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[1994] ZASCA 167
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Berea Park Avenue Properties (Pty) Ltd v Commissioner for Inland Revenue (624/90) [1994] ZASCA 167; 1995 (2) SA 411 (AD); [1995] 1 All SA 422 (A) (23 November 1994)
Case no 624/90
IN THE SUPREME COURT OF SOUTH AFRICA
(APPELLATE DIVISION)
In
the matter between:
BERBA
PA
R
K
AVENUE PROPERTIES (PTY)LTD
Appellant
and
COMMISSIONER FOR INLAND REVENUE
Respondent
CORAM
: JOUBERT, VAN HEERDEN, NESTADT, KUMLEBEN JJA et NICHOLAS
AJA
DATE HEARD
: 22 SEPTEMBER
1994
DATE DELIVERED
: 23 NOVEMBER 1994
J U D G M E N T
NESTADT. JA
:
The respondent disallowed an objection by the
appellant
2
to the inclusion in its income for the year of assessment ended 28
February 1982 of a profit of R836 717,00 which accrued to the appellant
consequent upon the sale of certain of its fixed property. The objection was
based on the contention that the amount was a receipt
of a capital nature and
thus not subject to tax. The appellant's appeal to the Transvaal Income Tax
Special Court against the respondent's
decision was dismissed. The Special Court
held that the amount had rightly been regarded as income. The appellant's
further appeal
to the full court of the Transvaal Provincial Division also
failed. With the leave of the latter court, the appellant now appeals
to this
Court.
The basic facts are not in dispute. In summary they are the following.
The appellant is a private company which was
3
incorporated on 2 May 1974. Its main object was to acquire and develop
property situated in Pretoria. The property in question, namely
a certain vacant
consolidated erf, was acquired soon after the appellant's incorporation. On 21
July 1975 Costa Ellinas and Andrea
Pashiou purchased the shares and loan
accounts of the existing shareholders and were appointed directors of the
appellant. Ellinas
and Pashiou carried on business in Pretoria as building
contractors. This they did through a company called Pace Construction (Pty)
Ltd
("Pace"). It had been incorporated in 1973. Here, too, they each owned half the
issued shares and were directors of the company.
In 1975 the appellant, now
under the control of Ellinas and Pashiou, decided to develop the appellant's
property. An eight storey
block of 45 flats known as Vasella was erected.
The
4
construction work was done by Pace. The building was completed in August
1976. The flats were then let and in this way rental income
was earned. On 29
October 1979 the appellant resolved to take the necessary steps for the approval
of a sectional title development
scheme in respect of Vasella. The sectional
plan was registered on 13 March 1980 in terms of sec 8(3) of the Sectional
Titles Act
66 of 1971. Some five months later, on 6 August 1980 the appellant
sold all the units for the sum of Rl,3m. It is the nature of the
resultant
profit of R836 717,00 which is in issue in this appeal. The appellant's
contention is that the proceeds resulted from the
realisation of a capital asset
and were therefore not taxable. The respondent's attitude on the other hand has
been that the sale
was in pursuance of a profit-making scheme so that the gain
bore the imprint
5
of revenue.
Two factors are of decisive importance in deciding
the
type of problem with which we are faced. They are (i) the
intention
with which the taxpayer acquired the property and (ii)
the
circumstances in which the property was sold
(Malan vs
Kommissaris
van Binnelandse Inkomste
1983(3) SA 1 (A) at
10 B). I commence
with a consideration of the former. The
appellant's intention is to be
determined by examining the state of
mind of Ellinas and Fashion
when they acquired the shares in the
appellant and when, shortly
afterwards, Vasella was erected. At the
time of the hearing before
the Special Court, Fashion's health was
such that he was unable to
testify. However, Ellinas gave evidence
on behalf of the appellant.
He stated that the project was an
investment "for ourselves and our
6
children"; the intention was "to keep the building for rental." Other
witnesses called by the appellant confirmed this. And, as the
Special Court
pointed out, not only was the evidence in question not seriously disputed, but
in argument its veracity was accepted
by the Commissioner's representative - an
attitude which was quite properly maintained before us by Mr
Dunn
, on
behalf of the respondent.
