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[1985] ZASCA 63
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Commissioner For Inland Revenue v Standard Bank of South Africa Ltd. (81/85) [1985] ZASCA 63; [1985] 2 All SA 512 (A) (22 August 1985)
IN THE SUPREME COURT OF SOUTH AFRICA (APPELLATE DIVISION.)
In the appeal of
COMMISSIONER FOR INLAND REVENUE
appellant
and
STANDARD BANK OF SOUTH AFRICA
LIMITED
respondent
Coram
: CORBETT, MILLER, VAN
HEERDEN, HEFER, JJA, ot: GALGUT AJA.
Date heard
: 15 May 1985
Date of J
udgment
: 22 August 1985
J U D G M E N T
CORBETT
JA :
This is an appeal from the Transvaal Income Tax Special Court, leave to
appeal direct to this Court having
/ been
2
been given by the President of the Special Court in terms-of sec. 86A(5) of
the Income Tax Act 58 of 1962, as amended ("the Act").
Respondent is the Standard Bank of South Africa Ltd ("the Bank"), a
registered commercial bank operating throughout the Republic of
South Africa and
having its head office in Johannesburg. In its income tax returns for the years
of assessment ended 31 December
1979, 31 December 1980 and 31 December 1981 the
Bank claimed as deductions from its income the Co II owing amounts respectively.
In relation to these three years of assessment, viz. R127 018 683, R117 275 018
and R299 409 076, as representing interest paid by
it on moneys borrowed. In
terms of additional assessments for the 1979 and 1980 tax years and an original
assessment for the 1981
tax year (all of these assessments having been issued in
about May 1982) the Commissioner for Inland Revenue ("the Commissioner")
dis-
/ allowed
3
allowed portion of each of these deductions, the amounts disallowed
being respectively R1 820
373, Rl 937
572 and R6 010 992, and taxed the Bank
accordingly. Its objection to the disallowance of these amounts having been
overruled by the
Commissioner, the Hank appealed to the Special Court,
which
upheld the appeal, set aside the assessments and
referred the matter back to the Commissioner for re-assessment in terms of its
judgment.
The Commissioner, as appellant, now seeks in this Court the reversal
of the decision of the Special Court.
In a nutshell, the dispute between the parties concerns the utilization by
the Bank, in the years of assessment under consideration,
of a portion of the
deposit moneys available to it for investment in the purchase of redeemable
preference shares. Since the amounts
received by the Bank by way of dividends on
these shares are not taxable in the hands of the Bank (by virtue of sec.
10(1)(k) of
the Act), the Commissioner contends that a proportionate amount of
the interest paid to depositors on the deposit moneys, being
/non-productive....
4
non-productive of "income" (as defined in the Act), should
be disallowed
as a deduction in the computation of the
Bank's taxable income. The Bank disputes the validity of this
contention.
Before I discuss the legal issues involved in this dispute, 1 must make some
reference to the facts. These appear from the dossier
of documents and the
evidence of Dr C B Strauss, the managing director of the Bank and the only
witness called in the Court a quo.
If one is to judge by the cross-examination
of Dr Strauss by the Commissioner's representative in the Special Court, it
would seem
that what he stated in evidence is not in dispute.
At the outset, I should explain that the Bank is a wholly-owned subsidiary of
Standard Bank Investment Corporation ("SBIC"), a company
quoted on the
Johannesburg Stock Exchange, and that the assets of the Bank represent about 70
per cent of the assets of 5BIC. In
addition, other subsidiary companies, such as
Standard Merchant Bank
/ Standard
5
Standard Bank Credit Corporation and Standard Bank Industrial Finance
Corporation, go to make up a Standard Bank Group. Various banking
operations are
conducted by different members of the Group, but,for the sake of simplicity, in
my
discussion of the facts I will refer merely to the Bank.
Judged by total assets held, the Bank is the second largest
commercial bank in the country.
What the evidence of Dr Strauss reveals is that basically and in simple terms
the business of the Bank (and of other commercial banks
like respondent)
consists of borrowing moneys by way of customers' deposits, upon which it pays
interest to the customer, and of
lending out these moneys in various ways and
thereby earning income (in the ordinary, non-technical sense of the word) in the
form
of interest and other forms of compensation paid by the borrower to the
Bank for the use of the money. Naturally, the Bank so arranges
its affairs that
the general return it obtains on the moneys lent by it exceeds the interest
/ which
6
which it has to pay to its customers/depositors. This excess represents,
broadly speaking, the gross profit of the Bank.
