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[1991] ZASCA 32
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Commissioner for Inland Revenue v Guardian Assurance Company South Africa Ltd. (301/1989) [1991] ZASCA 32; 1991 (3) SA 1 (AD); [1991] 2 All SA 193 (A) (26 March 1991)
LL
Case No 301/1989
IN THE SUPREME COURT OF SOUTH AFRICA APPELLATE DIVISION
In the matter between:
COMMISSIONER FOR INLAND
REVENUE
Appellant
and
GUARDIAN ASSURANCE COMPANY
SOUTH ÁFRICA LIMITED
Respondent
CORAM
: CORBETT CJ, NESTADT, KUMLEBEN JJA,
PREISS et KRIEGLER AJJA
HEARD
: 15 FEBRUARY
1991
DELIVERED
: 26 MARCH 1991
JUDGMENT
KRIEGLER AJA
:
2. This income tax appeal is brought direct
to this court pursuant to leave granted by the President of the Transvaal Income
Tax Special
Court in terms of section 86A(5) of the Income Tax Act No 58 of 1962
("the Act"). The point in issue is whether profits derived by
the respondent,
Guardian Assurance Company South Africa Limited ("GASA"), from the sale by it
during 1982, 1983 and 1984 of shares
it held in a number of companies listed on
the Johannesburg Stock Exchange formed part of its taxable income. In its
returns of income
and supporting accounts for the years of assessment ended 31
December 1982, 1983 and 1984 respectively GASA reflected the income
thus derived
as having been of a capital nature. The áppellant, the Commissioner for
Inland Revenue ("the Commissioner"),
however, included such profits in GASA's
taxable income in each of the three years. Its formal objections having been
disallowed,
GASA appealed to the Transvaal Income Tax Special Court in terms of
section 83 of the
3.
Act. Initially the appeal was to have been directed at the assessment for the
1982 year only but by consent it was belatedly expanded
to encompass the
assessments for the succeeding two years as well. The Special Court ruled in
favour of GASA and remitted each of
the three assessments to the Commissioner
for reassessment on the basis that the profits in question did not form part of
GASA's
taxable income. Hence this appeal.
The Special Court had before it a
dossier prepared by the Commissioner in terms of regulation B(3) of the
regulations promulgated
under section 107 of the Act, and two supplements
thereto. In addition counsel for GASA, shortly after the commencement of the
evidence
of the first witness, handed in two exhibits. The first, identified as
exhibit "A", was described by GASA's counsel as "a summary
of all the various
transactions in issue in this case." The second, exhibit "B", was described by
GASA's counsel as GASA's "bundle
of documents", to which he added "...
there
4. will be a certain amount of overlapping in the third dossier and the
appellant's bundle. Of course this bundle is not handed in
as evidence of all
the documents in it, except to the extent that they are referred to from time to
time by the witnesses and identified."
Unfortunately no particular 'care was
taken by counsel on either side in the course of the
viva voce
evidence
to identify documents being referred to. Thus the confusion, inherent in the
multiplicity of dossiers, the (unspecified)
degree of overlapping and the
apparent lack of any index, was compounded. Moreover, when the record on appeal
came to be prepared
in the Commissioner's office, the officials concerned,
unfamiliar with the case, were unable to do so satisfactorily. In particular
GASA's "bundle of documents", exhibit "B", which, judging by counsel's
_introductory remarks, must have comprised a considerable
number of documents,
is reflected in the record as consisting of a single four page letter.
5.
Furthermore a highly pertinent schedule reflecting movements of eguity shares
held by GASA, exhibit "B" 108 to 110, and which had
been referred to in the
evidence in the court
a quo
, was omitted from the record and had to be
handed in from the bar at the hearing of the appeal. Notwithstanding the
unsatisfactory
state of the record, however, a clear picture of the relevant
circumstances can be gleaned from the documentary and oral evidence
presented to
the Special Court.
Three witnesses were called, all on behalf of GASA. The
first was Mr Richard Morris who retired in mid-1987 after forty years with
the
firm Coopers and Lybrand, public accountants and auditors. He had for many years
been the audit partner for GASA and from approximately
1975 he was the review
partner involved in important matters of accounting principle relating to GASA's
affairs. He was also the
specialist tax partner in the firm. Although he had
never been
6. involved in the day to day affairs of GASA he was familiar with
its history and investment policy. He had moreover been involved
in the
representations on behalf of GASA to the revenue authorities relating to the
taxability of profits derived from the sale of
shares in its investment
portfolio.
The next witness to be called was Mr Michael Newman, the managing
director of GASA as also of its holding company, Guardian National
Insurance
Company Limited ("GNIC"). He started his career in the insurance industry in
1954, later became the general manager of
GASA and in 1973 attained a seat cm
its board of directors. Mr Newman was able to flesh out Morris's general
description of the history
of GASA and of its investment policy over the years.
He also described in detail the nature of GASA's business, its position in the
group of companies of which it was a member and how and when it underwent
certain fundamental changes. He too had been involved in
the
7. debate with
the revenue authorities concerning the taxability of the profits derived by GASA
from the disposal of shares held in
its investment portfolio. Although he had
knowledge of and was able to deal in evidence with a number of the more salient
of such
disposals, he had not been involved in the day to day administration of
the portfolio and traversed the terrain in more general terms.
