IN THE SUPREME COURT OF APPEAL OF SOUTH AFRICA
REPORTABLE
Case no: 358/02
In the matter between
THE COMMISSIONER FOR THE SOUTH
AFRICAN REVENUE SERVICE APPELLANT
and
SA SILICONE PRODUCTS (PTY) LTD RESPONDENT
Coram: HOWIE P, MARAIS, ZULMAN, CLOETE and HEHER JJA
Heard: 16 FEBRUARY 2004
Delivered: 5 MARCH 2004
Summary: Income Tax – Act 58 of 1962 s 11 (gA)(iii) – whether licence to use
trade marks ‘property similar in nature’ to trade mark – whether conclusion of
licence agreement ‘acquisition’ of such property.
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JUDGMENT
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2
H E H E R J A
HEHER JA:
[1] This is an appeal direct from the Income Tax Special Court (presided over by
De Klerk J) sitting at Pretoria. The issue is whether an amount of R14,5 million
claimed by the respondent as a deductible allowance in terms of s 11 (gA)(iii) of the
Income Tax Act 58 of 1962 in its return for the 1995 financial year was improperly
disallowed by the appellant.
[2] From about 1988 DB Silicones CC (“DBS”) carried on a small but successful
business marketing silicone products under licence from Dow Corning Corporation of
Michigan.
[3] The respondent is a subsidiary of a major participant in the South African
chemicals industry. During late 1994 it negotiated for the acquisition of the business
of DBS. At an advanced stage it instru cted a trade mark attorney, Mr Derek
Momberg, to ascertain whether there was an intellectual property component in a
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proposed purchase and, if so, to value it wi th a view to claiming the tax benefits
which might flow from an agreement of sale structured with regard to the provisions
of s 11(f) or 11 (gA)(iii) of the Act. T hose sections provided as follows at the
relevant time:
‘11 General deductions allowed in determination of taxable income
For the purpose of determining the taxable income derived by any person from carrying on
any trade within the Republic, there shall be allowed as deductions from the income of such
person so derived-
. . .
(f) an allowance in respect of any premium or consideration in the nature of a premium
paid by a taxpayer for-
. . .
(iii) the right of use of any patent as defined in the Patents Act, 1978 (Act 57 of
1978), or any design as defined in the Designs Act, 1967 (Act 57 of 1967),
or any trade mark as defined in the Trade Marks Act, 1963 (Act 62 of 1963),
or any copyright as defined in the Copyright Act, 1978 (Act 98 of 1978), or
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of any other property which is of a si milar nature, if such patent, design,
trade mark, copyright or other property is used for the production of income
or income is derived therefrom; or
(iv) the imparting of or the undertaking to impart any knowledge directly or
indirectly connected with the use of such film, sound recording, advertising
matter, patent, design, trade mark, copyright or other property as aforesaid:
Provided that-
. . .
(dd) the provisions of this paragraph sha ll not apply in relation to any such
premium or consideration paid by the taxpayer which does not for the
purposes of this Act constitute income of the person to whom it is paid,
unless such premium or consideration is paid under a written agreement
formally and finally signed before 10 April 1984 by every party to the
agreement;
. . .
(gA) an allowance in respect of any expe nditure (other than expenditure which has
qualified in whole or part for deduction or allowance under any of the other provisions of
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this section or the corresponding provisions of any previous Income Tax Act) actually
incurred by the taxpayer-
(i) in devising or developing any invention as defined in the Patents Act, 1978 (Act 57
of 1978), or in creating or producing any design as defined in the Designs Act, 1967
(Act 57 of 1967), or any trade mark as defined in the Trade Marks Act, 1963 (Act 62
of 1963), or any copyright as defined in the Copyright Act, 1978 (Act 98 of 1978),
or any other property which is of a similar nature; or
(ii) in obtaining any patent or the restoration of any patent under the Patents Act, 1952,
or the registration of any design under the Designs Act, 1967, or the registration of
any trade mark under the Trade Marks Act, 1963; or
(iii) in acquiring by assignment from any other person any such patent, design, trade
mark or copyright or in acquiring any ot her property of a similar nature or any
knowledge connected with the use of such patent, design, trade mark, copyright or
other property or the right to have such knowledge imparted,
if such invention, patent, design, trade mark, copyright, other property or knowledge, as the
case may be, is used by the taxpayer in the production of his income or income is derived by
him therefrom: Provided that-
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(aa) where such expenditure exceeds two hundred rand the allowance shall not exceed
for any one year such portion of the amount of the expenditure as is equal to such amount
divided by the number of years which, in the opinion of the Commissioner, represents the
probable duration of use of the invention, patent, design, trade mark, copyright, other
property or knowledge, or one twenty-fifth of the said amount, whichever is the greater;. . .’