What Dr Strauss referred to as the "primary function" of the Bank of
collecting deposits may be divided into two categories, retail
deposit-gathering
and wholesale deposit-gathering. The former function is carried on throughout
the country through the net-work
of more than a thousand branches of the Bank.
Funds are gathered through the deposit of moneys by customers in hundreds of
thousands
of current, savings and fixed deposit accounts maintained with these
various branches of the Bank. The wholesale deposit-gathering
function is
handled largely by the investment division of SBIC on behalf of the Bank. This
relates to deposits in excess of R100
000, usually made by institutions such as
pension funds, insurance companies, mining houses and other banks, in the form
of fixed
deposits or what are termed negotiable certificates of deposit.
/ The
7
The Bank accepts all deposits that are offered to it, provided that the
customer agrees to the quoted interest rate. Indeed all branches
are instructed
to take as many deposits as they can. This is a matter of commercial necessity.
In order to grant loans a bank must
have money available. This money i t
acquires by taking deposits. Moreover, the Hank has a large and costly
infrastructure and if
this is not used effectively and to its full potential,
then the cost of the Bank's overheads becomes disproportionate to its earnings,
and its commercial, efficiency diminishes. As Dr Strauss put it
".... it is simply not a practical business proposition for any bank, not
necessarily
this one, to refuse to take deposits
at the rate that is acceptable".
Of the deposits that have been gathered by the Bank, certain proportions
must, in terms of the Banks Act 23 of 1965, be devoted to
the maintenance of the
required minimum reserve balance with the Reserve Bank, of the minimum
/ liquid
8
liquid asset requirement and of the minimum prescribed investments
requirement (see secs. 16, 17 and 18 of the Banks Act). The balance
of the
deposits, apart from what is utilized in the acquisition of fixed property, then
goes into a common pool used for financing
the borrowing needs of the Bank's
customers. The Bank's main instrument of lending is the overdraft on current
account, which represents
the "vast bulk" of customer Financing. In addition,
the Bank also finances acceptance credits, leases and suspensive sales, provides
factoring facilities and grants medium-term loans. In recent years the taking up
of redeemable preference shares has emerged as a
requirement of customers in
certain instances.
The redeemable preference share transaction is seen as. an alternative to the
grant of a medium-term loan. Instead of the Bank advancing
loan moneys to the
customer, the Bank takes up redeemable preference shares issued to it by the
customer, the term of redemption
being equivalent to what would otherwise have
been the period of the loan.
/ In
9
In fixing the dividend rate applicable to the shares, termed the "coupon
rate", account is taken of the fact that the dividend is
exempt from taxation in
the hands of the Bank. This enables the Bank to offer a coupon rate
substantially cheaper than the interest
rate on an equivalent medium-term loan
would have been. Therein lies the main advantage to the customer.
On the other hand, from the Bank's point of view the non-taxability of the
dividend holds no particular advantage since the coupon
rate is correspondingly
lower than the interest rate on a medium-term loan (which interest is taxable)
would be. Moreover, the security
afforded by a preference share issue is
inferior to that pertaining to a loan in that in the latter case the Bank has
the status
of a creditor and in the former is merely a shareholder.
Nevertheless, though generally reluctant to do so, the Bank does participate
(and in the tax years in question did participate) in a small
/ number
10
number of redeemable preference share transactions at the customer's request.
Generally the Bank is prepared to do so in order to
accommodate special
customers, with whom it has a long banker/customer association which might be
prejudiced by a refusal, and also
customers of high financial standing where
there is the possibility of expanding the Bank's business with that customer.
But the
Bank never takes the initiative in offering a redeemable preference
share transaction to a customer. Dr Strauss emphasized that other
commercial
banks followed the same practice of entering into redeemable preference share
transactions and cited one instance in his
experience where the Wank felt
impelled to enter into such a transaction with an established customer because
the customer had been
offered a preference share loan" by another bank.
