Commissioner for Inland Revenue v Felix Schuh (SA) (Pty) Ltd

• Jurisdiction: South Africa
• Judge: Corbett CJ, Smalberger JA, Nienaber JA, Howie JA and Olivier AJA
• Judgment Date: 28 March 1994
• Docket Number: 392/92
• Court: Appellate Division
• Hearing Date: 22 February 1994
• Citation: 1994 (2) SA 801 (A)

Corbett CJ:

This appeal, which comes to us direct from the Transvaal Income Tax Special Court, concerns the deductibility under s 11(a) of the Income Tax Act 58 of 1962 ('the Act') of so-called 'foreign exchange H losses'. In the Special Court the parties submitted, by agreement, a statement of facts and no evidence was led. From this statement and from the usual dossier the following picture emerges.

The respondent, Felix Schuh (SA) (Pty) Ltd, is a South African company. It is the wholly-owned subsidiary of a German corporation, Felix Schuh & Co I GmbH ('Schuh'), whose main business is industrial insulation, painting and fire protection. Prior to February 1983 Schuh conducted business in South Africa from a branch in Johannesburg and was registered as an external company under the Act. In November 1982 the respondent was incorporated and in February 1983 a written agreement was entered into in terms of which Schuh sold its branch business in South Africa to the respondent. J The purchase price of the business was its

Corbett CJ

A nett asset value as at the 'effective date', which was agreed to be 1 January 1983, and it was to be paid by the issue to Schuh of shares in the respondent having an equivalent nominal value. The agreement was implemented.

During the 1983 tax year, which in respondent's case ended on 31 December B 1983, the respondent borrowed an amount from Schuh and from Schuh's own holding company, G & H Montage GmbH ('Montage'). It was alleged by the respondent in its letter of objection that this and subsequent similar borrowings were incurred in order to provide the respondent with working capital. On 1 August 1983 the respondent received the proceeds of this first loan, which amounted in South African currency to R360 000. The loan C was repayable, however, in Deutsch marks.

Between 1 August and 31 December 1983 the value of the rand as against that of the Deutschmark ('DM') declined substantially and on the basis of the rate of exchange prevailing on 31 December 1983 the indebtedness of D respondent to Schuh and Montage, expressed in rands, amounted to R370509,16 ie R10 509,16 more than it was on the day that the proceeds of the loan were received by the respondent. This sum of R10 509,16 was taken into account by respondent as a deductible loss in its income tax return for the 1983 tax year. The deduction of this loss was apparently allowed by the appellant in the assessment of the respondent's taxable income for E the 1983 tax year.

During the 1984 tax year a further amount of R200 000 was loaned to the respondent by Schuh and/or Montage. This loan was also repayable in DM. As a result of a further decline in the value of the rand as against the DM, the respondent's total indebtedness in respect of these two loans, expressed in rands as at 31 December 1984, stood at R730 382,65. This F represented a further 'loss' of R159 873,49, calculated as follows:

Total liability as at 31/12/1984		R730 382,65
Less total liability as at 31/12/1983	R370 509,16
Further loan	200 000,00
		570 509,16
		G R159 873,49

Again this amount of R159 873,49 was claimed and apparently allowed as a loss in the determination of the respondent's taxable income for the 1984 tax year.

No further loans were made during the 1985 tax year, but the value of the H rand relative to the DM continued to decline. As at 31 December 1985 the respondent's total liability in respect of these loans expressed in rands amounted to R1 195 199,33. This represented a further increase in liability, or 'loss', of R464 816,68. In its income tax return for the 1985 tax year the respondent, as before, claimed this last-mentioned amount as a deduction in the computation of its taxable income. This time, however, the appellant disallowed the deduction. The respondent appealed I to the Special Court, which upheld the appeal and referred the matter back to the Commissioner. The Commissioner now appeals to this Court.

