W J FOurie Beleggings CC v Commisioner of the South African Revenue Services (A264/2004) [2007] ZAFSHC 118 (27 September 2007)

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[2007] ZAFSHC 118
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W J Fourie Beleggings CC v Commissioner of the South African Revenue Services (A264/2004) [2007] ZAFSHC 118; 70 SATC 8 (27 September 2007)

IN THE HIGH COURT
OF SOUTH AFRICA
(ORANGE
FREE STATE PROVINCIAL DIVISION)
Appeal No: A264/2006
In
the appeal between:
W
J FOURIE BELEGGINGS CC
Appellant
and
COMMISIONER
OF THE SOUTH
AFRICAN
REVENUE SERVICES
Respondent
_____________________________________________________
CORAM:
HATTINGH,
J
et
VAN DER MERWE, J
et
C.J. MUSI, J
JUDGMENT:
C.J.
MUSI, J
_____________________________________________________
DATE HEARD:
6
AUGUST 2007
DATE DELIVERED:
27
SEPTEMBER 2007
[1] The appellant
taxpayer, W J Fourie Beleggings CC, appeals under section 86 A(1)
read with section 86 (2) (a) of the Income Tax
Act 58 of 1962 (the
Act), against the decision of the Free State Income Tax Special
Court.
[2] The question that
falls to be decided in this appeal is whether an amount of R1292
760.00 which was paid to the appellant, during
the year of assessment
ending 28 February 2002, pursuant to a settlement agreement was a
capital receipt and therefore non taxable
or a revenue receipt, which
is taxable.
[3] The appellant is the
lessee of the
Elgro Hotel at Potchefstroom. The owner/lessor is
Bultfontein Eiendomme Beleggings (Edms) Bpk. On 4 April 2001
Naschem, a division
of Denel (Pty) Ltd, requested the appellant to
provide accommodation and meals for students from the United Arab
Emirates (UAE) who
were to be trained by Naschem in South Africa.
The appellant agreed. Thirty eight students were to be accommodated
and supplied
with meals from 1 April 2001 for 791 days. Twelve
students were to stay from 1 April 2001 to 6 May 2001 (36 days);
seventeen were
to stay from 1 April 2001 to 30 September 2001(183
days); eighteen were to stay from 1 April 2001 to 30 September
2001(183 days).
Meals were also to be provided for five officers
from 1 April 2001 to 30 September 2001. The total value of the
contract was R
8 791 913.70.
[4] A few days after the
attack on, inter alia, the twin towers in New York (United States of
America) on 11 September 2001 the students
left the Elgro Hotel
without any rhyme or reason. The appellant viewed their conduct as a
breach of the agreement. After the appellant
threatened to sue
Naschem the parties agreed to settle the matter out of court.
[5] On 6 December 2001
they inter alia agreed to the following terms:
“
1. SKIKKINGSBETALING:
Naschem onderneem om ‘n bedrag van
R1 292 760.00 (Een miljoen twee honderd, twee en negentig duisend
sewehonderd en sestig rand)
BTW ingesluit aan ELGRO HOTEL, te betaal
in volle en finale vereffening van alle eise, van welke aard ookal,
wat ELGRO HOTEL teen
(hom) mag hê, ongeag of dit spruit uit die
kontraktereg, of ingevolge die Gemenereg.
2. AFSTANDDOENING VAN REGTE:
As teenprestasie vir die betaling van
bogenoemde skikkingsbedrag, onderneem ELGRO HOTEL om:
alle regte wat hy mag hê op
skadevergoeding te abandoneer, en
enige hangende – of beoogde
hofaksie teen NASCHEM te laat vaar.”
Naschem paid the money to
the appellant.
[6] The appellant called
two witnesses viz Ms Gerber – a legal advisor and member of the
executive committee of Naschem - and Mr
Fourie, the sole member of
the appellant.
[7] Ms Gerber, an
admitted attorney, confirmed the existence of the agreement between
Naschem and the appellant. She also confirmed
that the students left
the Elgro Hotel without notice. After she heard about their
departure from the appellant’s hotel she contacted
an attorney to
seek legal advice. She and the attorney agreed that the best course
of action would be to try and settle the matter
out of court in order
to save litigation costs, avoid being exposed to a claim for damages
and to retain the business relationship
with the appellant.
