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[2018] ZASCA 39
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Commissioner for the South African Revenue Service v Executors of Estate Late Sidney Ellerine (142/2017) [2018] ZASCA 39; 2019 (1) SA 111 (SCA); 80 SATC 389 (28 March 2018)
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THE
SUPREME COURT OF APPEAL OF SOUTH AFRICA
JUDGMENT
Reportable
Case
no: 142/2017
In
the matter between:
COMMISSIONER
FOR THE SOUTH AFRICAN
REVENUE
SERVICE
APPELLANT
and
THE
EXECUTORS OF ESTATE LATE SIDNEY
ELLERINE
RESPONDENT
Neutral
citation:
C
SARS
v The Executors of Estate Late Sidney Ellerine
(142/2017)
[2018] ZASCA 39
(28 March 2018)
Coram:
Navsa,
Wallis and Mbha JJA, Davis and Hughes AJJA
Heard
:
6
March 2018
Delivered
:
28 March 2018
Summary:
Eighth
Schedule to the Income Tax Act 58 of 1962 – valuation of
preference shares for the purposes of determination of a capital
gain.
ORDER
On
appeal from:
Gauteng
Tax Court, Johannesburg (Victor J sitting as a court of first
instance):
1.
The
appeal is upheld with costs, including the costs of two counsel.
2.
The
order of the Tax Court of 11 October 2016 is set aside and replaced
with the following order:
‘
The
deceased was entitled, on the date of his death, to convert the
preference shares to ordinary shares and the preference shares
must
be valued, for the purposes of paragraph 40 read with paragraph 31(3)
of the Eighth Schedule to the Income Tax Act, on this
basis.’
JUDGMENT
Davis
AJA (Navsa, Wallis and Mbha JJA and Hughes AJA concurring)
Introduction
[1]
This
case concerns the valuation of preference shares for the purposes of
determining a capital gain in terms of paragraph 40 read
together
with paragraph 31(3
)(a
)(i)
of the Eighth Schedule to the Income Tax Act 58 of 1962 (the Act).
[2]
The
issued preference shares were held by the late Sidney Ellerine
(‘deceased’). They formed part of the share capital
of
Sidney Ellerine Trust (Pty) Ltd (‘the company’) which, in
total, consisted of 600 ordinary shares of R1 each and
112 000 7
per cent redeemable non-cumulative preference shares of R1 each.
[3]
The
deceased held all of the redeemable preference shares issued by the
company. The registered and beneficial owners of the ordinary
shares
were as follows:
200
owned by the trustees of The Kevin Murray Ellerine Trust;
200
owned by the trustees of The Bradley Charles Ellerine Trust;
100
owned by the trustees of The Linda Caron Ellerine Trust;
100
owned by the trustees of The Maxine Tamar Ellerine Trust.
[4]
The
preference and ordinary shares enjoyed one vote for each share in
general meetings of shareholders so that the deceased held
the
overwhelming majority of the voting rights in the company. Appellant
assessed respondent’s liability for capital gain,
determining
that the deceased was entitled, by using his voting power, to convert
these preference shares to ordinary shares. Appellant
assessed the
value of the preference shares in the amount of R 563 376 418,
on the basis that the shares represented
99.47 per cent of the share
capital of the company and thus should be valued at 99.47 per cent of
the value of the company.
[5]
Respondent
submitted that the terms of special condition 5.8 of the Memorandum
read together with Articles 4.2 and 34 of the Articles
of Association
of the company precluded the deceased from converting these
preference shares to ordinary shares, without the voting
support of
at least 75 per cent of the ordinary shareholders; hence the
preference shares should be valued at their fair value
of R1 per
share.
[6]
The
only issue before the Tax Court was whether the rights that attached
to the preference shares and which entitled the holder
thereof to
convert them should be taken into account in the determination of the
market value.
