Burgess v Commissioner for Inland Revenue

• Jurisdiction: South Africa
• Citation: 1993 (4) SA 161 (A)

Burgess v Commissioner for Inland Revenue
1993 (4) SA 161 (A)

1993 (4) SA p161

Citation	1993 (4) SA 161 (A)
Court	Appellate Division
Judge	Corbett CJ, E M Grosskopf JA, Vivier JA, Kumleben JA, Nienaber JA
Heard	May 19, 1993
Judgment	June 2, 1993

Flynote : Sleutelwoorde H

Revenue — Income tax — Deductions — Expenditure incurred in the I production of income — Section 11(a) of Income Tax Act 58 of 1962 — 'Carrying on any trade' in s 11 of Act — If taxpayer pursuing course of conduct which, standing on its own, constitutes carrying on of a trade, taxpayer would not cease to be carrying on a trade merely because one of his purposes, or even his main purpose, in doing what he does is to obtain some tax advantage — If taxpayer carrying on a trade, his motive for J doing so irrelevant.

1993 (4) SA p162

A Revenue — Income tax — Deductions — Expenditure incurred in the production of income — Section 11(a) of Income Tax Act 58 of 1962 — Liability for interest — Taxpayer embarking on scheme whereby money borrowed from bank and invested for short period (one or two years) in B assets expected to appreciate — At end of period assets would be realised, bank repaid and balance pocketed — To reduce risk of assets not performing as expected, investment made not by purchasing assets themselves but by entering into single-premium pure endowment policy — Insurer thereafter managing money contributed by way of premium — Insurer issuing policy with guaranteed surrender value if policy surrendered after C one year — Transactions entered into not by taxpayer but by partnership en commandite consisting of taxpayer and limited liability company — Additional security for interest payments to bank provided by taxpayer in form of guarantee — Since liability for interest already accruing during first year, although interest only payable annually in arrear, and no D income being payable before end of first year, liability to pay interest accruing before accrual of income from scheme, resulting in tax deferment — Taxpayer seeking to deduct liability for interest in terms of s 11(a) of Income Tax Act 58 of 1962 — Commissioner contending that deduction not E allowable since expenditure not incurred in production of income from carrying on any trade, in that taxpayer's actual purpose in making investment was to reap reward flowing from fiscal advantages, namely tax deferment; alternatively, since an investment of that nature not, as matter of law and on common cause facts, amounting to carrying on of a F trade — If taxpayer pursuing course of conduct which, standing on its own, constitutes carrying on of a trade, taxpayer not ceasing to carry on a trade merely because one of his purposes, or even his main purpose, being to obtain some tax advantage — Commissioner's contention moreover not justified on evidence — Scheme amounting to a 'venture' which was G included in definition of 'trade' in s 1 of Act — Deduction in respect of liability for interest accordingly allowable.

Headnote : Kopnota

The appellant, a director of companies deriving his income mainly from salaries and directors' fees paid by these companies, had in 1987 entered into a scheme initiated by a company, F Investments (Pty) Ltd, ('F') and designed to earn for the appellant a considerable amount of money. In H essence the scheme contemplated that money would be borrowed from a bank and invested for a short period (one or two years) in assets such as shares which were expected to appreciate. At the end of the period the assets would be realised, the bank repaid and the balance pocketed. To reduce the risk that the assets might not perform as expected, the investment would be made, not by purchasing the assets themselves, but by entering into a single-premium pure endowment policy with an insurance I company ('L') which would then manage the money contributed by the appellant by way of the premium in the most advantageous way. The key to the scheme was that L would issue a policy with a surrender value which was guaranteed if the policy was surrendered after a year or two years. In the instant case L undertook to repay the amount invested after a year with a profit of 4%. To provide for the possibility that L might default, the transactions would be entered into not by the appellant but by a partnership en commandite, of which the appellant and F would be the members. The appellant would be the limited partner and would not be J liable for partnership debts except to the extent of the bank

