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[2014] ZAWCHC 123
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Capstone 556 (Pty) Limited v Commissioner For The South African Revenue Service (A49/14) [2014] ZAWCHC 123; 2014 (6) SA 195 (WCC); 77 SATC 1 (26 August 2014)
IN
THE HIGH COURT OF SOUTH AFRICA
(WESTERN
CAPE DIVISION, CAPE TOWN)
Case
No:
A49/14
In the matter
between:
CAPSTONE
556 (PTY)
LIMITED
...........................................................................................
Appellant
and
COMMISSIONER
FOR THE SOUTH AFRICAN
REVENUE
SERVICE
.............................................................................................................
Respondent
Court:
GRIESEL, YEKISO & BAARTMAN JJ
Heard:
1 August 2014
Delivered:
26 August 2014
JUDGMENT
Griesel
J:
[1]
This
is an appeal and a cross-appeal against a judgment and order of the
tax court (Davis J presiding).
[1]
It arises from an additional assessment in respect of the appellant’s
2005 year of assessment in terms of which an amount
of R200 633 728
was included in the appellant’s taxable income (over and above
the amount assessed as a capital
gain in the original assessment for
that financial year). This arose from the disposal by the appellant
of certain shares in JD
Group Limited (‘JDG’) in the 2005
year of assessment, the proceeds of which were taxed by the
commissioner
as being
of
a revenue nature. In addition, separate amounts of R45 123 050
in respect of
an
‘equity kicker’ and R55 million in respect of
an
indemnity obligation were disallowed by the
commissioner
as
deductions from gross income. Interest in the amount of
R50 188 561,99 was also imposed by the
commissioner
in
terms of s 89
quat
(2)
of the Income Tax Act 58 of 1962 (‘the Act’).
[2]
The appellant objected to the assessment of
the proceeds of the sale as revenue and also to the disallowance of
the expenses
in respect of
the
equity kicker and indemnity. These objections were dismissed by the
commissioner.
[3]
On appeal to the tax court, the appellant
was unsuccessful in relation to the main issue, namely whether the
amount in issue was
rightly included as part of its income (‘the
first issue’). However, the tax court held in the appellant’s
favour
in relation to the second and third issues, being the
deductions in respect of
the equity kicker
and the indemnity respectively. The tax court also remitted the
interest imposed by the
commissioner.
The present appeal is directed at the court’s
findings with regard to the first issue, whereas the cross-appeal is
directed
at the court’s findings with regard to the second and
third issues.
[4]
The
relevant factual background appears from the reported judgment of the
tax court.
[2]
I accordingly do
not propose to repeat the tax court’s full and elaborate
exposition of the factual scenario for purposes
hereof, save to
the extent necessary to explain my reasoning.
General
approach on appeal
[5]
Before
considering the issues arising on appeal, it is necessary to refer
briefly to the approach that should guide this court in
that process.
In
the heads of argument filed on behalf of the
commissioner
herein,
it was submitted that the finding of the tax court that the proceeds
of the disposal of the JDG shares by the appellant were a
receipt or
accrual of a revenue nature was one of fact, not law. In the result,
so it was submitted, where there is no material
misdirection on
fact by the trial court, the assumption is that its conclusion is
correct. The appeal court will only reverse it
where it is convinced
that it is wrong. In such a case, if the appeal court is merely left
in doubt as to the correctness of the
conclusion, then it will uphold
it.
[3]
[6]
As
counsel for the appellant rightly pointed out, however, in
CIR
v Pick ‘n Pay Employee Share Purchase Trust
,
[4]
the
Appellate
Division
reaffirmed
that the question whether receipts are capital or income is a matter
of inference from the facts ‘and therefore
ultimately a
question of law’. (However, counsel for the
commissioner
pointed
out, on the other hand, that the question as to the intention of the
taxpayer, although also a matter of inference from
the facts, is
regarded as a question of fact.
[5]
)
[7]
While
it is true that the
onus
of
establishing the facts from which the desired inference should be
drawn is on the taxpayer,
[6]
this factor is not a material consideration where, as in this
instance, the primary facts are either common cause or not in
dispute.
[7]
In the absence of
adverse credibility findings against any of the witnesses, this court
is accordingly at large to consider the
issues afresh.
Capital
or revenue
[8]
Turning
to consider this perennial problem in tax cases,
[8]
it has been pointed out that ‘[t]here is no simple and
universally valid litmus test, the decision whether particular income
falls on the one side of the ill-defined borderline between capital
and revenue or on the other being “a matter of degree
depending
on the circumstances of the case”’.
[9]
This
has given rise to ‘unpredictability of the outcome of
assessments’
[10]
and has
spawned a substantial body of jurisprudence.
[9]
In
Itc
1185
,
[11]
Miller J observed:
‘
The
test to be applied when it is necessary to determine whether profit
made on the sale of property by a taxpayer represents revenue
or a
receipt of a capital nature has been formulated in many ways but
there is no essential difference to be found between any
one
formulation and another and in so far as the general approach to the
problem is concerned. The fundamental inquiry is whether,
in buying
and selling the property and thus earning the profit which is the
subject of the inquiry, the taxpayer was
engaged
in carrying on a trade or business or profit-making scheme
.
