conhage
,
where the courts held that the parties intended their contracts to be
performed in accordance with their tenor, there were sound
reasons
for structuring the transactions as they did: the purchaser of the
car in
Friedman
was
required to give security in return for the funds advanced by the
bank. A pledge would have deprived him of the car and its
use. Hence
the sale and resale: it allowed the purchaser to keep and use the
car. In
Conhage
the
sale and leaseback of manufacturing equipment permitted the
manufacturer to retain possession of the equipment. There was a
commercial reason or purpose for the transactions to be structured as
they were. In both instances there was a genuine transfer
of
ownership. Had the purchaser failed to pay the seller he would have
lost the right to become owner in due course.
[55] In my view the test to determine simulation cannot simply be
whether there is an intention to give effect to a contract in
accordance with its terms. Invariably where parties structure a
transaction to achieve an objective other than the one ostensibly
achieved they will intend to give effect to the transaction on the
terms agreed. The test should thus go further, and require an
examination of the commercial sense of the transaction: of its real
substance and purpose. If the purpose of the transaction is
only to
achieve an object that allows the evasion of tax, or of a peremptory
law, then it will be regarded as simulated. And the
mere fact that
parties do perform in terms of the contract does not show that it is
not simulated: the charade of performance is
generally meant to give
credence to their simulation.
A genuine intention to borrow R96 415 776? The peculiar features
of the transactions
[56] In this matter the Commissioner contended that NWK had
deliberately disguised its contract to borrow R50m from FNB as a
transaction
in terms of which it would borrow R96 415 776, repayable
by the delivery of maize which in fact was never intended. The Tax
Court
found, however, that Barnard of NWK had intended the
transaction to have effect in accordance with its tenor. As I have
said, that
test is not enough to allay the possibility of simulation:
one must have regard to the purpose of the transaction – what
it is really intended to achieve.
[57] What then is the real purpose of the loan in this case? Does it
have any commercial substance or make business sense? NWK
argued that
the loan to it by Slab, like the sales to individuals in
Friedman
Motors
, was genuinely intended to have legal effect in accordance
with its tenor. But as I have said, the hire-purchase agreements in
that and similar cases made good commercial sense. They allowed the
purchasers to raise finance while at the same time retaining
possession of the vehicles. And there was a genuine transfer of
ownership.
[58] Was there any purpose or commercial sense – other than
creating a tax advantage to NWK – for the loan by Slab
to NWK
to be structured in the way it was? Was there any genuine intention
to deliver maize to Slab or a cessionary? The Tax Court
did not
address these questions, accepting the contracts in issue at face
value and not questioning their purpose. There were several
inexplicable aspects to the whole series of transactions that require
scrutiny.
The other loan from FNB to NWK concluded on the same day
[59] It will be recalled that on 1 April 1998, the same day as the
impugned loan was agreed, Barnard, for NWK, accepted the offer
made
by FNB on 23 February of a short-term loan of R50m. Why were two
loans agreed on the same day? And, more pertinently, why
was there an
agreement to borrow R96 415 776 at all when it was not needed by NWK?
The clear inference to be drawn was that the
loan for R96 415 776 was
a transaction concluded for a different purpose entirely, and that
the genuine agreement was to borrow
R50m.
Repayment of a loan of money through the delivery of maize?
[60] I have already indicated that a contract for the payment of
money in return for the delivery of a commodity such as maize
is a
sale and not a loan. That in itself is not necessarily significant.
The label attached to a contract does not determine its
validity. In
my view, however, the fact that the parties called it a loan shows
that what was really intended was that NWK would
borrow money from
FNB or its subsidiary and repay it in the usual way – repayment
of the capital and interest. The repayment
through delivery of
something other than money raises the question as to what was really
intended.
The payments out of and into FNB’s account on the same day:
‘round tripping’
[61] In terms of the forward sale agreement between First
Derivatives, a division of FNB, and NWK, the price payable to First
Derivatives by NWK was R45 815 776. It was paid on 1 April 1998. On
the same day, Slab ‘forward sold’ to First Derivatives
the same quantity of maize for R46 415 776. It too was paid on 1
April 1998. In effect, the money went out of FNB’s account
(pursuant to the loan) and straight back into FNB’s account
(pursuant to the first forward sale), with only the FNB fee making
any difference.
The amount of the loan and the quantity of maize
[62] The Commissioner argued that various factors showed that the sum
of the loan and the quantity of maize required to discharge
the loan
were artificially calculated. Given that it is NWK’s intention
that must be ascertained, Barnard’s evidence
itself is crucial
in determining whether there was a genuine loan from Slab to NWK.
