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[1985] ZASCA 86
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De Beers Holding (Pty) Ltd. v Commissioner For Inland Revenue (127/85) [1985] ZASCA 86; [1986] 1 All SA 310 (A) (16 September 1985)
127/85
IN THE SUPREME COURT OK SOUTH AFRICA
(
APPELLATE DIVISION
)
In the appeal of -
DE USERS HOLDINGS (PTY) LIMITED
.... appellant
and
COMMISSIONER FOR INLAND REVENUE
.... respondent
Coram
: Corbett, Miller et Hoexter, JJA, Galgut et Nicholas, AJJA.
Date of Hearing
: 26 August 1985.
Date of Judgment
: 16 September 1985
JUDGMENT
CORBETT
, JA:
Appellant company, which I shall call "Debhold", is a subsidiary of De Beers
Consolidated Mines Limited. It is a share-dealing company
with a large portfolio
of quoted and unquoted shares. In its income tax return
/ for
2
for the year of assessment ended 31 December 1979 (at all material times
Debhold's year of assessment has coincided with the calendar
year) Debhold
claimed to deduct a loss of R4 158 937 sustained on the sale of two ordinary
shares in a company known as Engelhard
Hanovia of Southern Africa (Pty) Ltd
("EHSA") . In determining Debhold's liability for normal tax for this year of
assessment, respondent,
the Commissioner for Inland Revenue ("the
Commissioner"), disallowed this deduction, added back the amount of R4 15b 937
and assessed
Debhold accordingly. An objection to this assessment having been
disallowed, Debhold appealed to the Transvaal Income Tax Special
Court. The
Court came to the conclusion that Debhold's objection was well-founded and
accordingly set aside the assessment and remitted
the matter to the Commissioner
for reassessment. The Commissioner
/ appealed
3
appealed against this decision to the Transvaal Provincial Division("TPD"),
which allowed the appeal and altered the order of the
Special Court to one
dismissing the appeal. This latter judgment has been reported (see
Commissioner for Inland Revenue v De Beers Holdings (Pty) Ltd
1984 (3) SA
286
(T) ). With leave of the Court a
quo
, Debhold appeals to this Court,
seeking the reversal of the decision of the TPD and the reinstatement of the
order of the Special
Court.
The background facts to the transactions with which this appeal is concerned
may be summarized as follows. In 1967 an agreement was
entered into with the
late Mr. Charles Engelhard in terms of which it was arranged that the Anglo
American Corporation ("AAC"),the
De Beers Group and the Rand Selections
Corporation Ltd ("Rand Selections") would acquire interests in the Engelhard
group of companies,
both in South Africa and in the
/ United
4
United States of America. This arrangement resulted in 1969 in Debhold, AAC
and Rand Selections together acquiring by subscription
659 940 Class "A"
ordinary shares (of 25c each) in EHSA in the following proportions respectively:
40 per cent, 40 per cent and 20
per cent. Debhold held its shares directly,
whereas AAC and Rand Selections held their shares through nominee companies. The
remaining
shares in EHSA, consisting of 500 000 ordinary shares (of R2 each) and
1 082 777 preference shares (of R2 each), were held by the
Engelhard Group.
At the time of these share acquisitions it was the intention of all
interested parties to place EHSA into voluntary liquidation, to
dispose of all
the assets of EHSA, amounting in value to some R20m, and to distribute the funds
amongst the shareholders. On 7 August
1970 EHSA was placed in voluntary
liquidation by a special resolution passed at a general meeting of shareholders
and
/ thereafter
5
thereafter most of its assets were realised in the course of liquidation.
For reasons which need not be canvassed (they are detailed in the judgment a
quo
at p 289 C - D) it was decided in March 1971 that all the shares held
by Debhold, AAC, Rand Selections (the latter two through their
nominee
companies) and the Engelhard Group in EHSA should be sold at cost to Meton
Investments (Pty) Ltd ("Meton"). Meton was a subsidiary
of Turnstone Investments
Ltd ("Turnstone"), in which Debhold, AAC and Rand Selections held the shares in
the same proportions of
40 per cent, 40 per cent and 20 per cent.
Difficulties were encountered in the liquidation owing to the complexity of
the share transactions entered into by EHSA and the failure
to keep a banking
account during liquidation. At the same time a recent ruling of the Commissioner
that a company removed from the
register in
/ terms
6
terms of sec. 199 of the Companies Act of 1926 would not
be regarded as having been wound up or liquidated within
the meaning of para. (a) of the definition of "dividend"
in sec. 1 of the Income Tax Act 58 of 1962 ("the Act")
made deregistration an unattractive alternative.
In the end the parties concerned decided to take EHSA
out of liquidation, to carry out a measure of reconstruction
and then
again to place it in liquidation.
In January 1973 an order of Court was obtained in terms of which the
voluntary winding-up of the company was terminated. On 31 October
1973 special
resolutions were passed by the members of EHSA resolving -
(1) to distribute the sum of R4 197 379,26, which was the amount standing to the
credit of the company's share premium account, to
the holders of the ordinary
and "A" class shares in the company;
/ (2) to
7
(2) To reduce the authorised capital of the company from R3 333 854, divided
into 500 000 ordinary shares, 673 2()0 class "A" ordinary
shares and 1 082 777
preference shares, to Rl,25, divided into 5 class "A" ordinary shares (25c
each); and to reduce the issued capital
from R3 330 539, divided into 500 000
ordinary shares, 659 940 class "A" ordinary shares and 1 082 777 preference
shares, to HI.