If that is what he was doing, the profits are income and taxable in
his hands. If however, he held the property as an investment
of
capital the realisation of the asset would simply be a conversion of
the capital asset to cash, which he would receive and hold
as
capital, not as revenue.’ (Emphasis added)
[10]
Meyerowitz
and Spiro on
Income
Tax
para
299 referred to the ‘rather clumsy phrase’, ‘operation
of business in carrying out a scheme of profit-making’
(partially italicised in the above extract) which, in plain language,
means ‘that receipts or accruals bear the imprint of
revenue if
they are not fortuitous, but designedly sought for and worked for’.
This formulation was quoted with approval
in the majority judgment
in the
Pick
‘n Pay
case
supra
.
[12]
[11]
A
variety of tests are employed in order to determine whether or not a
particular receipt is one of a revenue or capital nature.
They are
laid down as guidelines only – there being no single infallible
test of universal application; ‘no simple
and universally valid
litmus test’, as Kriegler AJA put it. One of the most widely
used tests applied by our courts over
the years – described by
Silke
on South African Income Tax
[13]
as
the ‘golden rule’ – is the test of ‘intention’:
with what intention did the taxpayer acquire and
hold the asset?
However, such intention is not conclusive, nor should the
ipse
dixit
of the taxpayer as to his or her intention be accepted without
critical scrutiny, since it may be coloured by self-interest,
[14]
or
it may prove to be unreliable or constitute pure reconstruction.
Instead, such evidence should be weighed with great care against
the
objective facts surrounding the transaction.
[15]
[12]
When
considering the intention of a taxpayer, it is important to bear in
mind, as Smalberger JA pointed out in
Pick
‘n Pay supra
,
that ‘[i]n a tax case one is not concerned with what
possibilities, apart from his actual purpose, the taxpayer foresaw
and with which he reconciled himself. One is solely concerned with
his object, his aim, his actual purpose.’
[16]
Put differently, the concept of
dolus
eventualis
as
applied in criminal law has no place in the context of tax law.
Consequently, it is important not to confuse contemplation
with
intention in the above sense.
[13]
Another
test frequently applied by the courts in this context is to
distinguish between ‘fixed capital’, on the one
hand, and
‘floating capital’, on the other. The distinction was
explained by Innes CJ in
CIR
v George Forest Timber Co Ltd
,
[17]
as follows:
‘
Capital,
it should be remembered, may be either fixed or floating. I take the
substantial difference to be that floating capital
is consumed or
disappears in the very process of production, while fixed capital
does not; though it produces fresh wealth, it
remains intact.’
[14]
These tests, though easy to state, are not
always easy to apply in practice, as the plethora of cases in our law
reports and widely
divergent opinions expressed therein amply
illustrate. Ultimately, each case has to be decided on the basis of
its own facts.
Discussion
[15]
In his grounds of assessment, the
commissioner contended that at the time the JDG shares were acquired
by the appellant, it did
not intend to hold them as capital assets
and/or for purposes of earning dividends, but intended to dispose of
them in the short
term for profit; ie ‘in relation to the JDG
shares it carried on business in pursuance of a scheme of
profit-making’,
as it was put in the grounds of assessment. The
commissioner based this contention,
inter
alia
, on the objective facts that the
JDG shares were held for less than five months before being disposed
of; that the purchase of
the shares was financed from external
sources, and not from the appellant’s available funds; and that
the appellant could
not benefit from the dividends generated by the
JDG shares, such dividends being earmarked for paying preference
dividends and/or
repaying the short-term shareholder loan.
[16]
The
objective facts relied on by the commissioner are among the
considerations often invoked to support an inference that the
shares
were acquired in pursuance of a scheme of profit-making and that
the proceeds of the sale are accordingly of a revenue
nature.
However, even if the objective facts suggest that the amount in
question is
prima
facie
of
a revenue nature, the taxpayer may be able to provide an explanation
to rebut such inference. The taxpayer’s explanation
of the
events, including his or her intention in respect of
the
transaction in question, is therefore relevant and must be tested in
the light of all the other circumstances.
[18]
[17]
In this instance, it is clear to me that it
would be an over-simplification to focus too closely on the bare
facts outlined
above in drawing an inference as to the intention of
the taxpayer. The true factual matrix as it emerges from the
voluminous evidence
before us is far more complex and nuanced. It is
essential, therefore, to consider the objective facts relied on by
the
commissioner
in
the broader context of the evidence as a whole.
Intention of the
taxpayer
[18]
There
was some debate before us regarding the intention of the taxpayer in
this case, more particularly whether such intention is
to be
determined with reference to the state of mind of Mr Daun or Mr
Jooste. The tax court found that Mr Jooste should, for purposes
of
this enquiry, be regarded as the ‘brain’ of the
company.
[19]
Counsel for the
appellant took issue with this finding and argued that Mr Daun was
for all relevant purposes the ‘brain’.
They also referred
to the undisputed evidence that Mr Daun was the ‘captain of the
ship’, as he repeatedly described
himself in the course of his
evidence. Mr Jooste was merely a ‘passenger’.
[19]
In
the view that I take of the matter, it does not really matter whether
one regards the one or the other as the ‘brain’,
as it
makes no difference to the eventual outcome for reasons that will
appear in due course.