[8] Naschem offered the
appellant R600 000.00 which was rejected. The appellant proposed R
1.2 million. The proposal was accepted
on condition, inter alia,
that the appellant should waive its right to institute any claim
against Naschem as a result of the students’
actions. According to
her, approximately two-thirds of the Elgro Hotel was occupied by
students from the UAE. As a result, the
appellant lost a lot of
clients. The students also caused extensive damage to the rooms.
She does not know how the amount that
was ultimately paid was
computed. Her brief was to get the appellant off their backs and to
settle the matter out of court by keeping
the settlement amount as
low as possible. The money paid to the appellant was therefore meant
as a settlement to get it off their
backs and to retain the good
business relationship that Naschem had with the appellant. She
conceded that the 2001 contract between
Naschem and the appellant had
no terms in relation to renovations that had to be done to the hotel.
[9] Mr Fourie testified
that he is the sole member of the appellant. The Elgro Hotel is
leased by the appellant. He confirmed the
accommodation and catering
contract that the appellant had with Naschem. According to him the
appellant had to effect many changes
to the hotel in order to secure
the contract. Those changes were done prior to the tax year that is
relevant to these proceedings.
The appellant also employed
specialist personnel to look after the dietary requirements of the
students. The hotel was doing good
business before the contract with
Naschem. It could accommodate up to 25 conferences per week. On
entering the contract with Naschem
70% of the hotel was occupied by
the UAE students. The students occupied all the double rooms and
only single rooms were available
for other guests. Days after the 11
September 2001 attack in the USA the students left the hotel. There
was still R4.7 million
outstanding on the contract. After the
students moved out they saw that the rooms in which they were staying
were wrecked. The
carpets were burned, the mattrasses had holes, the
furniture was damaged and the walls were dirty. He estimated that
the repair
costs would be in the region of R1.2 million. He settled
the matter to repair the rooms so that he could – as soon as
possible-continue
with his business. Initially he testified that he
did not know how the settlement amount was computed. He later stated
that the
settlement amount included repair costs as well as
operating, or running costs (salaries), water and lights etc. During
cross examination
the turnover, expenses and repair costs for the
years 1998 to 2004 of the hostel was put to him. He also conceded
that the appellant
used approximately R1 million of the money; ±
R500 000.00 to repay a loan and ±500 000.00 towards trade debts. He
later – during
re-examination - testified that the amount was
computed as follows: R1.1 million plus vat for damages and R34 000.00
for legal fees
and services rendered.
[10] The factual findings
as well as the legal conclusions of the Court a quo were challenged
by Mr Van Breda on behalf of the appellant.
The nub of his argument
was that the Special Court should – on the facts – have found
that the amount received by the appellant
was a capital receipt and
not a revenue receipt. Mr Stevens on behalf of the respondent
contended that the Court a quo was correct
in finding that the
settlement amount was a surrogatum for future profits surrendered.
[11] The Court a quo did
not actually make any credibility findings in relation to the
witnesses. In the absence of any findings
on demeanour and or
credibility this Court is at large to make its own factual findings
where necessary. See
Hicklin
v Secretary For Inland Revenue
1980 (1) SA 481
(AD) at 485 D – H.
[12] In relation to Ms
Gerber the Court a quo said that:
“
(H)aar
pogings om te probeer verduidelik dat dit die hele doel van die
kontrak was kom neer op ‘n oorneem van die funksie van die
hof.”
This criticism of this
witness is unfortunate. Ms Gerber was a party to the negotiations
that led to the signing of the settlement
agreement. She assisted in
the drafting thereof. She also signed it as a witness. Her evidence
is – the way I see it – helpful
to assist the court in
determining what in fact the receipt was actually for. The court
must not look at the form of the agreement
but its real nature. A
court in determining the true character of the receipt must of
necessity have regard to all the surrounding
circumstances. The
court may in particular also have regard to extrinsic evidence to
assist it in determining the purpose and sometimes
effect of the
receipt or expenditure. The court should not be bound by labels that
the parties attach to the compensation. It is
only after the court
has had regard to the full picture that it, not the witnesses,
attaches a particular label to the compensation
or receipt.