,25, divided into 5 class "A" ordinary shares (25c each), by
repaying to the shareholders the amount of A3 330 539 less R1,25; and
(3) to designate the 5 class "A" ordinary shares " ordinary shares".
As a result of this reconstruction Meton, as holder of all the shares,
received an amount of R4 197 379 from the share premium distribution
and an
amount of R3 330 538 from the
/ reduction
8 reduction of capital
It was thereafter decided that, before
proceeding
with the liquidation of EHSA, Meton
should sell at cost its
5 ordinary shares in EHSA to the beneficial owners thereof,
viz. Debhold, AAC (through the medium of a nominee, Marjoram (Pty) Ltd) and
Rand Selections, in the appropriate proportions. This
was done on 27 December
1973. Debhold received 2 such ordinary shares for which it paid R4 158 937,60.
This was the purchase that
has given rise to the dispute between Debhold and the
Commissioner. The reason for this transaction was that Meton would have had
problems with undistributed profits tax had it been the beneficiary of
further-distributions by EHSA.
At this stage EHSA still had revenue reserves amounting to about R300 000 and
capital reserves of R9 994 186. On 24 December 1973
the directors resolved to
distribute the revenue reserve as a dividend of R60 000 per share, payable
/on
9
on 31 December 1973. This was done and Debhold received as
dividend an amount of R120 000. This dividend fell within para. (a) of
the
definition of "dividend" in sec. 1 of the Act and consequently constituted
"gross income" in Debhold's hands (see para. (k) of
the definition of "gross
income" in sec. 1 of the Act). Because, however, sec. 10(1)(k) of the Act
exempts such a dividend from tax
when it is received by or accrues to a company,
the dividend did not constitute "income", as defined in the Act, in Debhold's
hands;
and accordingly it did not give rise to an income tax liability on
Debhold's part.
At that stage the intention was still to proceed with a new liquidation of
EHSA and with a distribution, by way of a liquidation dividend,
of the capital
reserves of the company. Debhold's share of such a distribution would have been
R3 997 674. The definition of "dividend"
in the Act provided, in effect, that in
relation to a company being
/ wound
10
wound up or liquidated any profits distributed which were of a capital nature
were excluded from the definition. Thus it was considered
that Debhold's share
of the proposed liquidation dividend, being derived from capital reserves, would
not constitute a dividend in
Debhold's hands and therefore would not be exempt
from tax; whereas, on the other hand, because Debhold was a shareholder, the
distribution
would have accrued to it as income and the amount thereof would
have been subject to income tax.
At this point the law was changed in two important respects. Firstly, in
terms of sec. 75(1)(b) of the new
Companies Act 61 of 1973, which came into force on 1 January
1974, a company having/share capital, if so authorized by
its articles, was empowered by special resolution to increase its
share
capital constituted by shares of no par value by,
inter
alia
,
transferring reserves to the stated capital without a
distribution of shares.
Secondly, sec. 4(1)(e) of the
/ Income
11
Income Tax Act 85 of 1974 amended the definition of "dividend" in the Act in
such a way Chat where there had been a transfer of capital
reserves to share
capital, a distribution thereof to shareholders by way of a reduction of capital
would in effect be regarded as
the distribution of a dividend. This amendment
was deemed, in terms of Act 85 of 1974, to have taken effect as from the
commencement
of years of assessment
ending on or after 1 January 1974. The
combined effect of
the the two enactments, in/case of Debhold and its co-shareholders
in EHSA, was that it became possible to transfer the capital
reserves of the company to stated capital without an issue
of shares
(thereby saving a substantial amount in stamp duty);
and thereafter to return
the capital to the shareholders in
cash by way of a reduction of capital in
which case the
amount received by each shareholder would constitute
a
dividend. Since all the shareholders were companies, this
/ dividend
12
dividend would be exempt from tax in their hands. This procedure, therefore,
had obvious advantages over the initial liquidation proposal,
which for
convenience I shall call "the first scheme".
In due course the shareholders in EHSA opted for the procedure involving a
transfer of the capital reserves to stated capital and
a distribution thereof by
way of a reduction in capital. I shall call this "the second scheme". And on 23
December 1975 special resolutions
giving effect to the second scheme were passed
by the members of the company. In pursuance thereof there was distributed to
shareholders
an amount of Rl 998 720 in cash in respect of each share held.
Debhold received a payment of R3 997 440, which constituted gross
income, but in
terms of sec. 10(1)(k), read with the definition of "income", not income in its
hands.
Upon the completion of (the second scheme there were no assets left in EHSA.
An application was made for the
/ deregistration
13
deregistration of the company in August 1977 on the ground that it had no
assets and no liabilities and that it had ceased to carry
on business. In
January 1978 application was made to halt the deregistration proceedings. On 31
December 1979 Debhold sold its two
shares in EHSA to Tarl Investments Limited
for Rl. Tarl Investments Limited is owned partly by Debhold and partly by AAC.
In January
1980 there was a re-application for the deregistration of EHSA and in
May 1980 the company was deregistered.