[20]
Dealing
briefly with the objective factors on which the
commissioner
relied,
it is true that the shares were finally acquired by the appellant
only on 5 December 2003 and they were sold less than five
months
later. If an investor in the street had acquired JDG shares on the
same day and disposed of them five months later at a
substantial
profit, there could be little argument if the commissioner were to
tax the resultant profit as revenue. However, as
appears from the
judgment of the tax court,
[20]
this is not what happened in the present case. The effective date of
the transaction as a whole dates back to 21 June 2002. It
is
accordingly at that date that one must look when considering the
period for which the asset was held.
[21]
Moreover, the purpose behind the
acquisition of the shares has been fully explained on behalf of the
taxpayer, based on facts which
are
sui
generis
. This appears,
inter
alia
, from an affidavit prepared for
submission to the Competition Commission in order to obtain the
necessary approval for JDG
to take over management of Profurn. It
sketches in some detail the origin and relevant background to the
transaction as well as
Mr Daun’s motivation for entering into
the deal:
‘
4.
I am indirectly still the holder of approximately 13% of the total
issued share capital of Profurn and having had intimate knowledge
of
the company and being a major contributor towards its success, I am
saddened as to what has transpired and the fact that the
company
could collapse as a result of its debt burden, lack of management and
other negative factors.
5.
I have been approached by FirstRand Bank Limited, a major creditor
and shareholder of Profurn, to mount a rescue operation (in
the sum
of R600 million) and I am prepared to do so conditionally upon same
being structured through JD Group Limited which, in
my opinion, is
the only competent professional manager in the retail furniture
industry in South Africa which can turn around the
businesses of
Profurn and in the absence of which same will in my opinion result in
a massive corporate failure.’
He
thereupon sketched the two possible scenarios that may arise
regarding Profurn, depending on whether the
de facto
situation
is retained, or whether the ‘rescue mission’ is
successful. He concluded as follows:
‘
7.
I emphasise that I will not be prepared to mount any rescue operation
and invest the substantial amount afore-referred to unless
the JD
Group Limited is placed in immediate management control thereby being
able to address all the negative aspects or the business.
It is in my
opinion not possible to deal with such issues in three to four
months’ time as based upon the present trading
losses being
sustained by Profurn, it will not survive such period and even if it
did, the nature of the business three to four
months down the line
would not evidence any interest for me.’
[22]
This
is a crucial piece of evidence, which was not challenged in
cross-examination nor was it contradicted by any other evidence.
The
reasons why a court is ordinarily wary of accepting the
ipse
dixit
of a taxpayer as to his or her intention
[21]
are absent in this instance, as the affidavit was deposed to by Mr
Daun on 12 June 2002, ie some nine days
prior
to the effective date of acquisition of the asset. The contents of
affidavit make it clear that the whole purpose behind the scheme
was
a ‘rescue operation’, not a profit-making scheme.
[23]
That
this was indeed the dominant purpose behind Mr Daun’s decision
to acquire the JDG shares is borne out by the fact that
this decision
was made at a time of great economic uncertainty; was attended by
considerable risk; and that a period in excess
of three years
was anticipated by all concerned as being the minimum time that would
be required before the transaction could be
‘bedded down’
– if indeed it was ‘bedded down’ at all – for
which period the appellant and
Daun et Cie were committed to remain
as shareholders. Moreover, the success of the venture was by no means
assured and depended
on a number of uncertain factors:
[22]
Dr
Lategan testified that ‘these were absolute desperate times’
when the transaction was concluded.
Mr
Jooste confirmed this when he testified that ‘in 2001 the
[furniture] industry was really in deep trouble’.
In
the words of Mr Muller, ‘Profurn was nearly bankrupt and it
was debatable whether JD would make it, you know, to turn
around
quickly and successfully’.
To
illustrate the risk of failure, Dr Lategan pointed to the fact that
after Mr Daun had committed himself to the deal in terms
of the MOU,
the share price of Profurn deteriorated by a further 50c, from the
agreed acquisition price of R2,80 to R2,30 per
share.
At
that stage, Profurn faced imminent liquidation. This threatened
to destabilise the entire retail furniture industry in
South Africa,
in which both Mr Daun and Mr Jooste were major players. Moreover,
Profurn also owed between R70–90 million
to Steinhoff,
of which Mr Jooste was the chief executive and Mr Daun was a
director. Thus, from both their perspectives
the rescue of Profurn
via a merger with JDG was seen as essential in order to protect
Steinhoff from economic harm and at the
same time to restore
stability to the industry.
[24]
The objective evidence thus shows
overwhelmingly that the transaction involved a large-scale rescue
operation in the South African
furniture industry, one that was
anticipated to require both capital and management expertise;
that it would take between
three and five years to be successfully
accomplished (if at all); and there was no short-term intention on
the part of anyone who
participated in the arrangements
concerning the JDG shares. This is further borne out,
inter
alia
, by the facts – (a) that
the acquisition of the JDG shares was accompanied by the assumption
of a five-year indemnity
to the extent of R125 million (R62.5
million, in the case of the appellant), which five-year period was
later extended until 23
April 2010; and (b) that Mr Jooste
attempted to raise finance for the JDG transaction for a 3 to 5 year
period.
[25]
In summary, the appellant’s intention
when it first decided to acquire the JDG shares was to make a
strategic investment in
a leading company in the furniture industry
and to hold those shares for however long it took to turn around the
Profurn ship,
which was anticipated to take in excess of three years.
