WJ Fourie Beleggings v Commissioner for the South African Revenue Service (168/08) [2009] ZASCA 37; 2009 (5) SA 238 (SCA) ; [2009] 3 All SA 230 (SCA) (31 March 2009)

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[2009] ZASCA 37
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WJ Fourie Beleggings v Commissioner for the South African Revenue Service (168/08) [2009] ZASCA 37; 2009 (5) SA 238 (SCA) ; [2009] 3 All SA 230 (SCA); 71 SATC 125 (31 March 2009)

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THE
SUPREME COURT OF APPEAL
REPUBLIC
OF SOUTH AFRICA
JUDGMENT
Case
No: 168/08
W
J FOURIE BELEGGINGS
….......................................................................
Appellant
And
THE COMMISSIONER FOR THE SOUTH
AFRICAN
REVENUE
SERVICE
….......................................................................
Respondent
Neutral citation:
Fourie
Beleggings v CSARS
(168/08)
[2009] ZASCA 37
(31 March 2009)
Coram:
STREICHER,
FARLAM, NUGENT JJA, LEACH and BOSIELO AJJA
Heard:
13
March 2009
Delivered: 31
March 2009
Summary: Income
tax – amount paid to appellant, a hotelier, to compensate it for
the cancellation of a contract to accommodate
a number of people in
its hotel for more than two years – such contract not forming part
of the appellant’s income- producing
structure – payment not of
a capital nature and subject to tax.
__________________________________________________________________________
ORDER
__________________________________________________________________
On
appeal from: High Court, Bloemfontein (CJ Musi J, Hattingh and Van
Der Merwe JJ concurring, sitting as a court of appeal).
The
appeal is dismissed with costs.
_____________________________________________________________
____
JUDGMENT
LEACH AJA (STREICHER, FARLAM, NUGENT JJA and BOSIELO
AJJA concurring):
[1] The so-called “9/11” attack
upon the World Trade Centre in New York in September 2001 caused
shockwaves which reverberated
around the world, reaching as far
afield as Potchefstroom in the North West Province of this country
where the appellant conducted
business as a hotelier, and leading to
the cancellation of a lucrative trading contract the appellant had
concluded a few months
earlier. Subsequently, in full and final
settlement of all claims arising from the cancellation of this
contract, the appellant
received a payment of almost R1,3 million.
[2] In assessing the appellant’s
tax liability for the 2002 tax year the respondent, the Commissioner
of the South African Revenue
Service, regarded this payment as
forming part of the appellant’s gross taxable income. The
appellant objected to this under
s 81 of the Income Tax Act, 58 of
1962 (“the Act”), contending that the payment was an accrual or
receipt of a capital nature,
not subject to tax. When this objection
was disallowed, the appellant appealed to the Tax Court. The appeal
was also unsuccessful,
as was a further appeal under s 86A(2)(a) to
the Full Bench of the High Court, Bloemfontein which dismissed the
appeal on 27 September
2007.
1
With leave of the High Court, the appellant appeals now to this
court.
[3] At all material times the
appellant conducted business at the Elgro Hotel in Potchefstroom
which it had leased from a company
known as Bultfontein Property
Investments (Pty) Ltd. The appellant had previously done business
with a company known as Naschem,
a division of Denel (Pty) Ltd and a
manufacturer of munitions, for whom it had provided accommodation for
people referred to as
‘students’ but who appear to have been
members of the military forces of the United Arab Emirates, while
they received training
in South Africa. In doing so, the appellant
had made special arrangements to meet the dietary needs of the
students as well as
a number of their special needs. In April 2001,
this led to the appellant concluding a further agreement with Naschem
in which
it agreed to accommodate and provide meals to substantial
numbers of such students from April 2001 to 30 May 2003. Although
the
number of people to be accommodated was to vary from time to time
during that period, the majority of the hotel’s rooms had to
be set
aside for this purpose - which the appellant was prepared to do as it
anticipated earning approximately R8,7 million from
the contract.
[4] The conclusion of this agreement
led to the appellant accommodating students from the Emirates from
April to September 2001,
during which period it earned some R4
million for doing so. And then news of the ‘9/11’ attack reached
Potchefstroom. Immediately
thereafter, without offering any
explanation, the students residing in the hotel at the time packed up
and left, and it soon became
apparent that they would not return. In
the light of this unforeseen development, Naschem repudiated its
contract with the appellant.
[5] The appellant thus found itself
in a quandary. The vast majority of its clientele had absconded.
Many of the rooms had been
left in a state of considerable disrepair
as not only had many of the students kept pets in their rooms but
they had also smoked
hookahs (described in evidence by the
appellant’s director, Mr Fourie, as ‘hubbly bubbly pipes’)
which had burned carpets,
bedding and curtains. While Fourie stated
that if the contract had run its full course the appellant would have
shrugged off this
damage as an inevitable expense of a profitable
contract, it suddenly found itself faced with a considerable repair
bill in order
to return the rooms to a condition in which they could
be hired out. And of course, the appellant also had to meet its
normal,
on-going running costs which were substantial. All this it
had to do with an extremely compromised client base.
[6] In these circumstances the
appellant felt that it had no option but to look to Naschem for
compensation, and threatened to bring
legal proceedings. However,
although the balance of the cancelled contract was worth an estimated
R4,7 million, the appellant
was wary of attempting to recover this
entire amount from Naschem with whom it had always enjoyed good
business relations and hoped
to continue to do so in the future. As
a result, instead of issuing summons it entered into settlement
negotiations with Naschem
which initially offered to pay R600 000 in
order to settle the dispute. This offer was was rejected, but the
appellant subsequently
accepted an increased offer of R1 292 760
which was paid in settlement of all claims it might have arising from
the early termination
of the contract. It was the payment of this sum
which precipitated the current dispute as to whether the payment is
to be regarded
as capital or revenue.
[7] Whether a receipt or an accrual
should be regarded as capital or revenue is probably the most common
issue which arises in
income tax litigation. A taxpayer’s gross
income is defined in s 1 of the Act as ‘the total amount, in cash
or otherwise,
received by or accrued to or in favour of (the
taxpayer) . . . excluding receipts or accruals of a capital nature’.
Accordingly,
if a receipt or accrual was not of a capital nature,
it must have been of an income or revenue nature. But the phrase
‘receipts
or accruals of a capital nature’ is not defined in the
Act and although it has been held that the ordinary economic meaning
should
be attached to the word ‘capital’
2
it has not been possible to devise a definitive or all embracing test
to determine whether a receipt or accrual is of a capital
nature,
despite the regularity with which the issue has arisen. At the same
time, and although common sense has been described
as ‘that most
blunt of intellectual instruments’,
3
it remains the most useful tool to use in deciding the issue.
4
[8] The settlement agreement under
which the amount in issue was paid recorded that as Naschem had
unilaterally cancelled its
agreement with the appellant who viewed
this as a breach of contract which would cause severe financial loss
and give rise to a
valid claim for damages, the parties had agreed
that Naschem would pay the appellant R1 292 760 in full and final
settlement of
all claims it might have, whether arising from the law
of contract or the common law. The only realistic claim the appellant
would
have had against Naschem would have been in respect of its loss
of profit suffered through the early termination of the agreement

