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[2016] ZASCA 2
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CSARS v Capstone 556 (Pty) Ltd (20844/2014) [2016] ZASCA 2; [2016] 2 All SA 21 (SCA); 2016 (4) SA 341 (SCA); 78 SATC 231 (9 February 2016)
Links to summary
THE
SUPREME COURT OF APPEAL OF SOUTH AFRICA
JUDGMENT
Reportable
Case
No: 20844/2014
In the
matter between:
THE
COMMISSIONER FOR THE SOUTH AFRICAN
REVENUE
SERVICE
APPELLANT
and
CAPSTONE
556 (PTY)
LTD
RESPONDENT
Neutral
citation:
CSARS
v Capstone 556 (Pty) Ltd
(20844/2014)
[2016] ZASCA 2
(9 February 2016).
Coram:
Ponnan,
Bosielo, Wallis and Mbha JJA and Van der Merwe AJA
Heard:
13
November 2015
Delivered:
9
February 2016
Summary:
Income tax ─
whether proceeds of sale of shares revenue or a receipt of a capital
nature ─ dominant purpose of acquisition
of shares long term
capital investment to rescue a distressed business ─ at time of
acquisition sale of shares at a profit
contemplated only as one of
several possibilities to be explored at the appropriate time in
future ─ subsequent sale of shares
unsolicited and fortuitous ─
proceeds a receipt of a capital nature ─ cross-appeal ─
calculation of base cost
for capital gains tax purposes ─
inclusion of indemnity payment.
ORDER
On
appeal from:
Western
Cape Division of the High Court, Cape Town
(Griesel,
Yekiso and Baartman JJ sitting as court of appeal):
1 The
appeal is dismissed with costs, including the costs of two counsel.
2.1 The
cross-appeal is upheld with costs, including the costs of two
counsel.
2.2 It is
declared that the liability undertaken by the taxpayer during July
2004 to pay the amount of R55 million to Daun et Cie
Aktiengesellschaft, formed part of the base cost of the acquisition
of the shares in JD Group Ltd.
JUDGMENT
Van
der Merwe AJA (Ponnan, Bosielo, Wallis and Mbha concurring):
[1]
During April 2004 the respondent, Capstone 556 (Pty) Ltd (Capstone),
disposed of approximately 17 million shares in J D Group
Ltd (JDG)
and made a profit of nearly R400 million. The principal question in
this appeal is whether Capstone is liable for tax
on the amount of
the profit on the basis that it constituted income (as the appellant,
the Commissioner for the South African Revenue
Service (the
Commissioner) contends) or a receipt of a capital nature (as Capstone
contends). The Tax Court, Cape Town (Davis J
presiding) found for the
Commissioner on this issue, but that finding was overturned by the
full court of the Western Cape Division
of the High Court, Cape Town
(Griesel, Yekiso and Baartman JJ) on appeal to it. This court granted
leave to the Commissioner to
appeal against the order of the full
court.
Background
[2] In
the tax court, Capstone presented the evidence of several witnesses,
whom I shall identify in due course. The Commissioner
called no
witnesses. The picture that emerged from the evidence was set out in
the reported judgments of the tax court (ITC 1867
(2013) 75 SATC 273)
and that of the full court (
Capstone 556 (Pty) Ltd v Commissioner
for the South African Revenue Service
2014 (6) SA 195
(WCC);
77
SATC 1).
In the result I will restrict myself to those facts that I
consider material and necessary for a proper understanding of this
judgment.
[3] By
the end of 2001, Profurn Ltd (Profurn), a JSE listed company in the
retail furniture industry, had run into serious financial
difficulties. It owed FirstRand Bank Ltd (FirstRand) in excess of
R900 million. Profurn also owed between R70 and R90 million to
Steinhoff International Holdings Ltd (Steinhoff). Steinhoff was then
a major manufacturer and supplier of furniture to the retail
industry. Its chief executive officer was Mr Markus Jooste, who was
also a major shareholder in Steinhoff. Dr Theunie Lategan,
head of
the corporate division of FirstRand, was responsible for Profurn’s
account. FirstRand also had exposure to other
furniture retailers.
Profurn risked imminent liquidation in view of its critical financial
position. This represented a serious
financial risk to FirstRand and
Steinhoff, as well as a major threat to the stability of the retail
furniture industry in South
Africa as such.
[4] Dr
Lategan, who was under immense pressure to come up with a solution to
the Profurn problem, discussed it with Mr Jooste. Mr
Jooste referred
him to Mr Claas Daun, a wealthy German businessman and director and
shareholder of Steinhoff. Mr Daun also indirectly
held a 13 per cent
shareholding in Profurn so stood to suffer financially if Profurn was
liquidated. FirstRand had determined that
for Profurn to survive, it
needed to reduce its debt to FirstRand to some R300 million. Hence
Profurn needed a capital injection
of approximately R600 million. For
this purpose Dr Lategan entered into discussions with Mr Daun early
in 2002. Mr Daun was interested
but held a firm view that what was
required to save Profurn, was both an injection of capital and sound
management. He held the
managerial skills of Mr David Sussman,
executive chairman of JDG, in high regard. He made it clear that he
would only be prepared
to invest if the management of Profurn was
taken over by Mr Sussman. FirstRand therefore approached Mr Sussman.
Mr Sussman was
agreeable but in turn insisted that the investor
should be committed to remain on board as a shareholder for as long
as it would
take to turn the business of Profurn around. Mr Sussman
discussed the matter with Mr Daun, who gave the required undertaking.
[5] These
developments were followed by a series of discussions between mainly
Dr Lategan, Mr Jooste, Mr Daun and Mr Sussman. They
resulted in a
plan to rescue Profurn and stabilise the retail furniture industry.
All concerned were ad idem, however, that the
attempt to rescue
Profurn would be a difficult operation, would involve high risks and
would probably require a period of three
to five years.
