ABC Ltd v Commissioner for the South African Revenue Service

• Jurisdiction: South Africa
• Judge: Louw J
• Judgment Date: 14 March 2011
• Docket Number: 11470
• Court: Tax Court
• Hearing Date: 14 March 2011
• Citation: 2013 JDR 0349 (Tax)

Louw J

[1]

In 2001 the ABC group of companies merged with the LC Corporation group of companies. Prior to the merger the appellant, then known as ABC Ltd, was a wholly owned subsidiary of ABC Holdings Ltd which company was in turn wholly owned by ABC Group Ltd.

[2]

I shall refer in this judgment to the appellant as Limited and to ABC Group Ltd, as ABC Group.

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[3]

On 1 February 1991 F Co, a subsidiary of GF plc, both based in the United Kingdom, concluded a joint venture agreement (the JV agreement) with Group and LC Corporation (SA) Ltd. The JV agreement led to the formation of G Co. in which ABC Group and LC Corporation SA Ltd each held a 25 percent shareholding and F CO. held the other 50 percent shareholding.

[4]

Pursuant to the JV agreement and foreshadowed in that agreement, a further agreement, referred to in the papers and the evidence as the distribution agreement was concluded on 12 May 1992 between F Co. and an entity referred to in the agreement as 'ABC'. The identity of the party who contracted with F Co. is in dispute. Limited contends that it is the entity that contracted with F Co. while the respondent states that ABC Group is the party who contracted with F Co. For purposes of this judgment I will accept, without finding, that Limited is the entity which entered into the distribution agreement with F Co.

[5]

In terms of the distribution agreement:

1.

Limited was appointed as the exclusive distributor for resale in South Africa, Lesotho, Botswana and Swaziland (the designated territory) of JK whisky, YZ whisky and ST whisky (the designated whiskies), for a period of ten years commencing on 1 February 1991, terminable thereafter on a notice period of one year. The exclusive distribution right was consequently, depending on when notice of termination is given, due to terminate on 31 January 2002 or any time thereafter.

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2.

Limited undertook not to distribute any products which compete with the designated whiskies in the designated territory.

[6]

Of the three designated whiskies covered by the distribution agreement, JK whisky was by far the most important both as to volume sold and as to income generated. Unless the context otherwise demands, I will for ease of reference refer to the three designated whiskies as JK.

[7]

On 17 December 1997 two major UK companies, MM plc and GF plc merged. The merger of these two companies brought together the spirit and wine businesses of F CO. and of F Co. and DP Ltd and resulted in a structural change in the liquor market in Europe. The merger resulted in a further consequence for the liquor trade in South Africa. In order to accommodate the changes brought about in Europe in South Africa, F Co. sought the termination of the JV agreement and approached Limited with a proposal for the early cancellation of the distribution agreement.

[8]

Negotiations ensued and culminated in the conclusion of the dissolution agreement on 27 August 1998. It provided for the termination of the distribution agreement against F Co. paying Limited R67m. In the result, the distribution agreement came to an end some 41 months before F Co. could, by giving notice in terms of the agreement, have terminated the distribution agreement without paying any compensation.

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[9]

In an additional assessment of Limited for the 1999 tax year, the respondent levied income tax and interest on the amount of R67m received by Limited. Limited objected to the assessment on the basis that the amount received was of a capital nature and that no income tax was payable on the receipt of the amount. The objection was rejected by the respondent, hence this appeal.

[10]

The first issue to be decided on appeal is whether the R67m is of a revenue or capital nature.

[11]

The second issue to be decided arises only if the assessment is not set aside and is whether the respondent was correct in declining to exercise its discretion in terms of section 89 quat (3), to waive interest payable in terms of section 89 quat (2) on the underpayment of provisional tax and whether this court should set aside the decision and substitute its own decision in terms of section 89 quat (5).

[12]

On appeal, Limited adduced the evidence of the following witnesses: its erstwhile managing director, Mr. Y, Mr. Z a chartered accountant, as an expert witness, Mr. X, a chartered accountant who was the erstwhile Corporate Strategy and Planning manager of Limited, Mr. N, who was the managing director of F Co. at the time and Mr. O, the executive chairman of S Liquors, a chain of 39 discount liquor stores. The respondent called no witnesses.

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[13]

JK is a proprietary brand of whisky and carries a premium on its price. In contrast, a cut price whisky is bought because of its price. Although JK has over the years held a modest position internationally amongst the top 100 distilled products generally and amongst whiskies in particular, in South Africa, JK has for many years been the market leader in volume and value, both amongst whiskies in general and amongst the premium brands sold in South Africa.

[14]

Limited has carried on the business of a wholesaler selling liquor (including JK) to retailers in the liquor trade since the 1970's. Prior to the conclusion of the distribution agreement in 1991, JK was imported and sold in the Republic by Limited and by a competitor, T (Pty) Ltd. The distribution agreement changed this. It entitled Limited to purchase and then to exclusively sell JK, ST and YZ in the Republic. It, however, also restricted Limited from selling any other brand of whisky in competition with JK, ST and YZ whiskies.

[15]

Limited lost the exclusive right to distribute JK as a result of the conclusion of the termination agreement and was paid R67m in compensation for the loss of the right.

[16]

Mr. Cilliers who appeared with Mr. Louw on behalf of Limited submitted that the amount received by Limited as compensation for the lost right was of a capital nature and took as point of departure the proposition that where payment is made by way of compensation (or, where there has been a

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breach, by way of damages) upon termination of a contract or the termination of the benefits arising from a regime created by a contract, the compensation generally takes on the character of the loss for which the compensation is paid. (LAWSA 2 Ed (2009) Vol 22 Part 1 para 56 (b). Silke on South African Income Tax, 2010 Service 41, p3-51 para 3.23.) Therefore, if the payment received 'fills a hole' in the capital assets of the taxpayer, the receipt is of a capital nature. In Estate AG Bourke v CIR (1991) SATC 86 at 93 – 94 it was put as follows:

When the receipt in question represents compensation to the taxpayer, a test which is sometimes applied is to ask the question whether the compensation was designed to fill a hole in the taxpayer's profits, or whether it was intended to fill a hole in his assets. Cf Burmah Steam Ship Co Ltd v Inland Revenue Commissioners [1931] SC 156, 16 TC 67. However, as was pointed out by Broomberg Tax Strategy 2 ed (1983) at 199-200, the fact that what is plugged is a hole in assets does not, by itself, conclude the inquiry:

'Of course, it is not sufficient to establish that the compensation is being paid in order to fill a hole in the taxpayer's assets. It is necessary, in addition, to ascertain the true nature of asset in the recipient's hands. More particularly, was the asset, prior to its destruction or damage, an asset of a capital nature or was it floating capital? If it was floating capital, such as trading stock, standing crops or consumable stores (like petrol, oil and so forth) the compensation will, obviously, be of a revenue nature, and will be subject to tax. In

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short, it is only where the payment received is to fill a hole in the capital assets of the taxpayer that the payment will escape the tax net.'

[17]

As Mr. Emslie who appeared with Mr. Sholto-Douglas on behalf of the respondent pointed out, it is often the case in tax matters that it is sometimes easy to state the test and guidelines to be used, but that it can be more difficult to apply such test and guidelines to determine whether an amount is...