Dr Strauss maintained that these redeemable preference share transactions
were "purely incidental
/ to
11
to the main business of the Bank. To illustrate "the relative total
insignificance of this investment or its incidental nature to
the total
operation of the Bank", Dr Strauss referred to certain schedules prepared by the
Bank. These show:-
(a) That in the years 1974 to 1983 inclusive 34 such
transactions took place, an average of 3,4 per year. In 1975 there were no such
transactions, while in 1980 there were six and in
1981 twelve. Dr Strauss
ascribed the greater-than-average number of transactions in 1980 and 1981 to the
very rapid expansion in
the economy of the country which took place at that
time. In 1982 and 1983 the figures were three and two respectively. The amounts
invested in each such transaction varied over the years between R170 000 and
R30m.
/ (b)
12
(b) That during the three tax years in question the
ratio of the dividend income of the Bank attributable to the holding of
redeemable preference shares to total funds income was as
follows:
1979
1980
1981
1,98% 1,81% 2,55%
(c) That during these three tax years the ratio of the
asset value of the redeemable preference shares held
to the total assets and guarantees of the Bank was
as follows:
1979
1980
1981
1,04% 1,39% 1,51%
As I have explained, in order to maintain profitability the Bank has
generally to exact a higher rate of interest or return on the
moneys which it
lends than the rate of interest which it pays depositors. The margin between
lending rates and borrowing rates had
thus to be
/ constantly
13
constantly monitored and, having regard to the general economic conditions
and the market situation, adjustments have to be made by
the Dank from time to
time. In the case of redeemable preference shares, the coupon rate is determined
with reference to the prime
Lending rate and is fixed by an agreement (with the
customer), which may provide for the rate to fluctuate. A schedule of redeemable
preference share transactions prepared and put in by the Bank indicates
considerable variation in the coupon rate and shows that
in most instances the
rate is a fluctuating one.
Dr Strauss was asked in examination-in-chief whether there was any connection
between the acceptance of deposits or the rates at which
the Bank would accept
deposits, on the one hand, and the making of these investments in redeemable
preference shares on the other.
His reply was emphatic:
"I can say categorically, no. The Bank was in no way whatsoever influenced in
setting deposit rates or in taking deposits by these
particular assets, which,
in my view, are purely incidental to the main business of the Hank - on the
assets side of the balance
sheet."
/ No
14
No cross-examination was directed at this evidence.
In delivering the unanimous judgment of" the Court a quo the President
(MELAMET J) indicated the Court's acceptance of the evidence
of Dr Strauss,
which was "not disputed"; referred extensively to the decision of this Court in
the case of Com
missioner for Inland Revenue v Allied Building Society
,
1963 (4) SA 1
(A); and held that the facts of the present case were
"principially" indistinguishable from those in the
Allied Building
Soci
ety case and that, accordingly, the present case was governed by the
principles laid down and applied therein. This led, as in the
Allied Building
Society case, to the success of the taxpayer's appeal.
On appeal, counsel for the Commissioner did not in any way challenge the
correctness of the decision in the Al
lied Bu
ilding Society case, but
contended in general that the facts in that case were "clearly distinguishable"
from those in the present
case. Counsel for the Bank, on the
/ other
15
other hand, relied heavily on the
Allied Building Society
case. It is,
therefore, necessary to consider that decision in some detail.
The facts were very similar to those in the present case. The taxpayer was a
registered permanent building society. It raised funds
from the public by the
issue of various types of shares, upon which it paid dividends, and the
acceptance of saving and fixed deposits,
upon which it paid interest. As a
matter of commercial necessity the Society, like Che Wank in this case, accepted
all moneys offered
to it in respect of shares, on savings account or on fixed
deposit. With these borrowed moneys the Society granted loans upon the
security
of the mortgage of urban property and made advances against the security of
deposits made with, or shares held in, the Society.
All moneys received by the
Society were regarded as forming a single pool which was utilised generally for
making all payments due
by the Society, including, i
nter alia
, interest
due to depositors, dividends due to shareholders,
/ management
16
management expenditure, expenditure (including capital expenditure) on
properties and buildings owned by the Society, and payments
made by the Society
in the ordinary course of its business. It was not possible to link any cash
receipt with any particular outgoing.
Amongst the immovable properties held by
the Society during the tax year in question were certain properties which were
either temporarily
unproductive, eg. buildings under alteration or
reconstruction, or non-revenue producing, such as vacant stands. In determining
the
Society's liability Tor income tax in that tax year, the Commissioner
disallowed as a deduction portion of the total sum paid out
by the Society in
dividends and interest on moneys borrowed by it. The amount deducted was
calculated in accordance with a formula
based upon the ratio of the value of the
non-revenue producing assets of the Society to the value of its total assets.