The detailed
information was furnished in evidence by Mr J R McAlpine, a specialist in the
field of share portfolio management. He
was the managing director of Liberty
Asset Management Company Limited ("LIBAM"), a member of the Liberty group of
companies, which
administered some 80 to 85 share investment portfolios for a
variety of principals. Each portfolio was administered in accordance
with the
specific objectives of the client concerned. Thus the portfolio of a pension
fund or of a unit trust is sensitive to fluctuations
in share market prices and
requires
8. frequent adjustments. Others, like investment trusts, call for a
much more conservative approach, the objective being a steady
income in the long
term with disposals of counters taking place only when necessitated by some
extraordinary circumstance. Irrespective
of the specific objectives of the
client concerned, however, McAlpine, who was the person in LIBAM essentially
concerned with the
investigation and recommendation of investments, followed the
same fixed and conservative policy: one never buys on tips nor for
quick profit
or speculatively. The witness detailed a series of investigative steps taken and
criteria considered before any investment
was recommended. He also described in
detail how GASA's share investment portfolio had been administered from the mid
1970's to 1987
and explained the circumstances giving rise to each of the
transactions which generated prqfits giving rise to disputes as to their
taxability. The court
a quo
, "fully cognizant of the fact
9.
that the
ipse dixit
of witnesses in a case such as the
present must not be accepted uncritically", accepted the evidence of Messrs
Newman and McAlpine
as truthful and reliable. There is no reason to differ. Nor
can any criticism be levelled at the evidence of Mr Morris, although
in his case
there was no express endorsement by the court a
quo
. Indeed the
Commissioner did not seriously challenge their veracity or accuracy in either
court, the main thrust of his case being
directed at the surrounding
circumstances. Consequently a composite factual summary derived from the
evidence of all three witnesses
read with the documents to which they referred
will suffice.
Although empowered by its memorandum of association to conduct
many types of insurance business, GASA at all times material prior
to 1 January
1981 carried on business as a casualty, or short-term, insurer. It also built up
a substantial share invest-ment portfolio,
financed solely from
shareholders'
10. funds. Requirements laid down by the Registrar of Insurance
prescribed a certain ratio to be maintained between GASA's premium
income and
the investments it held as also between its liabilities and investments of a
prescribed kind. Apart from maintaining such
ratios GASA's insurance business
and the investment portfolio were managed as separate entities. The necessity to
dispose of any
part of the investment portfolio in order to finance shortfalls
in the insurance business never arose.
In 1974 McAlpine became entrusted with
the administration of the portfolio. Previously various staff members of LIBAM
had been responsible
for the portfolio and had allowed it to become, as McAlpine
put it, "cluttered up" with a variety of counters, many of which he regarded
as
unsuitable having regard to GASA's "investment objectives. Over a period of
several years thereafter, more especially in 1978,
the portfolio was "cleaned
up". This entailed the disposal of a number
11.
of counters which did not fit in with the conservative investment policy
recommended by LIBAM and espoused by the chairman of the
Liberty Life group, Mr
Donald Gordon. Thus in the year of account ended 31 Decêmber 1976 fifteen
counters were shed of which
six were relatively minor ordinary shareholdings and
the balance preferent shares, debenture stock and nil paid letters. The upshot
in that year was a surplus of but R1 684. The sale óf ordinary shares in
the year of account ended 31 December 1977 produced
a small surplus. of R4 074
on a total selling price of R303 662. In the following year of account sales
totalling R2 420 039 took
place with a surplus of R41 860. There were only two
sales of equity shares during that year, the first resulting in a loss of R22
298. The second, the sale of ordinary shares in Clydesdale Collieries Limited,
resulted in a profit of R131 781 . Messrs Newman and
McAlpine testified that the
latter transaction was an extraordinary and "strategic" one in that the
Liberty
12.
group severed a long-standing relationship with Clydes-dale Collieries
Limited and GASA merely followed suit. The disposal was in
no way motivated by
an intention to reap a profit. The balance of the disposals dúring 1978
constituted "cleaning up", the
counters sold being regarded as inappropriate in
a stable and long-term investment portfolio aimed at dividend income.
In the
year of account ended 31 December 1979 only four equity counters were sold - for
a total selling price of R59 786 and resulting
in a loss of R6 441. The balance
of the disposals during 1979, as in 1978, comprised holdings in preferent
shares, debentures, government
stock and the like, which were regarded as
unsuitable for such a portfolio. In 1980 there was only one sale of equity
shares, which
produced a profit of R2 542 028 on sale proceeds of R4 719 942.
That, too, was a strategic sale and was accepted by the revenue authorities
as
being of a capital nature and the proceeds were excluded from
13.
GASA's taxable income.
Objectively viewed, the sales data for the years of
account from 1976 up to and including 1980 give little or any indication that
the sales of counters that took place were steps in a scheme of profit making.
On the contrary, they tend to bear out the evidence
of the witnesses, more
especially that of Mr McAlpine, that the portfolio was administered
predominantly as a long-term income-producing
capital asset, disposals having
been necessitated by extraordinary circumstances or, by "cleaning up", to render
the portfolio more
suitable for the predominant purpose. If one then has regard
to the available data regarding purchases of eguity counters during
the five
year period in question the impression created by the oral evidence and the
sales data is confirmed. During the three years
of account 1978, 1979 and 1980
more than R10 million was expended in major acquisitions of largely "blue chip"
equities (e g Stanbic
at a cost of
14. R534 529, Sasol at R500 000 and Barlow Rand at R2 728 707). The composite
picture of purchases and sales reaffirms that the portfolio
was intended to be
and was managed as a dividend-producing capital asset.
In 1980 there was a
fundamental change in the affairs of GASA. Pursuant to a reverse take-over dated
7 August 1980 and ef f ective
from 1 July 1980, GASA became a wholly-owned
subsidiary of Union National South British Insurance Company Limited, which
latter company
later changed its name to GNIC. GASA's short-term insurance
business was merged with that of GNIC and from 1 January 1981 GASA wrote
no new
business. During that year all the policies of insurance it had issued in
previous years expired and its liabilities in respect
of outstanding insurance
claims as at the end of that year were assumed by GNIC with effect from 1
January 1982. In the result GASA
was lef t with an insurance licence, on which
it at no stage thereafter operated, and its share portfolio containing 4 982
095
15.
equity shares acquired at a cost of R11 225 436.
At a meeting of the board
of directors of GNIC held on 8 November 1980 it was resolved to reduce the board
of GASA to four members
"as only business of a formal hature would be undertaken
in future with all policy decisions being handled by the full board of Guardian
National." The chairman, Mr Gordon, mentioned "the possibility of retaining GASA
as an investment holding company." GASA having become
a non-trading wholly-owned
subsidiary, an investment shell, its investment portfolio ought rationally to
have been transferred to
GNIC in order to perfect the merger. Ways and means of
attaining such objective without incurring fiscal liabilities were investigated,
but to no avail. In the result it was decided to transfer GASA's fixed interest
investments to GNIC but to retain the balance of
the portfolio in GASA's hands.