[7]
After
interpreting the relevant provisions of the Memorandum and Articles
of Association, the Tax Court concluded that, on the date
of his
death, the deceased was not entitled to convert the preference shares
to ordinary shares, in that, at least 75 per cent
of the holders of
each class of shares had to agree to the conversion. The court held
that, contrary to special condition 5.8 of
the Memorandum, the
conversion would result in an amendment to the terms applicable to
these preference shares as provided for
in Article 34 of the Articles
of Association and consequently their rights. However, without the
prior written approval of at least
75 per cent of the holders of each
class of shares, Article 34 could not be amended. It was common cause
that no such approval
had been obtained.
[8]
On
this basis the Tax Court held that the deceased at the time of his
death was not entitled to convert the preference shares to
ordinary
shares. The preference shares had to be valued accordingly for the
purposes of paragraph 40 read together with paragraph
31 (3) of the
Eighth Schedule to the Act.
The
nature of the appeal
[9]
The
dispute in this case thus turned on the resolution to two questions:
1.
Could the holder of the deceased’s preference shares convert
these shares into ordinary shares without an amendment to
Article 34
of the Articles of Association, which, when read with special
condition 5.8, required the written approval of 75 per
cent of the
holders of each class of shares in the issued share capital of the
company.
2.
Whether, in terms of Article 4.2, conversion of the deceased
preference shares to ordinary shares could take place without the
approval of 75 per cent of the holders of the ordinary shares.
[10]
An
analysis of these arguments requires an examination of the relevant
provisions of the company’s articles as well as special
condition 5.8.
The
background
[11]
The
material parts of this case are set out in a statement of agreed
facts. Since 1969 the deceased had been the registered owner
of the
issued preference share capital of 112 000 7 per cent redeemable
non-cumulative preference shares of R1 each. These
shares conferred
upon the holder, being the deceased, the right to vote 99.47 per cent
of the votes at general meetings of the
company.
[12]
The
company, in which the deceased enjoyed the controlling interest, held
40 per cent of the issued share capital in another company,
Ellerines
Brothers (Pty) Ltd (EB), an investment holding company, which owned
the bulk of the family investments. The remaining
60 per cent of EB
shares were held by Eric Ellerine Trust (Pty) Ltd (EET) a company
controlled by the deceased’s brother
Eric Ellerine. The dispute
concerning the value of the preference shares necessitates an
examination of key provisions of the company
governance structure.
[13]
On
12 May 2006 two special resolutions were unanimously adopted by the
company in terms of which an amendment was made to the company’s
Memorandum and Articles of Association, which amendments were then
registered under the Companies Act 61 of 1973.
[14]
In
terms of Special Resolution 1, it was resolved to amend the company’s
Memorandum of Association by the inclusion of special
conditions in
terms of s 53(a) of the Companies Act in a new paragraph 5 of the
Memorandum of Association. This dealt with restrictions
on the
disposal of shares of the company prior to a certain event, described
as ‘a distribution event’, being 10 November
2033, the
hundredth anniversary of Eric Ellerine’s birth.
[15]
A
new paragraph 5.2 was inserted to define the term ‘dispose’
as including to sell, alienate, transfer, exchange, pledge,
encumber
or otherwise dispose of (including but not limited
eiusdem
generis
by way of repurchase, donation, dividend or by way of the terms of a
will). ‘Disposal’ bore a corresponding meaning,
unless a
contrary intention appeared.
[16]
A
further part of special resolution 1 was the inclusion of clause 5.8
which provided:
‘
This
special condition and also the provisions of articles 29 and 34 of
the company’s Articles of Association may be amended
only by
way of the passing and registration of a special resolution which
shall be of no force or effect unless the prior written
approval of
at least 75% (seventy five percent) of the holders of each class of
shares in the issued share capital of each of the
company and Eric
Ellerine Trust (Proprietary) Limited is obtained for so long as Eric
Ellerine Trust (Proprietary) Limited holds
any shares in Ellerine
Bros (Proprietary), or any successor in title thereto.’