[6] In
essence, the solution agreed upon was the following. FirstRand would
underwrite a R600 million rights issue by Profurn, thereby
converting
R600 million of the debt owed to FirstRand into equity. This would be
followed by a merger between Profurn and JDG,
whereby the Profurn
shares would be exchanged for JDG shares. FirstRand would then sell
the JDG shares so acquired by it for R600
million to a South African
special purpose vehicle, to be created in due course when needed
(Capstone). Daun et Cie Aktiengesellschaft
(Daun et Cie), a German
private holding company controlled by Mr Daun, would invest R300
million in Capstone, which would be used
to pay half of the purchase
price. R200 million of the purchase price would be settled by the
issue by Capstone to FirstRand of
redeemable preference shares and
the balance by a participating loan by FirstRand to Capstone. In this
manner the required capital
injection and management would be
achieved.
[7] Most
of this was reflected in a memorandum of understanding (MOU) signed
by Mr Daun on 26 June 2002 at Rastede in Germany. In
terms of the MOU
it was naturally envisaged that final written agreements would be
entered into and that the requisite regulatory
approval be obtained.
It was nevertheless accepted by all relevant parties that the MOU
gave rise to a binding commitment by Mr
Daun and his associates via
the proposed special purpose vehicle to purchase the JDG shares from
FirstRand and that the risk and
reward in respect of the shares
passed with effect from 26 June 2002, which was the express effective
date of the MOU.
[8]
Despite some efforts by FirstRand to encourage existing shareholders
of Profurn to take up the rights offer, only a handful
did so,
raising less than R1 million. This was an indication of the desperate
position of Profurn, as was the fact that after the
MOU was signed,
Profurn’s share price fell even further. As a consequence
FirstRand acquired a 78,8 per cent shareholding
in Profurn.
Thereafter JDG and Profurn merged and FirstRand acquired
approximately 42 million JDG shares.
[9] In
the agreements and amended agreements entered into following on the
MOU, the rescue plan was varied in two material respects.
First,
FirstRand determined to retain one-sixth of its JDG shares. In the
result five-sixths of the JDG shares would be transferred
to
Capstone. This translated to approximately 35 million JDG shares and
a 20,9 per cent interest in JDG. Second, Mr Daun invited
Mr Jooste to
participate in the transaction, which required some restructuring of
the special purpose vehicle to keep Mr Daun’s
financial
interests separate from those of Mr Jooste. As a result, half of the
35 million shares were sold to Daun et Cie for R250
million and the
other half to Capstone for the same purchase price. In terms of these
agreements the purchase price of the shares
was fixed as at 26 June
2002 and the purchasers had to pay interest on the purchase price
calculated from that date. Daun et Cie
eventually paid R262 725 131
(R250 million plus interest) to FirstRand in cash. This constituted a
significant foreign
investment in South Africa. The funding of the
purchase price payable by Capstone was of course the responsibility
of Mr Jooste.
Daun et Cie and Capstone thereby committed themselves
to a significant investment of indefinite duration, the ultimate
profitability
of which depended upon the ability of Mr Sussman to
turn around the operations of Profurn and integrate them profitably
into those
of JDG.
[10]
Capstone was incorporated on 2 April 2003. It was wholly owned by
another special purpose vehicle, Business Ventures Investments
No 687
(Pty) Ltd (BVI). The financial interest in BVI was held by Mr Jooste
and his associates. Genbel Securities Ltd (Gensec)
advanced the
amount of R150 million to BVI on condition that it be utilized to
enable Capstone to acquire the JDG shares. BVI thereafter
made a
shareholder’s loan to Capstone in the amount of R150 million on
the same terms and conditions as those contained in
the loan
agreement between Gensec and BVI. The balance of the purchase price
was settled by the issue by Capstone of three year
and one day
redeemable preference shares to FirstRand. For this reason Capstone
was required to comply with FirstRand’s standard
terms and
conditions in respect of preference shares. In the result Capstone
took a number of registered special resolutions. One
of these inter
alia provided that a special condition be inserted in Capstone’s
memorandum of association that until the
date on which the preference
shares have been redeemed in full, Capstone shall not:
‘
.
. . be entitled to conduct any business whatsoever, enter into any
contract or undertake any obligation whatsoever, other than
in
respect of the sale and subscription agreement and a voting pool
agreement relating to its shares in JD Group Limited, provided
however that this shall not prevent the company from acquiring any
additional shares in the share capital of the JD Group Limited
from
time to time . . . without the express prior written consent of
FirstRand.’
The
effect of this and other terms and conditions was that for the period
of three years and a day from 30 May 2003, Capstone was
prohibited
from disposing of its JDG shares without the consent of FirstRand.
[11] Two
additional liabilities were attached to the acquisition of the JDG
shares by Capstone. First, a due diligence investigation
performed in
respect of Profurn at the instance of JDG, revealed contingent
liabilities of Profurn in respect of tax. FirstRand
indemnified JDG
in respect of these liabilities in the amount of R150 million.
FirstRand required the purchasers of the shares
to carry
proportionate shares of its liability in terms of the indemnity to
JDG. As a result, as part of the consideration for
the shares, Daun
et Cie and Capstone each indemnified FirstRand in the amount of R62,5
million. The indemnities were given for
a period of five years
commencing in early 2003. Second, the loan agreement between Gensec
and BVI provided, in addition to interest
on the loan, for payment of
what was referred to as an ‘equity kicker’. The equity
kicker was a portion of any gain
in the market value of the JDG
shares as on date of repayment of the loan, calculated in accordance
with an agreed formula. It
was payable by BVI to Gensec upon
repayment of the loan, irrespective of whether or not the JDG shares
had been sold. As the BVI-Capstone
loan duplicated the terms of the
Gensec-BVI loan, Capstone in turn was obliged to pay the equity
kicker to BVI.
[12] When
Mr Daun invited Mr Jooste to participate, he made it clear that he
would retain sole control over the 35 million JDG shares,
which would
at all times be dealt with as one package by Mr Daun. This was
understood and accepted by Mr Jooste. He felt honoured
by the
invitation and was content that Mr Daun would be the ‘captain
of the boat’ in which he would be the ‘passenger’.