Subsequently, at a meeting of the board of GNIC held on 27 August 1981
inter
alia
the following was resolved
16.
under the heading "Taxation of capital gains":
"It was agreed that certain fixed interest securities be transferred to the
holding company at book value and that the remaining
investments held by GASA,
consisting mainly of equities, be retained in that company which would operate
as an Investment Trust."
At subsequent meetings of
the board of GNIC the matter
was raised again from time to time. The minutes
of the
meeting held on 19 November 1982 contain the following:
"
TRANSFER OF ASSETS FROM GUARDIAN ASSURANCE COMPANY SOUTH AFRICA LIMITED
("GASA") TO GUARDIAN NATIONAL INSURANCE COMPANY LIMITED
Mr Gordon advised the Board that detailed discussions had been held with the
company's auditors regarding the transfer of equities
from GASA to Guardian
National Insurance Company Limited. Mr Gordon said that after these discussions
it was felt that GASA should,
for the time being operate as an investment trust,
and where necessary to sell investments which were not suitable for that
company's
investment objectives. Should the Receiver of Revenue decide to tax
any profit arising from the sale of these investments the matter
would be
contested in the taxation court on the basis of being a test
case."
On 11 May 1983 the board of directors of GASA
adopted
17.
the following resolution:
"
CESSATION OF INSURANCE ACTIVITIES
IT WAS NOTED THAT with effect from 1 July 1980 Guardian National Insurance
Company Limited (formerly Union National South British
Insurance Company
Limited) ('Guardian National') had acquired the company's entire issued equity
share capital and that in terms
of the arrangements concluded at that time
Guardian Assurance Company South Africa Limited would cease trading as an
Insurance company.
IT WAS PURTHER NOTED THAT the company would not underwrite any further insurance
business from 1 January 1981 and that an adequate
reserve be created within the
company's accounts for the provision of all liabilities incurred prior to that
date.
IT WAS FURTHER NOTED THAT the company would retain its investment portfolio as a
long term investment and for the purpose of deriving
investment income for the
benefit of the company.
IT WAS RESOLVED THAT the aforegoing matter in regard to the cessation of
activities as an insurance company is a true and accurate
record of the
intentions of the company at 1 July 1980."
The board
of directors of GNIC discussed the GASA
investment portfolio at a meeting held on 17 May 1984,
18.
the relevant minute reading as follows:
"
GUARDIAN ASSURANCE COMPANY SOUTH AFRICA LIMITED
The investment portfolio of Guardian Assurance Company South Africa Limited
('GASA') was submitted to the meeting and reviewed by
the Board. Mr Gordon said
that the uncertainty in regard to the taxation of any surpluses arising from the
disposal of investments
of GASA was adversely affecting investment decision
making by the investment managers and he felt it necessary to consult outside
advisers with a view to obtaining clarity from the Revenue authorities in this
regard.
It was further agreed that the portfolio remain unchanged unless any profits
could be off-set against any losses arising from the
sale of any
investments."
In the interim the
administration of the GASA
portfolio under the aegis of LIBAM continued. In the
year of account ended
31 December 1981 three equity
counters were sold, yielding an overall profit
of
R384 929. One of these, Fidelity Bank and Trust
Company Limited, was an extraordinary or strategic sale
which was explained in evidence by Messrs Newman and
19.
McAlpine. The Liberty Life group had enjoyed a
business relationship with
the purchaser and when the
latter exerted pressure GASA deemed it expedient in the
interests of the group to accede, realising a profit of
R281 250.
In 1982 two of the 35 equity counters in
GASA's portfolio were sold, namely, Sappi and De Beers,
producing a
surplus of R358 132. The proceeds
represented 4,7% of the balance sheet value
of the
shares held by GASA as at 31 December 1982. The Sappi
shares had
been bought from 1969 to 1979 at a total
price of R220 776 and were sold in
November 1982 for
R714 123. The De Beers shares had been bought in
1979
and 1980 at R570 616 and were sold in 1982 at R435 400.
With regard
to the first counter sold, McAlpine
testified as follows:
"...Sappi was a share that we were holding for the reasons which I've already
outlined to the Court and early 1980's it announced
a massive expansion project,
the cápital cost of which was two or three times its
current
20.
market capitalization. We're always very wary of those types of massive
expansions and because of that we thought that the dividend
growth prospects
could be impaired and after investigation we decided that that holding no longer
fulfilled the role which we originally
meant it to do and we disposed of
it."
With regard to the sale of the De Beers
shares
McAlpine's evidence was as follows:
"De Beers shares, here the industry itself, the diamond industry itself went
through a fundamental restructure in the early 1980's,
in fact there was a stage
when the very viability of the diamond industry was, you know, was open to
question, this after De Beers
had been regarded as the deepest of blue chip
counters. I think it was about the entire 1960's and the entire 1970's.
Fundamental
change in the industry cut its dividend and we thought it no longer
fulfils the requirements, so it was
sold."
Representations notwithstanding, the
Commissioner
assessed the nett profit of R358 132 to tax and such
assessment formed the
first issue in the appeal to the
court
a quo
.
In the succeeding accounting year GASA sold
three of its 33 equity counters (representing less than
21. 2,5% of the
balance sheet value of its total portfolio as at the end of that year) for a
total price of R765 046 and producing
a profit of R332 007. In the course of his
evidence Mr McAlpine dealt with the circumstances motivating each of the
disposals in
the 1983 year. In the one instance there was concern about the
continued viability of the company concerned, in another there was
a fundamental
change in the business and management of the company while in the third
instance, Anamint, the reason for the disposal
was the same as that regarding
the De Beers shares. During the same year there were two major share exchanges
resulting in profits.
In the first 250 000 S A Breweries shares were exchanged
for 88 500 shares in the Premier group as a result of a public offer pursuant
to
a major corporate reconstruction. In the second case, too, the change in
shareholding was occasioned by a corporate reconstruction
and a consequent offer
to shareholders. The overall result
22.
was a profit during the financial year ended 31 December 1983 amounting to R2
294 858, the whole of which the Commissioner assessed
to income tax. Such
assessment was the second issue in the court below.