That completes the factual story. I come now to the fiscal side of the
matter. Being a dealer in stocks and shares, Debhold, as a
matter of practice,
included in its financial statements attached to its annual income tax returns
schedules reflecting its holdings
of, and dealings in, shares in listed and
unlisted companies. These schedules, compiled in accordance with the provisions
of sec.
22 of the Act relating to trading stock, deal individually with each
/ company
14
company in respect of which Debhold held or acquired shares during the year
in question. They indicate in each case an opening balance
(if any) of shares
held, purchases, sales, transfers by way of exchange, and a closing balance (if
any). If there have been dealings
in the shares during the year the profits or
losses made on these transactions are also reflected in the schedules. In the
schedules
two sets of figures are shown in respect of these various items. One
set, termed "tax amount", shows the figures for tax purposes;
while the other
set, termed "book amount", shows the figures for accounting purposes. The main
reason for differences in these figures
lies in the fact that for tax purposes
Debhold is required by sec. 22 to value trading stock held and not disposed of
at the beginning
and end of each year of assessment at cost, whereas for
accounting purposes the value of such stock is sometimes written down from
cost
at the end of the year. Sec. 22(1) stipulates that the value of trading
/ stock...
15
stock held and not disposed of at the end of a year of
assessment shall be the cost price -
"... less such amount as the Commissioner may think just and reasonable as
representing the amount by which the value of such trading
stock,
not being
shares held by any company in any other company
, has been diminished by
reason of damage, deterioration, change in fashion, decrease in the market value
or for any other reason
satisfactory to the Commissioner". (My
italics.)
(I quote the subsection in
its present form. The only
difference in the wording of the section between
now and as it was
in 1975 is that the Commissioner was then called the Secretary.)
In its income tax return for the year of assessment ended 31 December 1973
Debhold treated the purchase of the EHSA shares as an acquisition
of trading
stock and the relevant entry in its share dealing schedules, under EHSA, shows
in the tax amount column a nil opening
balance, purchases in the sum of R4 158
937,60, nil sales or transfers and a closing
/ balance
16
balance of the same amount. In the book amount column, however, an amount of
R120 000 figures against transfers (this obviously relates
to the dividend
received) and the shares are written down by an amount of R41 337,60, leaving a
closing balance of R3 997 600. (This
latter figure is approximately equivalent
to Debhold's share of the capital reserves still left in EHSA.) I shall later
refer again
to this writing down figure of R41 337,60.
The schedules for the 1974 tax year simply reflect under EHSA opening and
closing balances of R4 158 937,60 in the tax amount column
and of R3 997 600 in
the book amount column. In the tax amount column of the schedules for the 1975
tax year the same opening and
closing balances are given as for the previous
year; but in the book amount column there is an item "sundry realisations"
(which
is explained in a note to relate to the reduction of capital) amounting
to
/R3 997 440,
17
R3 997 440, leaving a closing balance of R160. For the reasons already
stated, the provisions of sec. 22(1) precluded Debhold from
similarly reducing
or writing down the closing balance in the tax amount column.
In the following year (1976) opening and closing balances of R4 158 937,60
and of R160 appear in the tax amount and book amount columns
respectively. This
is repeated in the schedules for the 1977 and 1978 tax years. In the schedules
for the 1979 tax year the tax amount
column shows an opening balance of R4 158
937,60, sales of R1,00, a loss of R4 158 936,60 and a nil closing balance. The
corresponding
figures in the book amount column are R160, R1,00, R159 and, of
course, a nil closing balance. It is this loss in the tax amount
column
amounting to R4 158 936,60 in the 1979 tax year which was added back by the
Commissioner when assessing Debhold to income
tax for that year and which forms
the subject-matter of this appeal.
/ Debhold's
18
Debhold's case in regard to this claimed loss, as presented to us on appeal,
may be summed up as follows:
(1)
The two EHSA shares which
Debhold acquired in the 1973 tax year constituted trading stock in its
hands.
(2)
The expenditure incurred by Debhold
in paying the purchase price of the shares was a proper deduction in terms of
secs. 11(a) and
23 (f) of the Act for that tax year since the purpose of the
acquisition was to earn income in the form of a liquidation dividend
paid out of
EHSA's capital reserves;
and this deduction was
properly allowed by the Commissioner when issuing Debhold with an assessment for
that tax year. In argument
Debhold's counsel, Mr
Welsh
, conceded that
since the purpose of the acquisition was partly in order to obtain a relatively
small dividend from revenue re-
/ serves
19
serves, which constituted exempt income in Debhold's hands, the Commissioner
might have been entitled to apportion the expenditure
in accordance with the
principles laid down in the recent decision of this Court in the matter of
Commissioner for Inland Revenue v Nemojim
1983 (4) SA 935
(A); but he
pointed out that this had not been done and argued that it was too late for the
Commissioner to re-open the 1973 assessment.
(3) As a matter of principle each year of assessment has to be treated as an
independent and distinct unit. Income tax is assessed
on an annual basis in
respect of taxable income received by or accrued to the taxpayer during the
period of assessment and determined
in accordance with the provisions of the
Act. Thus expenditure or losses incurred in a particular year must be claimed in
that year.
/ (4) The
20
(4) The EHSA shares, being trading stock in Debhold's hands, had to he dealt
with in terms of sec. 22, which is cast in imperative
terms. Debhold duly
reflected the shares in its returns for the 1973 to 1979 tax years (inclusive)
in accordance with sec. 22. In
its return for 1979 appellant was obliged by sec.