One proceeds then on the basis that, initially at least, Vasella was a
capital asset. But this is not conclusive in favour of the
appellant. As has
been indicated, the circumstances in which the property was sold must be looked
to. In a given case they may reveal
that there was a change of intention in the
sense not merely of a decision to realise the asset (to best advantage) but by
the adoption
of a new policy which has the effect of converting the character
of
7
the asset to trading stock in a profit-making scheme or business
(Elandsheuwel Farming (Edms) Bpk vs Sekretaris van Binnelandse Inkomste
1978(1) SA 101(A) at 118 F-119 in fin). This, so it was contended on behalf of
the respondent, is what happened in the case of the
appellant. On grounds to
which I shall in due course refer, it was argued that the intention to hold the
property as a long-term
investment changed in 1979 and the appellant thereafter
crossed the Rubicon and used the property in a profit-making scheme. The
appellant disputed this. And most of the evidence adduced by it to the Special
Court was aimed at discharging the onus which it bore
of negativing the alleged
change of intention. The Special Court, however, found that the appellant had
failed to do this and on
this basis dismissed the appeal. The court a quo agreed
with the Special
8
Court's conclusion though, as will be explained, not quite for the same
reasons.
Often the reason why a taxpayer sells an asset will be irrelevant. A
capital investment may be disposed of for whatever motive. But
where the status
of the asset at the time of the sale is in issue, the position is different.
Here the reason for disposal might
provide a good indication that there had been
a change of intention and that a profit-making scheme was afoot. It is therefore
not
surprising that in its evidence the appellant sought in some detail to
explain why, contrary to its declared intention to retain
Vasella, the property
was sold. The reason advanced hinged around Pace and was to the following
effect. The financial well-being
of this company was all important to Ellinas
and Pashiou. According to their
9
auditor, Pace was "the goose that laid the golden egg"; it was their main
source of income. The company had big construction contracts.
But by 1978
liquidity problems had developed. The company was short of working capital. Its
overdraft facilities were inadequate.
Time limits for paying suppliers of
building materials could not be kept to. And over the next two years its
financial position worsened.
The company was "in a very precarious state."
Efforts were accordingly made to borrow money which could be injected into Pace.
They
were unsuccessful. This left two remaining sources of funds. One was a
company called Sumaco (Pty) Ltd ("Sumaco"). Though its shareholders
were the
children of Ellinas and Pashiou (together with the children of a certain Mr
Schewitz) the company was effectively controlled
by Ellinas, Pashiou
10
and Schewitz. The main asset of Sumaco was a block of flats which had
been erected by Pace early in 1978. On 26 September 1978 Sumaco
resolved to
apply for a sectional title development scheme. This was approved on 30 November
1978. A few months later it was decided
to sell the individual units and pay
over the proceeds to Pace (partly in discharge of what Sumaco owed Pace in
respect of the cost
of erecting the flats and partly by way of a loan). This was
done. Pace received an amount of about R660 000. However, Pace's liquidity
problems persisted. Additional funds were required. As Ellinas said, there was
no option but to sell; he did not want to sell Vasella;
he had to sell it to
save Pace; had he not done so Pace could have been liquidated. Save that Pashiou
was even more reluctant to
dispose of the property, this reflected his state of
mind
11
as well. Thus it was that the units comprising Vasella were sold. With
the proceeds of the sale the appellant repaid the sum of R160
520 owing to Pace
for the construction of Vasella and in addition, lent Pace R638 958. Pace
accordingly received from the appellant
just under R800 000. In the result, so
it would seem, Pace was restored to financial stability; at least its liquidity
crisis was
overcome.
On this evidence, it is clear, I think, that Vasella remained a capital
asset; that there was no change of intention as alleged by
the respondent. The
Special Court found that Pace, during 1978 and 1979, did have a liquidity
problem and that the profits on the
sale of Sumaco's units were used to resolve
this problem. It held, however, that when in August 1980 Vasella was
12
sold "the elimination of the illiquidity of (Pace) was not as pressing as
suggested in evidence". Indeed, on a reading of the rest
of the judgment, it
would seem that the appellant's contention that it was compelled to sell Vasella
in order to save Pace was rejected.
