Commissioner for Inland Revenue v Cactus Investments (Pty) Ltd

• Jurisdiction: South Africa
• Judge: Southwood J, Wunsh J and Ginsburg AJ
• Judgment Date: 05 July 1996
• Counsel: A G Derksen for the appellant P A Solomon SC for the respondent
• Hearing Date: 17 April 1996
• Citation: 1999 (1) SA 264 (T)
• Court: Transvaal Provincial Division
• Docket Number: A560/95

Southwood J:

This is an appeal in terms of s 86A(2)(a) of the Income Tax Act 58 of 1962, as amended ('the Act') against a decision of the Transvaal Income Tax Special Court. The questions to be decided relate to the C taxability in the 1988 and 1989 years of assessment of amounts of interest and the rights thereto which were ceded by the respondent to various institutions, who in turn ceded to the respondent their rights to dividends. The primary question is whether the rights to the interest had accrued to the respondent as gross income in terms of s D 1 of the Act prior to the cession. The secondary question is whether, if the right to interest had not accrued to the respondent prior to the cession, the interest is taxable in any event by virtue of the provisions of s 103 of the Act. The transactions in question took place before the introduction into the Act of s 103(5) which deals specifically with such cessions.

Only two witnesses testified on behalf of the respondent. One was Mr Leon Kirkinis who was a general manager E at Union Acceptances Ltd at the time of the transactions and the other was Mr Durk Holtes who was a financial adviser at UAL Merchant Bank at the relevant time. Most of their evidence was not disputed and it is amply supported by the documentary evidence. The Special Court did not doubt the reliability of the two witnesses. F

The respondent is a private company which had two equal shareholders, UAL Merchant Bank and UAL Pension Fund. The main business of the respondent was managing and holding the preference share book. It issued preference shares to clients who wished to invest in preference shares and invested in preference shares issued by other clients who required funds. Until the 1988 tax year the respondent did not have any investments which G produced interest income. Apart from its investments in preference shares it had investments in two dormant associate companies. By 1987 the value of the respondent's preference share portfolio had grown to about R400 000 000. At all material times there was considerable and continual demand from clients who wished to invest in H preference shares.

At the end of 1987 Mr Kirkinis and a Mr Peter Cooper devised the scheme which is the subject of this appeal. The essence of the scheme was that the respondent would invest funds (in respect of which interest would accrue) for a fixed period and then cede the right to the interest payable on the investment to certain financial and I other institutions with large shareholdings in return for a cession by these financial and other institutions of their rights to the dividends from their shares. The object as far as the respondent was concerned was the receipt of dividend income which was, in terms of s 10(1)(k) of the Act, as it then was, exempt from income tax. The object as far as the other institutions were J

Southwood J

concerned, was to increase the return on their shareholdings because to make the scheme attractive to them the A respondent would cede a larger amount of interest to them than the amount of dividends which they ceded to the respondent. This difference was carefully calculated to ensure that the other institutions received more (about four percent) than the respondent. While the other institutions received no tax benefit they did receive an B increased return because the income received was either still not taxable or was still subject to the same tax rate.

To implement the scheme the respondent entered into agreements with two insurance companies, Lifegro Assurance Ltd ('Lifegro') and Commercial Union Assurance Company of South Africa Ltd ('Commercial Union') C and two universities, the University of Cape Town ('UCT') and the University of Stellenbosch ('US'). In each case at least one 'master' agreement was entered into and sometimes the parties entered into one or more 'extension' agreements. The effect of the extension agreements was to increase the amounts ceded by the D respondent and the other party to the agreement and change the dates by which the cessions would take effect.

The master agreements were in a standard form. The first master agreement between the respondent and Lifegro is a typical example. The relevant provisions of this agreement read as follows:

'Agreement entered into between Lifegro Assurance Ltd (''the long-term assurer'') (registration No 76/03028) and E Cactus Investments (Pty) Ltd (''Cactus'') (registration No 66/10047/07).