22 to take into account the cost price of the EHSA shares in its opening stock
values and to reflect a nil value for these shares in its closing stock figure.
The resulting loss, taking into account the R1,00
for which the shares were sold
to Tarl, resulted inevitably from a proper application of the relative
provisions of the Act. There
was accordingly no basis for the Commissioner's
disallowance of this loss as a deduction.
(5) The facts of this case are clearly distinguishable from those in
Nemojim
's case,
supra
, and the prin-
/ ciples
21
ciples there enunciated are not applicable here. Consequently the Court a
quo
erred in relying on
Nemojim
's case when coming to its
decision.
Before considering the validity of this
argument, I wish to make certain preliminary observations.
Although the recital of the facts has been a fairly lengthy one, the basic
nature of the transaction in issue may be simply and shortly
stated. In essence
Debhold and its two co-shareholders purchased their shares in EHSA with the
common intention of immediately (a)
distributing the revenue reserves of the
company by way of an ordinary dividend, and (b) liquidating the company and
distributing
its capital reserves by way of a liquidation dividend. In Debhold's
view its share of the ordinary dividend would be nontaxable,
but its share of
the liquidation dividend subject to tax. On this view, and assuming at least the
pro rata
/ deductibility
22
deductibility of the cost of the shares (which would have exceeded the total
proceeds thereof), this transaction would not have produced
any taxable income
in Debhold's hands. Substantially income received would have been balanced by
expenditure. This was the first
scheme, which was implemented only as regards
the ordinary dividend.
EHSA's capital reserves, which embraced the vast bulk of its remaining
assets, devolved upon the shareholders in terms of the second
scheme, which was
implemented in 1975. In the result Debhold received in terms of the capital
reduction an amount of nearly R4m,
which because of amendments to the law was
not income (as defined) in its hands.
Thus, taking a broad and approximate view of the transaction, what Debhold
actually achieved by it was to outlay approximately R4m
and to receive back
approximately R4m. From the commercial point of view, Debhold suffered no
loss.
/(I ignore
23
(I ignore for the moment the relatively small excess of expenditure over
receipts.) From the taxation point of view, Debhold expended
approximately R4m
and received amounts of approximately R4m, which did not constitute income (as
defined) in its hands; and yet Debhold
claims that the expenditure is deductible
in terms of sec 11(a) as having been incurred "in the production of the income"
and that
its deductibility is not prohibited by sec. 23(f), which denies
deduction in respect of an expense incurred in respect of "amounts
received or
accrued which do not constitute income as defined". Thus, in a broad sense, the
allowance of such a deduction would appear
to be an anomalous result, both
commercially and legally. Mr
Welsh
acknowledged this, but contended that
the proper application of the provisions of the Act, especially sec. 22, led
inescapably to
such a result.
There is a further observation to be made about this transaction. According
to the figures placed before the Court, the transaction
in regard to the EHSA
shares, as
/ originally
24
originally conceived and as actually implemented, was calculated to result,
and in the end did actually result, in a commercial loss,
in Debhold's case, of
some R41 000. This is the excess of the cost of the shares to Debhold over the
amounts receivable or received
by it, to which I have already alluded. And this
no doubt explains the aforementioned figure of R41 337,60 by which the shares
were
written down in the book amount column of Debhold's trading schedules for
the 1973 tax year.
It is a corner-stone of Debhold's case that the acquisition of the EHSA
shares was an integral part of its activities as a dealer
in stocks and shares
and that the shares, once acquired, formed part of Debhold's trading stock. But
is this so? The normal way in
which a dealer in shares operates is to buy shares
and re-sell them at a profit. They constitute his stock-in-trade, as do
groceries
in a grocer's business. Unlike groceries, however, shares, if held
long enough, may also yield income in the form of
/ dividends
25
dividends; and such dividends would constitute part of the return which a
share-dealer might expect possibly to receive in his share-dealing
transactions.
Indeed, as in the dividend-stripping type of case (exemplified by
Commissioner
o
f Inland Revenue v Nemojim
,
supra
) the
dividend to be received may constitute the major component of the dealer's
return. But in all these cases the dealer acquires
the shares with the intention
of ultimately disposing of them as part of a scheme of profit-making. This
distinguishes his trade
from that of an investor in shares who buys shares to
hold them as a capital asset and reap a return in the form of dividends.
Exceptionally,
a dealer in shares may make his profit not by reselling, or
receiving a dividend and re-selling, but by putting the company whose
shares he
has acquired into liquidation (cf.
Commissioner for Inland Revenue v Rand
Selections Corporation Ltd
1956 (3) SA 124
(A) ) or, as in the case of
Overseas Trust Corporation Limited v
/ Commissioner
26
Commissioner for Inland Revenue
1926 AD 444
, buying shares in a
company which is in the process of being liquidated. If such a transaction is
embarked upon as a profit-making
scheme, then the proceeds of the liquidation
will constitute gross income in the dealer's hands.
Of course, the attainment of a profit is not necessarily the hallmark of a
trading transaction. A trader may for commercial reasons
be compelled to re-sell
goods at a loss. Conceivably also he may elect to resell goods at a loss in
order to gain some other commercial
advantage for his business. The practice of
putting on sale the so-called "loss leaders" by some merchants would fall into
this category;
and there seems little doubt that merchandise so sold would
constitute stock-in-trade and the proceeds thereof gross income.