In the court's view there was, commencing
with the application for the opening of a sectional title register in October
1979, a change
of intention. The property was thereby converted to a more
marketable form. Thereafter the appellant's overriding motive was to sell
it
when it became profitable to do so. Alternatively the property was then held
with a dual intention, namely for rental income and
for sale at a profit. In
either event, so it was concluded, the appellant had failed to discharge the
onus of proving that the profit
was of a capital nature.
13
The approach of the court a
quo
was somewhat different. After an
analysis of a number of factors, it concluded that though "on a clinical
analysis of the objective
facts one may wonder whether Pace's problems were
(such that)...there was a real need to sell at that stage...the criticism
advanced
on behalf of the appellant of the conclusion of the Special Court, that
the liquidity problems of Pace had been overstated, is justified"
and that
"credible evidence supports the submission that Ellinas at least was led to
believe that it would be prudent to dispose
of the sections in Vasella." This
notwithstanding, the full court agreed that there had been a change of
intention. Its reasoning
was that Ellinas and Pashiou were in substance
partners; that all their business activities had to be taken into account; by
1979
these included dealing in fixed property and
14
making use of sectional title systems; Ellinas and Pashiou were, in other
words, land-jobbers; from then on Vasella was earmarked
as part of the
stock-in-trade of such business; it would be disposed of should this be required
or should circumstances be propitious;
as it turned out the liquidity problems
of Pace made it advisable to sell Vasella so as to provide that company with
working capital.
In considering the correctness of both courts' judgments and in
particular their finding that there was a change of intention, it
will be
apparent that there are, broadly speaking, three factors that require analysis.
They are (1) Pace's illiquidity; (2) the
conversion of Vasella to a sectional
title scheme; and (3) the land-jobbing activities of Ellinas and Pashiou.
Obviously they are
interdependent and must be cumulatively weighed. It will be
convenient, however,
15
to deal with them separately. I proceed to do so. (1)
Pace's
illiquiditv.
As has been indicated, it was not the appellant's case that the units in
Vasella were sold simply because a good offer was received.
I therefore agree
with the observation of Eloff DJP (who gave the judgment of the full court) that
if "the appellant's contention
that the main motive for the sale of the units in
Vasella was to enable it to pay Pace its due and thus ameliorate the liquidity
problems of the matter" was correctly rejected by the Special Court "it becomes
difficult to think of any reason for the sale other
than that it had become the
business of Ellinas and Pashiou to trade in assets such as the sections in
Vasella, and that Vasella
was kept as part of that business".
16
Certainly, and as Mr
Dunn
during the course of his thorough
argument pointed out, there are factors which support the Special Court's
conclusion that the sale
was not due to Pace's illiquidity. The allegation that
it was Pace's illiquidity which was the reason for the sale of Vasella was
only
belatedly raised by the appellant in its pre-trial communications with its local
Receiver of Revenue. Pace did not retain all
the monies paid over to it by
Sumaco and the appellant (as one might have expected had Pace been short of
working capital); instead
it repaid directors' and shareholders' loan accounts
and also made loans to certain unspecified persons; these repayments and loans
totalled R856 203,00. By the time Vasella was sold, Pace had already received a
large injection of capital from Sumaco. There was
no
17
evidence that Pace was ever sued; nor was it insolvent. Although the deed
of sale was entered into on 6 August 1980, the purchase
price of R1.3 m was only
payable on 1 March 1981; this is not an indication that funds were urgently
required for Pace.
Based mainly on these considerations, it was submitted on behalf of the
respondent that the liquidity problems of Pace had been overstated
or at least,
by mid-1980, alleviated; that they were advanced as an afterthought in order to
obscure the true reason for the sale
of Vasella; and that the Special Court's
conclusion on the issue under discussion was the correct one. I am unable to
agree. Clearly
Pace had continuing liquidity problems. That Ellinas and Pashiou
perceived Pace's position as serious and felt compelled to sell
Vasella is also
plain. It is a theme that runs throughout the evidence.