[26]
In
the light of this evidence, the tax court held, correctly in my view,
that ‘[t]he objective evidence, read as a whole,
suggests that
the investment in the JDG shares was to last for a period of at least
3 years, arguably slightly longer, depending
upon the success of the
venture.’
[23]
[27]
Somewhat surprisingly, therefore, the tax
court later concluded:
‘
The
evidence concerning the intention on acquisition is thus not
definitively in appellant’s favour; it does no more than
show
that there was always an intention to realise the shares for a
significant profit. The question was not if but when a sale
would
occur. Hence, a profit making intention was always a dominant purpose
within the mind of those who controlled appellant;
. . .’
[24]
and
‘
.
. . the evidence does not provide an answer, on the probabilities,
that this was to be a long term investment. There may have
been a
purpose to so hold, but there is no clear proof of it being the
dominant purpose. . . . When both the purpose
at the
time of acquisition and sale are considered, it cannot be concluded,
on the probabilities, that a long-term investment was
realised to
best advantage. To the contrary, the mixed intention had converted
into a clear purpose of selling to “cash in”
on the
profit.’
[25]
[28]
I respectfully disagree with the reasoning
contained in these extracts. First, these findings are contrary to
the weight of the
evidence and the court’s own earlier finding
referred to above to the effect that ‘the investment in
the JDG shares
was to last for a period of at least 3 years, arguably
slightly longer’. Secondly, it was not incumbent upon the
appellant
to prove that the intention on acquisition of the shares
was ‘definitively’ in its favour; a balance of
probability
is sufficient. Thirdly, it was likewise not incumbent
upon the appellant to prove that that it bought the JDG shares as a
‘long-term
investment’; all that it was required to prove
was that it did not buy the JDG shares as trading stock in pursuance
of a
scheme of profit-making.
[29]
As
for the decision to sell, the tax court placed considerable reliance
on this fact in finding that the earlier ‘mixed’
intention had converted into a clear purpose of selling to ‘cash
in’ on the profit. For the reasons I have stated above,
I read
the evidence somewhat differently and differ from the assessment as
to an earlier ‘mixed’ intention on the part
of the
appellant. As for ‘cashing in’ on a profit, this is
neither here nor there: any investor who sells a capital
asset at a
profit after holding it for some length of time also ‘cashes
in’ on its profit. In any event, the alleged
‘intention
to realise the shares for a significant profit’ was no more
than a fond hope that the transaction would
turn out to be
successful. It does not convert the transaction into a profit-making
scheme. As mentioned earlier, it is not what
the taxpayer
contemplated
that is relevant, but ‘his object, his aim, his actual
purpose’.
[26]
[30]
In
so far as the tax court sought to justify its conclusion with
reference to ‘the duration of the Gensec loans [which] only
adds to the picture of a mixed intention’, the duration of the
loans has been fully explained by the appellant. As rightly
pointed
out by the tax court, Mr Jooste had initially attempted to raise
finance for the transaction for a maximum of a 3 to 5
year
period.
[27]
This was going to
be granted by Gensec until its holding company, Sanlam, decided to
scale down its (Gensec’s) operations
and Mr Muller (with some
trepidation) had to break this news to Mr Jooste. The point is that
it was not the appellant’s decision
to settle on a relatively
short-term loan with Gensec; it had no control over it whatsoever.
Decision to sell
[31]
The intention at the time when the asset
was disposed of may be relevant for different reasons. In
Lawsa,
the position is summarised as follows:
‘
The
taxpayer’s intention at the time when the asset was disposed of
is relevant in determining the capital or revenue nature
of the
proceeds of the disposal. If the taxpayer’s intention at that
time was merely to realise a capital asset, this supports
a
conclusion that the proceeds of the disposal are capital; but if the
taxpayer’s intention at the time of disposal was to
treat the
asset as trading stock, this suggests that the proceeds of the
disposal are income, and the intention with which the
asset was
acquired and held will be irrelevant. The possibility of a change of
intention by the taxpayer, between acquisition and
disposal of the
asset, must be considered. A different intention at these two points
implies that there has been a change of intention
in the
interim.’
[28]
[32]
The tax court referred to the fact that
‘[w]ithin a very short period however, the sale of the JD
shares was on the agenda,
initiated by Mr Jooste and explored further
by Mr Daun’. From this fact it drew the inference that the
appellant’s
perceived ‘mixed intention had converted into
a clear purpose of selling to “cash in” on the profit’.
However,
this inference is based on a shaky foundation, as the
decision to sell must again be seen in proper context. As mentioned
earlier,
the shares were effectively acquired during June 2002, not
December 2003. Moreover, the circumstances that prevailed at the
time when the decision to sell was made were materially different
from those prevailing during the middle of 2002, when the obligation
was incurred. Since the effective date, much had changed:
‘miraculously the world economy changed in about
2003/2004’,
in the words of Dr Lategan. The management
takeover of Profurn by JDG’s Mr Sussman and the ‘unique
turnaround
strategy’ employed turned out to be an
unqualified success, which contributed to the Profurn
‘ship’
being ‘turned around’ in a much
shorter period than anticipated. Of course, all of this was reflected
in a substantial
increase in the price of JDG shares between the
effective date in 2002 and the eventual date of sale in 2004.