During the year of
account ended 31 December 1984 there was one transaction only. In October of
that year , GASA sold a parcel of
31 600 Edgars participating preference shares
(which it had acquired in April 1977) at a profit of R463 855. Once again the
precipitating
factor was not a decision to sell with a view to profit. Although
GASA would have preferred to retain the counter it responded to
what it regarded
as a strategically important offer to minority share-holders emanating from a
company with which the Liberty group
had a close relationship. Representations
and a formal objection notwithstanding, the Commissioner adhered to the view
that the resultant
profit of R463 855 was liable to income tax. Such assessment
then formed the third issue before the court a
quo
.
23.
The case presented to that court on behalf of
GASA was somewhat ambivalent. Although the main thrust
of the evidence
presented was to the effect that the
merger in 1980 and the consequent
cessation of short-
term insurance business precipitated a change
of
intention regarding the investment portfolio, each of
the three
witnesses nevertheless emphasised that, even
prior to the.merger, the
portfolio had been regarded
and administered as a capital asset. Thus Mr
Morris,
in dealing with GASA's pre-merger intention with regard
to the portfolio, said the following:
"... it was my understanding from what was said to me and what I could observe
for myself that the investment policy was to hold
their equity portfolio,
long-term for income ... Income in the form of
dividends."
Mr Newman's evidence regarding GASA's
pre-merger
investment policy was, albeit of a more general nature,
substantially to the same effect as that of Mr Morris.
In his
evidence-in-chief he confirmed a statement put
to him that GASA's "overriding and dominating intention
24.
in relation to the portfolio was to retain the
portfolio as a permanent
investment showing an ever
rising dividend yield". He added that GASA had
"never
been what I would describe as traders in eguity
investment". Later,
in the course of cross-
examination, he described the purpose with which
the
share portfolio had been held prior to the merger in
the following
terms:
"My lord, prior to 1981 for some years, the company had a very close association
with the Liberty Life group and Donald Gordon was
the chairman of the company.
Donald Gordon is a very selective investor and the investments that we developed
in GASA, to my certain
knowledge, are essentially blue chip invest-ments and
they were, I am talking of equity ihvestments, purchased for long-term for
income producing purposes.
My lord, I will first say that prior to 1981 GASA was a short-term insurer with
a share portfolio largely comprised of investments
that were effected for
long-term investment purposes."
Mr
McAlpine, although not a member of the
25. board of GASA nor even an employee of that company, was well qualified to
express a view cm the intention with which the portfolio
had been held and
administered from 1974 onwards. He was intimately involved with the day to day
management of its investment portfolio
in accordance with the policy directives
of its board of directors, whose meetings he regularly attended. He understood
LIBAM's mandate
at all times, i e even pre-merger, to have been to administer
GASA's investment portfolio as an investment trust where:
"... the board of directors laid down a mandate that the brief was to look for
steady income, at the income growth over a long period
of time. In an investment
trust, even if . I thought a counter was overpriced relative to others, we would
not sell it, we would
hold on to it on the basis that it's been a long-term
investment. The only cir-cumstances under which we would contemplate making
a
disposal in an investment trust would be if something fundamental happened to
change our company's view on the likelihood or otherwise,
of that company
continuing to grow its earnings as it has in the past and of course that could
be for various reasons. The first
one possibly the very industry
in
26.
which it's operating, the outlook for that industry might change drastically.
The company might sell off a very large part of its
undertaking and it may
totally change its nature. The management might totally leave the company and
leave the company in what we
deem to be incompetent managements. So those would
be the sort of things that might cause us to re-appraise and therefore adjust
the structure of an investment trust. A casualty insurance company would be
something similar to an investment trust. Well, basically
the longer term
objectives there are steadily increasing
income."
Notwithstanding their evidence regarding
the capital
nature of the investment portfolio prior to the merger,
each
of the witnesses was at pains to underscore that
there had been a change of
intention subsequent to and
as a result of the merger. Mr Morris described it
as
"a very, very fundamental change of circumstances ... a
totally new
ball-park." When pressed ih cross-
examination by the Commissioner's
representative to
identify the change the witness, predictably, was in
some difficulties and
eventually said the following:
"We simply retained an investment portfolio in the place it was already in. We
created
27.
no new structure whatsoever. We left the portfolio exactly where it was. I've
admitted it was left there because the directors who
were responsible in the
stewardship manner for the funds of the shareholders were not prepared to accept
a course of action which
would entail either immediate or long-term tax
implications when the safest course appeared to be to leave the portfolio
exactly
where it was and to make it clear that there would be a long-term
investment policy, which is what they have carried out.
"
To this he added a little later:
"... from the time of the change of this decision, the policy with regard to
GASA's investments was to be stringent and that sales
would only be contemplated
if there were the most compelling reasons. In other words, they wanted and
decided to cut their transactions
to a minimum ... The instruction went out:
this is now an investment trust, investment transactions are to be cut to a
minimum and
only for the most compelling
reasons."
When Mr Newman was pressed in
cross-examination to
identify the change he too was in some
difficulty.
Eventually, in response to a question by the President,
he
said:
"There was a change in philosophy in post
28.
1981 certainly, but pre-1981, if we look at the year 1980 when the merger with
Unsbic was contemplated, we had a portfolio with Equity
Investments that had
always been seen as an investment portfolio with stable nature. We may have
traded in certain counters but certainly
not extensively, but then post the
merger with Unsbic there was a definite change in intention towards that
portfolio, and it was
regarded as an investment
trust."
McAlpine, when obliged to describe the
alleged change
of intention brought about by the merger, was
eventually
constrained to answer:
"Well, as far as the portfolio is concerned here I'll say that we've gone from
probably passive to extremely passive and by extremely
passive I mean we've got
to a stage here where over the last three years we haven't done one single
transaction."