[63] I referred earlier to the negotiations preceding the conclusion
of the loan agreement. FNB had suggested a means of providing
finance
to NWK and NWK had needed R50m. The proposal itself did not relate to
the sum actually needed by NWK. It suggested ‘indicative’
figures.
[64] Barnard conceded that NWK required only R50m and did not
question the calculation of the amount purportedly lent. In fact,
the
amount of the loan should have been insignificant since repayment was
to take place by delivery of a specified quantity of
maize. And
whatever amount NWK borrowed, it would in fact receive a net amount
of R50m.
[65] The amount of the loan was obviously calculated with reference
to a factor that did not bear any relation to the amount needed
by
NWK. Calculations done by an expert witness for the Commissioner,
Professor H Wainer, showed how the loan sum was calculated
in order
to yield interest of R74 686 514, the face value of the promissory
notes. The loan sum was thus established by taking
the interest
payable and calculating what capital sum was needed to generate that
interest at the rate agreed. NWK argued that
Wainer’s evidence
was irrelevant and inadmissible, but did not dispute the
calculations. The Tax Court held Wainer’s
evidence, and that of
a Professor Brink, an expert in agricultural trading, to be
inadmissible. It was irrelevant, said that court,
because the
opinions were based on the transactions from an accounting and
financial point of view: they did not deal with the
intention of the
parties. Thus Wainer’s view that there was no economic
substance to the transactions was disregarded by
the Tax Court.
[66] The calculation of the quantity of maize to be delivered was
done by an agricultural economist, employed by FNB, Mr E Janowsky.
Barnard did not question the calculation or take steps to verify it.
He accepted Janowsky’s estimate as soon as it was proffered
without taking into account the volatility of the maize market, or
any forecast of the maize price five years hence.
[67] Janowsky, who testified for NWK, also conceded that an estimate
of the maize price five years after the loan was advanced
was
impossible. He said that the price per ton in 2003 – the year
when delivery was to have taken place – fluctuated
by over R1
000 per ton. No attempt was even made to forecast an average price
per ton.
[68] Moreover, no account was taken of the cost of storage of what
was admittedly a very large quantity of maize. So too, no provision
was made for actual transportation and delivery costs. And the
contract itself made no provision for any adjustment to the quantity
of maize to be delivered by NWK. Barnard’s responses to
questions about storage and transport costs were that with hindsight
he might have thought of these matters.
The description of the maize
[69] The maize was described in the loan and other agreements as
‘dried white maize fit for human consumption’. The
Commissioner argued that the description was vague since there are
three classes of white maize that could have been meant, each
with a
different value. NWK would thus have had a choice whether to deliver
maize of a lesser value. Barnard was not perturbed
by this feature.
He said that he assumed that the maize would be ‘WM1’,
the best quality produced, but acknowledged
that there were two other
classes that could be covered by the description. His responses to
the questions put about the quality
of the maize to be delivered to
Slab were evasive.
The absence of security
[70] NWK was not required to provide security to Slab for the
repayment of the loan. As the Commissioner argued, if NWK had been
liquidated prior to 28 February 2003, Slab (and FNB as cessionary)
would have been in a precarious position. The absence of security,
the Commissioner contended, is explicable only on the basis that NWK
and FNB knew that Slab would almost immediately after the
conclusion
of the loan, cede its rights to delivery to FNB, and that both NWK
and FNB would be relieved of their respective duties
to deliver the
maize. And indeed that is what happened.
[71] Barnard attempted to explain the lack of security on the basis
that NWK did not usually give banks security for funds borrowed.
But
in fact NWK had previously given security to the Land Bank which
required it. His evidence in this regard is thus not credible.
In my
view the lack of provision for security is explicable on the basis
that there really was nothing to secure: the parties knew
that the
respective obligations to deliver maize had been extinguished by
confusio
. Had the obligations to deliver five years after the
loan was made been genuine, security would no doubt have been
provided.
The context in which the loan was concluded
[72] When Barnard concluded the loan agreement on behalf of NWK he
knew that the forward sale agreement between Slab and FNB would
be
concluded, and that the promissory notes would be sold by Slab to
FNB. He thus knew that Slab had no real role to play in the
whole
transaction. It would sell its rights to delivery of the maize, to be
effected five years later, almost immediately after
the loan had been
concluded. The loan agreement made express provision for the cession
by Slab of any of its rights.