[33]
On the negative side, there was the fact
that during the latter part of December 2003 and the first months of
2004, the South African
Rand weakened significantly, losing
value at an alarming rate against major currencies, with foreign
investors, including
Mr Daun, becoming increasingly nervous
about the outlook for the South African economy and its ability to
generate investment returns
in terms of foreign currency risk. He
explained that he reassessed his investment portfolio, which he
regarded as having become
disproportionately exposed to the South
African Rand at that time. His large exposure to the South African
currency, together with
structural economic-risk factors,
resulted in Mr Daun becoming inclined to realise certain of his
interests in South Africa.
[34]
More or less at the same time, Mr Jooste –
quite fortuitously – came to hear, through his association with
Citibank
in the context of a completely unrelated transaction,
that it would be theoretically possible to dispose of a substantial
parcel of shares of a listed company by means of a process of ‘book
building’. This process was subsequently explained
to, and
found favour with, Mr Daun. He accordingly approached Mr David
Sussman of JDGroup, to whom he had given a commitment when
the
transaction was conceived that he would stay the course and would
remain invested until the Profurn ship had been turned around,
or
‘bedded down’. To his surprise, Mr Sussman released him
from his commitment without demur. Finally, his wife (and
financial
confidante) also urged him to sell. All of these factors contributed
to Mr Daun’s decision, late in March
2004, to sell the whole
parcel of JDG shares.
[35]
This was confirmed in the evidence of Mr
Daun, where he replied in the affirmative to the following question
during cross-examination:
‘
Let
me understand this: your inclination to sell JD Group shares came
only because of the approach from Citigroup?’ and Mr
Daun
replied ‘Yes’.
Later
during cross-examination, the following exchange took place:
‘
Simply
put, Mr Daun, it’s not that you owned these shares and then had
a change of heart and decided to sell them: you owned
these shares,
an opportunity presented itself to you, and you took that
opportunity. --- Yes, I must repeat what I told yesterday
about
meeting with my wife, and I was always unsecure, do it or not do it.
You know when in life and you make decisions, you think
what is the
pro
, what
is the
contra
,
was I missing future opportunities. So the original plan was not to
sell. Therefore it was a change of my original intention was
this
book building on the table. And then the last kick might have come
from my wife, that she said why you not taking this? It’s
an
opportunity on the table, cash on the table – take it. And then
I decided on this, ja, and I accepted that.’
[36]
He also explained that the decision to sell
was ‘an opportunistic decision’ which could not have been
contemplated when
the shares were acquired in 2002.
[37]
In
ITC
1185, supra
,
[29]
Miller J held:
‘
The
fact that a property is sold for a substantial profit very soon after
it has been acquired is, in most cases, an important one
in
considering whether an inference adverse to the taxpayer should be
drawn, but it loses a great deal of its importance when there
has
been a
nova causa interveniens
.
[38]
Counsel for the appellant relied on the
evidence quoted above in support of a submission that the approach
from Citigroup was solely
responsible for Mr Daun’s inclination
to sell the JDG shares, and that this represented a
nova
causa interveniens
as contemplated by
Miller J. In my view, this argument is sound.
[39]
In the final analysis, the decision to sell
was taken by Mr Daun for reasons that have been explained. The
appellant, as a separate
legal entity, had no say in the matter: it
was a junior partner in a consortium controlled by Mr Daun. It
was a material term
of the underlying agreement that Mr Daun would
control the decision when to sell the parcel shares as a whole; not
only his 50%
thereof. As a fact, therefore, the appellant had no
choice in the matter. In the circumstances, the intention of the
appellant
at the time of the sale is irrelevant in determining
the question whether the asset was of a capital or revenue nature.
Its
only intention at that time was to honour its commitment to its
consortium partner.
[40]
Apart from the considerations referred to
above, there are further objective factors that point in the
direction of the shares being
acquired and held as a capital asset:
The
sole purpose of the appellant was to acquire and hold the JDG
shares, and that – as an SPV – the appellant engaged
in
no activity whatsoever other than what was required by the
acquisition and holding of the shares. Indeed, the appellant was
contractually precluded from doing anything else. This tends to
strengthen the inference of the shares being held as fixed, as
opposed to floating, capital.
This
was also the way the asset was reflected in the appellant’s
financial statements for the financial year ending February
2004,
namely as ‘non-current assets’. Thus, the appellant
clearly did not regard the relevant asset as ‘trading
stock’,
or ‘stock-in-trade’, or ‘floating capital’.
In
any event, as pointed out by Smalberger JA in
Pick
‘n Pay supra
:
‘Where no trade is conducted there cannot be floating
capital.’
[30]
In this
case, it is clear that the appellant conducted no trade; it did not
even hold board meetings.
[41]
On the evidence as a whole, the inference
is accordingly more probable, to my mind, that the JDG shares were
acquired and held by
the appellant as a capital asset. I am
accordingly satisfied that the taxpayer has discharged the onus of
proving on a balance
of probabilities that the JDG shares
constituted capital and they were acquired with a capital
intention.
Change
of intention?
[42]
There was some debate before us on the
question whether the eventual decision to sell the shares should be
seen as a change of intention
on the part of the taxpayer. The
significance of such a change in intention lies in para 12(2)(
c
)
of Schedule 8 to the Act, which provides that there would have been a
deemed disposal of the JDG shares on the date of the change
of
intention, and the difference between the cost of the shares and
their value on the date of the change of intention would be
subject
to capital gains tax. The difference between the market value on such
date and the eventual proceeds would then be subject
to income tax
because they were not of a capital nature.