18
I have already referred to the allegations of Ellinas in this
regard.
They were corroborated by a number of witnesses who testified
for
the appellant. Mrs Spengler, the bookkeeper and financial
manageress of Pace, testified:
"Now, when the agreement of sale was concluded on the 6th of August 1980,
what was the reaction of Mr Ellinas and Mr Pashiou, would
you describe them as
eager sellers? ... Definitely not.
Would you tell his lordship why? ... Well, the building had been put up
as an investment and it was as far as they were concerned,
the last investment
and they would have no more and Mr Pashiou was very much against that. They had
built
it for themselves and now they had to dispose of it
Now, Mrs Spengler, you said to the court that your impression
was that Messrs Ellinas and Pashiou, that they sold these
properties reluctantly. Is that correct? --- Berea Park and
Sumaco.
Yes, were those your impressions or did they come to you and
did they say to you 'Listen we don't want but we have to.
—
They were quite emphatic about it, particularly Mr Pashiou."
Mr Davis was a partner in the firm of auditors acting for Pace
and
19
the appellant. The following extracts from his evidence are
relevant:
"Are you aware whether the directors of Berea Park Avenue Properties (Pty)
Ltd were anxiously desiring to sell this block of flats
owned by this company?
.... They didn't want to sell this block at all. How would you describe their
decision to sell the block?
... It
was a decision they were forced to take in my opinion
Mr Davis, I think I've asked you what was the attitude of Mr Ellinas and Mr
Pashiou at that stage to the disposal of the property
owned by Berea Park Avenue
Investments (Pty) Ltd. .... Neither...Mr Ellinas or Mr Pashiou wished to sell.
Mr Ellinas said it was
necessary to sell in order to save Pace Construction and
Mr Pashiou was adamant that that property would not be
sold."
Finally there is the evidence of Schewitz (who
until 1978 was Ellinas
and Pashiou's attorney but in August 1980 was negotiating to buy
Vasella on behalf of the eventual purchaser). Having stated that
because of Pace's lack of capital the company was in "a
difficult
financial situation" and that "they [Ellinas and Pashiou] were
petrified
20
that they were going to lose their company", he went on to testify
as
follows:
"Can you tell his lordship, did you discuss: what was the attitude of Mr
Ellinas and Mr Fashion to the sale of the property at that
stage? --- Mr Pashiou
was very violent and he
did not want to sell it What did Mr Ellinas do? --- Mr
Ellinas wanted to save Pace at all costs. He wasn't happy about it but he
felt that he had to sell something in order to inject cash
into
Pace."
He also explained that Pace "wanted cash...almost
immediately".
Schewitz therefore arranged for a substantial advance payment on
account of the purchase price to be made to Pace prior to 1
March
1981. And the fact that the units were sold not individually but
as
a whole served to support the inference that the sale was regarded
as
urgent. The appellant's witnesses made a good impression on the
Special Court. Moreover, as the court a
quo
observed, the
evidence
21
that Pace was thought to be "in a tight spot" and that the sale of
Vasella would significantly ease Pace's position was not really
challenged. Mr
Dunn
was also constrained to concede that a number of factors on which he
relied in support of his argument were not, as they should have
been, put to the
witnesses. It might be that they would have been able to provide an acceptable
explanation for the criticisms that
are now levelled against the appellant's
version. This must detract from their cogency. It is clear that genuine efforts
were made
to avoid selling Vasella. I refer to the unsuccessful attempts by Pace
and the appellant to increase their respective overdraft facilities
and to raise
money by way of second bonds. There was detailed evidence in this regard.
Finally, there is the consideration that the
rental income produced by Vasella
gave what was described
22
in the evidence as "an excellent return". This is a further indication
that the appellant was an unwilling seller. In my opinion therefore,
the matter
fell to be decided on the basis that it was established that in the perception
of Ellinas and Pashiou, Vasella had to
be sold to save Pace.
It is, of course, true that the object of paying the proceeds of the sale
of Vasella to Pace was to enable Pace to continue with its
profit-making
activities (and probably to enhance them). But this cannot avail the respondent.