[4] In February 1995 the re spondent received a written opinion from Momberg. He
advised that the value of the business lay principally in the product franchise which
DBS enjoyed and which was composed of two major elements: first, the Dow
Corning products denoted by its trade marks and the right to repackage and sell under
the trade marks, and, second, the distribution network established by DBS which was
embodied in distribution agreements wi th sub-distributors and confidential
information and copyright material in th e form of customer lists, customer
consumption patterns and product application know-how. (This second element was
referred to throughout the proceedings as ‘the customer connection’.) Momberg
regarded both these elements as intellectual property.
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[5] Momberg noted that-
‘DB Silicones does not own the Dow Corning trade marks, but rather enjoys certain transferable
rights. We understand that to date its user right has not been formalised, but that steps are being
taken to record and render transferable the rights it has exercised to date and that the trade mark
user agreement will provide inter alia that:
6.4.1 DB Silicone’s (sic) exclusive right to use the Dow Corning trade marks in its repackaging
and distribution business since 1 July 1988 will continue for a period of 5 years; and
6.4.2 That (sic) such right entitles DB Silicones to transfer it to a third party, acceptable to Dow
Corning, to whom it may wish to sell its business. As such Chemserve [respondent’s
holding company] will acquire a 5 year user right to the Dow Corning trade marks.’
[6] Momberg made certain suggestions wh ich, he advised, would conduce to
bringing the agreements to be concluded wi thin the terms of one or other of the
aforementioned sections of the Act. In the result his suggestions were not
implemented and, as will be seen, his assumptions as to the content of the agreements
proved unwarranted in material respects. Although he was of the opinion that the
trade mark rights alone were worth R10,27 million, Momberg advised the respondent
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that, for valuation purposes, the customer connection could not practically be
separated from the trade mark licence. He placed a market value of R14,87 million on
the total intellectual property which the respondent was to acquire from DBS. Late in
February 1995, however, following discussions with his client, consideration was
given to valuing separately the trade mark licence and the customer list with the
copyright in it. Not until shortly before the hearing in the Court a quo was Momberg
instructed to prepare a revised valuation. He then valued the trade mark rights and the
customer connection at R7,61 million each. He justified his valuation of the customer
connection in the following words:
‘There appears to be a basis for significantly increasing the value of the customer list relative to the
trademark licence – on the grounds inter alia that possession of it –
- will put Chemical Services into a strate gically sound position to continue in the
silicone market, using a competitive source of supply (e g GE or Wacher) were Dow
Corning to terminate the trade mark licence and distributorship; and
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- by the same token, will provide Chemical Services with not insignificant leverage
to dissuade Dow Corning from any pr ecipitous termination should it wish
unilaterally to re-invest in this country.’
It is clear that these conclusions were founded on an assumption that the respondent
had acquired the customer connection generated by the trade marks from DBS, giving
rise to what he described in evidence as ‘a proprietary conflict between the trade mark
owner and the distributor in the vital element of goodwill under the trade mark’ and
‘a different proprietorship in the two incidents’. As will become clear, this was an
erroneous assumption.
[7] On 20 February 1995 DBS sold its business to the respondent as a going
concern. The elements of the purchase pr ice were R183 000,00 in respect of fixed
assets, stock dependent on a valuation, R14,5 million for the trade mark rights and
R650 000,00 in respect of goodwill. The ag reement made no reference to the
‘customer connection’ or any of its elements.