which, on payment, would clearly have been revenue.
5
In this respect the matter is similar to
ITC
312.
6
In that case the appellant,
whose business consisted of letting property, had let a portion of a
building it owned for five years.
When the lease still had more than
two years to run, the tenant sought to cancel. After negotiations, it
was agreed that the appellant
would be paid a lump sum less than
two-thirds of the total of the remaining rentals. In holding that
this payment was income and
not capital, the court said:
7
‘
The
contract was a contract of lease, and it seems to me that a lump sum
paid in lieu of, and as compensation for, the balance of
rent due for
the period stipulated, is a sum paid under and by virtue of the
letting of property
.”
[9] The appellant, however, argued
that in the present case the contract itself amounted to an asset
that formed part of the its
income-producing structure. Accordingly,
so the argument went, the amount paid by Naschem had been paid for
the loss or ‘sterilisation’
of an income earning asset and should
be regarded as capital. In the light of this, the enquiry becomes, as
was classically put
by Lord Macmillan in
Van
den Berghs, Ltd v Clark (Inspector of Taxes)
8
,
‘whether the congeries of the rights which the recipient enjoyed
under the contract and which for a price he surrendered was
a capital
asset’.
[10] In arguing that the contract
it had with Naschem had been a capital asset, the appellant placed
particular emphasis on the
decision in this court in
Taeuber
and Corssen (Pty) Ltd v Secretary for Inland Revenue
.
9
In that case, the appellant taxpayer had for many years acted as the
sole agent in South Africa of a German producer. Its agency
agreement
provided that, on termination, the principal (the producer) would be
entitled to require the agent (the taxpayer) not
to sell or assist in
the sale of any products in competition with the principal for a
period of two years. In return for this undertaking,
the principal
undertook to pay the agent an amount calculated with reference to the
commission the agent had previously earned.
The agency agreement was
subsequently cancelled and the principal duly paid the agent the
amount it had undertaken to do on that
event. This court found the
payment to be of a capital nature, with Rumpff CJ holding that the
agent had established ’an income-producing
structure’ consisting
in part of the contractual obligations ‘that flowed from the
contract with (the principal)’. The learned
Chief Justice then went
on to say:
10
“
What
the parties intended . . . was a payment of a sum of money to
restrain the [agent], for a period of two years, from earning
income
by the sale of all products competing with those of [the principal].
In the result, in my view, that part of [the agent’s]