It is not inconsistent with the appellant's
evidence regarding the reluctance of
Ellinas and Pashiou to sell the building. Nor is the fact that the total amount
paid by the
appellant to Pace was possibly more than what was immediately
required to alleviate Pace's liquidity crisis. The court
23
a
quo
found it significant that Ellinas and Pashiou did not rather
utilise the "surplus funds" to provide a pension for themselves. I cannot
agree.
As already indicated, Pace was the core of their business operations. They
obviously regarded it as a good investment. They
were entitled to place the full
proceeds of the sale of Vasella there. The court a quo, however, also laid
stress on the appellant's
indebtedness to Pace (arising from the cost of the
construction of Vasella). Its reasoning was that Ellinas and Pashiou must have
realised that the appellant would not be able to discharge it out of the
appellant's income; that it would have to sell at least
part of its interest in
Vasella. But this is not borne out by the evidence of Ellinas. He said that in
1976 when Vasella was erected,
he did not contemplate that Pace would have any
difficulty in
24
carrying the loan owed by the appellant; it was not foreseen that
repayment would be required by Pace at least not until the appellant's
bond had
been paid; and thereafter the appellant would be able to pay Pace from its
rental income. (2)
The conversion of Vasella to a sectional title
scheme.
It will be apparent from what has been said that this fact played a
significant role in the conclusion of both the Special Court and
the court a
quo
that a change of intention occurred. In many cases a sale by
sectional title will indicate that a trade for earning profits had been
embarked
on. But this is not necessarily so (ITC
1348 44 SATC 46
at 49). And I do not
think that the opening of a sectional title register in respect of Vasella
pointed to a profit-making scheme.
The appellant's attorney was a Mr Klagsbrun.
He testified
25
that from about 1978 it was feared that amending legislation would be
passed making it more difficult to sell by sectional title unless
a register had
already been opened; he therefore advised the appellant (and Sumaco) that as a
precaution this should be done; it
was in these circumstances that Vasella was
converted to a sectional title scheme. Both Ellinas and Schewitz confirmed this.
Ellinas
described sectional title schemes as being "the trend" (during 1979 and
1980).
The Special Court, however, did not think that this evidence "takes the
matter any further". Its view was that Ellinas and Pashiou
made the application
for a sectional title scheme "in the light of their success with the sale under
sectional title of Sumaco";
this evidenced the necessary change of intention. I
must respectfully
26
differ. Klagsbrun's evidence refutes this. There is no warrant for not
giving full effect to it. This I think is so despite the appellant's
delay,
until October 1979, in taking steps to apply for the registration of a sectional
title scheme. This was more than a year after
Sumaco's application and (so one
can infer) after Klagsbrun's recommendation that a sectional title register be
opened. But this
was never put to any of the appellant's witnesses. It should
accordingly not be used (as the court a
quo
did) as indicating that the
decision to convert to a sectional title scheme was not motivated by Klagsbrun's
advice. (3)
Land-jobbing activities of Ellinas and Pashiou.
Besides the appellant and Sumaco, Ellinas and Pashiou were minority
shareholders in five other property-owning companies
27
whose shares or properties (blocks of flats) were (for the most part
during 1979 and 1980) sold at a profit. It was, however, not
suggested that
these sales constituted speculation in fixed property. In each case the proceeds
were regarded by the Receiver of
Revenue as of a capital nature. What the court
a
quo
mainly relied on as establishing that by the time Vasella was sold
Ellinas and Pashiou had become land-jobbers, were the operations
of two other
private companies. They were Wessels Street Gardens (Pty) Ltd ("Wessels Street")
and Cosmian Investments (Pty) Ltd ("Cosmian").
Ellinas and Pashiou were equal
shareholders. In 1979 Wessels Street and in 1980 Cosmian erected a block of
flats on their respective
properties and then within a short period sold the
individual units by sectional title. The resultant profits were in each case
reflected
as
28
income and taxed as such. In addition there was, of course, the
profitable disposal by Sumaco of its units during 1979. It will be
recalled that
they were sold (also by sectional title) within about a year of their
construction.