[17]
Special
Resolution 2 provided that the existing Articles of Association dated
13 December 1968 be abrogated in their entirety and
be replaced with
a fresh set of Articles of Association dated 12 May 2006. These were
in force at the time of the deceased’s
death.
[18]
Turning
to the rights of a preference shareholder, Article 34, headed
‘Redeemable Non-Cumulative Preference Shares’,
provided
in Article 34.1 that a number of rights, privileges and conditions
attached to these preference shares, including that
they conferred
the right to a preferential dividend at the rate of 7 per cent per
annum on the capital, paid out of the profits
of the company resolved
to be distributed in respect of each financial year, but not to an
entitlement to any further profits.
[19]
As
is typical in these provisions, article 34.2 limited the right of
preference shareholders to have a preferential right to repayment
of
capital paid but with no further rights to participate in or receive
assets or capital.
[20]
Article
34.3 provided that holders of the preference shares would have the
right to attend and vote at all meetings of the company.
At each such
meeting, whether on a show of hands or on a poll, every holder of a
preference share, in person or represented by
proxy at any such
meeting, ‘shall have one vote for each preference share of
which he is a holder’.
[21]
Article
34.4 provided that the company shall ‘by resolution of the
directors to that effect, be entitled to redeem the whole
or any part
of the preference shares for the time being issued and outstanding
out of any monies which may lawfully be applied
for such purpose at
par, upon giving the holder of the Shares to be redeemed not less
than 1 (one) month’s prior written
notice, provided that no
such notice may be given so as to expire prior to the occurrence of
the Distribution Event….’
[22]
The
determination of whether a conversion of preference shares to
ordinary could take place without the consent of ordinary
shareholders
is further affected by Article 4.2, which provides:
‘
All
or any of the rights, privileges or conditions for the time being
attached to any class of Shares for the time being part of
the share
capital of the company may (unless otherwise provided by the terms of
issue of the Shares of that class) whether or not
the company is
being wound up, be varied in any manner with the consent in Writing
of the holders of not less than 3/4 (three-fourths)
of the issued
Shares of that class, or with the sanction of a resolution passed in
the same manner as a special resolution of the
company at a separate
general meeting of the holders of the Shares of that class….’
[23]
Article
7.1.10, which specifically dealt with the conversion of shares,
provides:
‘
7.1
The company may from time to time by special resolution -
7.1.10
convert any shares in the capital of the company to Shares of a
different class and in particular (but without derogating
from the
generality of the foregoing) convert ordinary Shares or Preference
Shares to redeemable preference Shares.’
The
key issue for determination
[24]
Appellant
was required in terms of the Eighth Schedule to the Act to make a
determination of the capital gains resulting from the
deemed disposal
of the deceased’s preference shares. Paragraph 40 (1) of the
Eighth Schedule provides that ‘a
deceased person is
treated as having disposed of his/her assets … for an amount
received or accrued equal to the market
value of those share at the
date of the person’s death’.
[25]
The
market value of the shares in a company, not listed on a recognised
exchange, must be determined as the value equal to the price
that
could have been obtained upon the sale of the shares between willing
buyer and a willing seller dealing at arm’s length
in an open
market.
[1]
[26]
As
noted, appellant valued the preference shares at the date of the
deceased death in the amount of R563 376 418. By contrast,
respondent contended that the value of the preference shares as at
the date of the deceased’s death was equal to the par
value of
the shares, namely R112 000.
[27]
The
essence of appellant’s case is set out in its Rule 10 Statement
as follows:
‘
The
nominal value of the 112,000 preference shares does not reflect the
market value of the shares, as the voting rights attached
to the
shares entitled the deceased to convert his preference shares into
ordinary shares at any stage after 9 May 2006, this by
virtue of
article 7.1.10 of the Articles adopted on 09 May 2006 by the Company,
and notwithstanding the provisions of Special Condition
5.8.’