The other agreements concluded pursuant to the proposal
[73] The transactions that were concluded by NWK on the same day as
the loan agreement was entered into, and the subsequent cessions
in
June 1998, have already been discussed. Slab sold the same quantity
of maize that NWK was supposed to deliver to First Derivatives,
an
FNB division, on the day that the loan was concluded – 1 April
1998. Again, no provision was made for securing payment
of the price
of R45 815 776. The peculiar features of this contract were that the
price, which was required to fund the loan to
NWK, was determined
with reference to the amount of the loan – R96 415 776. The
quantity of maize and its price were determined
in the same way as
they had been calculated for the loan. The description of the maize
was the same as that in the loan and was
equally deficient.
[74] The Commissioner argued that it was no coincidence that after
the sale of the promissory notes by Slab to FNB for R50 697
515, Slab
was left with the right to claim R45 718 258: that meant that it made
a profit of R97 518 which was effectively its fee.
Although NWK was
not a party to this contract it was envisaged in the initial proposal
and Barnard was aware that it would be concluded.
It was an integral
part of the finance arrangement. And on the same day that that sale
was concluded (1 April 1998), FNB sold the
same maize to NWK for R46
415 776, the price being based on Janowsky’s estimate. Again,
delivery would be effected on 28
February 2003. The price was in fact
paid on 1 April 1998, yet no security was given for the delivery five
years later. The difference
in the prices for the respective sales
was R600 000 – 1.2 per cent of R50m, which was the amount that
NWK had needed in the
first instance. This represented FNB’s
fee.
[75] Slab ceded its rights to delivery of the maize to FNB in June
1998. As I have said, the loan made express provision for the
cession
and it was envisaged in the proposal made to NWK at the outset.
Barnard understood the consequences of the cession: effectively
NWK’s
obligation to deliver the maize was cancelled. The debts were
reciprocally discharged by
confusio
– the concurrence of
the right and the obligation in the same person – FNB.
[76] Although NWK argued that set-off would have taken place only
when both debts were due (when NWK had to deliver the maize to
FNB
and FNB had to deliver to NWK on 28 February 2003) in fact Barnard
must have appreciated that any delivery would be meaningless.
Although silo certificates were exchanged they were in respect of the
identical maize, and the exchange and notarial certificates
had no
purpose. Barnard’s protestations that the delivery obligations
remained extant are not credible. The entire transaction
in respect
of the maize was effectively of no significance. At the outset, there
was, as the Commissioner has contended, no intention
to effect
delivery at all. Contrast this result with that in
Friedman
and like cases: there, although the goods remained with the purchaser
when the full amount owed had been paid, there was a genuine
change
of ownership, delivery being constructive.
[77] Similarly, the cession by NWK of its rights to delivery of maize
to FNB as security for NWK’s obligation to deliver
maize
pursuant to the cession from Slab to FNB made no commercial sense.
The obligation was illusory given that FNB’s and
NWK’s
obligations in effect cancelled each other. There were no longer any
rights that could be ceded.
[78] Barnard attempted to explain the arrangements in respect of the
delivery of maize as a ‘hedge’: the additional
R46m added
in respect of the maize was to ensure that its obligation to deliver
the maize as repayment of the loan could be fulfilled.
But in fact
there was no ‘hedge’ and the agreements, examined
together as they must be, envisaged no actual delivery
of maize as
provided for. The Tax Court found nothing unusual in the creation of
a hedge or safety net within the same banking
group. First
Derivatives, a division of FNB, was in fact a large trader in the
agricultural market. What the Tax Court did not
consider, however,
was that there was no commercial reason for the so-called hedge given
the extinction of the respective obligations
to deliver maize.
Simulation and motive for deception
[79] The Tax Court found that although NWK required only R50m for
business purposes, it had been offered a greater sum by FNB,
structured in a particular fashion that would enable it to claim a
tax advantage to which it would not otherwise have been entitled.
NWK
was not obliged, the court said, ‘to choose the less
tax-effective route’. That is of course correct, as the
authorities
cited earlier show. But the Tax Court went on to say that
given the apparent tax benefit of the structure proposed by FNB it
was
difficult to see why NWK would have wished to simulate the
transaction. There was, it held, ‘no financial or other
disadvantage
to actually implementing the alternative structure as
opposed to pretending to do so’. NWK, the court said, had no
motive
for deception. Hence it had established on a balance of
probabilities that its true intention was to contract with Slab and
FNB
on the terms reflected in the contracts.
