Brief Summary

Income Tax — Capital gains — Nature of profits from share sales — Nedbank Limited sold shares in Sasol Ltd, realizing a profit included in taxable income by the Commissioner for Inland Revenue — Transvaal Income Tax Special Court ruled profits were of a capital nature, leading to a successful appeal by Nedbank — Legal issue centered on whether profits from the sale constituted revenue or capital gains — Supreme Court of Appeal upheld the lower court's decision, affirming that the profits were capital in nature, reflecting Nedbank's original intention to invest for long-term benefits rather than for resale.

Comprehensive Summary

Summary of Judgment

1. Introduction

The matter was an income tax appeal in the Supreme Court of South Africa (Appellate Division), concerning whether a substantial profit realised by a commercial bank on the disposal of listed shares constituted taxable revenue or a non-taxable capital accrual for purposes of the definition of “gross income” in the Income Tax Act 58 of 1962.

The appellant was the Commissioner for Inland Revenue (“the Commissioner”). The respondent was Nedbank Limited (“Nedbank”), a registered commercial bank.

Procedurally, the Commissioner assessed Nedbank for the year of assessment ending 30 September 1981 and included in taxable income the profit Nedbank made on the sale of Sasol shares. Nedbank appealed under section 83 of the Income Tax Act 58 of 1962 to the Transvaal Income Tax Special Court, which upheld Nedbank’s appeal and held the proceeds to be capital in nature, remitting the assessment for reassessment. The Commissioner then appealed under section 86A to the Transvaal Provincial Division, which dismissed the appeal with costs (including the costs of two counsel). Leave to appeal to the Appellate Division was refused by that court but later granted by the Appellate Division, where the present appeal was heard.

The general subject-matter of the dispute was the capital-versus-revenue characterisation of profits arising from the sale of shares held by a bank, where the acquisition was said to have been motivated not by resale for profit but by the pursuit of collateral banking advantages (in particular, the prospect of obtaining Sasol’s banking business and strategic positioning in a particular business community).

2. Material Facts

Nedbank’s financial year and year of assessment ended on 30 September. During the year of assessment ending 30 September 1981, Nedbank sold 9,300,000 ordinary shares held in Sasol Ltd. The sales realised a profit of R19 300 041, which the Commissioner treated as taxable income.

The evidence accepted by the courts below came from Mr R J N Abrahamsen, Nedbank’s managing director and chief executive at the relevant times, who was the only witness. The Special Court expressly found him to have been a frank and honest witness and accepted his evidence, subject to the general principle that a taxpayer’s ipse dixit is not conclusive and must be tested against the surrounding circumstances.

Chronologically, the factual sequence relied upon by the court was as follows. In February 1979, following an announcement by the Minister of Finance that Sasol would be opened up for private investment, Nedbank’s management committee agreed that Nedbank would offer Sasol R100 million by way of investment, with Abrahamsen making clear that the bank’s participation would need to be via preference shares. Abrahamsen testified that Nedbank frequently provided finance to highly creditworthy corporate customers by subscribing for preference shares, and that the reason for targeting Sasol was to obtain commercial banking business and specifically to make a “breakthrough” in the Afrikaner business community.

It ultimately emerged that Sasol would offer only ordinary shares, not preference shares. Although it was not Nedbank’s policy to invest in ordinary shares, the bank decided to proceed. The investment occurred through a private placement among financial institutions, in terms of which Nedbank was allotted 12.5 million ordinary shares at R2 per share, for a total cost of R25 million. Nedbank did not participate in the public issue. Sasol phased the inflow of funds, and Nedbank subscribed in tranches, taking up the first parcel on 5 September 1979 and the last parcel on 2 January 1981. Abrahamsen’s evidence (accepted by the Special Court) was that Nedbank would have invested more (up to the originally contemplated R100 million) had Sasol permitted it, and that the limitation to R25 million was Sasol’s choice.

In furtherance of the anticipated collateral banking relationship, a meeting took place on 5 December 1979 between Nedbank and Sasol executives, aimed at obtaining “some normal banking business”. Sasol indicated it was traditionally a “one-bank-concern” and would not then split its current account business, but Nedbank was to have an opportunity to quote for certain foreign exchange business and large/special transactions. Abrahamsen confirmed this understanding in writing on 7 December 1979. Despite this, the expected business did not materialise: no current account, foreign exchange, or special transactions were obtained by Nedbank from Sasol.

In September 1980, Nedbank’s management committee decided to sell the Sasol shares. The court relied on two reasons for the decision. First, the bank considered it no longer likely to obtain the collateral benefits originally hoped for. Second, the market value of the shares had risen substantially, reducing the yield from about 7% on cost to 3.5% or less, which Nedbank regarded as unattractive compared to alternative uses of capital. Nedbank instructed brokers to sell “in an orderly manner” to avoid disrupting the market. By 30 September 1981, Nedbank had sold 9.3 million of the 12.5 million shares; the balance was disposed of in the ensuing financial year.