In fairness to the witnesses it should
be said that the
difficulty they encountered in trying to define
the
change of intention brought about by the merger was not
really of
their making. It was inherent in the
ambivalence of GASA's case. Nor is the
ambivalence
fairly to be laid at GASA's door. Its root cause is
that,
while it was still conducting business as a
29.
short-term insurer, it fell foul of a policy adopted by
the revenue authorities with regard to such taxpayers.
Mr Morris described
the policy in the following terms:
"... there has been applied to short-term insurers, a concept of an all-in
company i.e. that its investments are trading stock willy
nilly. This has been
of great convenience to the Revenue Department, I think, because under this
approach, they were always entitled
to assume taxability. However, in fairness
to the Department, they did not apply it absolutely rigidly and on at least
three occasions
we successfully, in GASA, put up submissions that certain
investments were strategic and not ordinary investments and on each of
those
occasions we got acceptance from the Revenue Department that they were of a
capital nature."
Mr Morris testified that, although
he had "always had some reservations about the validity of the all-in concept"
he did not regard
it as worthwhile to force the issue with the revenue
authorities and that GASA "didn't want to be sort of guinea-pigs to take the
all-in concept on appeal because it could be a costly and protracted
business."
Mr Newman, when confronted with the paradox
30.
that GASA, prior to the merger, had purportedly held
its investment portfolio as fixed capital but had at
the same time
generally reflected its surpluses and
losses on disposals of counters from
the portfolio as
revenue, replied:
"My lord, I think I should say there has always been a debate at GASA board
meetlngs as to the merits of the 'all in' classifica-tion
definition for a
short-term insurance company. It was with a measure of reluctance or a feeling
of reluctance that the company accepted
the ruling of 'all in' rather than to
the extent of appealing the revenue's decisions. ...
... we were a short-term insurer, there seemed to be little evidence of a
prospect of success, the matter had been considered by
numerous insurance
companies to my knowledge and whilst there was a general feeling that 'all in'
classification was not necessarily
fair to a short-term insurer, nonetheless it
was agreed to allow it to continue. ... To remove that unhappiness would be
extremely
costly and might not succeed in the end anyway."
Mr McAlpine was even more explicit. From the
outset
he had regarded his mandate from GASA regarding
its equity investment
portfolio that it should be
31.
managed like an investment trust. That is why he shed
the unsuitable
counters and, apart from the prescribed
holdings for liquidity ratio
purposes, administered the
portfolio precisely as he did the pure
investment
trusts under his control. In the case of the latter he
was
mindful of the risk that undue frequency or volume
of transactions might
expose the trust to taxability on
gains but in the case of GASA, a "casualty
insurance
company it was always operated under the so-called
'all embracing' situation which, although we didn't
agree with it at that
stage, we had to admit it was the
practice." When asked whether GASA in his
opinion had
been a sharedealer prior to 1980 , he
answered
unequivocally:
"No, no, although I can see that the revenue, in the revenue's opinion all
casualty insurers were classified as share-dealers here
but in my personal
opinion here we were not share-dealers because share-dealers is a connotation
that you are buying and selling
shares with the objective of making profits and
that never was and never has bêen part of the investment objectives in the
appellant
32.
company."
The court a
quo
, having analysed
the
viva voce
and documentary êvidence in the light of the
applicable legal principles, found in favour of GASA on the basis that both
before
and after the merger the investment portfolio had been held as a capital
asset. Although the question whether there had been a change
of intention
consequently did not arise, the Special Court observed that no such change
pursuant to the merger had been established.
On appeal to this Court the
observation as to the absence of adeguate proof of a change of intention was
supported on behalf of the
Commissioner while the finding as to the intention
with which the portfolio. had been held throughout was challenged. The substance
of the Commissioner's case was that, while GASA's primary intention had
admittedly been the acquisition of a permanent investment
with a view to
long-term dividend yields, a secondary and integral part of its investment
holding had been the
33.
business of dealing in shares. The argument in support rested on four main
contentions. The first was that GASA, prior to the merger,
had accepted that it
was a sharedealer in relation to the management of the investment portfolio,
recognising that of necessity it
would have to deal in counters as and when its
investment policy so dictated. On the basis of that proposition it was then
submitted
in the second instance that the merger had brought about no real
change in either the intention with which the portfolio was held
nor in . the
manner in which it was administered. The third main submission was founded on
the use of the phrase "for the time being"
in the above quoted minutes of the
meeting of the board of directors of GNIC of 19 November 1982. There, it will be
recalled, the
chairman, Mr Gordon, was recorded as having opined "that GASA
should, for the time being operate as an investment trust". It was
contended
that the use of the particular phrase evidenced some
34. reservation on the
part of GASA concerning the intentions with which the portfolio was to be held.
The fourth main contention
was based on an analysis of the disposals of counters
during the years of assessment ended 31 December 1982, 1983 and 1984
respectively.
Those transactions, so it was argued, demonstrated that GASA had
recognised at all times that the management of a share portfolio
such as the one
in question necessarily entailed some dealing in shares. In the result, so it
was argued, although GASA's primary
intention had been the acquisition and
holding of a permanent investment with a view to long-term dividend yields, it
had not discharged
the onus resting upon it under s 82 of the Act of
establishing that.some dealing in shares for profit had not been a secondary yet
integral part of its business.
It is convenient to deal with the submissions
on behalf of the Commissioner in the order in which they were advanced. The
first was
that GASA had
35. accepted the correctness of its categorisation as
a dealer prior tó the merger. It can be accepted for purposes of argument
that, generally speaking, acceptance by a taxpayer over a protracted period of a
particular basis of taxation and the arrangement
of his affairs accordingly can
give rise to the inference that such basis is well-founded. Such inferential
reasoning founders on
the facts of the present case however. GASA at no stage
accepted that it had been correctly assessed to income tax on the profits
derived from the disposal of counters held in its investment portfolio, nor did
it arrange its affairs on the basis that it was a
sharedealer in respect of such
transactions. Each of the three witnesses made it plain that the portfolio was
regarded by GASA as
an income-producing capital asset, administered as such
separately from the insurance side of its business: The counters held during
the
relevant period had been acquired wholly with shareholders' funds, were
surplus
36.