The Commissioner's
contention was that is proportion of the Society's
expenditure
/ in
17
in the form of dividends and interest must be regarded as having been
incurred in respect of borrowed moneys employed in the acquisition
of capital
assets not utilized by the Society in its income earning operations or in the
course of its trade; and that, therefore,
such expenditure was not deductible in
terms of sec, 11(2)(a) of the Act and was prohibited from deduction in terms of
sec. 12(g).
The Society's objection to this form of assessment was upheld on appeal to
the Special Court. On appeal to this Court by the Commissioner,
the Court (per
OGILVIE THOMPSON JA, BEYERS JA and HOLMES JA concurring and STEYN CJ dissenting)
upheld the decision of the Special
Court and dismissed the appeal. Before
considering the rationale of the majority judgment delivered by OGILVIE THOMPSON
JA it is
necessary to put the problem into its proper statutory perspective.
/ The
18
The Allied Build
ing Society
case was decided in relation to the Income
Tax Act of 1941, whereas in the present case the relevant legislation is the
Act, but
the statutory provisions under consideration are to all intents and
purposes the same in each of these Acts. Firstly, there is the
general deduction
formula which permits the deduction from the taxpayer's income of -
"expenditure and losses actually incurred
in the production of the income,
provided such expenditure and losses are not of a capital nature."
(Sec. 11(2)(a) of the 1941 Act and sec. 11(a) of the Act.)
Then there are the so-called "negative counterparts" of
the general deduction formula, viz. sec. 12(f) and (g) of the
1941 Act and sec. 23(f) and (g) of the Act, which prohibit
a deduction in respect of (I quote the wording of the latter
subsections) -
(f) any expenses incurred in respect
of any amounts received or accrued which do not constitute income as defined
in section
one
;
/ (g)
19
(g) any moneys claimed as a deduction
from income derived from trade, which are not wholly or exclusively laid out
or expended for the purposes of trade".
In regard to the general deduction formula, it is settled law that generally
in order to determine in a particular case whether moneys
outlaid by the
taxpayer constitute "expenditure incurred in the production of the income"
important, sometimes overriding, factors
are the purpose of the expenditure and
what the expenditure actually effects. And in this connection the Court has to
assess the
closeness of the connection between the expenditure and the
income-earning operations (see
C1R
v
Nemojim
1983 (4) SA 935
(A),
at p 947 G-H and the authorities there cited).
As to the negative counterparts to the general deduction formula, subsection
(g) does not in this case evoke particular comment. Subsection
(f) is more
pertinent in that its purpose is to exclude from deduction expenses
/ incurred
20
incurred by a taxpayer in respect of such parts or forms of "gross income" as
fall within the exemptions of sec. 10 of the Act, including
sec. 10(1)(k) which
relates to dividends received by or accruing to a company (see
CIR v
Nemojim
,
supra
, at 947 U - C). Here too, when considering whether
moneys outlaid by the taxpayer constitute expenses incurred in respect of
amounts
received or accrued which do not constitute income, ie constitute
"exempt income", the court must assess the closeness of the connection
between
the expenses incurred and the exempt income received or accrued, havjng regard
to the purpose of the expenses and what the
expending thereof actually effects
(
CIR v Nemojim
,
supra
, at p 947 H - 948 A).
I return now to the majority judgment in the
Allied Building Society
case. In support of the Commissioner's general contention in that case his
counsel argued in this Court that the true criterion of
deductibility was not
the
/ purpose
21
purpose for which the Society borrowed but the actual use to which the
borrowed money was put: the Society's business consisted of
(a) revenue
producing operations and (b) the acquisition of capital assets and the cost of
borrowing money for (b) was not deductible
expenditure.
Although no non-revenue producing properties were acquired by the Society
during the tax year in question and although the Society's
reserves exceeded the
value of all its immovable properties, it was assumed, for reasons which
need
not be detailed, that part of the interest, etc. paid by the Society in that
year related to borrowed moneys utilized in the
acquisition of non-revenue
producing properties.