[8] ‘[T]he sole assets’ were defined as ‘the fixed assets, the stock, the name “DB
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Silicones” and the trade mark rights’.
‘[T]he trade mark rights’ were defined as
‘the rights of the seller to use the trade marks in respect of the business in terms of the trade mark
licence agreement’.
A copy of the trade mark licence agreement between Dow Corning and DBS was
annexed to the Sale of Business Agreement. It was undated. The evidence suggests
that it was concluded in late 1994 or early 1995 although it was made effective from 1
July 1988.
The ‘goodwill’ was not the subject of definition.
[9] On 27 February 1995 Dow Corning consented to the assignment of the trade
mark licence agreement to the respondent, ‘subject to all rights and obligations
contained in said Trademark License’.
[10] The trade mark licence agreement cont ained several (unnumbered) clauses
which have a bearing on the decision of this appeal:
‘Article II Ownership
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All use of the trademarks by Licensee shall inure to the benefit of Licensor.
The ownership of the Trademarks, and the goodwill relating thereto, shall always remain vested in
Dow Corning, both during the period of this Agreement and thereafter.
Licensee shall never challenge, contest or call in to question the validity or ownership of the
Trademarks or any registrations of the trademarks.
Article III Grant of Rights and Conditions Regulations Use (sic)
Dow Corning hereby grants to Licensee a non a ssignable and non-exclusive right to use the
Trademarks in the Territory.
Licensee shall limit its use of the Trademarks to the products listed in Exhibit A, which are packed
by Licensee for resale.
. . . . . .
Licensor shall have the exclusive right to file ac tions and receive awards for infringement of its
Trademarks.
. . . . . .
Article IV Term of the Agreement
Unless terminated earlier under Article VII herein, this Agreement shall be effective on the date
first set forth above and shall terminate on 31 December 1994 with the understanding that this term
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will be automatically extended from year to year thereafter unless the Agreement is terminated by
either party to this agreement by a sixty (60) day prior written notice to the other party.
. . . . . .
Article V Assignment and Sub-Licences
Licensee shall not transfer or assign this Agreement. Licensee shall not allow any third party to use
the Trademarks, without the express written consent of Licensor.
Article VI Reservation of Rights
Dow Corning expressly reserves the right to use the Trademarks and also reserves the right to grant
to others the right to use the Trademarks in the Territory.’
[11] On 1 March 1995 Dow Corning and the respondent concluded a distributor
agreement valid for five years from that date. Clause 11 provided that the use of the
trade marks would be governed by the trade mark licence.
[12] On 23 June 1995 a deed of cession and assignment was c oncluded between
DBS and the respondent in respect of all the former’s rights under the trade mark
licence agreement for a consideration of R14,5 million it being agreed further ‘that the
assignment includes an assignment of the whole of the goodwill of the business of the Assignor in
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relation to the said agreement [the trade mark license agreement]’.
[13] When the respondent submitted its tax return for the 1995 year it included a
deduction for the allowance provided for in s 11 (gA)(iii) of the Act. The appellant
disallowed the deduction. The respondent appealed to the Income Tax Special Court.
[14] The Special Court heard Mr Engelbrecht, managing director of the
respondent’s holding company, who was not a signatory to any of the agreements. His
evidence was of no assistance in resolving the disputes. Momberg also testified. His
evidence was largely of interest in relation to the valuation but it also highlighted
once more his misconception in relation to the acquisition of the customer connection
by the respondent. He testified:
‘There are very, very many silicone products and applications all requiring, from a sales point of
view, specific knowledge of the requirements of the particular industry and the specific custom and
my analysis of that information was that that was crucial to being able to access the market and it
prompted the question – were Dow Corning to terminate the license, whoever owned that business
and had this customer connection, the real customer connection could then approach another
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supplier – and there are many in the world – although Dow Corning is the leader – and substitute
those products and virtually keep the turnover going. So, it is against that general background I saw
that there was a scope to independently value the customer connection as held by D B Silicones
because it wasn’t proprietary to Dow Corning, it was held by D B Silicones. Although the two were
linked in the total product franchise there was actually a proprietary conflict between the trade mark
owner and the distributor in the vital element of the goodwill under the trade mark.’