For this reason Mr Daun and the manager of his South African
interests, Mr Schouten, were directors of Capstone at all times
material
to the appeal, whilst Mr Jooste was not. The other directors
of Capstone were Dr Lategan and Mr Steve Müller, who represented
the interests of FirstRand and Gensec respectively. The shares in BVI
were held by Daun et Cie as nominee for companies controlled
by Mr
Jooste and his associates. Mr Daun was also the only director of BVI
and thus at all times relevant hereto also in control
of BVI.
[13] In
terms of an agreement entered into on 20 June 2002, Profurn was
placed under the interim management of JDG pending the final
authorisation of the merger application by the Competition Tribunal.
However, substantial delays occurred due to the need to obtain
approval from the Competition Tribunal and on appeal, the Competition
Appeal Court, as well as the South African Reserve Bank.
The Tribunal
approved the merger on 12 December 2002, subject to conditions which
were set aside by the Competition Appeal Court
on 28 May 2003. The
JDG shares were ultimately paid for and transferred to Daun et Cie
and Capstone only on 5 December 2003. By
that date, the share price
had risen considerably from the levels at which it stood when the
transaction was originally devised.
[14] In
November 2003, when Steinhoff undertook an international ‘book
building’ exercise with the assistance of Citigroup
Global
Markets Ltd (Citigroup), Mr Jooste was having coffee with Mr Nicholas
Pagden of Citigroup in San Francisco and enquired
whether a similar
exercise could be done in respect of the JDG shares that Daun et Cie
and Capstone were in the course of acquiring.
A book building
exercise is a means of determining a price and acquiring
institutional investors through either the issue and acquisition
of
new shares, or the sale of an existing block of shares in
circumstances where the disposal of such a large block of shares in
the market would detrimentally affect the price of the shares on a
stock exchange. The institution undertaking the book building
approaches institutional investors to ascertain how many shares they
might buy and at what price. Once the price is determined
the shares
are disposed of other than through the exchange on which they are, or
are to be, listed. As a result, in March 2004,
Citigroup, represented
by Mr Pagden, made a presentation to Mr Daun concerning a book
building. The proposed book building entailed
disposal of the full
block of JDG shares controlled by Mr Daun. Mr Daun accepted the
proposal in respect of the approximately 14
million shares held by
each of Daun et Cie and Capstone. Each retained approximately 3,5
million shares. The sale by book building
by Citigroup took place on
29 April 2004. It realised the price of R42.50 per share. More or
less at the same time Capstone sold
its remaining 3,5 million JDG
shares to Mayfair Speculators (Pty) Ltd, a company holding the
interests of Mr Jooste and his family,
for R45 per share. The shares
had been purchased as at 26 June 2002 for R14.17 per share.
[15] On
30 April 2004 Mr Daun, Mr Schouten and Dr Lategan resigned as
directors of Capstone. On the same date Gensec and BVI entered
into a
further written agreement to settle the loan. In terms of this
agreement the liability in respect of the equity kicker amounted
to
R45 123 050, calculated on the actual proceeds realised.
Although BVI (and therefore Capstone) were entitled to temporarily
retain a portion of the equity kicker, the liability for the full
equity kicker arose on 30 April 2004. Mr Müller resigned
as
director of Capstone on 5 July 2004 and shortly afterwards Mr Jooste
and an associate were appointed as its directors.
[16] What
remained was Capstone’s contingent liability in terms of the
indemnity to FirstRand. However, during July 2004 Daun
et Cie and
Capstone, represented by Mr Daun and Mr Jooste respectively, agreed
that Daun et Cie would accept the full contingent
liability of
Capstone towards FirstRand in return for payment of the amount of R55
million. Capstone thus incurred liability for
payment of R55 million
to Daun et Cie in the 2005 year of assessment in substitution of its
contingent liability towards FirstRand.
This debt was settled much
later, by operation of set-off.
[17]
Capstone calculated and paid capital gains tax on the proceeds of the
sale of its JDG shares (the proceeds). The Commissioner,
however,
issued an additional assessment in respect of the 2005 year in terms
of which the proceeds were taxed as revenue. In addition,
the
Commissioner disallowed deductions from gross income of R45 123 050
in respect of the equity kicker and R55 million
in respect of the
settlement of the indemnity obligation (the indemnity settlement).
Capstone’s objection to the additional
assessment was dismissed
and it appealed to the tax court. As I have said, the tax court held
that the proceeds constituted revenue.
However, it revised the
assessment to allow for the deduction of the equity kicker and the
indemnity settlement from gross income
in terms of s 11
(a)
read with s 23
(g)
of the Income Tax Act 58 of 1962 (the
Act). Because Capstone’s contention that the proceeds were of a
capital nature was
upheld on appeal to the full court, the question
arose whether the equity kicker and the indemnity settlement formed
part of the
base cost of the acquisition of the JDG shares in terms
of paragraph 20 of the Eighth Schedule to the Act. The base cost is
deducted
from the proceeds to determine the taxable capital gain.
[18]
Subject to an exception, paragraph 20(2) of the Eighth Schedule
provides that the base cost does not include ‘borrowing
costs,
including any interest as contemplated in s 24J or raising
fees’. The exception is that one-third of the interest
as
contemplated in s 24J of the Act on money borrowed to finance
the acquisition of listed shares, does form part of the base
cost.
Section 24J defines ‘interest’ to inter alia include:
‘the gross amount of any interest or related finance
charges,
discount or premium payable or receivable in terms of or in respect
of a financial arrangement’. The full court
found that the
equity kicker constituted interest as defined. On this basis it
concluded that R30 082 033, that is two-thirds
of the
amount of R45 123 050, fell to be included in the capital
gain. Before us the parties were ad idem that this conclusion
was
correct. However, the full court found that the indemnity settlement
in the amount of R55 million did not constitute part of
the base
cost. Capstone noted a cross-appeal against this finding. It also
noted a conditional cross-appeal in the event of a finding
that the
proceeds were not of a capital nature.