The Special Court accepted as material that Nedbank’s original intention was not profitable resale but a long-term investment. This was supported by a contemporaneous auditors’ letter of 21 June 1979 confirming an agreement that the Sasol equity participation was a long-term investment, held for dividend yield, and that fluctuations (other than permanent diminution) need not be provided for in the annual accounts. After the sales, the profits were not transferred to the profit-and-loss account but to an internal reserve, said to reflect their extraordinary nature. The court also relied on the finding that it was not Nedbank’s policy to deal in equity shares, and treated the Sasol investment as an extraordinary transaction for the bank.

Where the courts below distinguished between disputed and undisputed matters, they treated as indisputable that Nedbank did not ordinarily deal in equities and did not generally invest banking funds in such securities as part of its ordinary business. The Commissioner’s challenge focused not on the occurrence of the acquisition and disposal but on the legal character of the transaction and the relevance of Nedbank’s asserted motive.

3. Legal Issues

The central legal question was whether the profit of R19 300 041 realised by Nedbank on the sale of Sasol shares during the 1981 year of assessment was a receipt or accrual of a revenue nature (and therefore included in “gross income” and taxable) or a receipt or accrual of a capital nature (and therefore not taxable as income).

The dispute primarily concerned the application of law to fact, in particular the established inquiry into the true nature of the transaction and the role of intention (including dominant motive) in classifying share-sale profits in the hands of a commercial bank. It also involved an evaluative characterisation, based on factual findings, of whether the acquisition and disposal formed part of a profit-making scheme or instead amounted to the realisation of a capital asset acquired as an addition to the bank’s permanent business structure to secure collateral advantages.

A further question raised by the Commissioner was whether the transaction should be characterised as the furnishing of finance to Sasol in the ordinary course of banking business, such that the profit was inherently revenue in character, and whether the hoped-for collateral banking benefits were legally irrelevant to that characterisation.

4. Court’s Reasoning

The Appellate Division approached the matter by emphasising that the distinction between capital and revenue for purposes of “gross income” is fact-sensitive and must be decided on the circumstances of each case. It treated the factual findings by the Special Court—particularly those regarding Nedbank’s intention in acquiring the shares—as central to the inquiry, and found no basis to interfere with the conclusion reached on those facts.

A substantial portion of the court’s reasoning turned on the relevance of Secretary for Inland Revenue v Trust Bank of Africa Ltd 1975 (2) SA 652 (A). The court regarded the present matter as materially analogous. In Trust Bank, a commercial bank acquired a significant shareholding not primarily for resale profit but predominantly to obtain collateral advantages connected to its banking business, and later sold at a profit. The court in the present case extracted and applied the principle articulated in Trust Bank that where share dealing is carried on by a banker only ancillary to its banking business, the question whether a particular shareholding falls within ordinary share dealing or instead constitutes an extension of the bank’s business structure is of a different kind from that posed by an investment-dealing company, and the intention with which the transaction was entered into becomes fundamental (even if not necessarily decisive in every conceivable case).

Applying those principles, the court accepted the factual premise (also effectively conceded in argument) that Nedbank did not acquire the Sasol shares with a view to resale at a profit. It accepted that the acquisition was a long-term investment designed to generate collateral benefits, specifically the securing of Sasol’s banking business and broader strategic positioning. The court treated Nedbank’s non-dealing posture in equities as reinforcing that the Sasol investment was an extraordinary transaction, not part of routine trading operations.

The Commissioner attempted to distinguish Trust Bank by contending, among other things, that the “true character” of Nedbank’s transaction was simply the provision of finance to Sasol in the ordinary course of banking, rendering the resulting profit revenue; and that Nedbank’s hope of collateral advantages was legally irrelevant. The court rejected that approach on the facts as found, treating the collateral-advantages purpose as central to why the shares were acquired and held. It further held that the fact that Nedbank ultimately did not obtain the hoped-for banking business did not undermine the legal characterisation, because the decisive inquiry was the purpose of acquisition, not whether the purpose was achieved. The court regarded the actual accrual or non-accrual of collateral benefits as evidential, capable of supporting or undermining an asserted purpose, but not itself determinative where other acceptable evidence established the purpose.

The court then considered the Commissioner’s reliance on a line of cases dealing with profits from the realisation of securities by banks or insurers, including African Life Investment Corporation (Pty) Ltd v Secretary for Inland Revenue 1969 (4) SA 259 (A), Income Tax Case No 836 21 SATC 330, and the Privy Council decision in Punjab Co-operative Bank, Ltd, Amritsar v Income Tax Commissioner Lahore [1940] 4 All ER 87, together with Australian and United Kingdom authorities. The court held that these decisions did not assist because they concerned circumstances where the buying and selling of shares or securities formed part of the taxpayer’s ordinary business operations, or where securities were realised as a normal step in meeting depositor demands, and the factual matrix was therefore materially different. By contrast, in Nedbank’s case, it was not part of its ordinary business to deal in equities, and the Sasol acquisition was found to be a long-term capital investment undertaken to secure a collateral banking relationship.