(My emphasis.)
[15] It is clear from this passage that Momberg continued to believe that although
the customer connection had been developed in consequence of the use by DBS of the
trade marks, the ownership in the connection resided in DBS and could therefore be
transferred by DBS to the re spondent. But this belief was irreconcilable with the
terms of the trade mark licence agreement: DBS did not acquire the customer
connection built up through the use of the trade marks and could not have transferred
it to the respondent.
[16] The Court a quo decided that the respondent had been entitled to the allowance
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for expenditure of R14,5 million incurred in purchasing the business: the sale assets
included the trade mark licence and the customer connection was to be found in the
‘basket’ of rights which necessarily accompanied the licence. The trade mark licence,
the learned President said, was property sim ilar in nature to the trade mark itself
‘although leaner, truncated and abbrevia ted’, and the know-h ow and knowledge
associated with the market for the pr oduct identified by the trade mark was
‘connected with the use of the trade mark and also in the present case, with the lesser
“other property of a similar nature” i e the trade mark licence, as meant in section 11
(gA)’. Further, so the Court found, the respondent ‘bought that knowledge from DB
Silicones and bought “the right to have such knowledge imparted” as meant in s 11
(gA).’
[17] Before this Court the respondent mainta ined its stance that the ‘trade mark
rights’ included the licence and the customer connection and that it had paid R14,5
million for those rights.
[18] To qualify for the allowance under s 11 (gA) the property, on the acquisition of
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which a taxpayer spends money, must be a patent, design, trade mark or copyright
or ‘any other property of a similar nature’. The respondent’s counsel submitted that
the trade mark licence was property similar in nature to a trademark. The expression,
properly interpreted, requires, in my view, that any property which is similar in nature
shall possess fundamental characteristics common to those possessed by the
specifically identified properties; minor or superficial similarities will not of
themselves suffice. This narrow interpretation is consistent with the manifest
intention behind the creation of the allowance, viz the stimulation of investment in
intellectual property which is commerciall y productive and likely to provide an
enduring economic advantage to the Republic. The common natures of the identified
properties, in the sense which I have discussed, embrace their intellectual origins, ie
their derivation from a creative mind, their potential for commercial exploitation, the
fact that the law regards such exploitation as creating a justifiable monopoly which is
available only to the creator of the property or persons to whom the creator transfers
his rights according to law and that the law accords the rights and protection of
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ownership to such property. (That the recognition is accorded by statute rather than
by common law does not seem to me to be of importance. Nor does it detract from the
monopolistic character of a right that its owner may, if so minded, choose to license
more than one person to use it.)
[19] By the test of the statute the licence acquired by the respondent does not
qualify for the allowance under s 11 (gA): it is not ‘property similar in nature’ to a
trade mark. The licence is not intellectual property. It is merely the grant of a
temporary right of use, conferring no m onopoly in the hands of the licensee and
neither proprietary interest nor the protection accorded by law to such an interest. The
limited duration, absence of a power in the respondent to dispose of its interest in the
licence, the inability of the respondent to restrict the use of the use of the marks by
Dow Corning or others or to defend itself or act against infringers are such material
deviations from the essential natures of the identified properties that the limited
power of exploitation of the marks which the licence confers is quite insufficient to
justify the description of the licence as ‘similar in nature’. The learned Judge a quo
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said:
‘For commercial purposes the protected trading operations of the licencee in the permitted territory
in dealing under the banner of the trademark are for all practical purposes identical to that of the
holder in the areas where the holder trades.’
Even if that is a correct statement (which I would question having regard inter alia to
the non-exclusive nature of the licence a nd the limitation on the use of the trade
marks to specified products), it does not a ddress similarity or dissimilarity in the
nature of the properties (the licence and the trade marks) but only the consequences
of possessing the right to use each of them.