Test
on appeal
[19]
Prior to its repeal by the
Tax Administration Act 28 of 2011
with
effect from 1 October 2012, s 86A of the Act dealt with appeals
from a tax court. In
Commissioner for Inland Revenue v Da Costa
[1985] ZASCA 32
;
1985 (3) SA 768
(A) at 775B-F, this court
characterised the nature of an appeal in terms of s 86A as
follows:
‘
Section
86A now provides for a full right of appeal against any decision of a
Special Court on issues of fact or law. As was pointed
out by Trollip
JA in
Hicklin
v Secretary for Inland Revenue
1980 (1) SA 481
(A) at 485, such an appeal
“
is
therefore a re-hearing of the case in the ordinary well-known way in
which this Court, while paying due regard to the findings
of the
Special Court on the facts and credibility of witnesses, is not
necessarily bound by them”.
Having
pointed out that the section is silent about the powers of this Court
in such an appeal, Trollip JA went on to say that it
was manifestly
the intention of the Legislature that this Court was to have those
general powers that are conferred upon it by
s 22 of the Supreme
Court Act 59 of 1959. In my view it is implicit in these
dicta
that in an appeal from a Special Court those powers should be
exercised according to the principles and subject to the restrictions
applicable to appeals in general. And, there is indeed no reason to
differentiate between an appeal from a Special Court and an
appeal
from a Local or Provincial Division. Unlike the position obtaining in
a Special Court where a decision is given on facts
which may not have
been considered by the Commissioner, this Court hears an appeal from
a Special Court on the record of the proceedings
in that Court.’
[20]
Capstone lodged an objection to the additional assessment on 17 May
2010 and lodged the appeal to the tax court on 2 August
2010. The
parties are nevertheless rightly agreed that the appeal from the tax
court was governed by the provisions of Part E of
Chapter 9 of the
Tax Administration Act (ss
133-141). This is provided for in
s 270
of the
Tax Administration Act. Section
270(2)
(d)
,
in particular, provides:
‘
The
following actions or proceedings taken or instituted under the
provisions of a tax Act repealed by this Act but not completed
by the
commencement date of the comparable provisions of this Act, must be
continued and concluded under the provisions of this
Act as if taken
or instituted under this Act:
. . .
(d)
an objection,
appeal to the tax board, tax court or higher court, alternative
dispute resolution, settlement discussions or
related High Court
application; . . .’
[21] The
provisions of s 86A of the Act and of Part E of Chapter 9 of the
Tax Administration Act are
substantially the same. In terms of
s 134(2)
(b)
of the
Tax Administration Act, a
notice of
intention to appeal against the decision of a tax court must indicate
the findings of fact or rulings of law appealed
against.
Section
139(3)
(b)
requires the same of a notice of cross-appeal. In my
judgment the principles set out in
Da Costa
are equally
applicable to appeals from a tax court in terms of the
Tax
Administration Act. Such
appeal is on the same footing as an appeal
from a division of the High Court. It follows that the full
court was bound by
the factual findings of the tax court, unless they
were affected by material misdirection or the full court was
convinced that
they were wrong. And in exercising its powers on
appeal in terms of
s 19
of the
Superior Courts Act 10 of 2013
,
this court essentially has to consider what order the full court
should have made on application of these principles.
Revenue
or capital
[22] In
terms of s 82 of the Act (now
s 102
of the
Tax
Administration Act) the
burden of proving that the decision of the
Commissioner subject to appeal was incorrect, rested on Capstone. In
line with its predecessors,
s 1 of the Act defines ‘gross
income’ in essence as the total amount received by or accrued
to a person, excluding
receipts or accruals of a capital nature. Our
courts have therefore taken the view that any receipt or accrual must
be either income
or capital, and ‘there is no third category or
halfway house’ (see
Crowe v Commissioner for Inland Revenue
1930 AD 122
at 129; 22(1)
Lawsa
, 2
ed, para 46). It
follows that Capstone could only discharge the onus by showing, on a
balance of probabilities, that the proceeds
were capital. That is a
question of law to be decided on the particular facts of each case,
for which there is no single infallible
test. (See
Commissioner
for Inland Revenue v Pick ‘n Pay Employee Share Purchase
Trust
[1992] ZASCA 84
;
1992 (4) SA 39
(A) at 56G).
[23]
In
Overseas Trust Corporation Ltd v Commissioner for Inland Revenue
1926 AD 444
at 452-3, Innes CJ said the following:
‘
It
was pointed out in
Commissioner
of Taxes v Booysen’s Estate
(1918, A.D., p. 576) that the profit resulting from the sale of an
asset might be either capital or income, according to the
circumstances.
If the transaction were a mere realisation of capital
at an enhanced value, the entire proceeds would remain capital; but
if it
were an act done in the ordinary cause of the vendor’s
business, then the resulting gain would be income. The reason for the
distinction is clear. Where an asset is realised at a profit as a
mere change of investment there is no difference in character
between
the amount of enhancement and the balance of the proceeds. But where
the profit is, in the words of an eminent Scotch Judge,
see
Californian
Copper Syndicate v Inland Revenue
(41 Sc.L.R, p.684)
, “a gain made by an operation of business in
carrying out a scheme for profit making,” then it is revenue
derived from
capital productively employed, and must be income.’
[24]
Whilst recognising that it is not universally valid, our courts have
in circumstances such as the present consistently applied
the test
that a gain made by an operation of a business in carrying out a
scheme of profit-making, is income and vice versa. In
Commissioner
for Inland Revenue v Stott
1928 AD 252
at 259-260 the passage
from
Overseas Trust
at 452-3 was quoted with approval. Wessels
JA added (at 261): ‘It is not sufficient that the cutting up of
the land and its
sale in lots should in its result prove to be a
profit-making matter so as to stamp the proceeds as gross income. The
gain must
be acquired by an operation of business in carrying out a
scheme for profit-making’. In
Commissioner for Inland
Revenue v Leydenberg Platinum Ltd
1929 AD 137
at 145, Stratford
JA referred to this passage in
Overseas Trust
and said that
the principles applicable to the question whether profits are taxable
as income or are accruals of a capital nature,
‘are now well
settled’. He made clear that the profit in respect of a single
transaction of a company may on application
of this test constitute
income.
