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

• Jurisdiction: South Africa

De Beers Holdings (Pty) Ltd v Commissioner for Inland Revenue
1986 (1) SA 8 (A)

1986 (1) SA p8

Citation	1986 (1) SA 8 (A)
Court	Appellate Division
Judge	Corbett JA, Miller JA, Hoexter JA, Galgut AJA and Nicholas AJA
Heard	August 26, 1985
Judgment	September 16, 1985

Flynote : Sleutelwoorde

Revenue — C Income tax — "Trading stock" as defined in s 1 of Act 58 of 1962 — Definition discussed — Definition, D while preceded by word "includes", exhaustive and comprehends what is ordinarily understood by "trading stock" — Does not include things the proceeds of which would form part of the taxpayer's income were he to dispose of them if the taxpayer had no such intention at the time of acquisition or at any other time during the tax year in question.

Revenue — E Income tax — Deductions — Requirement, in s 23 (g) of Act 58 of 1962, that expenditure (in order to qualify for deduction in terms of s 11 (a)) must be wholly or exclusively expended for purposes of trade — Expenditure laid out in a non-profitable transaction not necessarily hit by s 23 (g) — Moneys may well have been disbursed on grounds of commercial necessity or in order to facilitate trade — F Where, however, a trader normally carries on a business of buying goods (in this case, shares) and selling them at a profit, then, as a general rule, a transaction entered into with the purpose of not making a profit must, in order to satisfy s 23 (g), be shown to have been so connected with the pursuit of trade so as to justify the conclusion that, despite G absence of profit motive, the moneys were indeed paid out wholly and exclusively for the purposes of trade.

Headnote : Kopnota

The definition of "trading stock" in s 1 of the Income Tax Act 58 of 1962 falls naturally into two parts, viz (1) anything produced, manufactured, purchased or in any other manner H acquired by a taxpayer for manufacture, sale etc; (2) anything the proceeds from the disposal of which will form part of gross income. Part (2) of the definition relates to articles or things which (a) are disposed of (so as to produce proceeds) or (b) will be so disposed of in the future. Category (a) would cover things held at the beginning of the tax year and disposed of during that year, and category (b) things held throughout the tax year but to be disposed of thereafter. The argument I that category (b) relates to, or at any rate includes, things the proceeds of which would form part of the taxpayer's income if he were to dispose of them, notwithstanding the fact that he had no intention of disposing of them at the time of acquisition or at any other time during the relevant tax year (postulating a notional disposal of things not disposed of), is unsound and does violence to the plain meaning of the words used.

The definition of "trading stock", while preceded by the word "includes", would seem to comprehend what is ordinarily J understood by "trading stock" and is intended to be exhaustive.

1986 (1) SA p9

It is true that the absence of a profit does not necessarily A exclude a transaction from being part of a taxpayer's trade; and correspondingly moneys laid out in a non-profitable transaction may nevertheless be wholly or exclusively expended for the purposes of trade in terms of s 23 (g) of the Act. Such moneys may well have been disbursed on grounds of commercial expediency or in order to facilitate indirectly the carrying on of the taxpayer's trade. Where, however, a trader (in this B case, a share-dealer) carries on a business of buying goods (shares) and selling them at a profit, then as a general rule a transaction entered into with the purpose of not making a profit, or in fact registering a loss, must, in order to satisfy s 23 (g), be shown to have been so connected with the pursuit of the taxpayer's trade, eg on the grounds of commercial expediency or indirect facilitation of trade, as to justify the conclusion that, despite the lack of a profit motive, the moneys paid out under the transaction were wholly C or exclusively expended for the purpose of trade. Generally, unless the facts speak for themselves, this will call for an explanation from the taxpayer.

The decision of the Full Bench of the Transvaal Provincial Division in Commissioner for Inland Revenue v De Beers Holdings (Pty) Ltd 1984 (3) SA 286 confirmed, albeit for different reasons. D

Case Information

Appeal from a decision of the Full Bench of the Transvaal Provincial Division (STEYN J, GOLDSTONE J and FLEMMING J). The facts appear from the judgment of CORBETT JA and that of the Court a quo reported at 1984 (3) SA 286 (T).