With reference to counsel's argument (stated above) OGILVIE THOMPSON JA said
(at p 1.3 C-H):
"In my view, the ultimate use or destination of all the money borrowed is not
- as is implicit in the Commissioner's contention -on
the facts of the present
case to be
/ elevated
22
elevated into a decisive factor in deter
mining the deductibility or
otherwise of
the interest payable on that money. In
determining the
purpose of the borrowing,
the ultimate user of the money may, no
doubt, in
certain cases be a relevant fac
tor; but the dominant question
remains:
what was the true nature of the transaction?
In the particular
circumstances of the pre
sent case, the most important factor in that
en
quiry is, in my opinion, the purpose of the
borrowing
The Society's purpose in borrowing money, upon which it pays the interest in
issue, is manifestly to obtain the means of earning income.
The Society's basic
business is borrowing money cheaply and lending it more dearly. The money it
borrows constitutes its floating
capital which it lends out at interest, thereby
earning income; the interest the Society pays on the money so borrowed is prima
facie
clearly an expenditure incurred in the production of income."
The learned Judge of Appeal then went on to emphasize the "crucial facts"
that not only was it absolutely and vitally indispensable
to the Society's
business to borrow money, but that it was commercially necessary for the Society
to accept, i.e. borrow, all money
tendered to it by the public.
/ The
23
The payment of interest was thus a payment necessarily made
in order to
earn income and the pre-requisites of deducti
bility set out in
secs. 11(2)(a) and 12(g) were satisfied
(see p 14 A-C).
OGILVIE THOMPSON JA continued (at p 14 D - 15 A) :-
"It is not, in my opinion, material whether all the money borrowed is in fact
lent out again by the Society. lor the Court is not
concerned with whether a
particular item of expenditure produced any part of the income, but with whether
that item of expenditure
was incurred for the purpose of earning income. (See
Rand Speculation and finance Co. Ltd. v. Commissioner for Inland Revenue
,
1953 (1) S.A. 348
(A.D.) Nor, in my view, does the existence of the common pool
aid the Commissioner, as claimed by counsel for the appellant. For,
bearing in
mind that, in the sense explained above, unlimited borrowing is vital to the
Society's Income earning operations, it is
not, in my opinion, imperative for
the Society, in order to entitle it to deduct the full interest paid by it, to
keep the borrowed
money in a separate account directly available, as it were,
for immediate lending out again. Even on the assumption that, because
of the
existence "of the common pool or otherwise, the Society has not been able
affirmatively to show that all the money upon which
it paid
/ interest
24
interest during the 1959 tax year was in fact
actually used in its income
earning operations,
that circumstance would not, in my judgment,
preclude
the deductibility of all the interest
paid by the Society. For it is, I
think,
abundantly clear that the Society's business
is not the acquisition
of immovable property
- revenue producing or otherwise - but the
earning
of income by investment. The con
tention that the Society's business
consists
of both revenue producing operations and the
acquisition of
capital assets, is, in my view,
not borne out by the facts. The
acquisition
by the Society of such non-revenue producing
properties as it
holds is purely incidental
to the business of borrowing money in order
to
earn income by investment. The holding
or not holding of unproductive
properties has
never played any part in controlling the
Society's policy
in regard to the receipt
of moneys from the public. The only con
trolling
factor is what the public offers to
the Society on loan. If the Society
chose
to let some of the borrowed money lie idle,
that would afford the
Commissioner no suffi
cient ground for reducing the sum deductible
by the
Society in respect of interest paid by
it on the borrowed monies. financier
v
Commissi
oner of Taxes
,
1950 (3) S.A. 293
(S.R.),
relied upon by
counsel for the Commissioner,
does not assist him. The principles
enun
ciated by TREDGOLD, J., at p. 295 of the
Fi
nancier
case are in
accord with the views
I have endeavoured to express:
/ In
25
In the present case there is, in my opinion, no sufficiently close association
between the borrowing and the non-revenue producing
properties as to warrant the
view that portion of the interest paid by the Society on the money it has
borrowed is expenditure of
a capital nature, or the view that such interest is
not wholly or exclusively expended by the Society for the purposes of trade.
In
my judgment, the correct view of the facts of the present case is that the
Society's expenditure by way of interest on moneys
borrowed by it is not aimed
at augmenting its fixed capital in general or i ts non-revenue producing
properties in particular, but
is dictated by the very nature of its income
earning operations of cheaply borrowing all money offered and then more dearly
lending
out as much thereof as, subject only to the dictates of business
prudence, it can possibly invest."