[28]
Respondent
contended that the value of the preference shares must be determined
on the basis that the holder was precluded from
converting these
shares to ordinary shares without obtaining the prior written
approval of at least 75 per cent of the ordinary
shareholders and at
least 75 per cent of the holders of each class of shares in EET. This
argument is based firstly upon special
condition 5.8 read with
Article 34 and, secondly, on a reading of Article 4.2. Respondent
accepted that, apart from these arguments,
the deceased would have
been able to convert his preference shares into ordinary shares in
terms of Article 7.1.10.
The
argument based upon special condition 5.8
[29]
Respondent
was constrained to accept that , on a plain reading of the words
‘articles 29 and 34… may be amended…’
,there was no need to amend article 34 in order for preference shares
issued by the company to be converted to ordinary shares.
On this
reading, special condition 5.8 would not be engaged by such a
conversion and the restrictions it embodies would not apply
to it.
[30]
Its
argument was based on an interpretation of the purpose of special
condition 5.8 as protecting the shareholders of ‘each
class of
shares’ (which included both the ordinary shares and the
preference shares), from amendments to the terms of the
preference
shares which might impact upon their rights as shareholders. On the
basis of this purpose of the special condition,
the word ‘amended’
had to be interpreted to mean that, if the rights attached to the
preference shares of the deceased
as provided for in Article 34 were
amended, special condition 5.8 applied. A conversion of the
preference shares to ordinary shares
would, on this argument alter
the ‘rights’, privilege and conditions of the deceased’s
preference shares as provided
for in Article 34 and hence Article 34
would have been amended.
[31]
Whatever
debate may be developed with regard to the context urged upon this
court by respondent’s counsel, ‘consideration
must be
given to the language used in the light of the ordinary rules of
grammar and syntax’.
[2]
While the intention of the speaker is a vital component of the
interpretive inquiry, the basic unit of meaning remains the sentence
employed.
[32]
In
the present case the sentence in Article 34 which commences ‘the
Preference Shares shall be subject to the following rights
privileges
and conditions’, refers to the preference shares and not to a
particular holder of these preference shares. To
the extent that
there may be any doubt about this construction, Article 34.6 makes it
clear that the entire article concerns the
rights attached to the
preference shares as opposed to the rights of a particular holder
thereof, in particular where it provides:
‘no further shares
ranking in priority to or
pari
passu
with the preference shares shall at any time be created without the
consent or sanction of the holders of such last preference
shares
which may be issued and outstanding given in accordance with Article
4.2 unless such further shares be created and issued
for the purpose
of redeeming out of the proceeds of the issue thereof the preference
shares mentioned in this Article 34 or such
of the said shares as
shall for the time being be issued and outstanding’.
[33]
Any
interpretation regarding a company’s articles must be located
within the context of the nature of articles of association
which
confer rights or impose obligations on person who are members. There
is, in short, a recognized distinction between contracts
made by a
company with members in their private capacity and those made in
their capacity as members
[3]
.
Respondent appears to contend that without any clear language nor
authority to support its argument, a contract was concluded
between
the company and the deceased in his personal capacity. There is no
foundation for this submission.
The
Article 4.2 argument
[34]
Respondent
contended that, if the deceased’s preference shares were
converted to ordinary shares, the rights attaching to
the existing
ordinary shares would be varied as a consequence thereof. The
variation for which it contended was a drastic drop
in the value of
those shares. For this reason, article 4.2 would be of application
and hence the conversion would require the approval
of 75 per cent of
the holders of the ordinary shares.
[35]
English
law appears to support the view that a variation of rights occurs
when the rights which attach to the shares are varied
and not when
they become commercially less valuable. Where additional preference
shares and ordinary shares had been issued, it
was held that the
rights of preference shareholders had not been varied.
White
v Bristol Aeroplane Co Ltd
[1953] Ch 65
at 74 – 80. When the voting power of certain
ordinary shareholders had been diminished as a result of subdivision
of other
ordinary shares it was held that there had been no variation
of rights.
Greenhalgh
v Arderne Cinemas Ltd
[1946] 1 All ER 512 (CA)
[4]
.