R S Welsh QC (with him E B Broomberg) for the appellant: The appellant is a share-dealing company. It holds a very large portfolio of shares as stock-in-trade. Its income tax return for the year of assessment ended 31 December 1979 was as usual accompanied by its annual financial statements for that year. The financial statements disclosed that a loss of R4 158 936,60 had been incurred during the 1979 year as a result of the disposal by the appellant, for R1, of shares in Engelhard F Hanovia SA (Pty) Ltd ("EHSA"), which had been acquired in 1973 for R4 158 937,60. In September 1980 the respondent informed the appellant that "I cannot agree that the R4 158 936 loss on sale of the Engelhard Hanovia shares is allowable for income tax purposes and the... company's 1979 taxable income will G be adjusted accordingly". Shortly afterwards, the respondent issued an original assessment against the appellant for the year of assessment ended 31 December 1979, in which he added an amount of R4 158 937 to the appellant's taxable income in respect of "loss on Engelhard Hanovia shares". The appellant objected to the disallowance of the loss of R4 158 937 and H noted an appeal to the Transvaal Income Tax Special Court, which allowed the appeal. The present respondent noted an appeal to the Transvaal Provincial Division, which allowed the appeal. The issue in this appeal is whether the respondent was entitled to add back the amount of R4 158 937 to the appellant's taxable income for the 1979 year of assessment. It I is common cause that the appellant is, and always has been, a share-dealing company. The shares acquired by it have always been held by it as trading stock. In its accounts and in its income tax returns, it has always brought to account, as opening and closing stock respectively, the shares held by it at the beginning and at the end of each tax year in the manner required by s 22 of the Income Tax Act 58 of 1962. It is also common cause that the two EHSA shares with which this appeal is J concerned were held by the E

1986 (1) SA p10

A appellant as trading stock. The purpose and the intention of the appellant in acquiring those shares in 1973 were to derive the benefit of a distribution in liquidation which would have been taxable in its hands. Overseas Trust Corporation Ltd v Commissioner for Inland Revenue 1926 AD at 452 - 453; B Commissioner for Inland Revenue v Rand Selections Corporation Ltd 1956 (3) SA at 131A; Commissioner for Inland Revenue v Nemojim (Pty) Ltd 1983 (4) SA at 954E - F and 958F. It was, as the Special Court said, only because of the unexpected and, in that sense, fortuitous amendment of the definition of "dividend" in s 1 of the Income Tax Act by s 4 C (1) (e) of the Income Tax Act 85 of 1974, that it became possible for the appellant and the other shareholders in EHSA to distribute the EHSA capital reserves by means of a reduction of capital which escaped tax in the hands of the appellant because it was now a "dividend" and, as such, exempt from tax in terms of s 10 (1) (k) of the Income Tax Act. The Court below, whilst accepting that "the initial intention of the D appellant was not to obtain a tax advantage", attached much importance to the fact that that intention "was also not to obtain a commercial profit. The purchase price paid for the shares was equal to the value of the capital and revenue reserves of EHSA. Had the initial intention been carried out the appellant would have made neither a profit nor a loss on E the whole transaction." The Court below seems, for this reason, to have treated the present case as though it had been a "dividend-stripping" case. If this was the reason for the repeated emphasis by the Court below of this aspect of the case, the Court below erred. Indeed, the Court below itself correctly accepted that, if the original intention of the F appellant had been carried out, the distribution of the capital reserves of EHSA by way of a liquidation dividend would have attracted income tax in the hands of the appellant. The essence of a "dividend-stripping" operation is that the share-dealing company seeks to recover the whole or at least a substantial part of its outlay in the form of a dividend which will be exempt from tax in its hands. That was not the purpose G of the appellant in acquiring the shares in EHSA. The absence of any intention on the part of the appellant to obtain a "commercial profit" is irrelevant to the question whether the respondent was entitled to add back the amount of R4 158 937 to the appellant's taxable income for the 1979 year of assessment.

The decision of this appeal turns on the proper interpretation H of ss 10 (1) (k) (i), 11 (a), 23 (f) and 22 of the Income Tax Act and the application thereof to the facts. The meaning of the expression "expenditure... incurred... in the production of the income" in s 11 (a) was discussed in Port Elizabeth Electric Tramway Co v Commissioner for Inland Revenue I 1936 CPD at 244, in a passage which has frequently been approved by this Court. See, eg, Borstlap v Sekretaris van Binnelandse Inkomste 1981 (4) SA at 844 - 845; Sub-Nigel Ltd v Commissioner for Inland Revenue 1948 (4) SA at 589 - 592; Commissioner for Inland Revenue v Genn & Co (Pty) Ltd...