Certain other matters appearing from the statement of facts should be mentioned. Firstly, during the three tax years referred to no capital J repayments on the loans were made by the respondent. Secondly, for the

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A purposes of the present appeal no issue arises in respect of the 1983 and 1984 years of assessment. And, thirdly, it is agreed that the sole issue is whether the respondent is entitled 'as a matter of principle' to deduct the sum of R464 816,68 in the 1985 tax year as being an 'unrealised loss' resulting from exchange rate variations. The final paragraph of the B statement reads:

'If the Court holds that, as a matter of principle, the appellant [now respondent] is entitled to the deduction, the Court is asked, in terms of s 83(13)(a) of the Act, to refer the assessment back to the Commissioner for further investigation, and assessment on the basis that a deduction should be allowed to the extent that the loans were raised and utilised by C the appellant for the purpose of expenditure that was not of a capital nature.'

It is common cause that the resolution of this issue depends on whether a foreign exchange 'loss' such as that referred to above constitutes, in terms of s 11(a) of the Act, an expenditure or loss -

D '. . . actually incurred in the Republic in the production of the income. . .'.

The further question whether, accepting that it is such an expenditure or loss, it is of a capital nature or not does not, as I have indicated, arise for decision in these proceedings.

In coming to the conclusion that the respondent's foreign exchange 'loss' was an expenditure or loss actually incurred in the Republic in the E production of the income the Special Court relied mainly on three decisions: Caltex Oil (SA) Ltd v Secretary for Inland Revenue 1975 (1) SA 665 (A); Plate Glass & Shatterprufe Industries Finance Co (Pty) Ltd v Secretary for Inland Revenue 1979 (3) SA 1124 (T) and Commissioner for Inland Revenue v General Motors SA (Pty) Ltd 1982 (1) SA 196 (T). It is F necessary to consider these cases in some detail.

In the Caltex case the taxpayer was a South African company carrying on business within the Republic as an importer, manufacturer and distributor of petroleum products. It was a subsidiary of a company incorporated in the United States of America. The taxpayer purchased its supplies of crude G oil and other petroleum products and subsidiary supplies from two fellow subsidiaries both incorporated and carrying on business in the United Kingdom, viz Caltex (UK) Ltd ('Caltex UK') and Caltex Services Ltd ('Caltex Services'). The goods so purchased formed part of the taxpayer's stock-in-trade.

The taxpayer was obliged to pay for these goods in pounds sterling and the H suppliers would invoice the taxpayer accordingly. Upon receipt of such an invoice the taxpayer would convert the purchase price shown therein (in pounds sterling) into rands at the prevailing rate of exchange between sterling and the rand and enter the converted amount in its books as the cost price of the supplies received in terms of the invoice. The taxpayer's tax year ended on 25 December.

I On 18 November 1967 there were owing to Caltex UK and Caltex Services respectively the amounts of £4 659 486 and £48 925. These had been expressed in rands in the taxpayer's books of account as R9 353 920 and R98 217. On 19 November 1967 as a result of the devaluation of sterling on that date the rate of exchange between the rand and the pound changed from J R2 to £1 (approximately) to R1,7207 to £1.

Corbett CJ

A The amount owing to Caltex Services, viz £48 925, was paid by the taxpayer after 19 November, but before 25 December 1967. The discharge of this obligation cost the taxpayer in rand terms R84 186, ie R14 031 less than the amount owing prior to 19 November and as reflected in the relevant entries in the taxpayer's books of account. The amount owing to Caltex UK, B viz £4 659 486, was not paid during the 1967 tax year, but as at the close of the financial year it was known that by reason of the devaluation and the then prevailing rate of exchange this obligation could be discharged at a cost to the taxpayer of R8 017 647, ie R1 336 271 less than the cost would have been but for devaluation and so much less than the amount C reflected as owing in the taxpayer's books of account.

The question which then arose before the Special Court and later before this Court was whether in the determination of the taxpayer's taxable income for the 1967 tax year the full amounts of R9 353 920 and R98 217 should have been included in calculating the amount of 'expenditure D actually incurred' in terms of s 11(a) by the taxpayer in the acquisition of trading stock during that year; or whether these amounts should have been reduced by the aforementioned amounts of R1 336 271 and R14 031 respectively. The taxpayer contended for the former approach; the Commissioner (or Secretary as he was then known) for the latter. The Special Court upheld the Commissioner's contention and the taxpayer E appealed. For reasons which I shall elaborate this Court dismissed...