[20] Inherent in what I have said is a recognition that the acquisition of intellectual
property which s 11 (gA) requires as the fi rst step towards the right to claim the
allowance is an acquisition of a proprietary interest in such property. In this regard
the comparison of s 11(f)(iii) and 11 (gA) ill ustrates that the former provides tax
relief appropriate to a right of use of in tellectual property. See in this regard the
reasoning in ITC 353 (1936) 9 SATC 82 at 83-4 and ITC 613 (1945) 14 SATC 389 at
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392. As the trade mark licence conferred only a right of use and did not transfer a
proprietary interest, the respondent’s reliance on s 11 (gA) was misplaced for this
reason also.
[21] The submission that the customer connection formed part of the substance of
the trade mark rights for which the respondent paid R14,5 million is untenable. The
customer connection relating to the trade mark rights was, as I have concluded earlier,
not an asset in the hands of DBS which it had the right to dispose of. That, of course,
does not mean that DBS could not have purported to sell it nor prevent the
respondent, believing that DBS was selling the customer connection, from acquiring
it: Frye’s (Pty) Ltd v Ries 1957 (3) SA 575 (A) at 581A-E. That, however, is an
unusual situation which would require clear evidence to sustain a finding that that is
what occurred in this case. The evidence is to the cont rary. The Sale of Business
agreement contains no reference to the customer connection as a specific item of the
business for which payment was made. Howe ver, the sale was of a business as a
going concern and it is logical that the customer connection went with it. There were
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two possible sources for such a connection, - derived from the use of the trademark
or built up independently of the trademark. In the latter regard it is significant that the
respondent paid separately for the goodwill and the trade mark rights. The usual
meaning of ‘goodwill’ is ‘the possession of a ready-formed connection of customers considered
as a separate element in the saleable value of a business’ (Shorter OED 871). The trade mark
licence agreement excludes the possibility of the transfer of goodwill in the trade
marks. Such indications as there are in the Sale of Bu siness agreement, therefore,
point unequivocally to an intention from th e side of both parties that the goodwill
payment was to be made for the customer connection which did not derive from the
trade marks. Indeed the respondent did not lead evidence of a contrary intention held
by any representative of the respondent who was privy to the conclusion of the sale.
Instead it relied on an inference to be drawn from the fact that the sale was concluded
after advice had been taken from Momber g in which he treated the customer
connection as an asset which the buyer would acquire by virtue of the sale linked to
the subsequently acquired right to use the trade marks. For the reasons given earlier it
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appears that Momberg’s advice was more honoured in the breach than in the
observance. The best evidence of the respondent’s intention remains the terms of the
agreement which it concluded. It is true that more than three months after the sale of
the business, in the deed of assignment of the trade mark rights, DBS and respondent
purported to ‘confirm and agree that th e assignment as aforesaid includes an
assignment of the whole of the goodwill of the business of the assignor in relation to
the said agreement’, and stipulated that ‘In pursuan ce of the said agreement
[presumably the trade mark licence agreement referred to in the preamble] and for a
consideration of R14 500 000,00’ DBS ceded, assigned and transf erred all of its
rights under the trade mark licence agreement. I do not consider that much weight can
be given to this document as a statement of the parties’ intentions on 20 February
1995 when the agreement of sale was conc luded. The obligation to pay the R14,5
million had already been incurred as an element of the purchase price of the business.
The ‘confirmation’ that the assignment included the whole of the business in relation
to the trade mark licence agreement was only necessary because that intention was
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not apparent from the Sale of Business agreement. If the respondent intended to
acquire rights not already covered by the sa le agreement it had no intention to pay
anything extra for those rights. But the res pondent must at all relevant times been
aware of the content of the licence agreement. Consequently the purported
assignment was, at worst, a charade which added nothing to the sale agreement, or, at
best, a bona fide purported rectification of the agreement which was objectively
ineffective in law to transform the agr eement into something other than what it
originally was.
