Brief Summary

Income Tax — Assessed loss — Reduction of assessed loss due to compromise with creditors — Taxpayer's liabilities extinguished through issuance of redeemable preference shares in exchange for creditor claims — Commissioner for Inland Revenue disallowed portion of assessed loss based on alleged benefit received from creditors' concession — Court held that the substitution of creditor claims with shares constituted a concession, allowing the taxpayer to retain the assessed loss for carry forward.

Comprehensive Summary

Summary of Judgment

Introduction

The proceedings were an appeal to the Supreme Court of Appeal by the Commissioner for Inland Revenue (the Commissioner) against a decision of the Transvaal Income Tax Special Court (per Wunsh P). The Special Court had upheld an appeal by the taxpayer against an assessment for normal tax for the year of assessment ending 31 March 1990.

The parties were the Commissioner for Inland Revenue as appellant and Datakor Engineering (Pty) Ltd as respondent (the taxpayer). The dispute arose from the Commissioner’s application of section 20(1)(a)(ii) of the Income Tax Act 58 of 1962, on the basis that the taxpayer had received a “compromise benefit” which required a reduction of its balance of assessed loss.

Procedurally, the Commissioner had issued an assessment reducing the taxpayer’s assessed loss by R18 807 524,00, and the taxpayer successfully appealed to the Special Court. The Commissioner then appealed to the Supreme Court of Appeal, seeking the reinstatement of the assessment as issued and the reversal of the Special Court’s order.

The general subject-matter was whether the taxpayer’s assessed loss carry-forward could be reduced under the statutory anti-avoidance-style proviso in section 20(1)(a)(ii) where, pursuant to a scheme of arrangement under section 311 of the Companies Act 61 of 1973, creditors waived claims against the company in exchange for the issue of redeemable preference shares (which were then renounced in favour of the scheme proposer).

Material Facts

The taxpayer (previously known as GBS South Africa (Pty) Ltd) was finally liquidated on 15 August 1989. After liquidation, a scheme of arrangement in terms of section 311 of the Companies Act 61 of 1973 was proposed by an unrelated company, Datakor Ltd, and confirmed on 23 January 1990. Following confirmation, the taxpayer was discharged from liquidation, changed its name to Datakor Engineering (Pty) Ltd, and became a wholly-owned subsidiary of Datakor Ltd.

In terms of the scheme, Datakor Ltd was obliged to provide certain funds to the taxpayer, to be applied by receivers towards administration expenses, secured and preferential creditors, and then a pro rata payment to concurrent creditors. Concurrent creditors ultimately received a dividend of 43,48 cents in the Rand.

The unpaid balance of concurrent creditors’ claims was dealt with through capitalisation: the scheme required the taxpayer to create and issue cumulative redeemable preference shares equal in face value to the unpaid portion of those claims. For every 100 cents of claims not paid, a share with nominal value one cent was issued at a premium of 99 cents. The concurrent creditors, as consideration, waived payment of their remaining claims against the taxpayer and were to renounce their entitlement to the shares in favour of Datakor Ltd.

The amount waived by concurrent creditors as a result of there being no further claims against the taxpayer was R18 997 499,00. The issue of the redeemable preference shares produced a share premium account of R18 807 524,00. The taxpayer’s balance sheet reflected that it no longer had current liabilities, and its cash flow statement reflected that the proceeds of issuing the redeemable preference shares were used to liquidate accounts payable. The Commissioner treated the share premium amount used to extinguish liabilities as the relevant “benefit” for section 20(1)(a)(ii) purposes.

As to the taxpayer’s tax position, it had an assessed loss brought forward of R8 540 219,00, and a further tax loss for the year under consideration of R15 090 168,00. The taxpayer sought to carry forward the combined amount, but the Commissioner reduced the loss by R18 807 524,00 under section 20(1)(a)(ii).

The court noted that, although there were discrepancies between the scheme’s requirements and the taxpayer’s financial statements, these were treated as not material to the outcome.

Legal Issues

The central legal questions concerned the proper application of section 20(1)(a)(ii) to the scheme of arrangement implemented. In particular, the Supreme Court of Appeal had to determine whether, on these facts, the taxpayer had received or accrued “any benefit” resulting from a concession or compromise with its creditors whereby liabilities arising in the ordinary course of trade were reduced or extinguished, and if so, what “amount or value” was to be used to reduce the assessed loss.

The dispute was predominantly one of law (statutory interpretation and the juridical characterisation of the transaction), coupled with the application of law to largely common-cause facts (the extinguishment of liabilities and the issue of redeemable preference shares). There was also a procedural legal issue concerning whether a point about the quantification/value of the benefit and the onus of proof had been properly raised in the taxpayer’s notice of objection, given the limitation in section 83(7)(c).

