Commissioner for Inland Revenue v Nemojim (Pty) Ltd

• Jurisdiction: South Africa
• Judge: Corbett JA, Trengove JA, Hoexter JA, Botha JA and Nicholas JA
• Judgment Date: 23 September 1983
• Hearing Date: 15 August 1983
• Court: Appellate Division

Corbett JA:

This appeal - from a decision of the Natal Income Tax Special Court - concerns a financial operation known as "dividend stripping". The respondent (appellant a quo) is a private company. I shall refer to it as "Nemojim" or, where appropriate, as "the company". Nemojim was incorporated in 1975 with the main object of

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buying and selling movable and immovable property. The founder was a Mr M J Rogers, a chartered accountant. Rogers has at all material times been the sole director of and sole beneficial shareholder in Nemojim. As the trial Judge remarked, for A practical purposes Nemojim was his alter ego.

Rogers' aim in forming Nemojim was to carry on, through it, the business of buying and selling shares in dormant companies which held substantial cash reserves available for distribution by way of dividend. He had previously practised as a chartered accountant in England for some eight years and had gained B experience in the income tax field. In November 1974 he came to South Africa and joined a firm of chartered accountants practising in Durban. Shortly after his arrival in this country Rogers heard from a colleague that "people had companies which were of a nuisance value". By this was meant dormant companies with substantial cash reserves which were available for distribution by way of dividend, but which the shareholders C concerned were reluctant to have distributed because of the resultant tax liability. Rogers later conceived the idea of "buying these companies at a discount, ie buying the total shareholding in each company at a price less than the net asset value thereof. He reasoned that if he were able to do this he D would "make some money along the line". This was the background to the formation of Nemojim.

After forming Nemojim, Rogers set about looking for dormant companies suitable for purchase. Several persons expressed interest in selling, there were discussions and negotiations, but initially nothing materialized. Eventually in August 1976 the first deals were concluded. At about the same time Rogers E resigned from his firm in order to give fulltime attention to the affairs of the company. These first deals related to the total issued share capital in Bert and Toni Hairfashions (Pty) Ltd ("Hairfashions") and in Nicold Investments (Pty) Ltd ("Nicold"), both of which were dormant companies. The total cost (including stamp duty and other charges) of acquiring the F shares in Hairfashions was R7 434 and in the case of Nicold the cost was R394 669. The purchases were made in terms of written agreements in a standard form drafted by Nemojim's attorney. The Hairfashions agreement was placed before the Court a quo as being a typical agreement. In terms thereof the shares were purchased for cash against registration of transfer G and it was a "condition precedent... fundamental to the entire agreement" that as at the "effective date" (which was the date of signature of the agreement) the only assets of Hairfashions should be cash in an amount of R7 409 and an amount of R110 representing "prepayments"; and that its H liabilities, contingent and otherwise, should not exceed R50.

During September 1976 Nemojim sold all the shares in Hairfashions and Nicold to separate purchasers. The price paid by the purchaser of the Hairfashions shares was R290 and by the purchaser of the Nicold shares R3 750. In the meanwhile the shares had been transferred from the original sellers to Nemojim as purchaser and Nemojim as sole beneficial shareholder had in each case caused the "company purchased" to declare a dividend which effectively stripped it of its distributable

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reserves. In the case of Hairfashions the dividend amounted to R7 347 and in the case of Nicold R394 669. Consequently, when Nemojim sold the shares in these two companies the companies themselves no longer had any A distributable reserves. These reserves had found their way, in the form of dividends, into the hands of Nemojim.