1
It
is not always easy to discern from an agreement what a receipt was
for. The
tête
– a – tête
of the parties might then be of assistance to the court. The
intention of the taxpayer or the parties is also relevant to
determine
what the receipt was for. The intention
_____________________________________________________
See the English
decisions: CIR V church Commissioners for England
(1976) 50 TC 516
at 538; Burman v Thorn Domestic Appliances (Electrical) Ltd
(1981)
55 TC 493
at 507 I. See also ITC number 254 – 7 SATC p 56 at 58.
ITC
1338: 43 SATC 171
at
175.
of the parties is
relevant because if the facts show that the amount is
prima
facie
of an income nature, the taxpayer may be able to provide an
explanation, in person or through witnesses, to rebut the inference
that
the amount is of an income nature. The explanation of the
events, including the intention of the parties to the transaction is
therefore
relevant. This evidence must be evaluated in the light of
all the other objective facts and circumstances.
2
[13] It is clear from Ms
Gerber’s evidence that Naschem was under pressure to settle the
matter out of court. Naschem wanted the
appellant off their backs.
The settlement amount was not computed with reference to any damages
suffered by the appellant. She
testified as follows:
“
Soos
ek weer eens vir u sê, dit is nie skade wat ons bereken het nie, dit
is bedryfskostes en dit is weer om op die bene te kom dat
hy gewone
gaste in sy hotel kan ontvang.”
_____________________________________________________
2. See LAWSA First
Reissue volume 22 Part 1 page 24 – 25 paragraph 42.
Later
during cross examination she testifies as follows:
“
Nou
hierdie kontrak op bladsy 36 van die dossier, as daardie kontrak sy
volledige tyd uitgeloop het, wat sou gebeur het? Mnr Fourie
sou al
die inkomste uit Naschem ontvang het wat hy volgens daardie
bestelling op geregtig sou wees het. --- Ja, dit is korrek.
Dit
is korrek. Nou het die een party het uitgetrek uit die kontrak uit,
die studente, Naschem. Is dit met ander woorde korrek dat
mnr Fourie
sou gesê het hier is nou ‘n gaping. Hier is nou ‘n gaping in my
inkomste en ek wil hê u moet my bietjie help. ---Wel
hy het vir ons
gesê hier is ‘n probleem en hy het regtig hierdie probleem gehad
van bedryfskoste van skielik het hy niemand in
sy hotel nie.
Bedryfskoste, wat bedoel u daarmee?
--- Om daaglikse personeel te betaal en net om die hotel aan die gang
te hou.
Korrek,
dit was sy eintlike probleem. --- Ja.
Hy het ingestem dat ‘n bedrag van
R1.292 miljoen sal voldoende wees as vergoeding. --- Nie as
vergoeding nie, as skikking dat hy
kan aangaan en dat ons nie ‘n
hofsaak gaan hê nie.”
[14] In my view Ms Gerber
was not a dishonest witness neither did she attempt to usurp the
Court’s powers. She tried, as best as
she could, with a slight
bias in favour of the appellant, to recall the events giving rise to
the signing of the settlement agreement.
Her brief was to keep it as
low as possible. Likewise her evidence as to the condition of the
hotel after the students moved out
should also be ignored because she
never inspected the hotel. She was therefore not in a position to
testify as to whether the hotel
could accommodate ordinary guests.
[15] Mr Fourie could not
give a clear and coherent account of what the money was paid for.
Neither could he give an acceptable explanation
as to how the money
was computed. It was only during re-examination after he consulted
with his legal representative that he gave
an account of how the
money was computed.
3
Fourie vacillated to such an extent that the true purpose and effect
of the compensation, on his evidence, defies delineation.
The money
was initially only to effect repairs which he estimated to be in the
region of R1.2 million. He then changed tack and
said that the
compensation was for repairs and to alleviate his cash flow problems.
He later conceded that the appellant used approximately
R500 000.00
of the money to repay a loan
_____________________________________________________
3. The consultation took
place after the witness was cross-examined. The President correctly
pointed out that it is highly irregular
to consult with one’s
witness after cross examination but before re-examination. Such
conduct, without the opponent or the court’s
permission, is
irregular and contrary to the rules of the General Bar Council.
and that it used another
R500 000.00 to pay off its current liabilities.