In the present case the evidence shows firstly
/
that
27
that Debhold purchased the two EHSA shares not in order to dispose of them
but with a view to receiving an ordinary dividend and,
having put the company
into liquidation, a liquidation dividend. The sale of the shares for Rl in 1979
was never contemplated when
they were acquired in 1973. In fact the-application
for deregistration in 1977, the halting thereof in 1978, the sale in 1979 and
the re-application for deregistration in 1960 would seem to indicate that the
idea of selling the shares was conceived, as an afterthought,
in 1978. Mr L A
Lincoln, a director of Debhold and the only witness to give evidence (on
Debhold's behalf) before the Special Court,
as much as conceded this. Secondly,
the evidence shows that Debhold purchased the shares knowing that it would not
make any profit
from the transactions. In fact, as I have already pointed out,
on the figures reflected in EHSA's accounts Debhold must have known
that the
transaction would produce a loss of some R41 000.
/ These
28
These two features immediately take the acquisition of the EHSA shares
out of the ordinary run of Debhold's business as a share-dealer
and also prompt
the question: what was the purpose of the transaction? ' As Mr
Welsh
had
to concede, in this regard the evidence is meagre. In evidence Lincoln
maintained that Debhold's intention was "to acquire the
shares as
stock-in-trade"; but the features to which I have alluded tend to negative this.
Under cross-examination by the Commissioner's
representative Lincoln was asked
about the purpose behind the acquisition:
"The whole purpose was that the appellant would acquire the assets of
Engelhard - the purpose behind the liquidation was that the
appellant company
would acquire the assets of Engelhard?— No, that is not true. We bought an
asset - shares in the company
Engelhard Hanovia - for the proper price and this
was part of an acquisition. We did not intend to acquire the assets which were
contained in Che company.
Was that not the real purpose behind the liquidation of the company?—
No, the shares were portfolio shares and other
/ assets
29
assets which were sold, some on the market and elsewhere. 1 do not think that we
have any of those shares in our portfolio now, or
since 1969.
I do not think that I quite follow. What was the reason for the appellant
company wanting to liquidate Engelhard Hanovia?—
It was part of the
arrangements that had been made with Mr Engelhard when the other investments
that we spoke about - the American
investments - were bought, and seeing that
they were South African investments it was the intention that the Company,
Engelhard (SA),
would be liquidated.
MR VAN BREDA: Was it not in order to distribute the assets in kind to
shareholders?--
No, that was not the purpose at
all."
Bearing in mind the background
history to this acquisition — the original scheme in 1970 to put EHSA into
voluntary liquidation,
the distributions to Meton (in which Debhold held a 40
per cent interest) of the amount standing in share premium account and by
way of
a reduction of capital, and, after Debhold had acquired its shares in EHSA from
Meton, the first and second schemes for the
dismantling of EHSA — I find
this evidence somewhat unconvincing. The facts
/ speak
30
speak too strongly for themselves. At any rate, in my view, Debhold on whom
the onus rests has not shown that a distribution of the
assets of EHSA in cash
to the shareholders was not, as it appears to have been, the purpose of the
acquisition.
In the circumstances, did the EHSA shares, once
acquired by Debhold,
constitute trading stock in its hands?
"Trading stock" is defined in sec. 1
of the Act, unless the
context otherwise indicates, as including:-
".... anything produced, manufactured, purchased or in any other manner acquired
by a taxpayer for purposes of manufacture, sale
or exchange by him or on his
behalf, or the proceeds from the disposal of which forms or will form part of
his gross income."
The corresponding
definition, in the Afrikaans text of the Act,
of the word "handelsvoorraad"
reads:
"Tensy uit die samehang anders blyk,
beteken
hierdie Wet —
'handelsvoorraad' ook enigiets deur 'n belastingpligtige vir doeleindes
van
/ vervaardiging...
31
vervaardiging, verkoop of ruil deur of ten behoewe van horn geproduseer,
ver-vaardig, gekoop of op ander wyse verkry, of
enigiets
waarvan die
opbrings uit die van die hand sit daarvan deel van sy bruto inkomste uitmaak of
sal uitmaak". (My italics.)
The repetition of the word "enigiets"
(italicised by me) has no counterpart in the more elliptical English text. The
repetition makes
the definition clearer; and in considering the English
definition (the Act was signed in English) I shall interpolate the word
"anything"
after the word "or".
The definition falls naturally into two parts:
(1)
anything produced,
manufactured, purchased or in any other manner acquired by a taxpayer for
purposes of manufacture, sale or exhange
by him or on his behalf,
or
(2)
anything the proceeds from the disposal
of which forms or will form part of his gross
income.
/ Mr
Welsh
32
Mr
Welsh
conceded that the EHSA shares did not fall within part (1) of
this definition, but contended that they did fall within part (2) .
The
concession is clearly well-founded: the EHSA shares were unquestionably not
purchased by Deb-hold for the purpose of manufacture,
sale or exchange. But, in
my opinion, the contention is not well-founded.
Part (2) of the definition is somewhat cryptic and in its application may
lead to circuitous reasoning (e.g. often the question as
to whether the proceeds
of the disposal of an article constitute gross income is answered by considering
whether the article was
trading stock, or stock-in-trade, in the hands of the
seller). Be that as it may, in my view, this part of the definition (like part
(1) ) relates to articles or things which (a) are disposed of (so as to produce
proceeds) or (b) will be so disposed of in the future.