When Nemojim entered into these first two transactions Rogers did not know whether it would be possible to dispose of the shares in the companies after stripping. He soon found, B however, that there was a ready market in such dormant companies. He let it be known that Nemojim had "companies available for resale" and found the demand for them "very brisk". He also made it known, in appropriate quarters, that he was generally interested in purchasing dormant companies. The response was good and in this way Nemojim was able to build up C a profitable business in the buying and selling of shares in such dormant companies. In the tax year ended 28 February 1977 Nemojim purchased the total issued shareholding in 15 such companies and disposed of the shares in 12 of these companies. In the case of the remaining three companies (which were all acquired during February 1977) the shares concerned were D disposed of only in the 1978 tax year. During this last-mentioned tax year shareholdings in ten further companies were acquired and disposed of. As a result of a decision of the Transvaal Income Tax Special Court (apparently the Hicklin case) Nemojim decided to discontinue these share-dealing operations as Rogers was of the view that the sellers of shares would, in terms of that decision, find themselves liable to tax E on the proceeds of the shares, such proceeds being regarded as dividends in their hands. This decision was reversed by this Court in November 1979 (see Hicklin v Secretary for Inland Revenue 1980 (1) SA 481 (A)), but Nemojim did not thereafter recommence its share-dealing business.

In the meanwhile, during the 1978 tax year, Nemojim had also F commenced the business of buying, cleaning and selling agricultural bags. This side of its business showed a modest profit for that year. The company's accounts for the 1979 and 1980 tax years show an expansion of the bag business and increasing profits from this activity. It proved to be a very successful venture. With profits derived from the bag business G Nemojim later acquired farms and a company which owns the farms.

In this appeal we are concerned primarily with the share-dealing side of Nemojim's business. From the evidence placed before the Court a quo the following relevant facts and circumstances emerge:

(1)

The vast majority of the share-dealing transactions H entered into by Nemojim followed the general pattern established by the Hairfashions and Nicold deals. In each case the shares were acquired in terms of an acquisition agreement similar to the agreement used in the Hairfashions transaction and described above. In all instances the companies involved were dormant. In all but three instances the companies involved had substantial distributable reserves and the shares were sold by Nemojim after stripping the companies of their reserves by means of a

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dividend declaration. In the three exceptional cases referred to, the companies in question had no distributable reserves and the shares were bought and sold without any intervening dividend declaration. The amounts involved were small. In two cases a small profit was made and in the third Nemojim appears to A have broken even. In two cases, those of Chapel Properties (Pty) Ltd and Woodburn Service Station (Pty) Ltd, in addition to causing the company to declare a large dividend, Nemojim also applied for a reduction in the capital of the company, the surplus capital being returned to Nemojim, the sole B shareholder. This was done to make the companies more readily saleable.

(2)

In all cases, except the one referred to above where Nemojim merely bought and sold and broke even and another case where, owing to a miscalculation in regard to the provisional tax owed by the company, a C loss was sustained, the total effect of the transaction was to earn Nemojim a profit. That is to say, the total amount received by Nemojim by way of dividend, proceeds on the sale of the shares and, in two cases, reduction of capital, exceeded the original outlay consisting of the purchase price of the shares, D stamp duties and other costs. An important factor in this regard was the circumstance that by reason of s 10 (1) (k) of the Income Tax Act 58 of 1962 ("the Act") dividends declared by "purchased companies" in favour of Nemojim were exempt from tax in Nemojim's hands. The earning of a profit in this way was obviously the object of this share-dealing business E initiated by Nemojim.

(3)

The scheme also held out advantages to both the sellers of the shares to Nemojim and the buyers of the shares from Nemojim. It enabled the sellers in effect to receive a large proportion of the distributable reserves of the company concerned in a nontaxable form F (and for this reason they were prepared to sell their shares at a discount); and it enabled the buyers to obtain a "clean" company, ie a company with no assets or liabilities, other than the cash representing its share capital, at a very reasonable cost and without having themselves to incur the trouble and expense of G incorporation.

(4)

The amount of the dividend declared was generally sufficient to meet the cost of the shares. As the purchase price was payable against transfer of the shares and the dividend declaration could only take place shortly thereafter, bridging finance was necessary. This took the form of short-term loans from H Nemojim's bank.

I turn now to the financial results of Nemojim's trading. The company's accounting period coincides with the income tax year. During the 1976 tax year no relevant trading was done and the company commenced the 1977 tax year with an accumulated loss of R158. During the 1977 tax year the only trade carried on was share-dealing; while in the 1978 tax year the company carried on two trades, share-dealing and bag-recycling. The relevant figures relating to the share-dealing

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