Commissioner for Inland Revenue v Standard Bank of SA Ltd

• Jurisdiction: South Africa
• Judge: Corbett JA, Miller JA, Van Heerden JA, Hefer JA and Galgut AJA
• Judgment Date: 22 August 1985
• Citation: 1985 (4) SA 485 (A)
• Hearing Date: 15 May 1985
• Court: Appellate Division

Corbett JA:

This is an appeal from the Transvaal Income Tax Special Court, leave to appeal direct to this Court having been F given by the President of the Special Court in terms of s 86A (5) of the Income TaxAct 58 of 1962, as amended ("the Act").

Respondent is the Standard Bank of South Africa Ltd ("the Bank"), a registered commercial bank operating throughout the Republic of South Africa and having its head office in Johannesburg. In its income tax returns for the years of G assessment ended 31 December 1979, 31 December 1980 and 31 December 1981 the Bank claimed as deductions from its income the following amounts respectively in relation to these three years of assessment, viz R127 018 683, R117 275 018 and R299 409 076, as representing interest paid by it on moneys borrowed. In terms of additional assessments for the 1979 and H 1980 tax years and an original assessment for the 1981 tax year (all of these assessments having been issued in about May 1982) the Commissioner for Inland Revenue ("the Commissioner") disallowed portion of each of these deductions, the amounts disallowed being respectively R1 820 373, R1 937 572 and R6 010 I 992, and taxed the Bank accordingly. Its objection to the disallowance of these amounts having been overruled by the Commissioner, the Bank appealed to the Special Court, which upheld the appeal, set aside the assessments and referred the matter back to the Commissioner for re-assessment in terms of its judgment. The Commissioner, as appellant, now seeks in this J Court the reversal of the decision of the Special Court.

Corbett JA

A In a nutshell, the dispute between the parties concerns the utilization by the Bank, in the years of assessment under consideration, of a portion of the deposit moneys available to it for investment in the purchase of redeemable preference shares. Since the amounts received by the Bank by way of dividends on these shares are not taxable in the hands of the B Bank (by virtue of s 10 (1) (k) of the Act), the Commissioner contends that a proportionate amount of the interest paid to depositors on the deposit moneys, being non-productive of "income" (as defined in the Act), should be disallowed as a deduction in the computation of the Bank's taxable income. The Bank disputes the validity of this contention.

Before I discuss the legal issues involved in this dispute, I C must make some reference to the facts. These appear from the dossier of documents and the evidence of Dr C B Strauss, the managing director of the Bank and the only witness called in the Court a quo. If one is to judge by the cross-examination of Dr Strauss by the Commissioner's representative in the Special D Court, it would seem that what he stated in evidence is not in dispute.

At the outset, I should explain that the Bank is a wholly-owned subsidiary of Standard Bank Investment Corporation ("SBIC"), a company quoted on the Johannesburg Stock Exchange, and that the assets of the Bank represent about 70 per cent of the assets of E SBIC. In addition, other subsidiary companies, such as Standard Merchant Bank, Standard Bank Credit Corporation and Standard Bank Industrial Finance Corporation, go to make up a Standard Bank Group. Various banking operations are conducted by different members of the group, but, for the sake of simplicity, in my discussion of the facts I will refer merely F to the Bank. Judged by total assets held, the Bank is the second largest commercial bank in the country.

What the evidence of Dr Strauss reveals is that basically and in simple terms the business of the Bank (and of other commercial banks like respondent) consists of borrowing moneys by way of customers' deposits, upon which it pays interest to G the customer, and of lending out these moneys in various ways and thereby earning income (in the ordinary, non-technical sense of the word) in the form of interest and other forms of compensation paid by the borrower to the Bank for the use of the money. Naturally, the Bank so arranges its affairs that the general return it obtains on the moneys lent by it exceeds the H interest which it has to pay to its customers/depositors. This excess represents, broadly speaking, the gross profit of the Bank.

What Dr Strauss referred to as the "primary function" of the Bank of collecting deposits may be divided into two categories, retail depositgathering and wholesale deposit-gathering. The I former function is carried on throughout the country through the network of more than a thousand branches of the Bank. Funds are gathered through the deposit of moneys by customers in hundreds of thousands of current, savings and fixed deposit accounts maintained with these various branches of the Bank. The wholesale deposit-gathering function is handled largely by the investment division of SBIC on behalf of the Bank. This J relates to deposits in excess of R100 000, usually made by institutions such as

Corbett JA

pension funds, insurance companies, mining houses and other A banks, in the form of fixed deposits or what are termed negotiable certificates of deposit.

The Bank accepts all deposits that are offered to it, provided that the customer agrees to the quoted interest rate. Indeed all branches are instructed to take as many deposits as they B can. This is a matter of commercial necessity. In order to grant loans a bank must have money available. This money it acquires by taking deposits. Moreover, the Bank has a large and costly infrastructure and, if this is not used effectively and to its full potential, then the cost of the Bank's overheads becomes disproportionate to its earnings, and its commercial C efficiency diminishes. As Dr Strauss put it -

"... it is simply not a practical business proposition for any bank, not necessarily this one... to refuse to take deposits at the rate that is acceptable."

Of the deposits that have been gathered by the Bank, certain proportions must, in terms of the Banks Act 23 of 1965, be devoted to the maintenance of the required minimum reserve balance with the Reserve Bank, of the minimum liquid asset D requirement and of the minimum prescribed investments requirement (see ss 16, 17 and 18 of the Banks Act). The balance of the deposits, apart from what is utilized in the acquisition of fixed property, then goes into a common pool used for financing the borrowing needs of the Bank's customers. The Bank's main instrument of lending is the overdraft on E current account, which represents the "vast bulk" of customer financing. In addition, the Bank also finances acceptance credits, leases and suspensive sales, provides factoring facilities and grants medium-term loans. In recent years the taking up of redeemable preference shares has emerged as a F requirement of customers in certain instances.

The redeemable preference share transaction is seen as an alternative to the grant of a medium-term loan. Instead of the Bank advancing loan moneys to the customer, the Bank takes up redeemable preference shares issued to it by the customer, the term of redemption being equivalent to what would otherwise G have been the period of the loan. In fixing the dividend rate applicable to the shares, termed the "coupon rate", account is taken of the fact that the dividend is exempt from taxation in the hands of the Bank. This enables the Bank to offer a coupon rate substantially cheaper than the interest rate on an equivalent medium-term loan would have been. Therein lies the main advantage to the customer.

On the other hand, from the Bank's point of view the H non-taxability of the dividend holds no particular advantage since the coupon rate is correspondingly lower than the interest rate on a medium-term loan (which interest is taxable) would be. Moreover, the security afforded by a preference share issue is inferior to that pertaining to a loan in that in the latter case the Bank has the status of a creditor and in the I former is merely a shareholder. Nevertheless, though generally reluctant to do so, the Bank does participate (and in the tax years in question did participate) in a small number of redeemable preference share transactions at the customer's request. Generally the Bank is prepared to do so in order to accommodate special customers, with whom it has a long bank/customer association which might be prejudiced by a J refusal, and also customers of

Corbett JA

A high financial standing where there is the possibility of expanding the Bank's business with that customer. But the Bank never takes the initiative in offering a redeemable preference share transaction to a customer. Dr Strauss emphasized that other commercial banks followed the same practice of entering B into redeemable preference share transactions and cited one instance in his experience where the Bank felt impelled to enter into such a transaction with an established customer because the customer had been offered a preference share "loan" by another bank.

Dr Strauss maintained that these redeemable preference share transactions were "purely incidental to the main...