to any money required to meet insurance claims and the equity share component
of the portfolip was not affected by the liquidity ratio
requirements of the
Registrar of Insurance. According to Messrs Morris, Newman and McAlpine the
portfolio was managed conservatively
in the belief that it was akin to an
investment trust. Such disposals as there were during the period from 1976 to
the end of 1980
constituted (i) "cleaning up" of counters considered unsuitable
for an investment portfolio, (ii) strategic disposals where profit-taking
had
played no part and (iii) isolated sales, more often than not at a loss, of
relatively small parcels of shares whose dividend
yield had been or was
anticipated to become inadequate. The acquisitions during that five year period
were made with a view to compiling
a portfolio which would yield a long-term and
ever-increasing dividend income. The evidence, far from establishing acceptance
on
the part of GASA that it was a sharedealer and conducted its
37. affairs
in accordance with such acceptance, manifested a reluctant acquiescence in the
"all-in" approach adopted by the revenue
authorities, believing it to be wrong
but not considering it worth the candle to make it an issue. In this regard Mr
Morris pointed
out that the profits assessed to tax prior to the merger (and in
respect of which the revenue could not be persuaded that the disposals
in
question had been strategic) were relatively minor and largely off-set by losses
sustained on other disposals. On the evidence,
therefore, the first point argued
on behalf of the Commissioner cannot prevail. GASA neither accepted that it was
a sharedealer nor
did it manage the portfolio accordingly.
The second point,
i e that no real change of intention nor of manner of administration was brought
about by the merger, can be accepted
as substantially valid. Once it is accepted
that GASA's intention prior to the merger had been to hold and administer
the
38. portfolio as a capital base, the change in its circumstances
consequent upon the merger, however fundamental it may have been,
could not have
motivated a crucial change of intention with regard to its investment portfolio.
That was the dilemma faced by each
of the three witnesses in their testimony.
Upon a proper analysis of the history of the portfolio and giving due weight to
the board
resolutions quoted above, it becomes clear though that the dilemma was
more apparent than real. Although there was no true change
of intention, the
changed circumstances of GASA brought about by the merger, whereby it was
reduced to the status of a shareholding
conduit for its parent company, GNIC,
did
result in some change vis-á-vis the investment portfolio. Once
the insurance business had been shed, the "all-in" approach
of the revenue
authorities could be resisted with greater justification than before. The board
of directors of GNIC could then decide,
as it did on 19 November 1982,
39. that GASA should operate as an investment trust and the latter's board
could adopt the formal resolution of 11 May 1983 putting
on record its intention
to "retain its investment portfolio as a long-term investment and for the
purpose of deriving investment
income for the benefit of the
company."
Pursuant to the change in GASA's status and business LIBAM could be
instructed, as indeed it was, to adopt the self same cautious
and conservative
policy with regard to GASA's portfolio as was applied to the other investment
trust portfolios it managed. The result
of the change brought about by the
merger was therefore not so much a change of intention but rather a
strengthening of the resolve
of the directors, backed by the changed
circumstances which lent force to their resolve. Concomitantly the
administration of the
portfolio, as Mr McAlpine put it, went "from probably
passive to extremely passive". Although the portfolio had at all times been
administered as a capital base
40. with a vlew to the production of dividend
income, great care was taken after the merger to restrict disposals of counters
to the
minimum so as to avoid any suggestion of sharedealing. Whereas pre-merger
the portfolio had been managed as a capital base, the post-merger
administration
was directed at ensuring that it was manifestly seen to be such.
The argument
based on the use of the phrase "for the time being" by Mr Gordon at the GNIC
direc-tors' meeting on 19 November 1982,
should be viewed in its contextual
matrix. At that stage GASA had for more than two years been a whólly
owned subsidiary of
GNIC, it had withdrawn from the short-term insurance
business from the beginning of 1981 and all of its outstanding obligations had
been discharged by GNIC early in 1982. The fixed interest securities in the GASA
portfolio had been transferred to GNIC at book value
and, had it not been for
fiscal impediments, the rest of the portfolio would have been transferred
likewise. A tax expert had
41. been consulted about ways of overcoming such
impediments and had furnished a gloomy prognosis. LIBAM had been instructed to
manage
the GASA equity portfolio manifestly as a long-term investment for the
deriving of dividend income and had acted in accordance with
such mandate.
Nevertheless the board members of GNIC and GASA were left in the quandary that
the transfer of the portfolio from the
one company to the other, which they had
desired to effect from the outset as part and parcel of the merger, could not be
undertaken
without incurring the risk of a heavy tax burden. In those
circumstances the use of the phrase in question was probably intended
to convey,
as the court a
quo
held, an intention to mark time. In other words,
pending a satisfactory way out of the quandary, the GASA equity portfolio was to
be held and administered as a dividend-producing capital base. In that context
the words used were apposite. They aptly describe
the state of mind of Mr
Gordon: if and when
42.
the fiscal impediments to transfer of the portfolio could be overcome GASA
would be divested of the portfolio. During the indefinite
intervening period the
portfolio would be held in GASA. Upon a proper interpretation, therefore, the
phrase does not denote any uncertainty
or mixed intentions regarding thê
purpose for which the portfolio would be held and administered but accurately
reflected the
uncertainty as to the identity of the holder of the portfolio in
the future.
The contention that the sales of shares during 1982, 1983 and
1984 evidence an appreciation on the part of GASA that the management
of its
portfolio of necessity involved some sharedealing, finds no support in the
proven facts. On the contrary, the very paucity
of disposals during the years
under review lends support to the evidence of Messrs Newman and McAlpine that,
not only had there been
no contemplation of sales with a view to profit-taking,
but that there
43.
had been an acute awareness that ány suspicion of such contemplation
should be avoided. Indeed the evidence establishes that
there were occasions
when counters could. have been sold profitably and where such dis-posals were in
accordance with the sound administration
of a long-term dividend yielding
investment portfolio but where the opportunity was foregone in order to avoid
any semblance of sharedealing.
Faced with such cogent evidence of the
intention of the particular taxpayer in question, counsel for the Commissioner
submitted as
a general proposition that it was inherent in the management of any
share portfolio that a measure of sharedealing for profit would
be involved.