4
His evidence would test and find the most credulous person wanting.
His evidence should in my view only be accepted with a generous
measure of circumspection.
[16] When considering the
nature of a compensation receipt the court should seek to answer two
fundamental questions, firstly, is
the compensation a receipt of the
trade? Secondly, if the answer to the first question is yes, is it a
capital or a revenue receipt?
In casu the appellant alleges that the
amount is a receipt of trade and that it is capital. The appellant
bears the onus to prove
same on a balance of probabilities.
5
[17] If the answer to the
first question is in the negative and it is clear that the
compensation arose outside the trade then it
cannot be said that the
money was received as part of the
_____________________________________________________
4. Although the purpose
for which the compensation was used is strictly speaking irrelevant
it can however be relevant to determine
the effect of the
compensation, which in turn helps to determine what the receipt was
actually for.
5. See
section 82 of the Act which reads:
“Burden
of proof that any amount is –
exempt from or not
liable to any tax changeable under this Act; or
subject to any
deduction, abatement or set-off in terms of this Act; or
to be disregarded or
excluded in terms of the Eighth Schedule,
shall be upon the person
claiming such exemption, non-liability, deduction, abatement or
set-off, or that such amount must be disregarded
or excluded, and
upon the
profit making structure
of the business. Neither can it be said to be the fruit of the
profit making structure. There must therefore
be a close connection
between the trade being carried on and the cause of the payment of
the compensation.
6
In this matter it is clear that the compensation was indeed a receipt
of the trade. I now turn to the second question.
[18] Our income tax
system rests on the concept of
“gross
income.”
Generally, receipts or accruals of a capital nature are not
calculated as part of a person’s gross income.
7
Receipts or accruals of a capital nature are not defined by the
legislature. The distinction between receipts of a capital nature
and of a revenue nature has been the subject of numerous judicial
pronouncements. Marais JA eloquently points out that it is an
exercise in futility to endeavour to design a yardstick or test to
decide when an expenditure is revenue or capital. He states it
thus
8
:
_____________________________________________________
hearing of any appeal
from any decision of the Commissioner, the decision shall not be
reversed or altered unless it is shown by the
appellant that the
decision is wrong.”
See also ITC
1279:40 SATC 254 at 258.
6. See LAWSA
supra page 155 paragraph 263.
7. See definition of
gross income in section 1 of the Act.
8.
In Rand Mines (Mining & Services) Ltd v CIR
1997 (1) All SA 279
(A) at 285 (i) –
286 (f).
“
Yet
again this Court is required to label expenditure incurred by a
taxpayer as either capital or revenue expenditure. The distinction
is clear enough conceptually and by now so familiar that repetition
is unnecessary… An abiding problem has been to identify and
then
synthesise into reasonably accurate and universally applicable
yardstick the factors which are indicative of each of the two
classes
of expenditure. No such yardstick has yet been fashioned and the
attempt has come to be regarded as futile and has been
abandoned.
Instead the courts have identified useful indicia to which regard may
be had, emphasising that they are no more than
that and that in each
case close attention must be given to its particular facts. In
Commissioner of Taxes v Nchanga Consolidated
Copper Mines Ltd
[1964]
1 All ER 208
(PC) at 212,
[1964] AC 948
at 959
Lord Radcliffe warned against the
notion that any of the indicia identified by the courts, taken
singly, will lead to the right conclusion.
He said:
“…
all these phrases, as, for
instance, ‘enduring benefit’ or ‘capital structure’ are
essentially descriptive rather than definitive,
and, as each new case
arises for adjudication and it is sought to reason by analogy from
its facts to those of one previously decided,
a court’s primary
duty is to enquire how far a description that was both relevant and
significant in one set of circumstances is
either significant or
relevant in those which are presently before it.
Nonetheless, courts continue to be
regaled with comparisons. Given the absence of a satisfactory litmus
test of principle, it is
inevitable that casuistic comparisons will
be made and they undoubtedly have some value. Greater precision is
regrettably simply
not attainable when value judgments such as this
have to be made”
Although Marais JA was
referring to capital and revenue expenditure the quoted passage
applies to receipts or accruals as well.