[25] It
is true that in
Natal Estates Ltd v Secretary for Inland Revenue
1975 (4) SA 177
(A) at 198F-H, Holmes JA made reference to ‘selling
an asset in the course of carrying on a business
or
embarking
on a scheme of profit’ (my emphasis). However, reading the case
as a whole, it is clear that Holmes JA was not attempting
to propound
alternative tests. In my view it is clear that Holmes JA did not
intend to deviate from the established principles.
The court pointed
out that in
Stott
the remarks of Innes CJ in
Overseas Trust
were adopted and said that
Stott
had long been recognised as a
leading case. This is also apparent from the result of the
application of the principles to the facts
in
Natal Estates
.
The court found (at 204F-H) that the taxpayer ‘had crossed the
Rubicon and committed itself on a grand scale to the course
and
business of selling land for profit,
using the land as its
stock-in-trade
’. (See also the majority judgment of
Smalberger JA in
Pick ‘n Pay
at 56J-57E.)
[26]
Hefer AP, in
Samril Investments (Pty) Ltd v Commissioner, South
African Revenue Service
[2003] ZASCA 118
;
2003 (1) SA 658
(SCA)
para 2, confirmed that the ‘usual test for determining the true
nature of a receipt or accrual for income tax purposes
is whether it
constituted a gain made by an operation of business in carrying out a
scheme for profit-making’. He pointed
out that profit-making is
also an element of capital accumulation. He said that:
‘
Every
receipt or accrual arising from the sale of a capital asset and
designedly sought for with a view to the making of a profit
can
therefore not be regarded as revenue. Each case must be decided on
its own facts . . .’
Thus the
mere intention to profit is not conclusive. There must be ‘an
operation of business in carrying out a scheme for
profit-making’
for a receipt to be income. That expression refers to the use of the
taxpayer’s resources and skills
to generate profits, usually,
but not always, of an on-going nature. In
Pick ‘n Pay
at
58B-C, the majority similarly found for the taxpayer on the grounds
that it was not carrying on a business by trading in shares
and that
even if it was, it was not a business carried on as part of a scheme
for profit-making.
[27]
Where a profit is the result of the sale of an asset, the intention
with which the taxpayer had acquired and held the asset
is of great
importance and may be decisive. In essence, the question is whether
the asset was acquired for the purpose of reselling
it at a profit
and assumed the character of trading stock (see
Matla Coal Ltd v
Commissioner for Inland Revenue
1987 (1) SA 108
(A) at 129B-D).
[28] In
this regard Wessels JA said the following in
Stott
at 264:
‘
It
is unnecessary to go so far as to say that the intention with which
an article or land is bought is conclusive as to whether
the proceeds
derived on the sale are taxable or not. It is sufficient to say that
the intention is an important factor and unless
some other factor
intervenes to show that when the article was sold it was sold in
pursuance of a scheme of profit-making, it is
conclusive in
determining whether it is capital or gross income.’
In
determining this intention the court ‘is not concerned with
that kind of subjective state of mind required for the purposes
of
the criminal law, but rather with the purpose for which the
transaction was entered into’. (See
Secretary for Inland
Revenue v Trust Bank of Africa Ltd
1975 (2) SA 652
(A) at
669E-G.) This was formulated as follows in
Pick ‘n Pay
at 58F-G:
‘
Contemplation
is not to be confused with intention in the above sense. In 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.’
[29] And
in
Commissioner of Taxes v Levy
1952 (2) SA 413
(A) at 421,
Schreiner JA said that ‘where the purposes of an individual
taxpayer are mixed the only course, on principle
as well as for
practical reasons, is to seek and give effect to the dominant factor
operating to induce him to effect the purchase’.
(See also
Trust Bank
at 670H-671A). This is a matter of degree depending
on the circumstances of the case. (See
African Life Investment
Corporation (Pty) Ltd v Secretary for Inland Revenue
1969 (4) SA
259
(A) at 269E.)
[30] The
purpose or dominant purpose of the acquisition of an asset is a
question of fact. (See
Trust Bank
at 666B-C.) It must be
determined objectively in the same manner that any fact is determined
by a court of law. The credibility
and reliability of the evidence of
the witnesses for the taxpayer must be determined in the light of the
objective facts and inferences
drawn therefrom, the probabilities and
any evidence put up in contradiction thereto. (See
Commissioner,
South African Revenue Service v Pretoria East Motors (Pty) Ltd
[2014] ZASCA 91
;
2014 (5) SA 231
(SCA) at para 8.)
[31]
Apart from the intention of the taxpayer, a number of factors must be
considered. First, the nature of the business activities
of the
taxpayer must be scrutinised. As
Stott
and
Samril
Investments
demonstrate the line of demarcation between the
realisation of an asset at a capital gain (
Stott
) and turning
an existing asset to the purpose of generating revenue (
Samril
Investments
) may be a fine one. So close regard must be paid to
the nature of the business activities in which the taxpayer is
ordinarily engaged.
In
Stott
the sale of land acquired with
the surplus from the taxpayer’s profession as a land surveyor
was reasonably remote from his
main business activity. In
Samril
Investments
the sale of sand was closely connected to the farming
business already conducted on the property.
[32]
Second, the period for which the asset is held and the period for
which it was anticipated it would be held at the time of
acquisition
will be relevant. In general the longer that period the more likely
it is that the disposal is a realisation of capital
rather than a
receipt of income. Third, when dealing with an investment, the nature
of the risk undertaken has a bearing on whether
the exercise is one
directed at building up the value of the taxpayer’s capital or
directed at generating revenue and profit.
Finally, it must be
recognised that in many commercial situations there may be no clear
intention at the outset and any endeavour
to discern one or select
one as more prominent than another, rather than accepting that the
taxpayer’s future intentions
were indeterminate, may be
artificial and unhelpful. In such circumstances a better approach is
to accept the indeterminacy and
factor that into the enquiry. Other
relevant factors are set out in
Natal Estate
, at 202 in fine,
but the list is not exhaustive.