Shares, so the argument ran, are, by their very nature, risk investments which
have to be reviewed from time to time.
A portfolio comprising a number and
variety of counters will therefore necessitate continuous review and adjustment
as and when reguired.
Consequently an investor in
44
shares has of necessity to deal in such shares and a
simple intention to hold such shares indefinitely or
for a long time can make no difference. Unless and
until the shares are
made part of the permanent
structure of the investor on which its business
rests
and the shares are in effect taken out of its business
they remain
part of its floating capital. The argument
rested principally on the
well-known passage in the
judgment of Schreiner JA in
Commissioner for
Inland
Revenue v Richmond Estates (Pty) Ltd
1956 (1) SA 602A
at
610C to 611B. That passage reads as follows:
"One must not lose sight of the true nature of the inquiry in cases of this
kind. There is no legislative provision that makes the
intention of the taxpayer
decisive of whether the receipt or accrual was of a capital nature or not. The
decisions of this Court
have recognised the importance of the intention with
which property was acquired and have taken account of the possibility that a
change of intention or policy may also affect the result. But they have not laid
down that a change of policy or intention by itself
effects a change in the
character of the assets. The test has been variously expressed but it is enough
to say that the
45.
profits of a company's business activities are generally speaking part of its
income. Where, as here, a company is formed to carry
on land-jobbing and
land-letting, these are simply alternative methods of using the company's money
to make a business profit, each
method having advantages over the other
according to circumstances. This was pointed out in
L.H.C. Corporation of
S.A. (Pty.) Ltd. v. Commissioner for Inland Revenue
,
1950 (4) S.A. 640
(A.D.) at p. 646. There the company's money was used to buy shares, but for
present purposes there is no difference between shares
and land. The case was
decided on the principle that where a company is a share-dealing or land-dealing
company and has among its
objects both dealing and holding, a profit made on the
realisation of shares or land acquired for its business will ordinarily be
income profit. It was assumed at p. 646 E that in exceptional cases, this might
not be so. But the exceptional cases, assuming them
to exist, are not brought
into existence simply by an intention to hold the asset indefinitely or for a
long time; they would be
cases where property has beén made part of the
permanent structure of the company, on which its business rests; such property
would in effect be taken out of the field of the company's business, where
decisions are made from time to time on how best to make
a profit. In contrast
with such properties, which might be said
to be
truly
fixed capital, is property which the company would use in its business
operations, which it would deal with or hold as thé
prospects of
profitable user dictated that would be its
46.
floating capital.
In the case of a company having objects like those of the respondent company it
would seem natural to review the policy in regard
to the company's property as a
whole, or as to sections of it, or as to individual lots, at reasonable
intervals, in order to decide
whether to sell or to hold. Changes of policy
might be frequent or rare according to circumstances, and might affect few, many
or
all of the properties. It seems to me to be wrong and, indeed, practically
impossible to treat such changes of policy as operating
alterations in the
character as capital of the properties
affected."
It is clear from the
passage quoted that the
taxpayer under discussion was a company which had been
formed to carry on
both land-jobbing and land-letting
as alternative methods of employing its
funds to make a
business profit as circumstances dictated. In the
L H C
Corporation
case referred to the taxpayer was a
company which had among
its objects both sharedealing
and shareholding in respect of which there can
be no
doubt that its profits derived from sharedealing would
be taxable as
income. Neither case is authority for
the proposition that a genuine investor
in long-term
47. dividend-producing shares is obliged to hold on to each and
every counter in his portfolio irrespective of the fortunes - or possible
demise
- of the companies concerned or run the risk of being taxed as a sharedealer.
Indeed both cases are based on the hypothesis
that there is a distinction
between a share investor and a sharedealer and both taxpayers were found to have
been an amalgam, using
their investments as both an income-producing capital
base and at the same time as stock-in-trade for sale at a profit. Therefore,
as
Schreiner JA made clear, as the profits made by a company are generally speaking
part of its income, profits derived from the
sale of assets held as both capital
and stock-in-trade are taxable. But nothing in the reasoning of the learned
judge can be regarded
as authority for the broad proposition that the management
of a wide and varied share investment portfolio, irrespective of the care
and
long-term investment intention with which it had been compiled,
48. causes it
to be regarded as floating capital. In the instant case the evidence is clear.
Proposed investments were painstakingly
investigated with a view to ascertaining
their long-term yield potential and the likelihood of growth in such yield.
Counters were
not acquired with a view to disposal at a profit and several
profitable opportunities that did present themselves were declined.
The
investment portfolio, or at least the equity share component thereof, was not
acquired with a view to possible sharedealing as
an al-ternative to holding for
dividend earnings. There was a meticulous and protracted investigation
procedure, which on the evidence
was invariably followed, whereby GASA
endeavoured to ensure a stable investment in coun-ters which would produce
satisfactory and
increasing dividend yields indefinitely and would not be sold.
The mere fact that such investments were made in the share capital
of trading
companies whose fortunes could not be predicted with absolute certitude did not
render
49. them risk investments. Likewise continuous monitoring of the portfolio by
LIBAM in the performance of its stewardship mandate
on behalf of the GASA
shareholders did not serve to cónvert what had been compiled as a capital
base for the production of
fruits into a pool of floating capital. Neither in
law nor in logic can dogged adherence to a counter or carelessness in the
management
of a share portfolio be posited as pre-requisites for qualification
as a capital investor. Prudence and foresight cannot be eguated
with an
intention to speculate.
The last proposition advanced on behalf of the
Commissioner sought to find support in the judgment of Steyn CJ in the case of
African Life Investment Corporation (Proprietary) Limited v Secretary for
Inland Revenue
1969 (4) SA 259
(A), more especially at 269G to 270A and
271C-F. Indeed the very language used by counsel echoes the words of the learned
Chief Justice
in the passages cited. The first passage reads
50.
as follows:
"As far back as in
Commissioner of Taxes v. Booysen's Estates Ltd
.,
1918
A.D. 576
at p. 602 and 604, it was pointed out that, whatever the primary
objects of a company may be, it is quite possible that it may derive
income in
the ordinary course of business from carrying out its secondary objects. Where
the sale of shares held as an investment
is in fact contemplated as an
alternative method of dealing with them for the purpose of making a profit out
of them, or, in the
case of a company, where it is one of the 'appointed means
of the company's gains' (cf.
