Barnato Holdings Ltd v Secretary for Inland Revenue

• Jurisdiction: South Africa
• Judge: Trollip JA, Muller JA, Kotzé JA, Miller JA and Diemont JA
• Judgment Date: 24 February 1978
• Citation: 1978 (2) SA 440 (A)
• Hearing Date: 21 November 1977
• Court: Appellate Division

Trollip JA:

This is an income tax appeal. During the years of assessment that ended on 30 June 1968 and 1969 appellant made surpluses of R1 600 658 and R1 775 619 respectively through disposing of some of its shareholdings in other companies. The Transvaal Special Income Tax

Trollip JA

Court (MARGO J presiding) held that those surpluses were income subject to tax under the Income Tax Act 58 of 1962 ("the Act"), since appellant had not proved, as it alleged, that they were accruals of a capital nature. A Appellant has appealed against that decision direct to this Court with the consent of the respondent ("the Secretary").

The main facts leading to the dispute can be summarized as follows:

(1) Appellant became a wholly-owned subsidiary of Johannesburg Consolidated Investments Ltd ("JCI") in 1961. The latter is an old, B well-established mining house and entrepreneur. Its income has been largely derived from dividends on share investments in mining, property, and industrial companies, and from dealing in shares. For tax purposes it has been regarded as an "all-in" company, ie, the profits and losses on the disposal of its shareholdings in other companies are taken into account in the determination of its taxable income. It also provides C services of various kinds for subsidiary and other companies in which it has interests. On 1 January 1963 the management and control of JCI was transferred from Britain to the Republic. Its board of directors thereafter decided to expand its interests in the industrial field and that appellant should be used as a vehicle for acquiring and holding most of its industrial investments. In particular, it was resolved that D appellant's future activities would be those of a holding company for permanent investments of fixed capital in industrial (in the sense of non-mining) undertakings.

(2) In anticipation of this change in policy appellant's name had been changed on 8 May 1961 to Barnato Holdings Ltd. In 1963, in order to E implement the new policy, appellant's memorandum of association was altered by the insertion of new provisions paras (a) to (e), the relevant parts of which read -

"The objects for which the company is established are:

(a)

To carry on the business of an investment holding company and for the sole purpose of investment (that is to say only for the purpose of producing revenue) and so that the investments shall form part of the fixed capital of the company:

(i)

F To invest the capital and other moneys of the company solely for the purpose of investment in the acquisition... of... shares, stocks... and securities of any kind issued... by any company, corporation, or undertaking...

(ii)

..................

(iii)

To vary any investments of the company from time to time and solely for such purpose to turn to account or sell all or any part of the investments of the company provided that the G proceeds resulting from the sale or realisation of any of the company's investments shall be applied by the company in the purchase or acquisition of other assets again for the sole purpose of investments... and that any profit arising from any such sale or realisation shall not be distributed by way of dividend but shall be placed or added to the capital reserves of the company."

H The remaining provisions of the objects clause, paras (f) to (r) remained unaltered. According to para (i) appellant was authorized

"to... take or otherwise acquire and hold shares or stock in, or securities of... any company, and to sell, hold... or otherwise deal with such shares, stock or securities."

And the final para (r) contained an "independent objects" provision according to which each of the above objects or powers were to be regarded as separate and distinct from and independent of each other. Hence, notwithstanding the provisions of para (a), appellant, if it so wished, could still "acquire and sell or otherwise deal with" its shareholdings or some of them by dealing in them for profit under para (i).

Trollip JA

(3) On 2 April 1963 appellant wrote to the Secretary informing him of its new policy, emphasizing that it would not deal in shares but "subject to periodic revision and appropriate re-investment" would retain its shareholdings as permanent investments. The chairman of JCI also referred to this new policy in his speech to its annual general meeting on 19 A November 1963. Incidentally, in this speech he also mentioned the recent rapid rise in the Stock Exchange prices of the shares of many industrial companies.

(4) Pursuant to those declarations of policy and intention appellant B proceeded to build up a portfolio of shares. JCI provided the capital required therefor by way of interest-free loans. It also provided appellant with the necessary administrative and secretarial services. In the acquisition of shares an important distinction was drawn between appellant on the one hand and JCI and other share-dealing companies in its group on the other hand. Generally those acquired for appellant were industrial (non-mining) shares purchased as long-term investments because C of their dividend yields, and those acquired for JCI and the share-dealing companies were purchased for short-term resale at a profit. But despite that distinction, as will presently emerge, appellant did from time to time dispose of its shareholdings, especially when the market (Stock D Exchange) prices began to rise towards the end of the 1960s.

(5) The selection of suitable investments for appellant was based on information and recommendations provided by JCI's investment department, which was staffed by experts on investment research and analysis. In 1963 this department was augmented by additional skills in the form of E economists, mathematicians, accountants, investment analysts, and operations research experts. The modus operandi of this department is set out at length in the judgment a quo and stated case. It need not be repeated here in such detail. It suffices to say merely that in determining whether or not appellant should acquire shares in any particular company, this department looked mainly at the company's probable profitability and future dividend yield (apparently over the F period of the next five years), and especially at the prospect of any growth in its dividend yield; the anticipated yield over the projected period was then calculated and discounted at an appropriate interest rate to give a present value to the shares; this value would then be compared with their marketprice and a decision made about whether or not to G recommend their acquisition and the price to pay for them. The recommendations of this department then came before the investment committee comprising the chairman, deputy chairman, and managing director of JCI, whose decisions were invariably acted upon by appellant. Once acquired the shares would be reviewed from time to time by the investment department or committee. How often that would occur is not clear. But it H seems that that would probably happen quite often during a tax year, especially during an active market. Thus appellant in its letter to the Secretary on 27 September 1968 said (my italics):

"The holdings of the company are constantly reviewed in the light of changes in the economic climate and current conditions in the markets in which the companies concerned were operating, with the object of replacing investments in companies whose prospects are thought to have deteriorated or whose shares are considered to be overpriced in relation to other shares."

Trollip JA

(6) It was said in the judgment of the Court a quo and the stated case that the circumstances in which appellant would normally dispose of its shareholdings from time to time were as follows:

(i)

A where the performance of the particular company concerned failed to reach or maintain the minimum expectations required of a satisfactory investment;

(ii)

where the capital value of the shares had become such in relation to the return on such shares that it was more B economical to replace the investment with another from which such capital would produce a substantially better return (as, eg, where the market value of the shares had risen appreciably without a corresponding increase in their dividend yield); or

(iii)

where, in the same field of investment, the performance of another company indicated the desirability of a switch to that company to achieve a substantially better return on the capital outlay.

C Those were regarded by appellant as "normal sales". In addition there were what appellant termed "abnormal sales". This distinction will be dealt with presently - see para (11) infra. According to the stated case appellant was generally not concerned with the market price once an D investment was made except in the circumstances mentioned in (ii) above or where fluctuations in the market price of a share indicated the need for its being re-investigated; whether a profit would be achieved or a loss sustained was not a relevant factor in deciding whether or not to dispose of any shares; the only relevant factors were the gross proceeds derivable therefrom and what return would be obtainable thereon if they were re-invested in other shares.

E (7) Appellant acknowledged that the switching out of share investments for one or other of the reasons mentioned in (i), (ii) and (iii) of para (6) above - the normal sales - was always contemplated as being part of its business, and indeed was unavoidable, since no investment analysis F could always be correct and no investment adviser or board of directors could foretell all future developments affecting the dividend yield of particular shares.

(8) According to a schedule of appellant's transactions in shares annexed to the stated case the cost of purchasing shares during the first few tax G years was R325 683 (1962), R273...