In
Financier v Commissioner of Taxes
, 1950 (3) SA
293 (SR) the principles enunciated by TREDGOLD J at p 295 C - D
and
approved of by OGILVIE THOMPSON JA were the following:
"1. Where a taxpayer borrows a specific sum of money and applies that sum to
a purpose unproductive of income, and not directly connected
with the
income-earning part of his business, then the interest paid on the borrowed
money cannot be deducted as expenditure incurred
in the production of
income.
/ 2. Where
26
2. Where a taxpayer has for good and sufficient reasons borrowed money for use
in the business producing his income, despite the
fact that he subsequently, in
pursuit of a legitimate business purpose, invested such money in an investment
which does not produce
taxable income, the interest is still deductible for
income tax purposes.
It would seem that
the test to be
applied is the purpose for which the money
was borrowed."
Finally, I would refer to the case of
CIR v Genn and Co (Pty) Ltd
1955
(3) SA 293
(A), in which it was expressly held that interest paid on money
borrowed and used as floating capital in the business of the taxpayer
constitutes deductible expenditure in terms of the general deduction
formula.
The aforegoing cases establish, I would venture to suggest, the
following:-
(1) Generally, in deciding whether monies outlayed by a taxpayer constitute
expenditure incurred in the production of the income
(in terms of the general
deduction formula) important and sometimes overriding
/
factors
27
factors are the purpose of the expenditure and what the expenditure actually
effects; and in this regard the closeness of the connection
between the
expenditure and the income-earning operations must be assessed. The same general
test applies to the provisions of sec.
23 (f) of the Act.
(2)
More specifically, in determining whether interest
(or other like expenditure) incurred by a taxpayer in
respect of moneys borrowed for use in his business is
deductible in terms of the general deduction formula
and its negative counterparts in the Act, a distinction
may in certain instances have to be drawn between
the case where the taxpayer borrows a specific sum of
money and applies it to an identifiable purpose, and the case
where, as in the instance of the Society in the Allied
Building Society case and the Hank in the present case,
the taxpayer borrows money generally and upon a large
scale in order to raise floating capital for use in his (or
its) business.
/ (3)
28
(3) In the former type of case both the purpose of the expenditure (in the form
of interest) and what it actually effects can readily
be determined and
identified: a clear and close causal connection can be traced. Both these
factors are, therefore, important considerations
in determining the
deductibility of the expenditure.
(4) In the latter type of case, however, and more particularly in the case of
institutions Like the Society and the Bank, there are
certain factors which
prevent the identification of such a causal connection and one cannot say that
the expenditure was incurred
in order to achieve a particular effect. All
that
one can say is that in a general sense the expenditure is incurred in order to
provide the institution with the capital with which
to run its business; but it
is not possible to link particular expenditure with the various ways in which
the capital is in turn
/ utilized
29 utilized. (It was, I deduce, with this in mind that in the
Allied
Building Society
case OGILVIE THOMPSON JA held that the ultimate use or
destination of the money borrowed by the Society was not on the facts of that
case to be elevated into a decisive factor in determining the deductibility of
the interest payable on that money; but that the most
important factor was the
purpose of the borrowing.)
(5) The factors 1 refer to are these:
(a)
As a matter of commercial
necessity the institution accepts, ie borrows, all moneys tendered to it by
depositors.
(b)
All moneys borrowed go into a
common pool which constitutes a general fund used for all
purposes.
(c)
Generally the institution's
expenditure by way of interest on borrowed moneys is not aimed at any particular
form of utilization of
the borrowed moneys: it is rather- dictated by the very
nature of the institution's income-earning opera-
/
tions
30
tions of cheaply borrowing all money offered and then dearly lending out as much
thereof as it can possibly invest.
As in the
Allied Building Society
case, therefore, it seems to me that the vital
enquiry in the present matter is the Bank's purpose in borrowing the moneys upon
which
it paid interest to depositors (cf. Judgment at p 13 C) ; and in regard
thereto it must be asked whether the connection between the
expenditure of the
interest (or some of it) and the acquisition of the redeemable preference shares
was sufficiently close to Justify
the conclusion that such expenditure was in
each year of assessment incurred in the production of the dividends derived from
the
shares or was an expense incurred in respect of exempt income. The immediate
purpose of the Bank in borrowing the deposit moneys
was to obtain the floating
capital with which to run its business. That floating capital was utilized by
the Bank in many different
ways.