Court’s Reasoning

The court approached section 20(1)(a)(ii) by identifying its interrelated components, while cautioning that isolating “elements” may obscure the integrated statutory inquiry. The focus of argument and decision lay mainly on whether the benefit resulted from a concession/compromise and whether a benefit was received or accrued, as well as on whether the Commissioner had to prove an ascertainable money value and bore the onus regarding that quantification.

On the question whether the benefit resulted “from a concession granted by or a compromise made with his creditors”, the court held that the Special Court’s reasoning was incorrect to the extent that it emphasised any concession made to a third party (Datakor Ltd). The statutory enquiry was concerned with the relationship between the creditor and the taxpayer: what mattered was whether the creditors granted a concession to the taxpayer, not what occurred between the creditors and the scheme proposer.

The court rejected the taxpayer’s contention that one first had to establish that the redeemable preference shares were worth less than the claims before concluding that there had been a concession. It held that the Act was concerned with the benefit to the debtor, not with whether the creditor subjectively gained or lost value. In the court’s analysis, the substitution of an enforceable debt claim with redeemable preference shares was, in itself, a concession/compromise because the creditor’s rights changed fundamentally: a creditor’s enforceable claim against the company’s assets is replaced by a shareholding interest with materially different incidents.

The court emphasised the legal nature of redeemable preference shares and relied on authority explaining that the right of redemption exists for the benefit of the company, not for the holder, and that a holder cannot compel redemption in the manner a creditor can compel repayment of a debt. The court treated this difference as central to showing that the creditors had compromised their enforceable claims and that this translated into a benefit to the taxpayer.

On the existence of a “benefit received by or accruing to” the taxpayer, the court accepted the core reasoning that extinguishing enforceable creditor claims and replacing them with redeemable preference shareholding positions benefited the company. The taxpayer’s argument—advanced with reference to academic commentary—that the conversion was merely a change in the form of the liability, leaving the obligation substantively unchanged, was rejected. The court held that the obligation to repay in the context of share redemption was not equivalent to a debt obligation, and that the statutory phrase “any benefit” is broad. For purposes of this part of the enquiry, the court treated the benefit as lying in the reduction or extinction of debt, which was common cause.

The Special Court had decided against the Commissioner on the basis that the “trigger” for section 20(1)(a)(ii) was an ascertainable “amount or value” of the benefit and that the Commissioner had failed to prove such a quantifiable amount, partly because redeemable preference shares carried dividends and would have to be redeemed. The Supreme Court of Appeal held that this approach was flawed in two important respects.

First, it held that the issue upon which the Special Court decided the matter (in substance, the valuation/quantification approach premised on “cost” to the taxpayer arising from dividends/redemption) had not been raised in the taxpayer’s notice of objection. The court applied section 83(7)(c), noting that an appellant in a tax appeal is limited to the grounds stated in its notice of objection unless amended by agreement or with the Special Court’s leave. The fact that a court might raise an issue during argument could not overcome the statutory limitation. Applying the test that one must look at the substance of the objection without undue technicality (as endorsed in authority), the court found the relevant point was not contained in the objection as filed; neither party had led evidence or asked questions directed to it, reinforcing that it was not properly in issue.

Second, the court addressed the onus of proof. It held that section 82 of the Income Tax Act placed the burden on the taxpayer to prove entitlement to a set-off. The taxpayer was claiming to carry forward an assessed loss without the reduction imposed by section 20(1)(a)(ii). The amount disallowed by the Commissioner was not an indeterminate figure but a fixed, ascertained amount reflected in the financial statements as share premium arising from the issue of redeemable preference shares and used to extinguish liabilities. In those circumstances, the court held the Special Court erred in placing the onus on the Commissioner to prove an ascertainable money value for the benefit.

In dealing with the Special Court’s reliance on earlier authority, the Supreme Court of Appeal distinguished the cited decision concerning a different statutory context (whether an “amount” had accrued or been received as a premium in a particular year) on the basis that, there, it was obvious no “amount” had been received in the year in question, whereas in the present matter the amount was fixed and recorded, and the taxpayer was seeking a set-off in relation to it. The court therefore concluded that the Special Court’s approach to onus and quantification could not stand, and that the Commissioner was entitled to invoke section 20(1)(a)(ii) on the facts.