Overseas Trust Corporation Ltd. v. Commissioner
for Inland Revenue
,
1926 A.D. 444
at p. 456 i.f.;
L.H.C. Corporation of
S.A. (Pty.) Ltd. v. Commissioner for Inland Revenue
,
1950 (4) S.A. 640
(A.D.) at p. 646), it can make no difference, I consider, that it is a secondary
or subsidiary purpose of their acquisition. It would
nevertheless be part of the
business operations contemplated for the production of income, and the profit
gained would be 'revenue
derived from capital productively employed'. In such a
case it could not be said that the pursuit of an overriding main objective
of
securing a dividend income merely provides the occasion for what is no more than
a purely incidental change of investment, even
though it be a profitable one.
There would be no absolving dominant purpose."
In
the second passage cited the learned Chief Justice,
51.
in response to an argument "that the manner in which
purchases and sales
were conducted is fully accounted
for by the requirements of an active
investment policy
directed at ensuring and preserving a durable yield
of
dividends at the best general level", made the
following
observations:
"It must be conceded, I think, that, whether or not the appellant set out to
deal in shares for profit, the varying of its many risk
investments would be an
inherent feature of its activities. It may be that such variations, however
gainful, need not in themselves,
in the case of an investment company,
necessarily lead to the conclusion that resultánt profits are to be
regarded as income.
On the other hand it might also be said that, because an
investment company has of necessity, as dictated by the nature of its assets,
to
deal in shares, and knows in advance that it will have to do so, such variations
are an essential feature of its business, that
the profits therefrom arise in
the ordinary course thereof, and that they should accordingly be regarded as
part of its contemplated
income. On that approach, the shares might not
inappropriately be dêscribed as
property
'which the company would use in its business operations, which it would deal
with or hold as the prospects of profitable user dictated;
that would
be
52.
its floating capital'. (
Commissioner for Inland Revenue v. Richmond
Estates (Pty.) Ltd
.,
1956 (1) S.A. 602
(A.D.) at p. 610 i.f.)."
The argument advanced on behalf of the Commissioner is
unsound and the authority sought to be invoked in
support thereof does not avail. The essential question
in a case like this is a factual one:
"The question whether any amount received by a taxpayer is a capital or
revenue accrual for the purpose of the definition of 'gross
income' in the
Income Tax Act is essentially a question to be decided upon the facts of each
case."
(Per Botha JA in
Secretary for Inland Revenue v Trust
Bank of Africa Ltd
1975 (2) SA 652
(A) at 671B.) A
variety of circumstances come into play, e g the nature
of the investment asset, the character of the investor,
the intention with which the asset had been acquired,
any change in such intention and the circumstances
surrounding disposals.
And it is inherent in the very
nature of the exercise that no single circumstance can
be elevated to decisive pre-eminence. Thus Schreiner
53. JA pointed out in
the
Richmond Estates
case,
supra
, that although the intention with
which property was acquired and a subsequent change in such intention are
important criteria, they
cannot by themselves change the character of the assets
and the nature of the profits derived from any sale thereof. What Steyn CJ
was
at pains to explain in the
African Life
case
supra
, was that not
even a main purpose would necessarily be decisive. It was in this context that
the learned Chief Justice, in the second
passage cited above, distinguished
between a dominant intention where incidental profits would not attract
liability for tax and
a main purpose aimed at dividend income but accompanied by
an additional, albeit subsidiary, purpose intended to yield a profit.
The
distinction is a subtle one and is to be made upon a conspectus of the relevant
facts. There is no simple and universally valid
litmus test, the decision
whether particular income falls on the one side of the ill-defined
54. borderline between capital and revenue or on the other being "a matter of
degree depending on the circumstances of the case".
When the circumstances of
the instant case are evaluated in accordance with the principles thus
enunciated, the conclusion is readily
apparent. GASA did not set out to
establish its portfolio with mixed intentions. Acquisitions were made solely
from shareholders'
funds; no need was envisaged to draw on such funds to
supplement the business requirements of the short-term insurance activities,
nor
did any eventuate; the portfolio was intended to be a nest-egg consisting of
sound investments to be held indefinitely with a
view to the production of a
steady and ever-increasing dividend income; from 1974 to 1978 McAlpine saw to it
that the portfolio was
suitably composed to meet such objectives; thereafter and
more especially once GASA had ceased any insurance business activities
the
portfolio was managed predominantly if not solely
55.
as a capital investment for the production of dividend income; such purpose
was in accordance with the interests ahd long-term plans
of the holding company,
GNIC, which were recorded in the minutes of the board of directors of GNIC and
formally minuted by GASA's
board. Lastly and most significantly the intention
was made manifest by the way in which the portfolio was actually managed over
a
period of many years. Indeed the only circumstance that could possibly be said
to support the argument on behalf of the Commissioner
that there had been a
concomitant intention to deal in shares for profit is the fact that the assets
acquired were shares in trading
companies. As pointed out above, that
circumstance, seen in isolation, could hardly warrant the inference sought to be
advanced.
When it is evaluated in the context of the numerous and weighty
considerations pointing in the opposite direction, it pales into
insignificance.
The assets comprising the portfolio constituted capital and the
56. profits derived from disposals thereof constituted receipts of a capital
nature within the definition of "gross income" in s 1
of the Act. It follows
that the court a
quo
correctly set aside the assessments of GASA to
normal tax for the years of assessment ended 31 December 1982, 31 December 1983
and
31 December 1984 and ordered re-assessment on the basis that the amounts of
R358 132, R2 294 858 and R463 855 respectively were to
be excluded from GASA's
income for the relevant years of assessment.
The appeal is dismissed with costs, including the costs consequent upon the
employment of two counsel.
KRIEGLER AJA
CORBETT CJ
NESTADT JA
KUMLEBEN JA
CONCUR
PREISS AJA