[19] Mr Van Breda and Mr
Stevens referred us to a plethora of authorities in favour of or
analogous to their respective cases.
[20] The following may be
pointed out from those cases. A payment received for the permanent
or sometimes temporary loss, deprivation
or
“sterilization”
of a capital asset of the business is a capital receipt. Likewise if
the payment is made pursuant to a restraint of trade clause
that
accrual will be of a capital nature. See
Glenboig
Union Fireclay Co. Ltd v Commissioner for Inland Revenue
12 TC 427.
Commissiner
for Inland Revenue v Illovo Sugar Estates Ltd
1951 (1) SA 306
(N). In contrast it has been pointed out that if the
compensation is for some temporary interference with the trader’s
use of
an asset then the accrual is of a revenue nature. See
Burmah
Steam Ship Company Ltd v CIR
(1930) 16 TC 67
where it was held that if the compensation is to
“fill
a hole”
in the income or profit of the taxpayer it will be regarded as
revenue and not capital. In
Bourkes
Estate v Commissioner for Inland Revenue
1991 (1) SA 661
(AD) at 672 A – C Hoexter JA pointed out with
reference to
Broomberg
Tax Strategy 2
nd
ed
(1983) at 199 – 200, that the fact that what was plugged is a hole
in the assets does not, by itself conclude the inquiry. The
passage
to
Broomberg’s
work reads as follows:
“
Of
course, it is not sufficient to establish that the compensation is
being paid in order to fill a hole in the taxpayer’s assets.
It is
necessary, in addition, to ascertain the true nature of that asset in
the recipient’s hands. More particularly, was the
asset, prior to
its destruction or damage, an asset of a capital nature or was it
floating capital? If it was floating capital, such
as trading stock,
standing crops, or consumable stores (like petrol, oil and so forth)
the compensation will, obviously, be of a
revenue nature, and will be
subject to tax. In short, it is only where the payment received is
to fill a hole in the capital assets
of the taxpayer that the payment
will escape the tax net.”
[21] The above
“tests”
are not always helpful when one is dealing with compensation for
cancellation of trading contracts. An amount paid by way of damages
or compensation takes on the character of the loss in compensation
for which it has been paid. If the payment is made in respect
of a
loss of income, the receipt will be of a revenue nature.
9
A receipt arising on the cancellation or variation of a trade
agreement is normally of a revenue nature. Where however a contract
is so crucial that its loss would cripple or destroy the business it
may transcend the status of an ordinary commercial contract.
Income received for the
termination of such a contract may – depending on the facts and
circumstances of the particular case –
be capital.
[22] In ITC 129:
40 SATC
254
at 258 Coetzee J followed the approach in
IRC
v Fleming & Co (Machinery) Ltd
.
10
In the
Fleming
matter Lord Russel said the following:
_____________________________________________________
9. LAWSA supra page 32
paragraph 46 (b).
10.
(1951) 33 TC 57
at
63.
“
The
sum received by a commercial firm as compensation for the loss
sustained by the cancellation of a trading contract or premature
termination of an agency agreement may in the recipient’s hands be
regarded either as a capital receipt or as a trading receipt
forming
part of the trading profit. It may be difficult to formulate a
general principle by reference to which in all cases the
correct
decision will be arrived at since in each case the question comes to
be one of circumstance and degree. When the rights and
advantages
surrendered on cancellation are such as to destroy or materially to
cripple the whole structure of the recipient’s profit-making
apparatus, involving the serious dislocation of the normal commercial
organisation and resulting perhaps in the cutting down of the
staff
previously required, the recipient of the compensation may properly
affirm
that
the compensation represents the price paid for the loss or
sterilisation of a capital asset and is therefore a capital and not
a
revenue receipt. Illustrations of such cases are to be found in Van
den Bergh Ltd
19 TC 390
,
[1935] AC 431
, and Barr, Crombie & Co
Ltd
26 TC 406
,
1945 SC 271.
On the other hand when the benefit
surrendered on calculation does not represent the loss of an enduring
asset in circumstances
such as those above mentioned – where for
example the structure of the recipient’s business is so fashioned
as to absorb the
shock as one of the normal incidents to be looked
for and where it appears that the compensation received is no more
than a surrogatum
for the future profits surrendered – the
compensation received is in use to be treated as a revenue receipt
and not a capital receipt.”