[43]
On
the facts of the present case, it would make very little difference
to the appellant’s overall tax liability, given our
finding as
to the capital nature of the asset in question. Nonetheless, I am
satisfied on the evidence as a whole that the decision
to sell was
simply one to dispose of a capital asset; not to convert a capital
asset into trading stock. The distinction is a subtle
but important
one. It was recognised in
John
Bell and Co
(
Pty
)
Ltd
v
SIR
,
[31]
where Wessels JA held:
‘
.
. . the mere change of intention to dispose of an asset hitherto held
as capital does not
per se
subject
the resultant profit to tax. Something more is required in order to
metamorphose the character of the asset and so render
its proceeds of
gross income. For example, the taxpayer must already be trading in
the same or similar kinds of assets, or he then
and there starts some
trade or business or embarks on some scheme for selling such assets
for profit, and in either case, the asset
in question is taken into
or used as his stock-in-trade.’
[44]
In the result, the profit realised from
disposal thereof can in my view only be described as ‘fortuitous’,
in the sense
as explained by Smalberger JA, with the result that it
constituted receipt of a capital nature within the definition of
‘gross
income’ in s 1 of the Act.
[45]
It follows that the appeal should succeed.
Deductibility
of equity kicker and indemnity obligation
[46]
Turning now to the deductibility of the
expenses claimed in respect of the equity kicker and the indemnity
obligation, these issues,
as mentioned earlier, were decided in
favour of the appellant by the tax court, which findings gave rise to
the cross-appeal herein.
Having found that the proceeds of the sale
were of a revenue nature, the tax court held that both items
qualified for deduction
from the appellant’s taxable income in
terms of s 11(a), read with s 23(g), of the Act as being
‘expenditure
and losses actually incurred in the
production of the income, provided such expenditure and losses are
not of a capital nature’.
[47]
In the light of our finding that the tax
court erred in finding that the proceeds of the sale were of a
revenue nature, it follows
that the cross-appeal has become academic.
This court nevertheless now has to consider whether the items in
question formed part
of the ‘base cost’ of the JDG shares
for capital gains tax purposes as being ‘expenditure actually
incurred in
respect of
the cost of
acquisition or creation of that asset’, as contemplated by para
20(1)(a) of schedule 8 to the Act. The
commissioner
resisted a finding to that effect, contending that the amounts in
question should be included in the appellant’s
capital gain.
Equity kicker
[48]
The background to the liability to pay the
equity kicker is dealt with in paras 32 and 80–90 of the
judgment of the tax court.
In a nut–shell, the liability arose
from the loan agreement for R150 million between the appellant’s
holding company,
BVI, and Gensec, in terms of which Gensec would, in
addition to interest on the loan, be entitled to a share of the
profit (if
any) yielded by the investment.
[49]
The
commissioner’s
opposition to this claim is based on the
contention
that the sum paid by the appellant to Gensec in relation to the
equity kicker was paid on behalf of BVI and in settlement
of its
(BVI’s) obligation to Gensec. Such liability was not delegated
or transferred to the appellant, with the result that
payment was
made by the appellant in the absence of any unconditional legal
obligation requiring it to do so, and no deductible
expenditure was
incurred by the appellant, so it was argued.
[50]
The
tax court rejected this contention and found, instead, that the
obligation to pay the equity kicker was, ‘in substance’,
incurred by Capstone, which was required to discharge the
obligation;
[32]
and
that it was Capstone ‘which “really” incurred the
obligation and which is thus entitled to the deduction as
opposed to
BVI, because it “actually”, as employed in the context,
incurred the liability’.
[33]
[51]
In this court, counsel for the
commissioner
assailed these findings and pointed,
inter
alia
, to the absence of any written
confirmation of the alleged arrangement between the appellant
and BVI. They also placed strong
reliance on the fact that the
financial statements of neither company reflect such an arrangement.
[52]
These arguments are by no means without
merit, but I am unpersuaded that the tax court erred in its
finding that it was the
appellant who actually incurred the expense.
In my view, the approach adopted by the
commissioner
is overly formalistic and fails to
have regard to the basic commercial reality of what actually took
place. I am accordingly
satisfied that the appellant is indeed the
party that actually incurred the expense.
[53]
However, this is not the end of the
enquiry, as the
commissioner contended in
the alternative that the equity kicker forms part of the ‘borrowing
costs’ of the transaction.
In this regard, reference is made to
pa
ra 20(2) of schedule 8, which provides
that –
‘
[t]he
expenditure incurred by a person in respect of
an
asset does not include any of the following amounts—
(a)
borrowing costs,
including any interest as
contemplated in s 24J or raising fees’.
[54]
The
concept, ‘borrowing costs’
[34]
is
not defined in schedule 8 or elsewhere in the Act. It is not
necessary for this court to attempt to lay down an exhaustive
definition
of the concept, but simply to attribute meaning thereto in
order to answer the question whether the equity kicker, as applied in
this case to the loan agreement between BVI and Gensec, falls within
its ambit. In this process, the court must employ the technique
prescribed by Wallis JA in
Natal
Joint
Municipal Pension Fund v Endumeni Municipality
.
[35]
As stated therein, ‘[t]he inevitable point of departure is the
language of the provision itself, read in context and having
regard
to the purpose of the provision and the background to the preparation
and production of the document’. Moreover, ‘[t]he
process
is objective not subjective’.