income-producing structure which had sold only [the principal’s]
products was not only permanently prevented from selling [the

principal’s] products by the termination of the agreement, but also
effectively closed for two years to the extent that it was
prevented,
for that period, from selling all such products as would compete with
[the principal’s] products, and the amount payable
in terms of [the
agency agreement] was intended to be, and must be construed as,
compensation for this closure
.’
[11] The appellant also relied on
the decision in
ITC 134I
11
in support of its contention that its contract with Naschem had been
part of its income-producing structure. In that matter the

appellant company had conducted business by registering the transfer
of shares although it also despatched dividend warrants, sent
out
notices to members of companies and handled the issue of new shares
in companies, including rights issues. The appellant had
been formed
when its shareholders, two other companies (A and B) had decided to
merge their respective share transfer departments.
In an effort to
attract business from other companies as well, the appellant was
given a neutral name not linked to either A or
B, although at no time
did outside business form a large part of its business. However,
virtually all A and B’s subsidiary companies
made separate
contracts with the appellant in which they bound themselves to employ
the appellant for the services it offered.
This state of affairs
endured for some twenty years until company B acquired control over
another financial institution, company
C, and decided that it and its
group of companies would withdraw from the existing arrangement with
the appellant in order to use
C’s share-transfer department. They
paid the appellant R260 048 in four equal instalments as compensation
for doing so. It was
argued by the tax authority that this amounted
to no more that a
surrogatum
for future profits surrendered. The court however concluded that the
withdrawal of the B group of companies undermined the whole
basic
structure of the appellant, that it resulted in an important ‘limb
of the fruit-bearing tree (being) chopped off’
12
and that it impaired the appellant’s income-producing structure.
The payment received in respect of the termination of the contracts

with the appellant was accordingly treated as capital.
[12] A
third
decision upon which the appellant placed particular emphasis was that
in
ITC 1259.
13
In that case the taxpayer had concluded a management agreement with a
large company, C, which had several subsidiaries and extensive

holdings in fixed property. In terms of the agreement the taxpayer
undertook not only to manage all C’s properties but also to
act as
the secretary and accountant of all C’s subsidiaries; to be the
sole selling agent of the properties owned by C and its
subsidiaries;
and to act as an agent for an insurance company associated with C.
The agreement was to last for a minimum of three
years. However, a
public company subsequently acquired a controlling interest in C and
cancelled the taxpayer’s contract after
only 20 months. In
consideration for the early termination of the agreement, the
taxpayer was paid the sum of R30 000 which the
Secretary for Inland
Revenue sought to tax as income. The Transvaal Special Court found
that the contract had been out of the ordinary
course of the business
earlier conducted by the appellant, and had resulted in a
considerable disruption of the appellant’s existing
business
structure which had been obliged to employ senior executives and
experts as well as additional clerical staff. When implemented,
the
contract had constituted by far the major part of the appellant’s
property management business. Having regard to these facts,
the court
concluded that the contract had constituted a substantial part of the
appellant’s income-producing structure and, relying
heavily on the
judgment in
Taeuber
as
authority for the conclusion that compensation paid for parting with
a portion of a firm’s business is to be regarded as capital,
held
the payment of R30 000 to be of a capital nature and not taxable.
[13] I accept that depending on the
circumstances a sum paid to a taxpayer as compensation for the
cancellation of a trading contract
may be regarded as being of a
capital nature.
14
But in considering whether that is here the case, it is of importance
to note that in each of the cases relied on by the appellant
the
contract in issue, or more properly the rights and obligations
flowing therefrom, were used by the taxpayers for the purpose
of
generating income. Thus in
Taeuber
,
the taxpayer had used his right to freely trade and his business
skills (which were sterilised by the restraint) to produce income.
In
ITC 1341
the various companies were contractually bound to use the taxpayer’s
services when required; the contract thus channelled work
to the
taxpayer from which it earned an income. Similarly, in
ITC
1259
, the management
agreement and the other contracts provided the structure through
which income earning activity was channelled to
the taxpayer. The
hallmark of each case is the fact that the contract created
income-earning opportunities for the taxpayer. The
contract was
therefore a means used to produce income and was correctly found to
have been part of the taxpayer’s income-producing
structure.
[14] There is of course a
fundamental distinction between a contract which is a means of
producing income and a contract directed
by its performance towards
making a profit.
15
This is graphically illustrated by the Australian decision in
Heavy
Minerals Pty Ltd v Federal Commissioner of Taxation
,
16
a case regularly followed in that country which has striking
similarities to the present case. In that matter the taxpayer was
a
party to contracts with both German and American buyers to which it
sold rutile it had mined under a mining lease. When the rutile
market
collapsed, the taxpayer agreed to the cancellation of these contracts
in consideration for the payment of monetary compensation.
Its
argument that this compensation was of a capital nature was rejected
by Windeyer J who, in finding the amounts paid to be revenue,
said:
17
‘
Even
if these contracts were such that they seemed to ensure that the
taxpayer would have a secure market and some regular customers,
that
would not of itself make them part of the capital of its business
.’
After then referring to the well known
remark of Lord Ratcliffe in
Commissioner
of Taxes v Nchanga Consolidated Copper Mines
18
that phrases such as ‘capital structure’ were ‘essentially
descriptive rather than definitive’, His Honour continued thus:
‘
The
appellant sought to liken the moneys which the buyers paid to be
released from their contracts to a price received as a consideration