/ These
31
These have been detailed. Some of this capital was, in each of the years
under consideration, used to take up redeemable preference
shares, which
produced exempt income. Can it, however, be said that there was a connection
between a certain proportion of the interest
paid to depositors and the
dividends received on these shares close enough to justify the conclusion that
the payment of such interest
was incurred in the production of exempt income
(and therefore not deductible in terms of sec. 1.1 (a) since it was not incurred
"in the production of income") or was an expense incurred in respect of an
amount not constituting income ( resuling in deductibility
being prohibited by
sec 23(f) )?
In my opinion, these questions must be answered in the negative. There are a
number of factors which lead to this conclusion. Firstly,
as the evidence shows,
the Bank accepts all deposits offered to it in accordance with its terms as a
matter of business policy. Deposit-raising
is not determined by the manner in
which the capital raised
/is
32 is to be utilized. Secondly, as Dr Strauss pointed out so
emphatically, there is no connection between the acceptance of deposits
or the
rates at which the Bank was prepared to accept deposits and the making of
investments in redeemable preference shares. Thirdly,
there is the unchallenged
evidence that the Bank is generally reluctant to participate in preference share
transactions; it does
so only in a few exceptional instances, for good business
reasons, at the request of particular customers; it never takes the initiative
in offering a preference share transaction. fourthly, preference share
transactions generally constitute a small and insignificant
part of the Bank's
total lending business and were described by Dr Strauss (again without being
challenged thereon) as being "purely
incidental to the main business of the
Bank". The figures substantiate this assertion. In view of the Bank's reluctance
to enter
into such transactions, it would be a matter of uncertainty every year
how many preference share acquisitions, if any, the
/ Bank
33
Bank would make. Thus, for example, in 1975 there were none and in 1977 only
one was made two weeks before the end of the financial
year.
Counsel for the Commissioner argued that the
Allied Building Society
case was distinguishable from the present case on the facts, in that "the
purchase of redeemable preference shares is part of the
Bank's business whereas
the acquisition of the properties by the Society was merely incidental to its
business". (1 quote from counsel's
heads of argument.) It is true that in the
present case the preference share transactions form part of the Bank's
money-lending,
operation, whereas this was not the case with the Society's
property acquisitions, but, in my view, this does not prevent each of
these
activities being regarded as incidental to the main business of the Bank or the
Society, as the case may be. If "incidental"
in this
/ context
34
context means "occurring or liable to occur in fortuitous or subordinate
conjunction with something else" (see Shorter Oxford Dictionary
sv
"incidental"), then for the reasons which I have already elaborated it seems to
me that the word aptly describes both the share
transactions and the property
acquisitions.
Counsel further submitted that the Court a
quo
wrongly held that there was "no
connection between the
raising of the deposits and the taking up of the
preference
shares" by the Bank. The finding quoted sounds like
an
overstatement when thus taken out of its context, for in a
sense there
was some sort of connection. But the learned
President went on to say —
"The deposits were not raised for this purpose - the appellant accepted all
deposits if the rate, was right. All money so raised went
into the general
pool."
/ It
35
It is thus clear that the Court a
quo
was considering whether there
was a close enough connection to link the purpose of the raising of the deposits
with the taking up
of the preference shares; and concluded that there was not.
With this conclusion I agree.
Counsel argued that the finance committee of the Group, which determined
interest rates, was aware that a known percentage of all
deposits accepted by
the Bank would have been used to acquire redeemable preference shares; and that
this knowledge must have had
an effect on the decision to raise or lower
interest rates from time to time. This argument is without substance. Its
factual premise
is denied by the unchallenged evidence of Dr Strauss.
My conclusion is that the Court a
quo
correctly held that this case
was governed by the principles laid down in the
Allied Building Society
case. And, in my view, there is no valid basis for treating portion of the
interest
/ paid
36
paid by the Bank to depositors as not falling within the general deduction
formula of sec. 11(a) or as being excluded from deduction
by sec. 23(f).
The appeal is dismissed with costs, including the costs of two counsel.
M M CORBETT
Miller JA)
Van Heerden JA)
Hefer
JA) CONCUR.
Galgut AJA)