Because the quantification point had not been raised in the notice of objection, the court expressly stated that it did not need to decide whether, on a proper interpretation of the provision, the “benefit” should be valued with reference to the alleged cost or liability created by the redeemable preference shares, or with reference to the pre-compromise value of the creditors’ claims, and it deliberately refrained from expressing a view on that broader interpretive question.

Outcome and Relief

The Supreme Court of Appeal upheld the Commissioner’s appeal. The order of the Special Court was altered to read that the taxpayer’s appeal to that court was dismissed.

The appeal was upheld with costs, meaning the taxpayer was ordered to pay the costs of the appeal proceedings in the Supreme Court of Appeal.

Cases Cited

AA Mutual Insurance Association Ltd v Century Insurance Co Ltd 1986 (4) SA 93 (A)

Ex parte De Villiers and Another NNO: In re Carbon Development (Pty) Ltd (In liquidation) 1993 (1) SA 493 (A)

Matla Coal Ltd v Commissioner for Inland Revenue 1987 (1) SA 108 (A)

Ochberg v Commissioner for Inland Revenue 1931 AD 215

Commissioner for Inland Revenue v Butcher Bros (Pty) Ltd 1945 AD 301

Trevor v Whitworth (1887) 12 AC 409

Legislation Cited

Income Tax Act 58 of 1962, sections 20(1)(a)(ii), 82, and 83(7)(c)

Companies Act 61 of 1973, sections 311 and 98(1)

Companies Act 46 of 1926, section 43 (mentioned in quoted authority)

Companies Act Amendment Act 23 of 1939 (mentioned in quoted authority)

Companies Act Amendment Act 46 of 1952 (mentioned in quoted authority)

Income Tax Act, 1925, section 7(1)(d) (mentioned in discussion of authority)

Rules of Court Cited

No rules of court were cited in the judgment.

Held

The court held that the replacement of concurrent creditors’ enforceable claims against the taxpayer with redeemable preference shares, coupled with the waiver of the remaining claims against the taxpayer under the scheme of arrangement, constituted a concession/compromise between the taxpayer and its creditors for purposes of section 20(1)(a)(ii) of the Income Tax Act 58 of 1962.

It held further that the extinguishment of those liabilities necessarily constituted “any benefit received by or accruing to” the taxpayer within the meaning of the section, and that the benefit lay in the reduction or extinguishment of debt, irrespective of arguments directed at the creditors’ position or asserted equivalence between debt and redeemable preference share obligations.

The court also held that, under section 82, the onus was on the taxpayer to establish its entitlement to the set-off (the assessed loss carry-forward without reduction), and that the Special Court erred in placing the burden on the Commissioner to prove an ascertainable money value for the benefit in the circumstances of this case.

Finally, the court held that the valuation/quantification issue relied upon by the Special Court had not been properly raised in the taxpayer’s notice of objection, and therefore did not require determination on appeal.

LEGAL PRINCIPLES

Section 20(1)(a)(ii) of the Income Tax Act 58 of 1962 requires the reduction of a balance of assessed loss by the amount or value of any benefit received or accrued as a result of a concession or compromise with creditors whereby trade liabilities are reduced or extinguished, and the statutory enquiry focuses on the relationship between the taxpayer and its creditors, not on concessions made to third parties connected to a restructuring.

For purposes of identifying the existence of a benefit and a concession/compromise, the substitution of a creditor’s enforceable claim with an issue of redeemable preference shares constitutes a material alteration of the creditor’s rights and is capable, in itself, of amounting to a concession/compromise: a debt claim enforceable against the company’s assets is not equivalent to a shareholder’s rights attaching to redeemable preference shares, particularly given the company-centric nature of redemption.

The expression “any benefit” in section 20(1)(a)(ii) is of wide import, and the benefit may be located in the reduction or extinction of the taxpayer’s debt, without requiring an enquiry at that stage into whether the creditor received equivalent value.

In tax appeals, section 83(7)(c) limits an objector to the grounds stated in the notice of objection unless properly amended; a court raising a point during argument does not, by itself, cure non-compliance with that limitation, and the substantive content of the objection must be assessed without undue technicality but with fidelity to the statutory constraint.

Under section 82 of the Income Tax Act 58 of 1962, the burden of proof that an amount is subject to a set-off rests on the taxpayer claiming that set-off, and the Commissioner may disallow a claimed set-off leaving it to the taxpayer to show the disallowance is wrong in the circumstances contemplated by the Act.

Commissioner for Inland Revenue v Datakor Engineering (Pty) Ltd. (405/96) [1998] ZASCA 71; 1998 (4) SA 1050 (SCA); [1998] 4 All SA 414 (A) (21 September 1998)