[80] It is correct that FNB and NWK outwardly performed in terms of
the various contracts, as indicated earlier. But before then,
in
January 2003 FNB wrote to NWK reminding it of its obligation to
deliver 109 315 tons of maize on 28 February, and stating that
on
receipt it would deliver the same quantity to NWK. Yet on 13 February
2003 Rand Merchant Bank, a division of FNB, wrote to Barnard
suggesting that set-off would occur, and that various clauses in the
original loan agreement should be amended retrospectively
in the
event that actual delivery would be made. Barnard must have known
then, if he did not know before, that the respective delivery
obligations had been extinguished by
confusio
. The intention
to perform in accordance with the terms of the contract is
accordingly questionable, and the Tax Court should have
considered
this. It should have asked whether there was actually any purpose in
the contract other than tax evasion. This is not
to suggest that a
taxpayer should not take advantage of a tax-effective structure. But
as I have said, there must be some substance
– commercial
reason – in the arrangement, not just an intention to achieve a
tax benefit or to avoid the application
of a law. A court should not
look only to the outward trappings of a contract: it must consider,
when simulation is in issue, what
the parties really sought to
achieve.
Barnard’s credibility
[81] The Tax Court found that Barnard was a credible and satisfactory
witness. It accepted at face value his evidence that he thought
he
was contracting with Slab despite the fact that the proposal and the
loan agreement had been drafted by FNB and that he had
not ever
encountered a representative of Slab who was not also an official of
FNB. It also accepted his evidence that delivery
of the maize was
always intended and had taken place.
[82] The Commissioner argued that various features of his evidence
showed that Barnard was not credible. I shall not traverse them
all.
In my view, the most significant are these: his concession that the
actual amount lent was not of any significance; his inability
to
explain the inadequate description of the maize in the loan and
forward sale agreements; his conflicting responses about knowledge
of
the Slab cession, first saying he did not know it would take place
and later admitting that it had been contemplated at the
outset and
was part of the structure of the FNB proposal; his refusal to accept
that the Janowsky forecast did not take into account
important
factors affecting the price of the maize, such as market
fluctuations, and storage and delivery costs; his insistence
that
security was not required for the performance of the obligations on
the basis that banks did not generally require security
from NWK,
this despite having provided the Land Bank with security for a loan;
and lastly, his acknowledgment that unless Slab
had discounted the
promissory notes it would not have had the funds to advance the loan.
[83] In my view the inconsistencies and obfuscations in Barnard’s
evidence are significant. And his inability to explain
the way in
which the prices and quantities were calculated was telling. His
evidence was simply not credible and the Tax Court
erred in finding
him to be a credible and satisfactory witness.
The loan was a simulated contract
[84] The Commissioner led the evidence of two experts on the way in
which the amount of the loan and the quantity of maize was
computed,
and on the factors that should have been taken into account in
determining the price of the maize in the future. The
Tax Court did
not admit this evidence and thus did not take it into account. It is
not necessary to determine whether that was
incorrect. It is plain
from a reading of Barnard’s testimony, and a comparison of it
with the documents tendered in evidence,
that the amount of the loan
was determined not by what was needed by NWK but by reference to
other factors.
[85] Moreover, Slab was able to advance the sum of R96 415 776 only
by discounting the promissory notes, the face value of which
was the
equivalent of the capital sum of R50m and interest at the rate
agreed. And NWK initially intended to borrow only R50m.
The balance
was added on for a purpose that Barnard could not explain, other than
as a hedge. But a hedge was needed only if the
real amount borrowed
was the artificially constructed sum of R96 415 776. The mere nature
of the hedge shows the artificiality:
why would NWK incur a liability
to deliver maize valued at R46m in order to purchase the same
quantity of maize to discharge the
same obligation? As pointed out by
the Commissioner, to ascertain the true intention of NWK one had to
ignore entirely all the
rights and obligations in respect of the
maize.
[86] As I have said, the appropriate question to be asked, in order
to determine whether the loan and other transactions were simulated,
is whether there was a real and sensible commercial purpose in the
transaction other than the opportunity to claim deductions of
interest from income tax on a capital amount greater than R50m. None
is to be found. What NWK really wished to achieve was a tax
advantage. What else could it, or did it, achieve through the
transactions in respect of the maize? Barnard did not explain any,
other than the creation of a hedge which had no effect. He could thus
not honestly have believed that the contract was to be performed
in
accordance with its tenor.