[36]
[55]
The context in which the words appear is in
a schedule to a fiscal statute, dealing specifically with capital
gains tax. The words
are used in a section excluding certain
expenditure for purposes of calculating the base cost of an asset. In
seeking to achieve
that purpose, the legislator has deliberately, it
seems, utilised a concept of very wide import, namely ‘borrowing
costs’.
It has gone further and expanded that wide meaning by
incorporating by reference the equally wide definition of ‘interest’
in s 24J(1) of the Act, which includes (as far as is relevant
for present purposes):
‘
(a)
gross amount of interest or related finance charges, discount or
premium payable or receivable in terms of or in respect of
a
financial arrangement;
(b)
amount (or portion thereof) payable by a borrower to the lender in
terms of any lending arrangement as represents compensation
for any
amount to which the lender would, but for such lending arrangement,
have been entitled; and
(c) …
irrespective
of whether such amount is –
(i) calculated with
reference to a fixed rate of interest or a variable rate of interest;
or
(ii)
payable or receivable as a lump sum or in unequal instalments during
the term of the financial arrangement.’
[56]
As I read these provisions of para
20(2)(a), their purpose is to exclude from deductible expenditure the
overall costs expended
by a taxpayer in acquiring an asset with
borrowed money.
[57]
Applying that interpretation to the facts
in this case, Gensec’s Mr Muller described the concept of an
equity-backed finance
transaction as one in which the lender could
get a higher return. Gensec’s higher return on its investment
was justified,
according to him, because of the greater risk it
undertook. Gensec described the equity kicker as an ‘IRR’
(Internal
rate of return). The IRR calculations by Gensec on the
loans show that it regarded the equity kicker as part of its return
on the
investment, ie a cost of finance or borrowing cost. Muller in
cross-examination conceded that the equity kicker made Gensec a
‘healthy
return’ on its investment. In summary, it is
clear that the equity kicker obligation arose under the loan
agreement in question
and formed part of the
quid
pro quo
for the loan. It was (in the
same way as interest) a type of consideration for the loan of money;
or, put differently, part of
the cost of borrowing.
[58]
I accordingly conclude that the equity
kicker clearly constitutes a ‘borrowing cost’ for
purposes of para 20(2)(
a
)
of schedule 8. This would ordinarily result in all such borrowing
costs being excluded from the base cost calculation. However,
para
20(2) itself creates an exception to this rule in relation to
‘borrowing costs and expenditure contemplated in subparagraph
(1)(g)’: this sub-paragraph makes provision,
inter
alia
, for expenditure directly
related to the cost of an asset which constitutes ‘a share
listed on a recognised exchange’.
The transaction under
consideration falls, of course, squarely within that exception in
relation to the listed JDG shares in question.
It follows that
one-third of the interest forms part of the base cost which may be
deducted.
[59]
In the final result, an amount of
R30 082 033 (two-thirds of the amount of R45 123 050)
falls to be included
in the capital gain on the basis that it does
not constitute part of the base cost of the shares by virtue of the
provisions of
para 20(2)(a), read with para 20(1)(g) of the
schedulre.
Indemnity
[60]
As for the claim in respect of
the
indemnity obligation, the facts appear from paras 29, 33 and 91–94
of the judgment. Based on those facts, the tax court
concluded as
follows:
‘
This
evidence serves to indicate that, as at July 2004, the appellant had
assumed an unconditional liability towards Daun et Cie
in the amount
of R55 million. This amount was then recorded as a loan in the
appellant’s books of account ending 28 February
2005. . . . The
evidence revealed that the appellant’s liability to Daun et Cie
in respect of this indemnity
was subsequently settled by way of a set
off. However that does not mean that this Court is not entitled to
conclude that R55 million
was expenditure actually incurred during
the 2005 year of assessment, because in that year of assessment an
unconditional liability
to pay that amount had been created.’
[37]
[61]
Assuming, without deciding, that the tax
court’s reasoning quoted above is sound and that the appellant
had assumed an unconditional
liability towards Daun et Cie during the
relevant tax year, this leaves the more fundamental question
unanswered, namely whether
the liability assumed towards Daun et Cie
can be regarded as expenditure incurred in respect of
the
‘cost of acquisition’ of the shares. The fact of the
matter is that the appellant’s original indemnity obligation
to
FirstRand was contingent in nature. By the time of the sale of the
shares, the appellant had not incurred any obligation in
terms of the
indemnity and it was uncertain whether any such obligation would ever
be incurred. The original indemnity liability
thus remained
contingent as at the date of the sale of the shares and no liability
attached to the appellant in respect of the
indemnity to FirstRand,
given its contingent nature. In the result no amount associated with
it could have formed part of the base
cost of acquiring the shares.
[62]
This contingent liability to FirstRand,
which may never have materialised, was voluntarily converted into an
unconditional liability
to Daun et Cie
after
the sale of the shares. The subsequent ‘indemnity settlement
obligation’ undertaken by the appellant in favour of Daun
in
the sum of R55 million was therefore something completely new
and served a different purpose. It was incurred as a direct
consequence of the sale of the JDG shares, and its purpose was
to clear up unresolved issues in the appellant after the sale
of the
shares. I accordingly agree with the
commissioner’s
contention
that the indemnity settlement
amount thus incurred by the appellant in favour of Daun
et
Cie constitutes a
novus
actus interveniens
, entirely separate
from the acquisition of the JDG shares. The cost may therefore more
properly be regarded as a cost of
disposal
,
not a cost of
acquisition
.