The court also dealt with the Commissioner’s submission that, had the investment been made in preference shares as originally contemplated, the transaction would have been revenue in character, and that the later choice of ordinary shares was merely a change of vehicle rather than of intention. The court described this line of argument as “sterile”, noting that the original scheme was never implemented, and indicating that it was in any event not clear that the suggested legal conclusion would follow on the facts.

Finally, the court rejected any general proposition that where a bank purchases shares using banking funds (circulating capital) the acquisition inevitably produces a revenue result on disposal. It viewed Trust Bank as demonstrating the unsoundness of such a generalisation. Having regard to the accepted findings—especially the findings as to intention—the court concluded that the Special Court had not reached the wrong conclusion in holding that the profit was a capital accrual.

5. Outcome and Relief

The Appellate Division dismissed the appeal and upheld the decision that the proceeds from the sale of the Sasol shares were capital in nature in Nedbank’s hands and therefore not taxable as income.

The Commissioner was ordered to pay costs, including the costs of two counsel.

Cases Cited

Commissioner for Inland Revenue v Nedbank Ltd. (64/86) [1986] ZASCA 63; [1986] 2 All SA 481 (A) (29 May 1986); Secretary for Inland Revenue v Trust Bank of Africa Ltd 1975 (2) SA 652 (A); L.H.C. Corporation of S.A. (Pty.) Ltd. v Commissioner for Inland Revenue 1950 (4) S.A 640 (A.D.); Durban North Traders Ltd. v. Commissioner for Inland Revenue 1956 (4) S.A. 594 (A.D.); Commissioner for Inland Revenue v Strathmore Consolidated Investments Ltd. 1959 (1) S.A. 469 (A.D.); Overseas Trust Corporation Ltd. v. Commissioner for Inland Revenue 1926 A.D. 444; Commissioner for Inland Revenue v Richmond Estates (Pty.) Ltd. 1956 (1) S.A. 602 (A.D.); African Life Investment Corporation (Pty) Ltd v Secretary for Inland Revenue 1969 (4) SA 259 (A); Income Tax Case No 836 21 SATC 330; Punjab Co-operative Bank, Ltd, Amritsar v Income Tax Commissioner Lahore [1940] 4 All ER 87; Commercial Banking Co of Sydney Ltd v Federal Commissioner of Taxation (1950) 4 AITR 406; Inland Revenue Commissioner.(NZ) v Auckland Savings Bank (1970) 2 ATR 51; Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1946) 3 AITR 450; Frasers (Glasgow) Bank Ltd v Commissioners of Inland Revenue 40 TC 698; National Bank of Australasia Ltd v Federal Commissioner of Taxation (1968) 1 ATR 53.

Legislation Cited

Income Tax Act 58 of 1962, including section 83 and section 86A and the definition of “gross income”; Unit Trusts Control Act 18 of 1947 (as amended).

Rules of Court Cited

No rules of court were cited in the judgment.

Held

The court held that, on the factual findings accepted from the Special Court (particularly as to Nedbank’s dominant purpose and intention when acquiring and holding the Sasol shares), the acquisition was not part of a profit-making scheme or ordinary share dealing but was a long-term capital investment undertaken to secure collateral advantages linked to Nedbank’s banking business. The later disposal, although profitable, was treated as the realisation of a capital asset in a commercially advantageous manner. The resulting profit was therefore capital in nature and not includable in taxable income as revenue.

LEGAL PRINCIPLES

The judgment applied the principle that whether an amount is a capital or revenue accrual for purposes of “gross income” under the Income Tax Act is essentially a factual inquiry to be decided on the circumstances of each case, and not by rigid categorisation or generalisation.

In the context of a commercial bank (particularly where share dealing is not its ordinary business or is merely ancillary), the judgment applied the principle articulated in Secretary for Inland Revenue v Trust Bank of Africa Ltd 1975 (2) SA 652 (A) that the intention with which shares are acquired is fundamental to determining whether the holding constitutes part of ordinary trading operations or an addition to the permanent structure of the business.

The judgment further applied the principle that the dominant purpose of acquiring shares may be to secure collateral advantages (such as additional banking business), and where that is established on acceptable evidence, the acquisition and later sale may properly be characterised as capital in nature, notwithstanding that the shares are sold at a profit. In that setting, the fact that the collateral advantages do not in fact materialise is treated as evidentially relevant but not legally determinative where the acquisition purpose is otherwise established.

Finally, the judgment applied the principle that profits realised on disposal are not automatically revenue merely because the acquirer is a bank or because bank funds were used; a bank may, depending on the facts and purpose of acquisition, hold shares as capital assets, and may realise them to best advantage without converting the transaction into revenue trading.