[36]
In
the present case, the deceased through the preference shares enjoyed
sufficient voting power to ensure a conversion of the preference
shares to ordinary shares. While the voting rights of the respective
class of shareholders would not have changed, by means of
the
conversion, the value of the existing issued ordinary shares would
have declined in value by way of the increased number of
the ordinary
shares pursuant to the conversion. However, to fall under the scope
of rights being “varied” it would
then have been
necessary to interpret the phrase to mean that the shares of the
ordinary shareholders were now commercially less
valuable. The
balance of the voting power would not be changed nor would there be
any alteration of the rights, privileges and
conditions attaching to
the ordinary shares as a class
[5]
.
[37]
A
further problem which confronts respondent’s argument is the
express wording of Article 7.1.10 which, as is clear from the
text
thereof, provides that any class of shares, by special resolution,
can be converted to shares of a different class, absent
any other
provision in the articles to the contrary. It is clear that the
deceased, by virtue of holding the overwhelming majority
vote could
have converted the preference shares to ordinary shares. This article
is not qualified by a reference to article 4.2,
both of which were
part of the original articles of the company. Had it been intended to
impose a qualification upon the position
as set out in article
7.1.10, express language would have been required to make this
position clear. The express meaning given
to article 7.1.10 finds
further support in that the overall consequence of these two articles
is a congruence with the distinction
between an effect on rights, as
opposed to a consequence of a diminished commercial value. Article
4.2 deals with the former, while
a conversion to ordinary shares in
terms of article 7.1.10 caters for a situation where only the latter
result might follow. The
result is that the argument based on Article
4.2 fails.
Costs
[38]
Both
parties were agreed that the Tax Court wrongly made a cost order
against appellant. In terms of
s 130(1)
(a)
of the
Tax Administration Act 28 of 2011
a tax court may grant a
costs order in favour of a taxpayer if SARS’ grounds for
assessment or ‘decision’ are
held to be unreasonable;
suffice to say that no such reason was given by the Tax Court as to
its award of costs.
[39]
In
the result:
1.
The
appeal is upheld with costs, including the costs of two counsel.
2.
The
order of the Tax Court of 11 October 2016 is set aside and replaced
with the following order:
‘
The
deceased was entitled, on the date of his death, to convert the
preference shares to ordinary shares and the preference shares
must
be valued, for the purposes of paragraph 40 read with paragraph 31(3)
of the Eighth Schedule to the Income Tax Act, on this
basis.’
____________________
D Davis
Acting
Judge of Appeal
APPEARANCES
For
the Appellant:
A R Sholto-Douglas SC with N Bawa SC
Instructed
by:
State Attorney, Bloemfontein
For
the respondent:
P A Solomon SC with J Boltar
Instructed
by
Werkmans Attorneys,
Symington
& De Kok, Bloemfontein
[1]
Paras 31 (3) of the Eighth Schedule
to the Act.
[2]
Natal Joint
Municipal Pension Fund v Endumeni Municipality
2012 (4) SA 593
(SCA) at para 18
[3]
Rosslare (Pty)
Ltd v Registrar of Companies
1972 (2) SA 524
(D & CLD) at 528 A-B, LAWSA (first re-issue) Vol
4 Part 1 at para 73 in respect of the 1973 Companies Act. The
position remain
the same under the
Companies Act 71 of 2008
. LAWSA
(second edition) Vol 4 Part at para110
[4]
For
the distinction between variation of rights and shares that become
commercially less valuable, see
White
,
supra at 74; and the minority judgment of Trollip JA in
Utopia
Vakansie-Oorde Bpk v Du Plessis
1974 (3) SA 148
(A) at 181-182. Blackman, Jooste and Everingham
Commentary
on the
Companies Act
Volume
1 at 5-286 argue that this distinction drawn in English law
is equally applicable in South African company law.
[5]
Blackman, Jooste
and Everingham
Commentary
on the
Companies Act
Volume
1 5-288. see also Gower and Davies
Principles
of Modern Company Law
(8
th
ed) at 668.