Commissioner for Inland Revenue v Giuseppe Brollo Properties (Pty) Ltd

• Jurisdiction: South Africa
• Judge: Corbett CJ, Hefer JA, Nienaber JA, Nicholas AJA and Harms AJA
• Judgment Date: 01 December 1993
• Docket Number: 392/92
• Hearing Date: 11 November 1993
• Court: Appellate Division

Nicholas AJA:

This is an appeal by the Commissioner for Inland Revenue I ('the Commissioner') against a decision of the Transvaal Income Tax Special Court upholding the appeal of Giuseppe Brollo Properties (Pty) Ltd ('the taxpayer') against the disallowance of its objections to assessments issued in respect of the 1984, 1985 and 1986 years of assessment.

J The taxpayer is a property company in the Barlow Rand group. It owns

Nicholas AJA

A a single property which it leases to Brollo Africa (Pty) Ltd, which is also a member of the Barlow Rand group. The taxpayer was one of the companies affected by a scheme of arrangement under s 311 of the Companies Act 61 of 1973 which was duly confirmed by the Witwatersrand Local Division in September 1983. The scheme provided for the merging of the B industrial interests of Metal Box South Africa Ltd with those of Robor Industrial Holdings Ltd ('RIH'), which was at the time a wholly-owned subsidiary of Barlow Rand Ltd ('Barlow Rand'). The scheme was a complex one but it will suffice to refer to one only of its facets.

In connection with the scheme an agreement dated 15 September 1983 was C concluded between Barlow Rand and RIH ('the sale agreement'), in terms of which RIH acquired seven property companies, of which the taxpayer was one. The agreement provided for the sale by Barlow Rand to RIH of 'the sale shares' (meaning shares representing the entire issued share capitals of the respective property companies) and 'the sale claims' (meaning all D claims against the property companies of companies in the Barlow Rand group). The purchase price in respect of each property company was its net asset value. In the case of the taxpayer, the sale shares comprised all the issued shares, namely 100 shares of R2 each, which were at that time held by Hume Ltd, also a subsidiary of Barlow Rand; and the sale claims comprised Hume Ltd's loan account.

E For the purposes of the scheme of arrangement independent valuators had revalued the land and buildings owned by each of the seven property companies. In the case of the taxpayer its land and the buildings thereon were revalued upwards by R4 779 260. This surplus was transferred by the directors to non-distributable reserves which, with this increment, F aggregated R6 160 586, and this sum was then transferred to distributable reserves, the total of which was thereby brought up to R6 289 144, which sum was then available for distribution as dividends.

Barlow Rand duly procured the transfer of the shares and the cession of the loan account by Hume Ltd to RIH. Stamp duty was payable under the Stamp Duties Act 77 of 1968 upon the transfer of the shares at the rate G prescribed under item 15(1) of Schedule 1 to the Act ('Tariff of Stamp Duties'). In this connection the taxpayer adopted a device which had the effect of reducing the value of the shares in the hands of Hume Ltd from more than R10 million to R200, the nominal value of the issued shares. (In 1983 this was a lawful way of reducing the incidence of stamp duty on the H transfer of shares.) On 4 November 1983 and 28 February 1984 respectively the directors of the taxpayer resolved that dividends of R1 509 884 and R4 779 260 be declared payable to shareholders registered in the books of the company on 1 October 1983. As a result dividends totalling R6 289 144 ('the dividend debt') became payable to Hume Ltd.

The taxpayer did not have liquid resources with which to pay the amounts I of the dividends. Its only assets of any significance were the land and buildings. Consequently, the dividend debt was simply credited to the interest-bearing loan account of Hume Ltd with the taxpayer, presumably with the consent, express or tacit, of Hume Ltd. The result was that the dividend debt which was due and payable, and which in terms of the J company's articles of association did not bear interest, was converted into

Nicholas AJA

A an interest-bearing indebtedness on loan account which was in the nature of a long-term investment in the taxpayer company. In consequence Hume Ltd's loan account increased from R4 428 336 as at 1 October 1983 to R10 717 480 as at 30 September 1984.

Barlow Rand (which was the controlling shareholder of RIH) had a group B policy, in terms of which every operating subsidiary of RIH had to operate as a self-sufficient profit centre and to this end 'the companies were structured on a one-to-one debt/equity ratio'. The loan indebtedness value of each company was split as to 50% 'equity loan' (which was treated as an interest free loan) and 50% as an interest bearing loan.

This policy was also applied to the taxpayer from the 1984 financial year, C as appears from the annual financial statements for the year ending 30 September 1984. In the balance sheet under 'Capital employed' is an item:

	'Notes	1984	1983
Holding company	6	10 717 480	4 428 336'
Note 6 to the financial statements reads:
		'1984	1983
6. Holding company
6.1 Equity loan		5 358 740
The loan is unsecured, interest free and no repayment terms have been arranged
6.2 long-term loan		5 358 740	4 428 336
The loain is unsecured, bears interest at 14% (1983-12%) per annum and no repayment terms have been arranged.
Total holding company		10 717 480	4 428 336'

Similar items appear in the financial statements for the 1985 and 1986 years, except that the rates of interest levied in those years increased to 15,3% and 17% respectively. The idea behind this policy was that the G property companies should pay market-related interest rates and receive market-related rentals. They would pay interest at a rate below prime so that the rate could be sustained and would not fluctuate as violently as prime. The long-term goal was that the rental earned would eventually exceed the interest paid so as to ensure ever-increasing net income. The effect of this policy was to establish a direct correlation between the H receipt of rental at market-related rates and the payment of interest to fund the owning of the property.

In each of its returns of income for the 1984, 1985 and 1986 years of assessment the taxpayer claimed as a deduction the interest which it paid to RIH calculated in terms of the Barlow Rand policy. These deductions I were allowed in the original income tax assessments issued in respect of those years, but in a letter dated 25 May 1987 the Receiver of Revenue advised the taxpayer as follows:

'The following adjustments have been made in the calculation of your taxable income/assessed loss and/or the determination of...