[87] The FNB proposal itself, the transactions concluded between NWK
and Slab, and Slab and FNB, with their peculiar features,
and
Barnard’s inability to give any credible explanation of aspects
of the transactions show, I consider, that NWK could
not have
believed, and did not in fact believe, that the loan was for the sum
of R96 415 776. The contract was dressed up in order
to create an
obligation to pay interest, and consequently a right to claim a tax
deduction, to which NWK was not entitled. NWK
deliberately disguised
the true nature of the loan for this purpose. It did not intend,
genuinely, to borrow a sum approximating
the one it purported to
borrow.
[88] There was no evidence that Barnard was deceived by FNB. He knew
how the contracts, even those to which NWK was not a party,
were to
be structured and that the deliveries in respect of maize were
simulated. And since NWK bore the onus of showing that the
Commissioner’s assessments were wrong, the production of the
contracts themselves was insufficient to discharge that burden.
Yet,
despite that, NWK did not call the officials of FNB who had proposed
the transactions to give evidence. I do not consider,
however, that
any inference need be drawn from the failure to call the FNB
officials. Barnard’s evidence speaks for itself.
[89] In summary: Barnard could not explain (and indeed there was no
explanation possible for) the following extraordinary features
of the
transactions. The sale of maize by NWK to FNB was dressed up as a
loan. NWK and FNB entered into two contracts of loan on
the same day,
the one where FNB lent NWK R50m and the other where it ‘lent’
NWK R96 415 776. Virtually the same amount
in excess of that which
was required by NWK (R46 415 776) was paid by FNB to NWK and then in
effect paid back by NWK to FNB on
1 April 1998. The amount lent in
the impugned loan was determined not by reference to what was needed
but by reference to a capital
sum needed to generate a particular sum
of interest. The description of the maize in the various contracts
was vague. No security
was afforded to Slab for repayment of the
loan. The loan was concluded with the knowledge on the part of
Barnard that Slab would
sell its right to delivery of the maize to
FNB and that Slab would sell the promissory notes at a discount to
FNB all on the same
day: Slab’s role in the transactions was
momentary. These aspects all lead to the conclusion that the
agreements in respect
of maize were illusory: there was never any
intention to deliver maize in the future. The loan was a simulated
transaction, designed
to create a tax benefit for NWK.
[90] In view of the conclusion that I have reached that the loan for
R96 415 776 was a transaction designed to disguise the real
agreement
between the parties – a loan of R50m – the Commissioner’s
assessments were correct, and the appeal
against the decision of the
Tax Court in this respect must succeed. There is thus no need to
examine whether s 103(1) of the Act
could have been applied. However,
since NWK argued that the Commissioner may not raise s 103(1) as an
alternative ground it is
convenient to deal briefly with this
submission.
Section 103(1) as an alternative basis
[91] It must first be noted that this section has
been repealed, and replaced by a new part to the Act.
23
I have set out the basis of the application of s
103(1) already. In summary, if satisfied that a transaction has been
entered into
which has the effect of avoiding or reducing liability
for tax, and would not normally be employed for bona fide business
purposes,
the Commissioner shall determine liability for tax as if
the transaction had not been entered into.
[92] NWK argued that if the Commissioner had been
satisfied that the loan was simulated and did not have a tax
avoidance or reduction
effect, he could not, even in the alternative,
be satisfied that the transaction was one that had a tax avoidance
effect. Satisfaction,
it was argued, is a subjective jurisdictional
fact. The Commissioner cannot be satisfied on two apparently
conflicting grounds.
NWK relied in this regard on ITC 1625
24
where Wunsh J said that unless the Commissioner
demonstrates that he is of the opinion that tax has been avoided, he
cannot issue
an assessment under s 103. Thus if tax has not been
avoided because the transaction was not simulated, he cannot, even on
an alternative
basis, be satisfied that tax has been avoided.
[93] In
CIR v
Conehage
25
this court was also presented with alternative
bases for the Commissioner’s assessments, one being that the
transactions were
simulated and the alternative that the Commissioner
was satisfied that they had been entered into for the purpose of
avoiding liability
for tax. The court found that the contracts were
genuine, but also considered s 103, finding that the Commissioner had
not shown
that the transactions had had the effect of avoiding
liability for tax. There is, implicit in this approach, a view that s
103
could be invoked as an alternative ground for assessment. There
appears to me to be no reason why an invalid transaction cannot
also
be abnormal and concluded for the purpose of avoiding tax. Had the
Commissioner not proved that the loan was a simulated contract,
it
would have been open to the Tax Court to consider the soundness of an
assessment under s 103.