It is unnecessary to say much about the Sumaco transaction. The
respondent sought to tax it. However, Sumaco's appeal against the
dismissal of
its objection to the assessment was allowed (see ITC 143,
50 SATC 60).
This
leaves Wessels Street and Cosmian for consideration. The appellant never sought
to deny that they were speculative projects.
As such they show that Ellinas and
Pashiou were at the time engaged in land-jobbing. But this was only to a limited
extent. It is
clear that Wessels Street and Cosmian were isolated cases of
property speculation. In each case Pace was
29
the contractor. The projects were undertaken to provide temporary work
for its employees and to generate a quick profit for the company.
They were not
repeated. Moreover, Ellinas and Fashion had interests in two other blocks of
flats (Devenish Gardens and Monopati)
which were held as long-term investments.
In the circumstances, I do not think that Wessels Street and Cosmian provide a
firm foundation
for the respondent's argument that in relation to the appellant
as well, Ellinas and Pashiou were trading in land.
There is, in any event, another difficulty with the argument. There was,
as the court a
quo
observed, credible evidence that Ellinas and Pashiou
were at pains to keep the speculative ventures apart from what they considered
to be
30
investments; "a clear divide", as it was referred to. This may, of
course, be done. A taxpayer who is a land-jobber may have other
property as an
investment and which is therefore not part of his trading stock (cf
Cohen vs
CIR
1962(2) SA 367(A) at 376 C-F). So it does not follow that all the
business affairs of Ellinas and Pashiou were (in the words of the
full court)
"interrelated and interdependent". If they continued to regard Vasella as an
investment, the building did not become
part of the stock-in-trade of their
business of dealing in land.
The test whether a taxpayer has embarked on a profit-making scheme is one
of degree. Often, therefore, a decision whether this has
occurred is a
finely-balanced one. The present matter exemplifies this. I have, nevertheless,
come to the firm
31
conclusion that the appellant succeeded in establishing that no change
(of the kind that converts a capital asset into stock-in-trade)
occurred in its
intention to hold Vasella as a long-term investment. The property was kept for
five years. The appellant's reluctance
to sell (see (1) above) is not easily
reconcilable with the voluntary undertaking of a profit-making scheme. The
proceeds were not
(as one would have expected had the sale of Vasella been part
of Ellinas and Fashion's land-jobbing) used to deal in other fixed
property. Nor
for the reasons stated in (2) can an inference of such dealing be drawn from the
opening of a sectional title register.
As I have said, this was done on legal
advice and as a precautionary measure. It was a prudent step. In any event, the
appellant
was entitled to adapt its asset to the exigencies of the market and
dispose of it to best
32
advantage. Sumaco's earlier adoption of the same course
simply
served to emphasise the benefits of this mode of disposal.
therefore cannot agree with the respondent's argument (based on
the
language of Wessels JA in
John Bell and Co (Pty) Ltd vs
SIR
1976(4) SA 415(A) at 429 C-D) that the appellant's conversion of
Vasella to a sectional title scheme was the "something more"
which
metamorphosed its character. More especially is this so seeing
(as
found in (3)) that Ellinas and Fashion's land-jobbing operations
were
of a restricted nature. In my view Vasella never became part of
such operations. The appellant never went over to the business
of
trading in fixed property. There was a mere change of intention
without the intervention of any new or additional factor. The
profit
on the sale of Vasella was of a capital nature. It was,
therefore,
33
incorrectly included in its taxable income.
The appeal succeeds with costs (save that the costs of an unnecessary
application by the appellant to condone the late filing of the
record are to be
paid by the appellant). The judgment of the court a
quo
is set aside. The
following order is substituted:
"The appeal is upheld with costs. The order of the Special Court and the
assessment for the year ended 28 February 1982 are set aside.
The matter is
referred back to the Commissioner for Inland Revenue for assessment on the
basis
that the profit of R836 717.00 on the sale of Vasella should not have
been included in the appellant's taxable income."
HH Nestadt Judge of Appeal Joubert, JA ) Van Heerden, JA ) Concur
Kumleben, JA ) Nicholas, AJA )