Coetzee J found this
approach to be crisp, logical and in sync with our legal principles.
I agree.
[23] If it is shown that
the cancellation of a commercial contract affected the profit making
structure of the business or that it
affected the whole manner in
which the business is conducted and that compensation has been paid
therefore then that compensation
would be of a capital nature.
11
If the amount to be paid
is computed with reference to future loss of profits the receipt will
remain of a capital nature. The method
used to compute the sum
therefore does not necessarily determine the nature of the sum.
12
[24] Mr Van Breda argued
that the facts of this matter show that the compensation in this
matter was of a capital nature. He emphasised
the following factors:
24.1 the
long term nature of the contract;
_____________________________________________________
11. See Taenber &
Corssen (Pty) Ltd v Sec for Inland Revenue
1975 (3) SA 649
(AD) at
662 A – D.
12. See ITC 254:
7 SATC
56
p58.
24.2 the
unexpired term at cancellation;
24.3 the amount due for
the unexpired period;
24.4 the
fact that the hotel was going to lose more than two
thirds of its occupants;
the extend of the costs
in relation to improvements to the structure in order to secure the
contract and the cost of repairing
the hotel which is between R1.1
million and R1.2 million;
the near loss of all
regular clients of the hotel.
[25] The court a quo
correctly, in my view pointed out that it is very dangerous in income
tax matters to move away from the
facts of a particular
case. An evaluation of the facts devoid of context will always lead
to a flawed conclusion. Mr Van Breda’s
arguments do not take
account of the facts of this matter. The capital asset of the
appellant is the lease of the hotel itself.
The hotel rooms are
hired out and those who receive the right to occupy must pay for
accommodation and catering. The hotel is put
to work by the
appellant to generate income.
13
_____________________________________________________
13. See Rand Mines
(Mining & Services) Ltd v CIR supra at 289 g – h.
The hotel itself is
therefore the income/profit producing structure of the appellant.
The hotel had 105 rooms. The hotel was not
going to be 70% occupied
by the students for the full duration of the contract. The contract
in respect of the 12 students (1 April
2001 to 6 May 2001) already
ran its course. Appellant was to be compensated according to the
contract on the 31 August 2001 in respect
of all the other students
except the 38 that were going to stay for 2 years. There is no
evidence to the effect that Naschem did
not deliver or pay on the
stated delivery date (31 August 2001). In any event when the
students moved out in September 2001 it was
less than 20 days from
the date on which all the other students, except the 38, were to move
out permanently. This much is made
clear in the contract and to some
extend during cross examination of Fourie. He said the following:
“
Ja
ek verstaan dit, maar 38 is ver van – die hotel was nie vol met
hulle nie, net met die 38 nie. --- Nee, ons het 105 kamers en
maksimum was sê maar 70 wat daarna gebly het, maar die hele tydperk
was daar, sê 38 maar dan het ons offisiere en goed wat ook
bygekom
het en hulle het die getal ook opgestoot.
Ja, maar as ‘n mens kyk na bladsy 36
weer, party van die studente het net vir April en Mei 2001 daar
gebly. --- Dit is so, ja.
En
daar lyk vir my volgens die inligting daar was daar net 38 studente
wat permanent daar sou gebly het vir twee jaar. Die ander
het gekom
en gaan. --- Daar was twee kontrakte gewees. Die een was vroeër
gewees en hierdie is ‘n nuwe kontrak en hulle het oorvleuel
vir ‘n
tydperk.
Maar
ons het dit nie op rekord nie. --- Nee, ek het nie daardie nommers
hier nie.
Is dit inligting op bladsy 36 met
ander woorde nie korrek nie?---
Dit
is korrek
My vraag aan u is net, u het nie 76
studente geboek vir ‘n volle tydperk van twee jaar nie. ---Nee.
U het net 38 studente geboek vir ‘n
volle tydperk van twee jaar. --- Dit is moeilik om vir u daarop te
sê, want deurgaans was daar
offisier gewees wat die heeltyd daar
gewoon het in die hotel. Hierdie een sê dit, maar daar was
deurgaans ekstra personnel van
hulle wat daar gebly het.