1. Cactus owns a portfolio of investments in respect of which interest income may accrue in future.

2. The long-term insurer owns a portfolio of shares in respect of which dividend income may accrue in future. F

3. On 1 March 1988 (''the start date'') Cactus and the long-term insurer enter into the following exchange transaction -

3.1

in exchange for the cession of the right to receive dividend income pursuant to 3.2 Cactus will cede to the long-term insurer by completion of a schedule or schedules in the form of schedule I hereto (as one or more G documents) and its/their delivery to the long-term insurer the right to receive interest amounting to not less than R13 000 000 arising from the investments set out in schedule I which amount will be received by the long-term insurer by not later than 30 September 1988;

3.1.1

Cactus undertakes to identify the investments in respect of which the right to receive interest is to be ceded to the long-term insurer at a time prior to the accrual of that interest to Cactus; H

3.1.2

by not later than the business day preceding those dates of accrual for the payment of the interest concerned, Cactus shall give the long-term insurer a notice in the form of schedule I and schedule II of the investments identified by Cactus and shall simultaneously and in such notice cede to the long-term insurer the right to receive such interest. I

3.2

in exchange for the cession of the right to receive interest pursuant to 3.1, the long-term insurer will cede to Cactus by completion of a schedule or schedules in the form of schedule II hereto (as one or more documents) and its/their delivery to Cactus the right to receive dividend income of not less than R12 500 000 which amount will be received by Cactus by not later than 30 September 1988; J

Southwood J

3.2.1

the long-term insurer undertakes to identify the shares in respect of which the right to receive dividends is to A be ceded to Cactus by not later than the time at which the company concerned announces that a dividend is to be paid on the shares issued by that company;

3.2.2

by not later than the business day preceding the last day to register in the share register of the relevant company for the payment of the dividend concerned, the long-term insurer shall give Cactus a notice in the B form of schedule II of the shares identified by the long-term insurer and shall simultaneously and in such notice cede to Cactus the right to receive such dividend.

4. The long-term insurer and Cactus reciprocally warrant to each other that -

4.1

the rights ceded to each of the other of them - C

4.1.1

. . .

4.1.2

are not and will not be subject to the fulfilment of any condition before the cessionary will be entitled to receive payment;

4.1.3

. . .

4.2

the cession of the rights ceded to each of the other of them is not prohibited by the issuer of the interest bearing D security in the case of the right to interest ceded by Cactus or by the memorandum of articles of association of the company issuing the shares in respect of which the right to dividend income is ceded to Cactus.

5. It is agreed that the dividend cheques received by the long-term insurer in respect of ceded dividend income shall not be banked by the long-term insurer but shall be made over and endorsed without recourse as payable to Cactus by not E later than 30 September 1988. Further, the interest cheques received by Cactus in respect of ceded interest income shall not be banked by Cactus but shall be made over and endorsed without recourse as payable to the long-term insurer by not later than 30 September 1988. In the event that any of the above cheques should be crossed ''Not Transferable'' the party concerned will deposit the cheque in its own account and immediately account to the other for the amount thereof. F

6. If Cactus fails to cede to the long-term insurer the right to receive interest income up to the amount of R13 000 000 or, if having ceded such right, the party in which Cactus has made an investment, the rights to interest on which have been ceded to the long-term insurer, fails to pay the interest on due date, the long-term insurer's sole remedy as a result of such breach will be to enforce performance of this contract or, failing performance, to claim damages. G

7. If the long-term insurer fails to cede to Cactus the right to receive dividend income up to the amount of R12 500 000 or if having ceded such right, the company concerned fails to pay a dividend, and the long-term insurer fails to substitute a cession of an equivalent right to dividend within 30 days Cactus will be entitled, without prejudice to such other remedies as are available to it in law, to elect in writing to cancel this agreement after the provisions of 8 and 9 have H been fulfilled.

8. If Cactus elects to cancel this agreement pursuant to para 7, the parties will be put in the same position as they would have been in if this contract had not been cancelled and accordingly - I

8.1

the cession of the right to receive interest will be deemed to have been suspended with immediate effect and the long-term insurer will be entitled to retain such interest, if any, as it may have received prior to Cactus making the election referred to in...