1993 (4) SA p163

A guarantee (to be referred to presently), while F, the disclosed partner, would be liable for the balance of the debts. The bank would lend the money to the partnership for a year and the partnership would pay this amount to L as a single premium on an insurance policy and cede the policy to the bank. At the end of the year the bank would receive the borrowed amount plus 4%. Since the bank's rate of interest was 121/2 %, it would require security for the balance, which would be provided by the appellant in the form of a bank guarantee. The cost of providing the guarantee would B be appellant's only outlay, the amount of the guarantee being the most he could lose on the transaction in terms of the partnership deed. In return he would obtain 90% of the profits made by the partnership while F would get the rest. The policy taken out would be a non-standard policy in terms of the Sixth Schedule to the Income Tax Act 58 of 1962 and the proceeds would fall within the appellant's gross income in terms of para (eA) of the definition of 'gross income' in s 1 of the Act, so that a gain would be taxable. However, the proposers thought that the scheme also provided C certain tax advantages. They considered that the interest paid to the bank would be tax deductible, and since liability for interest would already accrue during the first year (although interest would only be payable annually in arrear), and no income would be payable before the end of the first year, the liability to pay interest would accrue before the accrual of income from the scheme, resulting in a tax deferment.

At the time when the appellant was introduced to the scheme the stock market was booming and there was speculation that he could obtain an 18% D or 20% return on a borrowed amount of R5 million. After discussing the project with the insurance broker who had introduced him to it and consulting his bank manager, the appellant decided to enter into the scheme. He obtained a bank guarantee for an amount of R425 000 in favour of the U bank at a cost of some R6 000 and then entered into a partnership with F. An amount of R5 million was borrowed from the U bank for a year at a rate of 12n$% and paid to L as a single premium on a policy; the policy was issued and ceded to the U bank. L guaranteed that on the first E anniversary of the policy its surrender value would be at least R5 200 000. The interest payable to the bank for that year was R625 000, which was secured by L's guarantee of R200 000 profit on the policy combined with the appellant's bank guarantee for R425 000. In October 1987 there was a crash on the Johannesburg stock exchange and the value of the fund created by L from the money invested by the various F partnerships plummeted, so that it became clear that L would not, on the first F anniversary of the policy, pay more than the minimum amount guaranteed by it. In these circumstances the appellant decided that he would benefit by cutting his losses and getting out. The partnership accounts for the period ended 29 February 1988 showed a loss of R477 740, allocated to the appellant, in respect of interest payable to the U bank, being interest which had accrued up to that date. In fact this figure should have read R425 000 since in terms of the partnership deed appellant's liability for G partnership debts was limited to that amount.

In his return of income for the year ended 29 February 1988 the appellant claimed to deduct the amount of R477 740 in terms of s 11(a) of the Income Tax Act. In his determination of the appellant's taxable income, the respondent disallowed the deduction in its entirety. The appellant's objection having been overruled, the appellant appealed to the Special Court, which held that the deduction for interest had rightly been disallowed because the appellant had not shown that the expenditure had H been incurred in the production of income derived by him 'from carrying on any trade'. The appellant thereupon appealed to the Appellate Division.

On appeal, the respondent argued that there were two reasons why the appellant's activities could not be regarded as the carrying on of a trade: firstly, because, although it had been a part of the appellant's purpose to make a profit out of the transaction, his main purpose had been to secure the fiscal advantage of a tax deferment; and, secondly, because, I even if the appellant's main purpose in entering into the scheme had been to earn a profit, nevertheless an investment of the nature in question would not, as a matter of law, and on the common cause facts, amount to the carrying on of a trade. For the appellant it was argued, in this regard, that his participation in the F scheme amounted to a 'venture' which is included in the definition of 'trade'. Finally, the respondent argued that the expenditure in the instant case was of a capital nature and therefore fell outside the terms of s 11(a) of the Act, his contention J being that an insurance policy was a capital asset and a gain made

1993 (4) SA p164

A by investing in one was, in principle, a capital gain. The Legislature had, in para (eA) of the definition of 'gross income', included gains received or accrued from insurance benefits under non-standard policies but this did not change the essentially capital nature of the policy or of...