Category (a) would cover
things held at the begin-
/ ning
33
ning of the tax year and disposed of during the tax year; and category (b)
would cover things held throughout the tax year but to
be disposed of
thereafter. Mr
Welsh
argued that category (b) related to, or at any rate
included, things the proceeds of which would form part of the taxpayer's gross
income if he were to dispose of them, notwithstanding the fact that he had no
intention of disposing of them at the time of acquisition
or at any other time
during the relevant tax year, ie. postulating a notional disposal of things not
to be disposed of. To my mind,
the argument is unsound. Such an interpretation
would do violence to the plain meaning of the words used: words simply denoting
futurity
would be stretched to cover at the same time not only futurity but also
a hypothetical state of affairs which in fact did not and
would not come to
pass. Mr
Welsh
also submitted tentatively that the first scheme
constituted a "disposal" of the EHSA shares, but in the end, as I understood
the
/ position
34
position, did not press the argument - correctly, in my view. Applying what 1
believe to be the correct interpretation of the definition,
1 am satisfied that
the EHSA shares did not fall within its terms. Moreover, although the definition
is prefaced by the word "includes",
I am of the opinion, bearing in mind the
principles stated in
R v Debele
1956 (4) SA 570
(A), at pp. 575-6, and
the fact that the definition would seem to comprehend what is ordinarily
understood by the term trading stock
(cf.
Hex v McKenzie
1938 TPD 469
, at
p. 471), that the definition is intended to be exhaustive.
At the beginning of the hearing in the Special Court, the Commissioner's
representative, although conceding that Debhold was a share-dealing
company, did
not concede that the EHSA shares form part of the stock-in-trade. At the
argument stage, the Commissioner's representative
conceded (rightly, in the view
of the Special Court)
/ that
35
that the EHSA shares were held by the appellant as trading stock. And in the
Court a_
quo
counsel for the Commissioner did not contest this.
In argument in this Court, however, counsel for the Commissioner submitted
that the concession was not supported by the undisputed
facts and was wrongly
made. He submitted further that the fact that it was made, does not preclude
this Court from dealing with the
matter on the basis of the facts. Mr
Welsh
, although contending that the concession was rightly made, did not
suggest that it stemmed from anything other than an erroneous
appreciation of
the legal position. He therefore could not submit that this Court was precluded
from dealing with the matter on the
basis of the undisputed facts. Accordingly
there is no reason why this Court should not give what it considers to be the
right decision
on the facts. Cf.
Paddock Motors (Pty) Ltd v Igesund
1976
(2) SA 16
(A) at 23 D _ G. I proceed therefore on the basis that the EHSA shares
did not constitute trading stock in Debhold's hands.
/ One
35 (A)
One of the consequences of this finding is that the EHSA shares were not
governed by the provisions of sec. 22. In my opinion, the
term "trading stock"
in sec. 22 means "trading stock" as defined. There is no consideration of
context to lead to the conclusion
that the definition does not apply in sec. 22.
And furthermore the fact that the definition of "trading stock" was introduced
into
the income tax legislation in 1956 by the same Act (the Income Tax Act 55
of 1956) that introduced the statutory provisions equivalent
to the present sec.
22 indicates cogently that the definition was intended to apply to sec. 22 (and
its predecessor).
/ The
36
The finding that the EHSA shares did not constitute trading stock in
Debhold's hands does not, of course, conclude the enquiry as
to whether the cost
of the shares was deductible in terms of the Act in the 1973 year of assessment
or in any other relevant year
of assessment. This question must be separately
determined in the light of the relative statutory provisions. In this connection
counsel directed their argument before us mainly at secs. 11(a) and 23(f), the
general effect of which was fully considered in
Nemojim
's case,
supra
, at pp. 946 B - 948 A. No reference was made to sec. 23 (g) until
the applicability of this paragraph was raised by a member of this
Court during
the hearing.
/ Sec
37
Sec. 23 (g) provides that —
"No deductions shall in any case be made in respect of the following matters
namely —
(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
Joffe & Co Ltd v Commissioner for Inland Revenue
1946 AD 157
, at pp. 162-3, WATERMEYER CJ discussed the
meaning and effect
of secs. 11(2) and 12(g) of the Income
Tax Act 31 of 1941 (which are
virtually identical with secs.
11(a) and 23(g) of the Act) in relation to a deduction claimed
in respect of damages paid by the taxpayer and in the course
of doing so
stated (at p 163):
"The damages which were paid are, therefore, only deductible if they
constitute expenditure not of a capital nature, which was incurred
in producing
the income in respect of which the tax was levied. Sec 12(g) which, in the case
of income derived from trade, prohibits
the deductions of any
/ moneys
38
moneys 'which are not wholly or exclusively expended for the purposes of
trade', makes it clear that such expenditure, in order to
be deductible, must
not only be connected with the production of income but must have been paid out
for the purposes of trade.
'These words', said Lord DAVEY, in the case of
Strong & Co., Ltd.
v
.
Woodifield
(1906 A.C. 448
at p. 453), when speaking of similar
words in the English Income Tax Act of 1842, 'appear to me to mean for the
purpose of enabling
a person to carry on and earn profits in the trade, etc. I
think the disbursements permitted are such as are made for that purpose.