Daar
word hier gepraat van “five officers”. --- Ja, dit hang af watter
– dit was verskillende, ek ken nou nie die name van die
opleidingsgroepe nie, daar is verskillende name vir die
opleidingsgroepe en hulle offisiere het al ons suites opgevat. Dit
was ‘n
verpligting van hulle of ‘n vereiste van hulle dat hulle
in suites bly.”
[26] It is therefore
clear that only 38 students were going to stay for two years. The
evidence of Fourie that the students would
have occupied 70% of the
hotel for the full duration of the contract (two years) was clearly
exposed as being less than candid.
26.1 I will accept that
the appellant incurred costs in relation to improvements and repairs
made to the structure in order to secure
the contract. Those costs
were incurred in 1999 and 2000. The appellant could claim from the
respondent for the repairs done during
these periods. The
improvements to the hotel were not done to the appellants’
prejudice. The students as well as ordinary guests
could still use
the hotel after the renovations were done. There is no indication
that the renovations rendered the hotel unsuitable
for guests other
than the students.
26.2 It
was pointed out that the telephone bills for 2002 was R414 000.00
whereas during 2001 before the students arrived it was R465
000.00.
The linen expenses in 2001 was R172 718.00 and in 2002 when the
students were staying there it was R162 914.00. During
2001 –
before the students moved in the appellant had 58 cleaning posts and
during 2002 when the students were there the appellant
had 47
cleaning posts. The wages for 2001 was R2.3 million and for 2002 it
was R2.2 million and for 2002 it was R2.2 million. The
turnover for
2001 was R9.4 million whereas in 2002 it was R8.06 million. It is
significant that the appellant did not retrench or
lay off any
employees because of the loss of this contract. These facts and
figures clearly show that the Naschem contract was never
part of the
appellants profit / income making structure.
[27] This hotel
functioned quite well with or without the Naschem contract. There is
no indication that the appellant’s profit
making structure was
crippled or destroyed by the cancellation of the agreement. The
hotel could and did continue as a profit earning
asset. The
agreement between Naschem and the appellant was not an essential part
of the profit making machine or structure of the
appellant. It was
incidental to the working of the profit making machine. The
agreement was a normal contract incidental to the
normal course of
the appellant’s business. The appellant’s business, as a
provider of accommodation, was to secure as many contracts
for
accommodation and catering as the hotel could cater for and their
profits were gained by giving accommodation and catering at
a fee.
The cancellation of an individual booking or a group booking is a
shock that hotels are fashioned to absorb as one of the
normal
incidents to look for in the hotel business.
[28] The sum of money
received by the appellant was not in a material sense received as
compensation for not being allowed to make
profit by not hiring out
rooms at the hotel, i.e. it was not received in respect of the
termination or sterilization of any part
of the appellants’
business. It was also not received in respect of a capital asset.
The capital asset (the hotel) could forthwith
be harnessed to produce
profit by hiring out rooms.
[29] It is clear to me
that the appellant was compensated for the loss of profit that it
would have made had the students not moved
out. It was paid to help
with its cash flow problems. It is therefore not surprising that the
appellant used ±R500 000.00 of the
money to service a loan and
another R500 000.00 to pay its current liabilities. If the repairs
that had to be done to the hotel
were so extensive one would have
expected the appellant to use a substantial amount of the money in
order to do those repairs. The
appellant did not even quantify, in
monetary terms, the extent of the repairs. The figure given, was
clearly a thumb suck. In any
event if the money was paid in order
for the appellant – as Fourie contents – to effect repairs then
in my view that compensation
would still be of a revenue nature.
Expenditure to restore or maintain an asset to its normal function is
not capital. It is revenue
and is deductable as a revenue expense.
An accrual or compensation to effect the necessary repairs would
therefore also be of a
revenue nature.
14
In my view the appellant has not succeeded in proving on a balance of
probabilities that the compensation was of a capital nature.
[30] A
true reflection of what actually happened here is to be gleaned from
Ms Gerber’s evidence as quoted in paragraph 13 of this
judgment.