[22] The consequence is that the Court a quo erred in concluding that any part of the
expenditure of R14,5 million was devoted to the acquisition of property which fell
within the purview of s 11(gA). It fo llows that the deduction claimed by the
respondent was correctly disallowed by the appellant.
[23] The appellant submitted that the appor tionment of R14,5 million to the trade
mark rights in the Sale of Business agreement was a sham because
(a) a trade mark licence was unnecessa ry for the business of purchase,
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repacking and resale carried on by DBS and the respondent;
(b) the licence agreement was only concluded seven years after DBS
commenced selling Dow Corning products and at a time when DBS was
negotiating with respondent for the purchase of its business;
(c) DBS paid nothing for the licence ye t the parties thought R14,5 million
an appropriate price for its rights three months later;
(d) the really valuable asset of the DBS business was the distribution
agreement with Dow Corning, to wh ich no part of the purchase price
was attributed.
This is an attractive submission but because of my earlier conclusions it is
unnecessary to decide it.
[24] The appeal is upheld with the costs of two counsel. The judgment of the
Special Court is set aside and the assessment is restored.
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__________________
J A H E H E R
J U D G E O F A P P E A L
HOWIE P )Concur
MARAIS JA )
ZULMAN JA )
CLOETE JA:
[25] I have had the benefit of reading th e judgment of my brother Heher. I agree
with the order proposed, but I consider that this result can be achieved by a
consideration of the facts alone. In my respectful view it is unnecessary to embark on
an interpretation of s 11(gA)(iii) of the Income Tax Act and I would prefer not to do
so.
[26] Two fundamental submissions were ma de on behalf of the respondent in this
Court. One was that information relating to the customer network of the seller, DB
Silicones CC, was an asset sold in terms of the sale of busine ss agreement to the
respondent taxpayer; and that the amount of R14,5 million paid to the seller by the
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respondent, or part of that amount, fell under the section as it was paid in respect of
property covered by the phrase ‘any other pr operty of a similar nature’. I shall
assume, without deciding, that both of these propositions are correct. But the problem
which faces the respondent is that the amount of R14,5 million in respect of which the
respondent claims an allowance in terms of the section, was not, to use the words of
the section, ‘expenditure… actually incu rred by the taxpayer… in acquiring’ the
information relating to the customer netw ork of the seller. The amount of R14,5
million was paid for the rights of the seller in terms of the agreement between the
seller and a third party, Dow Corning; and as counsel representing the respondent was
obliged to concede, that agreement did not include information relating to the
customer network of the seller. There is accordingly no factual foundation for the
respondent’s reliance on the section so far as the customer network is concerned.
[27] The other submission ma de on behalf of the respondent was that the amount of
R14,5 million, or part of that amount, was paid for the licence D B Silicones CC had
from Dow Corning to use the Dow Corning trade mark when repackaging products
supplied by Dow Corning. But DB Silicones CC did not have the right to assign that
licence to the respondent or anyone else. The agreement between the seller as licensee
and Dow Corning provided in terms in Article III inter alia that:
‘Dow Corning hereby grants to Licens ee a non-assignable … right to use the
Trademarks ....’
I am content to accept at face value the following evidence of Engelbrecht, the
managing director of the respondent’s holding company:
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‘[W]e believed we needed the licence agreement to sell these trademark ─ to sell
the products with these trademarks in the territory.’
That means that the sale of business agreem ent would not fall foul of s 103 of the
Income Tax Act. But non constat it fell under s 11(gA)(iii). The test is objective, not
subjective; and unless there are facts which show that the amount in respect of which
a deduction is claimed under the section was ‘expenditure … actually incurred by the
taxpayer … in acquiring’ propert y etc., the section is not applicable. In the present
matter, the respondent could not acquire rights the seller did not have and the
subjective belief of one or both of the part ies to the sale of business agreement is
irrelevant.
[28] It is for these reasons that I concur in the order made by my brother Heher.
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T D CLOETE
JUDGE OF APPEAL