Additional tax and interest
[94] As indicated earlier, in the additional assessments for the
period from 1999 to 2003 the Commissioner levied a penalty of
200 per
cent and additional interest on the deductions claimed for interest
in excess of that on R50m. The penalty, he argued,
was warranted
because NWK had deliberately made incorrect statements in the returns
for the years of assessment, intending to evade
taxation. There were
no extenuating circumstances. This justified also the imposition of
the additional interest in terms of s
89quat of the Act.
[95] Section 76(2)(a) permits the Commissioner to remit the
additional tax, even where there is a dishonest attempt to evade tax,
where there are extenuating circumstances. NWK argued that he failed
to take into account the following extenuating factors. FNB
had
approached NWK with its proposal, and NWK had not solicited finance
from FNB. The proposal was said to be confidential and
proprietary to
FNB. NWK played no role in crafting the terms of the various
agreements. Barnard had relied on the expertise of
the officials of
FNB. FNB had furnished to Barnard the opinion of counsel which had
suggested that a structure similar (or the
same as – we do not
know) to that proposed was legally sound, although he had cautioned
against the application of s 103
by the Commissioner.
[96] The consequence of the imposition of 200 per cent of additional
tax is that the amount payable pursuant to the new assessments
would
have been R47 360 583. Only R15 786 861 of that would have been the
interest that should not have been claimed as a deduction
over the
five years of assessment. The penalty is severe and out of proportion
to the wrong committed by NWK.
[97] I consider that these factors do militate against the imposition
of the highest penalty possible, and would reduce the additional
tax
to 100 per cent of that for which NWK was liable. Counsel for the
Commissioner accepted that this would be appropriate. To
this extent
the appeal should fail. And NWK has conceded that if the appeal
succeeds on the first basis the interest in terms of
s 89quat was
properly levied.
[98] Accordingly:
1 The appeal against the order of the Tax Court is upheld with costs
including those of two counsel.
2 The order of the Tax Court is replaced with:
‘
(a) The objection to the assessments is
dismissed and the additional assessments are upheld.
(b) The objection to the imposition of additional tax of 200 per cent
is upheld.
(c) Additional tax of 100 per cent of the total amount of the
additional assessments is imposed in terms of s 76 of the Income
Tax
Act 58 of 1962.’
_____________
C H Lewis
Judge of Appeal
APPEARANCES:
APPELLANTS:
C Puckrin SC (with him D Fine SC, G D Goldman,
and T
Molokomme)
Instructed
by the State Attorney
Johannesburg
The State
Attorney
Bloemfontein
RESPONDENTS:
W Trengove SC (with him A Stewart SC and H V Vorster)
Instructed
by Vorster Pereira Attorneys
Sandton
Bezuidenhout Inc
Bloemfontein
1
The
section allows the deduction from income of expenditure and losses
actually incurred in the production of the income, provided
they are
not of a capital nature.
2
The
section provides that the burden of proof that any amount is subject
to any deduction is upon the person claiming the deduction:
in any
appeal against a decision of the Commissioner ‘the decision
shall not be reversed or altered unless it is shown
by the appellant
that the decision is wrong’.
3
[1996] ZASCA 35
;
1996
(3) SA 942
(A) at 953A-F.
4
60
SATC 1
(SCA) at 7.
5
IRC
v Duke of Westminster
[1936] AC 1
at
19, cited by the court in
Ladysmith
,
above. The principle is affirmed by Hefer JA in
CIR
v Conhage (Pty) Ltd
1999 (4) SA 1149
(SCA) para 1.
6
Above
at 950H-951D.
7
1931
AD 501
at 507.
8
At
951C-D.
9
At
951D-953A.
10
1910
AD 302
at 309.
11
1941
AD 369.
12
Above
at 395.
13
1941
AD 369.
14
Above
at 409.
15
1979
(1) SA 603
(A).
16
1982
(2) SA 710
(A).
17
[1991] ZASCA 174
;
1992
(1) SA 867
(A).
18
1999
(4) SA 1149
(SCA).
19
See
in this regard Professor Nereus Joubert ‘Asset-Based
Financing, Contracts of Purchase and Sale, and Simulated
Transactions’
(1992) 109
SALJ
707
, referred to in
Conhage
para 9.
20
At
877C-E.
21
1972
(1) SA 76
(T), upheld on appeal, 1972 (3) SA 421 (A).
22
At
80F-H.
23
Sections
80A to 80L: note, in particular, 80C which deals with transactions
that have no commercial substance.
24
59
SATC 383
at 395.
25
1999
(4) SA 1149
(SCA), referred to above.