It is clear from her evidence that the compensation was in truth for
costs incidental to the
_____________________________________________________
See section 11 (d) of
the Act which reads as follows:
General deductions
allowed in determination of taxable income.
For
the purpose of determining the taxable income derived by any person
from carrying on any trade within the Republic, there shall
be
allowed as deductions from the income of such person so derived –
…
…
…
expenditure actually
incurred during the year of assessment on repairs of
property occupied for the
purpose of trade or in respect of which income is receivable,
including any expenditure so incurred on the
treatment against attack
by beetles of any timber forming part of such property and sums
extended for the repairs of machinery, implements,
utensils and other
articles employed by the taxpayer for the purposes of his trade.
See also Fleming v
Kommissaris Van Binnelanse Inkomste
[1994] ZASCA 142
;
1995 (1) SA 574
(AD).
performance of the income
– producing operations of the appellant.
15
In
London
& Thames Haven Oil Wharves Ltd v Attwooll
(1966)
43 TC 491
the company’s jetty was damaged by an oil tanker. The
company received payment from the tanker owner and from its own
insurers,
which exceeded the cost of repairing the jetty. The
insurance was for physical damages only but it was agreed with the
insurers
that the recovery from the tanker owner should be taken to
include a sum of the loss of use of the jetty whilst undergoing
repair.
Lord Diplock found that the compensation for the loss of use
of the jetty was to make up a hole in the profits and was taxable.

He stated it as follows at page 515.
“
I
start by formulating what I believe to be the relevant rule. Where,
pursuant to a legal right, a trader receives from another person
compensation for the trader’s failure to receive a sum of
_____________________________________________________
15. See ITC
1267: 39 SATC
146
at 148 wherein the following quote from New State Areas Ltd v CIR
14 SATC 155
at 170 is quoted with approval: “The conclusion to be
drawn from all of these cases seems to be that the true nature of
each transaction
must be enquired into in order to determine whether
the expenditure attached to it is capital or revenue expenditure.
Its true nature
is a matter of fact and the purpose of the
expenditure is an important factor; if it is incurred for the purpose
of acquiring a capital
asset for the business it is capital
expenditure, even if it is paid in annual instalments; if, on the
other hand, it is in truth
no more than part of the cost incidental
to the performance of the income-producing operations … then it is
revenue expenditure,
even if it is paid in lump sum.”
money which, if it had been received,
would have been credited to the amount of profits (if any) arising in
any year from the trade
carried on by him at the time when the
compensation so received, the compensation is to be treated for
income tax purposes in the
same way as that sum of money would have
been treated if it had been received instead of compensation. The
rule is applicable whatever
the source of the legal right of the
trader to recover the compensation.”
This logical approach was
confirmed by Lord Hoffman in
Deeny
& Others v Gooda Walker Ltd & Others
(1996) 68 TC 458
at 509 G – 510 F. This approach is also in
conformity with what was said by Pollak AJ in ITC 723 :
17 SATC 496
that:
“
It
seems clear that an amount received such as the present, by way of
damages or by way of settlement of an action for damages, is
income
and not capital, if the transaction out of which the claim for
damages arose is a transaction which, had it been completed,
would
have resulted in an income and not in a capital gain or loss as the
case might be.”
[31] If the transaction
in casu had been completed the result would have been an income gain.
It would have been taxable. In my
view the compensation was a
revenue and not a capital receipt. The appeal ought to fail.
[32] Although Mr Stevens
is in the full time employ of the respondent he requested us to make
a cost order in the respondent’s favour
because the respondent
incurred expenses in relation to this appeal. The respondent is
successful and there is no reason why the
costs should not follow the
result.
[33]
Consequently
I make the following order:
The
appeal is dismissed with costs.
_________________
C.J. MUSI, J
I
concur.
____________________
G. A. HATTINGH, J
I
concur.
_______________________
C.H.G VAN DER MERWE, J
On
behalf of the appellant: Adv. C. Van Breda
Instructed
by:
Israel
Sackstein Matsepe inc.
BLOEMFONTEIN
On
behalf of the respondent: Adv. G. Stevens
Instructed
by:
The
State Attorney BLOEMFONTEIN
ms