for going out of business . . . . But there is no analogy. The
taxpayer’s business was mining rutile and dealing in rutile. Its

capital assets were the mining lease and the plant. After the
contracts were cancelled it still had these. It was free to mine
its
rutile and to sell it if it could find buyers: and it tried to do so.
The taxpayer was not put out of business by the cancellation
of its
overseas contracts. It did not go out of business when they were
cancelled.
’
[15] In the present case, the
appellant traded as a hotelier before the contract and continued to
do so, both once it had commenced
and after it had been cancelled.
The contract did not operate as a means by which the appellant
generated business or through which
it acquired business or obtained
opportunities from which to earn income. It was merely a memorial of
business the appellant had
concluded, in which the number of persons
it had agreed to accommodate, when that would take place and the rate
that would be charged,
were recorded. It may be that the appellant
stood to earn a great deal from the contract which was to form the
major source of
its income during the period it lasted but that, and
its anticipated duration of more than two years, did not transform it
into
part of the appellant’s income-producing structure. That
structure was made up of its lease of the hotel and the use to which

the hotel was put. The contract the appellant agreed with Naschem was
concluded as part of its business of providing accommodation.
It was
therefore a product of the appellant’s income earning activities,
not the means by which it earned income.
[16] In the light of these
considerations, I conclude that the appellant’s contract with
Naschem cannot be construed as being
an asset of a capital nature
forming part of the appellant’s income-producing structure. That
being so, the amount paid to the
appellant on termination of the
contract is not in the nature of capital and must, by definition, be
regarded as part of the appellant’s
gross income. The conclusions
of both the Tax Court and the High Court in that regard were correct.
[17] The appeal is therefore
dismissed with costs.
________
________________
L
E LEACH
ACTING
JUDGE OF APPEAL
Appearances:
For appellant: C Van Breda
Instructed by: Weavind & Weavind,
Pretoria
Matsepes Attorneys,
Bloemfontein
For respondent: G Stevens
Instructed by: State Attorney,
Bloemfontein
1
Its
judgment has been reported as
WJ
Fourie Beleggings CC v Commissioner for South African Revenue
Service
(2008) 70 SATC 8.
2
Commissioner of Taxes v Booysens Estates, Ltd
1918 AD
576
at 582
3
Henry Hitchings
Doctor Johnson’s Dictionary
John Murray
Publishers (UK) (2005) at 132
4
Commissioner
for Inland Revenue v
Pick ‘n
Pay Employee Share Purchase Trust
case
at 56I.
5
Compare
ITC 724
(1952)
17
SATC 496
at 498 and
ITC 1761
(2004)
66 SATC 33
at 39.
6
(1937)
8 SATC 154.
7
At 156.
8
[1935] AC 431
(HL) at 443.
9
1975 (3) SA 649
(A).
10
At
663H-664A.
11
(1981)
43 SATC 215.
12
At 223.
13
(1977) 39 SATC 65.
14
See eg
ITC 1279
(1997) 40 SATC 254
at 258.
15
See the speech of Lord Moncrieff in
Kelsall,
Parsons & Co v IRC
[1938] ScotCS CSIH_1
;
21 TC 608
at
623.
16
[1966] HCA 60
;
(1966) 115 CLR 512
;
10 AITR 140
17
At CLR
517; AITR 143.
18
[1964] AC 948
at 959.