De Beers Holdings (Pty) Ltd v Commissioner for Inland Revenue

• Jurisdiction: South Africa
• Judge: Corbett JA, Miller JA, Hoexter JA, Galgut AJA and Nicholas AJA
• Judgment Date: 16 September 1985
• Citation: 1986 (1) SA 8 (A)
• Hearing Date: 26 August 1985
• Court: Appellate Division

Corbett JA:

Appellant company, which I shall call "Debhold", is C a subsidiary of De Beers Consolidated Mines Ltd. It is a share-dealing company with a large portfolio of quoted and unquoted shares. In its income tax return for the year of assessment ended 31 December 1979 (at all material times Debhold's year of assessment has coincided with the calendar year) Debhold claimed to deduct a loss of R4 158 937 sustained on the sale of two ordinary shares in a company known as D Engelhard Hanovia of Southern Africa (Pty) Ltd ("EHSA"). In determining Debhold's liability for normal tax for this year of assessment, respondent, the Commissioner for Inland Revenue ("the Commissioner"), disallowed this deduction, added back the amount of R4 158 937 and assessed Debhold accordingly. An E objection to this assessment having been disallowed, Debhold appealed to the Transvaal Income Tax Special Court. The Court came to the conclusion that Debhold's objection was well-founded and accordingly set aside the assessment and remitted the matter to the Commissioner for reassessment. The Commissioner appealed against this decision to the Transvaal F Provincial Division ("TPD"), which allowed the appeal and altered the order of the Special Court to one dismissing the appeal. This latter judgment has been reported (see Commissioner for Inland Revenue v De Beers Holdings (Pty) Ltd 1984 (3) SA 286 (T)). With leave of the Court a quo, Debhold appeals to this Court, seeking the reversal of the decision of the TPD and the reinstatement of the order of the Special Court.

G The background facts to the transactions with which this appeal is concerned may be summarized as follows. In 1967 an agreement was entered into with the late Mr Charles Engelhard in terms of which it was arranged that the Anglo American Corporation ("AAC"), the De Beers Group and the Rand Selections H Corporation Ltd ("Rand Selections") would acquire interests in the Engelhard group of companies, both in South Africa and in the United States of America. This arrangement resulted in 1969 in Debhold, AAC and Rand Selections together acquiring by subscription 659 940 class "A" ordinary shares (of 25c each) in EHSA in the following proportions respectively: 40 per cent, 40 I per cent and 20 per cent. Debhold held its shares directly, whereas AAC and Rand Selections held their shares through nominee companies. The remaining shares in EHSA, consisting of 500 000 ordinary shares (of R2 each) and 1 082 777 preference shares (of R2 each), were held by the Engelhard group.

At the time of these share acquisitions it was the intention of all interested parties to place EHSA into voluntary J liquidation, to dispose of all the assets of EHSA, amounting in value to some R20m, and to

Corbett JA

distribute the funds amongst the shareholders. On 7 August 1970 A EHSA was placed in voluntary liquidation by a special resolution passed at a general meeting of shareholders and thereafter most of its assets were realised in the course of liquidation.

For reasons which need not be canvassed (they are detailed in the judgment a quo at 289C - D) it was decided in March 1971 B that all the shares held by Debhold, AAC, Rand Selections (the latter two through their nominee companies) and the Engelhard group in EHSA should be sold at cost to Meton Investments (Pty) Ltd ("Meton"). Meton was a subsidiary of Turnstone Investments Ltd ("Turnstone"), in which Debhold, AAC C and Rand Selections held the shares in the same proportions of 40 per cent, 40 per cent and 20 per cent.

Difficulties were encountered in the liquidation owing to the complexity of the share transactions entered into by EHSA and the failure to keep a banking account during liquidation. At the same time a recent ruling of the Commissioner that a D company removed from the register in terms of s 199 of the Companies Act of 1926 would not be regarded as having been wound up or liquidated within the meaning of para (a) of the definition of "dividend" in s 1 of the Income Tax Act 58 of 1962 ("the Act") made deregistration an unattractive alternative. In the end the parties concerned decided to take E EHSA out of liquidation, to carry out a measure of reconstruction and then again to place it in liquidation.