Effective
date
[33] The
tax court rightly noted that it had been accepted by all the relevant
parties that the MOU gave rise to a binding commitment
to acquire the
JDG shares at the purchase price to be determined as at 26 June 2002
and bearing interest from that date. The full
court found that the
effective date of the transaction as a whole dated back to 26 June
2002, that ‘it is accordingly at
that date that one must look
when considering the period for which the asset was held’ and
that the shares were effectively
acquired during June 2002, not
December 2003.
[34] I
agree with what was said by McCreath J on behalf of the full court in
Commissioner for Inland Revenue v General Motors SA (Pty) Ltd
1982 (1) SA 196
(T) at 204A, namely:
‘
Finally,
I consider that the correct approach in a matter of this nature is
not that of a narrow legalistic nature. What has to
be considered is
the commercial operation as such and the character of the expenditure
arising therefrom. This is perhaps but another
way of expressing the
concept that it is the substance and reality of the original loan
transaction that is the decisive factor.’
(See also
Commissioner for Inland Revenue v Conhage (Pty) Ltd (formerly
Tycon (Pty) Ltd)
[1999] ZASCA 64
;
1999 (4) SA 1149
(SCA) at para
1.) In this regard I find the following remarks of Lord Hoffman in
MacNiven (Inspector of Taxes) v Westmoreland Investments Ltd
[2001] UKHL 6
;
[2001] 1 All ER 865
at para 32, instructive:
‘
The
innovation in the
Ramsay
case was to give the statutory concepts of “disposal” and
“loss” a commercial meaning. The new principle
of
construction was a recognition that the statutory language was
intended to refer to commercial concepts, so that in a case of
a
concept such as a “disposal”, the court was required to
take a view of the facts which transcended the juristic individuality
of the various parts of a preplanned series of transactions.’
If the
receipt or accrual arises from a detailed commercial transaction the
transaction must be considered in its entirety from
a commercial
perspective and not be broken into component parts or subjected to
narrow legalistic scrutiny.
[35] In
substance and in commercial reality the purpose of the acquisition of
the shares must in my judgment be determined as at
26 June 2002, in
the context of events leading to the MOU.
Directing
mind
[36] The
tax court found that Mr Jooste was the ‘brain’ and the
‘mind’ of Capstone. On the view that it
took of the
matter, the full court found it unnecessary to decide this issue. I
am convinced, however, that this finding of the
tax court was wrong.
[37]
Generally the intention of a company must be determined by
ascertaining what its directors acting as such intended. (See
Commissioner for Inland Revenue v Richmond Estates (Pty) Ltd
1956 (1) SA 602
(AD) at 606G-H.) But in
Trust Bank
Botha JA
explained at 669A-D:
‘
Just
as there cannot in a case of a one-man company be any reason in
principle why it should be incompetent for him to give evidence
as to
what the intention of his company at any given time was,
Commissioner
for Inland Revenue v Richmond Estates (Pty) Ltd
,
supra at p.606, so I can see no reason in principle why the persons
who are in effective control of a company cannot give evidence
as to
what was the intention or purpose of a company in relation to any
matter at any given time. That the management committee
was for
practical purposes in effective control of the affairs of the
respondent bank is clear from the evidence. It was under
its
leadership that the respondent’s business activities had been
diversified to such an extent that, in addition to ordinary
commercial banking, it had become engaged in a number of other
incidental business activities as indicated above. I cannot find
any
reason in principle why the intention of the members of the
management committee in regard to any matter in which it was
concerned
on behalf of the respondent cannot be taken to indicate the
intention of the respondent.’
[38] Mr
Daun was de facto in control of the shares from their effective
acquisition to their disposal. Mr Daun therefore determined
the
purpose of their acquisition. At the time of their disposal, he,
aided by Mr Schouten, was in any event the controlling director
of
Capstone. Whether or not the shares should be sold, was solely the
decision of Mr Daun.
Mr
Daun’s intention
[39] Thus
Mr Daun’s intention at the time of effective acquisition of the
shares had to be determined. As the full court indicated,
the
findings of the tax court in this regard were somewhat ambivalent.
The following would, however, appear to be its central findings,
irrespective of who had determined the intention (paras 77-78):
‘
The
evidence concerning the intention of 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;
. . .
[T]he
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.’
The full
court disagreed and summarised its findings as follows (para 24):
‘
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.’
[40] In
my view both approaches are flawed. In the tax court the fact that,
if the turnaround strategy involved in the takeover
of Profurn by JDG
was successful, Mr Daun, as an investor and entrepreneur, wanted to
recover his investment together with an increase
in its value, did
not mean that a profit-making intention was his purpose in making the
investment, much less the predominant purpose.
Nor was it correct to
say that this was not a long term investment. The duration of the
investment was dependent on Mr Sussman’s
skills in merging the
two businesses as well as factors beyond the control of either Mr
Daun or Mr Sussman, such as the general
economic climate. On the
other hand the full court stopped its enquiry at the first stage,
without exploring further the implications
of the strategic
investment made by Mr Daun. A more rounded and complete consideration
of the whole transaction was called for.
[41]
Before us, counsel for the Commissioner disavowed reliance on a
change of intention after the effective acquisition of the
shares.
The essential submission for the Commissioner was that from the
outset, that is when the transaction was first contemplated
in early
to mid-2002, the intention was to acquire the shares for resale at a
profit, that that intention never changed and that
the shares were
acquired as trading stock. The argument for the Commissioner
therefore correctly recognised that if this were shown
not to be the
case, the proceeds would be capital.
[42] The
witnesses for Capstone were Mr Daun, Mr Jooste, Mr J P Burger, the
chief financial officer of FirstRand, Dr Lategan, Mr
Sussman, Mr
Müller and Mr Pagden. The tax court did not comment on the
credibility of the witnesses. No doubt that is because
no adverse
comment was called for. The evidence reads well. It portrays Mr Daun
as a straight forward, no-nonsense businessman
who regarded a
handshake agreement as binding and more important than hundreds of
pages of legal documents. There can be no criticism
of any of the
other witnesses. Mr Daun’s evidence was materially corroborated
by all the other witnesses. His evidence was
not detracted from by
objective facts or the probabilities and, importantly, was not
contradicted. It follows that there was no
reason not to accept the
evidence of Mr Daun as to the aim with which the shares were acquired
or the circumstances in which they
were sold.