[63]
It follows that the amount of R55 million
falls to be included as part of the appellant’s capital gain in
disposing of
the shares.
Costs
[64]
The above result means that the appellant
was successful on appeal in relation to the main issue, which would
ordinarily entitle
it to its costs of appeal. Although the
cross-appeal has become academic, the commissioner’s
alternative contentions with
regard to the equity kicker and the
indemnity obligation were, substantially, upheld in this judgment.
The commissioner thus
succeeded in achieving partial success, which
cannot be regarded as negligible in the light of the substantial
amounts involved.
I would accordingly regard it as fair to make some
adjustment to the costs recoverable by the appellant. On a fairly
robust assessment
of the varying degrees of success and the relative
costs involved, I regard it as fair to hold the respondent liable for
80% of
the appellant’s costs of the appeal.
[65]
In the light of the fact that the issue of
costs and the basis that I have proposed has not been canvassed
before us during argument,
this part of the order will be
provisional. The parties will be granted leave, if so advised, to
address written submissions to
this court, within five (5) court days
from the date of this judgment, to show cause why the proposed order
regarding costs should
not become final. In the absence of any
submissions, the provisional order will become final.
Order
[66]
For the reasons set out above, the
following order is issued:
(a) The appeal is
upheld and the additional income tax assessment in respect of the
appellant for the 2005 tax year is set aside
and referred back to the
Commissioner for reassessment in the light of this judgment.
(b)
The respondent is ordered to pay 80% of the appellant’s costs
on appeal, including the costs of two counsel.
(c)
Paragraph (b) of this order is provisional. The parties are granted
leave, if so advised, to address written submissions to
this court,
within five (5) court days from the date of this judgment, to show
cause why the proposed order regarding costs should
not become final,
failing which, the provisional order will become final.
B
M Griesel
Judge
of the High Court
YEKISO
J: I
agree.
N
J YEKISO
Judge
of the High Court
BAARTMAN
J: I
AGREE.
E
D BAARTMAN
Judge
of the High Court
[1]
Income
Tax Case No 1867, 75 SATC 273.
[2]
ITC
1867, 75 SATC 273
in paras 5 51.
[3]
Counsel
cited
S
v Naidoo
[2002]
4 All SA 710
(SCA) para 26;
Mkhize v S
[2014] ZASCA 52
para 14 in support of these submissions.
[4]
1992
(4) SA 39
(A) at 56G H (majority judgment per Smalberger JA)
and at 51H J (minority judgment per Nicholas AJA). See also
Revenue
22
Lawsa
(2ed) para 49 n 7 and the authorities cited therein.
[5]
Lawsa
op cit
para
51 n 3 and the authorities cited therein.
[6]
Pick
‘n Pay supra
at 52A.
[7]
Ibid,
at 56G H.
[8]
See
eg the opening remarks of Miller J in Itc 1185;
(1972) 35 SATC 122
(N) at 122 3.
[9]
CIR
v Guardian Assurance Co South Africa Ltd
1991
(3) SA 1
(A)
at
19D F per Kriegler AJA.
[10]
Lawsa
op cit
para 49.
[11]
Supra,
loc cit
.
[12]
At
57F.
[13]
AP
de Koker and RC Williams
Silke
on South African Income Tax
(SI 51, March 2014) para 3.2.
[14]
Itc
1185
supra
at 121.
[15]
Malan
v KBI
1983
(3) SA 1
(A) at 18G. These principles were recently reaffirmed by
the Supreme Court of Appeal in
SARS
v Pretoria East Motors (Pty) Ltd
[2014] ZASCA 91
para 8.
[16]
At
58E G
[17]
1924
AD 516
at 524. See also
Solaglass
Finance Co (Pty) Ltd v CIR
[1990] ZASCA 157
;
1991 (2) SA 257
(A) at 269J 270J and the cases referred to
therein;
Lawsa
op cit
para 49.
[18]
Lawsa
op cit
para 50.
[19]
Judgment
paras 67 and 78.
[20]
Judgment
para 56. See also paras 7, 8 and 28.
[21]
Para
[11]
above.
[22]
Compare
the remarks of Smalberger JA in a similar context in
Pick
‘n Pay supra
at 58H I, where he stated:
‘
A
different conclusion might have been justified if the making of
profits was inevitable. But this was not the case. The prospect
of
profits was highly problematical. They depended upon the degree of
success achieved by the scheme.’
[23]
Judgment
para 68.
[24]
Judgment
para 77.
[25]
Judgment
para 78.
[26]
Pick
‘n Pay supra
.
[27]
Judgment
para 70.
[28]
Lawsa
op
cit
para
51.
[29]
35
SATC 122
at
128
.
[30]
At
60E.
[31]
1976 (4) SA 415
(A) at 429C D.
[32]
Judgment
para 89.
[33]
Judgment
para 90.
[34]
Afrikaans:
leenkoste
.
[35]
[2012]
ZASCA 13
;
2012 (4) SA 593
(SCA) para 18.
[36]
Loc
cit
(footnote omitted).
[37]
Judgment
para 95.