In January 1973 an order of Court was obtained in terms of which the voluntary winding-up of the company was terminated. On 31 October 1973 special resolutions were passed by the members of EHSA resolving:

(1)

to distribute the sum of R4 197 379,26, which was the F amount standing to the credit of the company's share premium account, to the holders of the ordinary and "A" class shares in the company;

(2)

to reduce the authorised capital of the company from R3 333 854, divided into 500 000 ordinary shares, 673 200 class "A" ordinary shares and 1 082 888 preference G shares, to R1,25, divided into five class "A" ordinary shares (25c each); and to reduce the issued capital from R3 330 539, divided into 500 000 ordinary shares, 659 940 class "A" ordinary shares and 1 082 777 preference shares, to R1,25, divided into five class "A" ordinary shares (25c each), by repaying to the shareholders the amount of R3 330 539 less R1,25; H and

(3)

to designate the five class "A" ordinary shares, "ordinary shares".

As a result of this reconstruction Meton, as holder of all the shares, received an amount of R4 197 379 from the share premium distribution and an amount of R3 330 538 from the reduction of capital.

It was thereafter decided that, before proceeding with the I liquidation of EHSA, Meton should sell at cost its five ordinary shares in EHSA to the beneficial owners thereof, viz Debhold, AAC (through the medium of a nominee, Marjoram (Pty) Ltd) and Rand Selections, in the appropriate proportions. This was done on 27 December 1973. Debhold received two such ordinary shares for which it paid R4 158 937,60. This was the J purchase that has given rise to the dispute between Debhold and

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A the Commissioner. The reason for this transaction was that Meton would have had problems with undistributed profits tax had it been the beneficiary of further distributions by EHSA.

At this stage EHSA still had revenue reserves amounting to about R300 000 and capital reserves of R9 994 186. On 24 B December 1973 the directors resolved to distribute the revenue reserves as a dividend of R60 000 per share, payable on 31 December 1973. This was done and Debhold received as dividend an amount of R120 000. This dividend fell within para (a) of the definition of "dividend" in s 1 of the Act and consequently constituted "gross income" in Debhold's hands (see C para (k) of the definition of "gross income" in s 1 of the Act). Because, however, s 10 (1) (k) of the Act exempts such a dividend from tax when it is received by or accrues to a company, the dividend did not constitute "income", as defined in the Act, in Debhold's hands; and accordingly it did not give rise to an income tax liability on Debhold's part.

D At that stage the intention was still to proceed with a new liquidation of EHSA and with a distribution, by way of a liquidation dividend, of the capital reserves of the company. Debhold's share of such a distribution would have been R3 997 674. The definition of "dividend" in the Act provided, in E effect, that in relation to a company being wound up or liquidated any profits distributed which were of a capital nature were excluded from the definition. Thus it was considered that Debhold's share of the proposed liquidation dividend, being derived from capital reserves, would not constitute a dividend in Debhold's hands and therefore would F not be exempt from tax; whereas, on the other hand, because Debhold was a shareholder, the distribution would have accrued to it as income and the amount thereof would have been subject to income tax.

At this point the law was changed in two important respects. Firstly, in terms of s 75 (1) (b) of the new Companies Act 61 G of 1973, which came into force on 1 January 1974, a company having a share capital, if so authorized by its articles, was empowered by special resolution to increase its share capital constituted by shares of no par value by, inter alia, transferring reserves to the stated capital without a distribution of shares. Secondly, s 4 (1) (e) of the Income Tax H Act 85 of 1974 amended the definition of "dividend" in the Act in such a way that where there had been a transfer of capital reserves to share capital, a distribution thereof to shareholders by way of a reduction of capital would in effect be regarded as the distribution of a dividend. This amendment was deemed, in terms of Act 85 of 1974, to have taken effect as from the commencement of years of assessment ending on or after I 1 January 1974. The combined effect of the two enactments, in the case of Debhold and its co-shareholders in EHSA, was that it became possible to transfer the capital reserves of the company to stated capital without an issue of shares (thereby saving a substantial amount in stamp duty); and thereafter to return the capital to the shareholders in cash by way of a reduction of capital in which case the amount received by each J shareholder would constitute a dividend. Since all the shareholders were companies, this

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dividend would be exempt from tax in their hands. This A procedure, therefore, had obvious advantages over the initial liquidation proposal, which for convenience I shall call "the first scheme".

In due course the shareholders in EHSA opted for the procedure involving a transfer of the capital reserves to stated capital and a distribution thereof by way of a reduction in capital. I B shall call this "the second scheme". And on 23 December 1975 special resolutions giving effect to the second scheme were passed by the members of the company. In...