[43] Mr
Sussman said that because of past experience he expected the
turnaround of the business of Profurn to take a long time and
that
‘what was of paramount importance was to have a shareholder
that would be behind us through these difficult times’.
Mr
Burger said that FirstRand needed somebody that was prepared to put
long term capital into the business. Both therefore required
a long
term investment for the purpose of rescuing the business. Both found
what they had required in Mr Daun when he made the
commitment in
terms of the MOU. He in turn said that what he did was ‘not
like buying shares’. He explained that he
made an
entrepreneurial long term investment aimed at rescuing Profurn’s
ailing business. He inter alia said:
‘
But
at that time it was an investment in uncertain surroundings with huge
risks. You didn’t know what happens, and therefore
it was not
suitable to make a quick buck, but first you had to re-organise, to
restructure this new business which has got huge
problems.
. . . For
me it was a difficult rescue operation which, in the end, with the
help of David Sussman’s management, went successful.’
[44] If
after three to five years the rescue operation was successful,
several options would be available. I refer to the following
evidence
of Mr Daun:
‘
And
I was thinking at that time, my personal thinking, that we need
perhaps four to five years when we ─ until we could see
real
results out of this effort to rescue this business.
MR
SHOLTO-DOUGLAS
:
And what would you do after the three to four years, or four to five
years?
MR
DAUN
:
This on that time was fully open, but for me was quite interesting, I
have known out of other
shares deals in South Africa, when you’re
a 20% shareholder in a quoted company, you have a lot of options and
possibilities.
You could increase your shares. I could ─ I
didn’t know where the share price was going. I was prepared,
perhaps, when
the public was negative, that I buy further shares on
the market perhaps to go to maturity or to control it.
. . .
MR
SHOLTO-DOUGLAS
:
Your original intention was to hold these shares until such time as
the transaction had bedded down,
although you may not have excluded
other options as well, is that right?
MR
DAUN
:
No, I had the full theoretically possible options when I have ─
I told you before, when
I have of the South African quoted company
more than 20% of the shares and in case it develops in a certain
direction I got a good
base as a strong shareholder to control, to
get control of this business. I could buy further shares on the
market, you know this
option created for me as well huge traction, it
was nothing in stone, so I could have been ─ it could have
been, I’m
looking back I should have done it, it could have
been that I bought more shares, more shares, and get control solely
of the operation
including Profurn.
. . .
But I
must be clear I was long term original, I had all options open, and I
had a good management, therefore I felt positive.
. . .
MR
SHOLTO-DOUGLAS
:
Yes, no I understand, I think we understand each other there now, I
mean essentially your share
in the benefit of the transaction with
what you were going to get on resale of the shares, not what you were
going to get in the
form of a dividend cheque if JD Group
declared a dividend?
MR
DAUN
:
One option was the sale of the share, other option is utilise 20% to
form another merger,
and I get other shares, you know it’s not
only selling, when you have only 1000 shares you have only one option
to sell the
shares. When you have 20% you have so many options, of
this I can talk about one hour.
MR
SHOLTO-DOUGLAS
:
I understand that, I understand you had many options, one of them was
to sell the shares at an increased
price and take the profit.
MR
DAUN
:
Yes, yes.’
Mr Jooste
confirmed this in the following terms:
‘
Claas
and I never discussed, and I think I tried to explain it this
morning, how we would exit JD. We spoke about what we would
do if it
goes wrong. We spoke about a long term investment in the industry.’
[45] Mr
Daun obviously made the investment because he was of the opinion that
the rescue operation could be successful. And it was
naturally
anticipated that a turnaround of the business would result in an
increased share price. But this is neutral, it says
nothing about the
aim of the acquisition. Virtually every capital asset is purchased in
the hope and anticipation that it will
increase in value and in
contemplation of the possibility that it may in future be sold at a
profit. Mr Daun contemplated a resale
of the shares at a profit as
one of several possibilities. These possibilities were to be explored
at the appropriate time in future.
[46] At
the time of the effective acquisition of the shares their disposal at
a profit was by no means inevitable. First,
the prospects of
the rescue operation succeeding were uncertain. An investment of a
very large sum of money ─ originally
R300 million ─ was
made in the anticipation that Mr Sussman’s managerial skills
would not only make a success of the
rescue but, over an
indeterminate period, provide some return in the form of growth in
the value of the investment. The risks involved
were substantial
bearing in mind that Profurn was staring insolvency in the face. The
element of salvaging something from Mr Daun’s
existing
investment in Profurn could not have been absent. And when he
committed himself to the deal Mr Daun had no idea of how
long his
commitment would have to last. Second, if the rescue operation was
successful, all options were open. Finally, in regard
to a possible
sale Mr Daun testified that the tradability of a block of shares of
this magnitude was low. His undisputed evidence
was that he would
never have been able to trade these shares in the market.
[47]
Counsel for the Commissioner placed considerable stress upon the
conversation between Mr Jooste and Mr Pagden and Mr Jooste’s
knowledge in November 2003 of the possibility of disposing of the
shares through a book building exercise. But Mr Daun had no knowledge
of the concept of book building at all before he was informed thereof
by Mr Jooste during January or February 2004 when the latter
was in
Germany to attend a furniture fair. The conversation between Mr
Pagden and Mr Jooste at the coffee shop in San Francisco
during
November 2003 therefore pales into insignificance. What transpired is
in any event clear from the evidence of both Mr Pagden
and Mr Jooste.
Only a brief discussion (‘a minute or two’) took place to
the effect that it would be possible to do
a book building
transaction in respect of the JDG shares. No decision was taken and
Mr Jooste said that it was not his decision
in any case. But Mr
Pagden sensed an opportunity to make a deal and pursued it. This led
to the presentation for a book building
transaction made by Mr Pagden
to Mr Daun in March 2004 when Mr Daun was in Johannesburg for a
Steinhoff board meeting.
[48]
Because of his commitment to Mr Sussman, Mr Daun could only consider
this opportunity if it had the blessing of Mr Sussman.