It is
not enough that the disbursement is made in the course of, or arises out of, or
is connected with the trade or is made out
of the profits of the trade. It must
be made for the purpose of earning the profits'.
All expenditure, therefore, necessarily attached to the performance of the
operations which constitute the carrying on of the income-earning
trade, would
be deductible and also all expenditure which, though not attached to the trading
operations of necessity, is yet
bona fide
incurred for the purpose of
carrying them on, provided such payments are wholly and exclusively made for
that purpose and are not
expenditure of a capital nature."
/Often
39
Often expenditure incurred in the production of the income (not being of a
capital nature) is also wholly and exclusively laid out
or expended for the
purposes of trade; but not necessarily so. To be deductible expenditure must
pass both tests.
Was the purchase price of the EHSA shares moneys wholly or exclusively laid
out or expended for the purposes of trade? I have already
analysed what I
conceive to be the normal
modus operandi
of a dealer in shares like
Debhold; and 1 have pointed to various features of the EHSA share transaction -
the intention not to resell
the shares, the contemplation that the
implementation of the first scheme would produce no profit, in fact a loss of
R41 000, and
the possible inference that the object of the transaction was
merely to transfer the cash assets of EHSA to its shareholders - which
cause it
to stand apart from Debhold's normal trade as a dealer in shares.
/ Mr
Welsh
40
Mr
Welsh
submitted that profit-making was not of the essence of
trading and he cited in this connection the following cases:
Modderfontein
Deep Levels Ltd and Another v Feinstein
1920 TPD 288
;
Weinstock and
Another v Commissioner of Taxes
1962 (3) SA 543
(PC);
Commissioner of
Taxes v BSA Co Investments Ltd
1966 (1) SA 530
(SR.AD); and
Commissioner
of Inland Revenue v The Incorporated Council of Law Reporting
(1888) 3 TC
103.
In my opinion, none of these cases assists, him in regard to the particular
facts of the instant case.
In the
Modderfontein
case the question arose as to whether a mining
company which sold articles of clothing to its employees from a store (which was
open
daily) at cost, was "carrying on a trade or business" within the meaning of
certain mining legislation. The Court held that it was,
DE VILLIERS JP remarking
-
/"No
41
"No doubt as a rule a trade or business is carried on for the purpose of
making a profit, but profit-making is not of the essence
of trading."
The
Modderfontein
case, apart from relating to different words in
entirely different statutes, is, in my view, wholly distinguishable. The mining
company
there was carrying on a non-profit-making trade or business. In the
instant case the taxpayer, Debhold, carries on a business of
share-dealing which
is obviously designed to produce profits; and the question is whether an unusual
transaction designed to produce
a loss was part of its trading operations and
whether the cost of the shares could be regarded as moneys wholly or exclusively
laid
out or expended for the purposes of trade. And here one must consider the
question in relation to the trade actually conducted by
Debhold. The same or
similar comment would apply to the last of the cases quoted by Mr Welsh.
/
Weinstock'
s
42
Weinstock
's case is, in my view, not relevant. There the taxpayer
entered into various share dealings and other transactions in carrying out
what
was clearly, and was found to be, a scheme of profit-making. In the
BSA
Company
case the taxpayer, an investment dealing company, purchased from
another company a whole portfolio of investments as a package deal
and these
investments formed the taxpayer's opening stock-in-trade. Included amongst these
investments was a certain Kariba loan
which was a "bad buy" and could not be
sold at a profit. It was held that nevertheless the Kariba loan, along with the
other investments
purchased, constituted the taxpayer's stock-in-trade and that
the expenditure incurred in the purchase of the Kariba loan was deductible
as
being "expenditure... wholly and exclusively incurred... for the purposes of
(the taxpayer's) trade" in terms of sec 13(2)(a)
of the Rhodesian Income Tax Act
of 1954. In his judgment (which was the judgment of the Court) BEADLE CJ
/ emphasized
43
emphasized that the Kariba loan was purchased as part of a package and held
that in such a package deal it was not permissible to
distinguish between the
two types of stock and call the stock which can be profitably sold
stock-in-trade, while branding the rest
assets of a capital nature. He said (at
p 532 E-G) :-
"As 1 see the situation, the case is no different from that of a merchant who,
in order to assist a fellow merchant in the same line
of business, buys the
stock-in-trade of that merchant, intending to sell as much of that stock as he
can at a profit and to cut his
losses as best he can on that part of the stock
which he knows he cannot sell at a profit, but who nevertheless hopes on the
transaction
as a whole to show a profit. The stock which cannot be sold at all
or which can only be sold at a loss is, in the circumstances of
such a
transaction, just as much the merchant's stock-in-trade as that stock which can
be sold at a profit."
In my opinion,
the instant case is wholly distinguishable.
It does not appear from the evidence that the EHSA shares
were purchased
as part of a package deal;
they were not purchased for re-sale; they were
/ purchased
44
purchased very possibly as part of a scheme for distributing the assets of
EHSA in cash to its shareholders; the transaction was calculated
from the start
to show an overall loss.