When he spoke
to Mr Sussman, this is what transpired:
‘
And
obviously I didn’t know book building. He didn’t know it.
He says, yes, this is ─ ja, I said, David, but I
have to go
back to Germany to think about the whole thing, if it is worthwhile.
My plan was long term. I have to discuss this with
my supervisory
board at home, that’s my wife and family.
But
in case, David, I asked him, when we would consider to sell, it’s
against our understanding. What would you say, I asked
David. I said
would you have any complaints, because I never would consider this
thing when you would say no. And then I was quite
surprised, and
David was laughing, he said, the whole thing, this restructuring of
Profurn and this new group works far quicker
or better than I
thought. If you really decide ─ I would not recommend that you
move, but if you decide to go out, I would
not complain about it
because then I get new, it might be exciting, partners or
shareholders, but it’s your decision, he
said to me.’
[49] Mr
Jooste was in fact opposed to selling the shares. He attempted to
persuade Mr Daun not to do so by saying that the share
price might
rise further (as it did) and that there might be other restructuring
possibilities in future. Eventually he only managed
to persuade Mr
Daun to withdraw the seven million shares from the book building
exercise, half of which was obtained by Mr Jooste
through Mayfair
Speculators (Pty) Ltd.
[50] Back
in Germany, Mr Daun’s wife (and financial confidante) urged him
to sell on the ground that he was overexposed in
South Africa. And so
it happened that after much consideration Mr Daun decided to sell the
shares. It is abundantly clear that
from the perspective of Mr Daun,
this decision was the result of the unsolicited and fortuitous offer
of book building.
[51] The
Commissioner argued and the tax court accepted that the short term of
the Gensec loan and the nature of the equity kicker
indicated an
intention to fund the loan repayments by way of the sale of the
shares. But the loan agreement was entered into on
5 December 2003,
long after the MOU. In any event, the equity kicker was payable
irrespective of whether the shares were sold or
not, the short term
of the loan was fully explained and it is common cause that
refinancing of the transaction would have presented
no difficulty.
[52] In
my judgment it is clear from the evidence that the first and primary
purpose of the acquisition of the shares was to rescue
a major
business in the retail furniture industry by long term investment of
capital. This involved a commitment of capital for
an indeterminate
period involving considerable risk and only a very uncertain prospect
of a return. Assuming the rescue was successful,
it was uncertain
what would happen next. In effect all options were open. All of this
was consistent with an investment of a capital
nature that was
realised sooner than initially expected because of skilled management
and favourable economic circumstances. It
was not a purchase of
shares as trading stock for resale at a profit. The factual findings
of the tax court in respect of the intention
with which the shares
had been purchased, were therefore clearly wrong. Although the full
court did not say so in so many words,
I am satisfied that it was
convinced on appeal that the findings were wrong. It did say that
(para 27) ‘these findings are
contrary to the weight of the
evidence’ and continued to make its own factual findings to the
contrary. At any rate, this
is what the full court should have found.
I find that Capstone proved on a balance of probabilities that the
proceeds were of a
capital nature. The appeal must therefore be
dismissed.
Cross-appeal
[53] In
the result the conditional cross-appeal falls away. It remains to
consider the cross-appeal. It raises the question whether
the
indemnity settlement formed part of the base cost of the shares for
purposes of capital gains tax.
[54] In
terms of paragraph 20(1)
(a)
of the Eight Schedule to the Act,
the base cost includes ‘expenditure actually incurred in
respect of the costs of acquisition’
of an asset. It is trite
that ‘expenditure actually incurred’ refers to an
unconditional legal obligation to pay. The
words ‘in respect
of’ connote a causal relationship. (See
Stevens v
Commissioner, South African Revenue Service
[2006] ZASCA 117
;
2007 (2) SA 554
(SCA) para 20.)
[55] It
is beyond question that the contingent liability of Capstone in terms
of the indemnity to FirstRand formed part of the consideration
for
the acquisition of the shares. Had payment in terms thereof taken
place during the 2005 year of assessment, it would have constituted
part of the base cost of the shares. The unconditional obligation in
terms of the indemnity settlement to pay R55 million to Daun
et Cie
was undertaken in substitution of the contingent obligation to
FirstRand. The full court rightly said that the liability
to
FirstRand was ‘converted’ into liability to Daun et Cie.
Whether this was financially a wise step is immaterial,
as is the
fact that it was taken after the sale of the shares. The causal link
with acquisition of the shares was not broken. The
acquisition of the
shares remained the
causa causans
of the indemnity settlement.
I am therefore unable to agree with the conclusion of the full court
that (para 59) the indemnity
settlement was ‘entirely separate
from the acquisition of the JDG shares’ and therefore a
novus
actus interveniens
. It was the mechanism by which the contingent
liability incurred as part of the acquisition of the shares was
monetised and rendered
a quantifiable component of the cost of the
shares.
[56] The
Commissioner accepted that the liability in terms of the indemnity
settlement was incurred during July 2004, that is, in
the 2005 year
of assessment. In my judgment the liability incurred by Capstone to
pay the amount of R55 million to Daun et Cie
was an ‘expenditure
actually incurred’ in respect of the acquisition of the shares.
It follows that the cross-appeal
must succeed.
[57] The
following order is issued:
1 The
appeal is dismissed with costs, including the costs of two counsel.
2.1 The
cross-appeal is upheld with costs, including the costs of two
counsel.
2.2 It is
declared that the liability undertaken by the taxpayer during July
2004 to pay the amount of R55 million to Daun et Cie
Aktiengesellschaft, formed part of the base cost of the acquisition
of the shares in JD Group Ltd.
___________________
C
H G van der Merwe
Acting
Judge of Appeal
APPEARANCES:
For
Appellant:
A R Sholto-Douglas SC (with M W Janisch SC and H Cassim)
Instructed by:
State Attorney, Cape Town
State Attorney, Bloemfontein
For
Respondent:
L Kuschke SC (with T Emslie SC)
Instructed by:
Werksman Attorneys, Cape Town
Lovius Block, Bloemfontein