The present case is in fact closer to an English case,
Petrotim Securities
Ltd v Ayres
(1964) 41 TC 389
, distinguished by BEADLE CJ in his judgment. In
the
Petrotim
case the taxpayer company, a dealer in securities, sold some
investments which it held as trading stock to R Ltd, of which the taxpayer
was
almost a wholly-owned subsidiary, at prices very much below cost and market
value (referred to as the "X" transaction). The taxpayer
also purchased some
stock and immediately resold it to another subsidiary of R Ltd at about
one-tenth of its cost and market value
(referred to as the "Y" transaction). In
the Court of the Special Income Tax Commissioners the issue was as to whether
the taxpayer
was entitled to tax relief in respect of the
/ losses
45
losses incurred on these transactions, which the taxpayer contended had been
carried out in the course of its trade. The Commissioners
concluded that they
were not trading transactions. The Commissioners, having referred to a
dictum
of Lord SIMONDS in a previous case to the effect that a trader's
job is to make profits, said at (p. 395):-
"In the present case it appears, in the absence of evidence to the contrary,
that the Company deliberately set out to make a very
substantial loss. We, of
course, recognise that, in the course of his trade, a trader may make sales at
much less than cost or even
make free gifts of the goods in which he deals:
e.g., when advertising. We have no evidence that the transactions in the present
case in any way resemble such sales or gifts. The agreements relating to the X
transactions support the fact of a purchase or sale,
but not the quality of the
sale. The profit-seeking motive, which is normally important, was absent, and in
its place there appears
to have been an intention to make a loss for a reason
which was not explained. It therefore seems a fair inference to draw that in
relation to those transactions the Company, at the time of the sales, was no
longer acting as a dealer or financier and accordingly
the sales were not made
in the course of the Company's trade.
/ A
fortiori
,....
46
A fort
iori
, the position is the same with regard to the Y transaction
as neither the purchase nor the sale, it seems to us, was made in the
course of
the Company's trade."
The decision of the Commissioners was upheld in successive appeals to the
Chancery Division and the Court of Appeal. In the Chancery
Division
UNGOED-THOMAS J remarked that
(at p 400) :-
"All these transactions were completely out of character with the rest of the
Company's trading operations and the way in which it
conducted its trade These transactions,
when seen in their context of the Company's trading operations, cry aloud for an
explanation."
(See also
Skinner
(Inspector of Taxes) v Berry Head Lands
Ltd
[l97l]
1 All ER 222.)
It is true, as I have already indicated, that the absence of a profit does
not necessarily exclude a transaction from being part of
the taxpayer's trade;
and correspondingly moneys laid out in a non-profitable transaction may
nevertheless be wholly or exclusively
expended
/ for
47
for the purposes of trade within the terms of sec. 23(g). Such moneys may
well be disbursed on grounds of commercial expediency or
in order indirectly to
facilitate the carrying on of the taxpayer's trade (see in this regard the
remarks of JENKINS LJ in
Morgan v Tate & Lyle Ltd
,
1953 Ch 601
, at pp
637-8; and
Boarland v Kramat Pulai Ltd
[1953] 2 All ER 1122).
Where,
however, a trader normally carries on business by buying goods and selling them
at a profit, then as a general rule a transaction
entered into with the purpose
of not making a profit, or in fact registering a loss, must, in order to satisfy
sec. 23(g), be shown
to have been so connected with the pursuit of the
taxpayer's trade, e.g. on ground of commercial expediency or indirect
facilitation
of the trade, as to justify the conclusion that, despite the lack
of profit motive, the moneys paid out under the transaction were
wholly and
exclusively expended for the purposes of trade (cf.
Nemojim
's case,
supra
,
/at
48 at pp. 947 H - 948 A). Generally, unless the facts speak for themselves,
this will call for an explanation from the taxpayer.
In the present case there was, as I have indicated, no satisfactory
explanation of the EHSA share transaction from Debhold. It was
not a normal
share-dealing transaction. It stood apart from Debhold's normal method of
trading. It was not a profit-making scheme;
on the contrary, it was entered into
in the contemplation of registering a loss and ultimately, in terms of the
second scheme, it
did result in a commercial loss. It may well have been a
procedure merely to distribute in cash the assets of EHSA. In my opinion,
Debhold did not establish that the deduction claimed in respect of the cost of
the EHSA shares passed the test of sec. 23 (g).
It follows from this that the cost of the EHSA shares was not a proper
deduction in the 1973 year of assessment. Furthermore, since
the shares did not
constitute
/ trading
49
trading stock, sec. 22 did not require the cost of the shares to be reflected
in Debhold's returns of the value of trading stock in
the 1973 and subsequent
tax years. The fact that Debhold erroneously did so cannot alter the true legal
position as far as the 1979
year of assessment is concerned. The cost of the
shares was consequently not a proper deduction in the 1979 tax year and was
rightly
disallowed by the Commissioner.
The consequences of the finding that sec. 23 (g) precluded the deduction of
the purchase price of the shares-on the 1973 assessment
do not arise for
decision. Nor need consideration be given to what the income tax position might
have been had the first scheme been
implemented, and to such questions as to
whether the liquidation dividend, not being the product of a profit-making
scheme, would
or would not have constituted gross income in Debhold's hands;
whether the EHSA shares were capital assets; or
/ whether
50
whether, as argued by counsel for the Commissioner before us, the purchase
price of the shares constituted capital expenditure by
Debhold.
In the result I agree with the conclusion reached by the Court a
quo
,
though for different reasons. The appeal is dismissed with costs, including the
costs of two counsel.
M M CORBETT MILLER, JA. ) NICHOLAS, AJA. )