Commissioner for the South African Revenue Service v NWK Ltd

• Jurisdiction: South Africa
• Judge: Harms DP, Lewis JA, Cachalia JA, Shongwe JA and Bertelsmann AJA
• Judgment Date: 01 December 2010
• Citation: 2011 (2) SA 67 (SCA)
• Docket Number: 27/10
• Hearing Date: 11 November 2010
• Counsel: C Puckrin SC (with D Fine SC, GD Goldman and WT Molokomme) for the appellant. W Trengove SC (with A Stewart SC and HV Vorster) for the respondent.
• Court: Supreme Court of Appeal

Lewis JA (Harms DP, Cachalia JA, Shongwe JA and Bertelsmann AJA concurring):

C [1] Over a period of five years, from 1999 to 2003, the respondent, NWK Ltd, claimed deductions from income tax in respect of interest paid on a loan to it by Slab Trading Company (Pty) Ltd (Slab), a subsidiary of First National Bank (FNB), in the sum of R96 415 776. NWK is a public company which formerly operated as a co-operative society trading in D maize. The deductions were allowed. But in 2003 the appellant, the Commissioner for the South African Revenue Service, issued new assessments, disallowing the deductions and refusing to remit any part of the interest on the amounts assessed. He also imposed additional tax and interest in terms of ss 76 and 89quat of the Income Tax Act 58 of 1962. The amount claimed pursuant to the additional assessments, including E additional tax, was R47 360 583.

[2] The basis of the revised assessments by the Commissioner was that the loan was not a genuine contract: it was part of a series of transactions entered into between NWK and FNB and its subsidiaries, all designed to F disguise the true nature of the transaction between NWK and FNB, with the intention of NWK avoiding or reducing its liability for tax.

[3] NWK appealed against the assessments and the imposition of additional interest and penalties. Boruchowitz J and two assessors in the Tax Court held at Johannesburg upheld the appeal. It is against the order of G the Tax Court that the Commissioner appeals. The basis of the Commissioner's argument on appeal is that the loan was simulated: that it had to be viewed in the light of several other agreements concluded between NWK and FNB, and FNB and its subsidiaries, which together showed that a sum of only R50 million was lent by FNB to NWK, and H that the transactions were devised to increase the ostensible amount lent, so that deductions of interest on a greater amount could be claimed. NWK argued, on the other hand, that there was an honest intention on the part of NWK, represented by Mr E Barnard, its financial director, to execute the contracts in accordance with their tenor, and the claims for deductions were valid. The Tax Court accepted this contention and I upheld the appeal to the Tax Court on this basis.

[4] The Commissioner contended, in the alternative, both before the Tax Court and this court, that s 103(1) of the Act, in operation at the relevant time, was applicable: the Commissioner was satisfied that the transactions in question had been entered into for the purpose of J avoiding tax. The Tax Court held that once the Commissioner had

Lewis JA (Harms DP, Cachalia JA, Shongwe JA and Bertelsmann AJA concurring)

concluded that the transactions were simulated he could not be 'satisfied' A that they had been entered into for the purpose of avoiding or reducing liability for tax. Section 103(1) thus had no application.

Background to the transactions and their conclusion

[5] Before discussing the transactions that the Commissioner sought to B impugn it is helpful to look at the events leading to their conclusion. As I have said, the main business of NWK was trading in maize. In 1998, according to Barnard, it had an annual turnover of R1,5 billion. Its net operating profit was R103 million. It had over the years borrowed money from the Land Bank and had banking facilities with a number of commercial banks, including FNB, but had not used the latter. In C January of that year, two representatives of FNB, Mr Louw and Mr McGrath, visited Barnard and offered a structured finance loan facility to NWK.

[6] Neither Louw nor McGrath testified. Indeed no witness from FNB D was called by NWK. I shall revert to this briefly, since there was criticism of the Commissioner for not calling any witnesses from FNB. It is of course NWK which bore the onus of proving that the transactions were not simulated, an issue to which I shall also return. The history and context of the impugned transactions emerge from Barnard's evidence, the written agreements and from other documents. E

[7] Barnard questioned aspects of the proposal, in particular the tax implications. FNB sent him an opinion written by senior counsel who had commented on similar transactions. There is nothing to indicate, however, what instructions were given to counsel, and whether the transactions on which he commented were identical or even similar to F those proposed to NWK by FNB. And while counsel indicated that his view was that the transactions described were tax-efficient, he did caution, in spite of having been advised that the transactions were normal, that there was always the possibility that the Commissioner might apply s 103(1) to them. The transactions, he suggested, might not be regarded as having bona fide business purposes. G

[8] On 13 February 1998 Louw and Mr J van Emmenes, also from FNB, wrote an internal memorandum to the General Manager, Group Credit within FNB on the proposal to offer a 'structured finance facility' of R50 million to NWK, 'repayable in 5 equal annual capital and interest H payments over 5 years'. The facility would be used, they said, to reduce existing liabilities. They recommended the grant of the facility. Barnard did not see this internal memorandum at the time, but he did confirm when testifying that it correctly reflected what had been discussed.

[9] The proposal was made formally in a letter FNB sent to NWK on I 28 February 1998, offering to update its existing banking facilities by the addition of a term finance facility of R50 million, subject to what it called a term finance agreement. The formal proposal attached was said to be confidential and 'proprietary' to FNB, and required NWK to sign a confidentiality undertaking to preserve FNB's trade secrets and highly confidential and sensitive information. J

Lewis JA (Harms DP, Cachalia JA, Shongwe JA and Bertelsmann AJA concurring)

A [10] A diagram reflected the suite of transactions that would constitute the finance facility. It used indicative amounts rather than the actual sums that would ultimately be paid and repaid. The diagram also appeared to indicate the sequence in which all contracts and performance would occur, though it did not specify that this was so, and in fact the transactions were not all concluded entirely as envisaged, nor did B they follow the apparent sequence.

[11] The contracts envisaged were these. (I shall not use the sums referred to in the proposals, but rather the actual amounts reflected in the transactions concluded later.)

(a)

C A subsidiary of FNB that dealt in financial instruments, Slab, would lend a sum of R96 415 776 to NWK, to be repaid over five years.

(b)

The capital amount would be repaid by NWK delivering to Slab, at the end of the five-year period, 109 315 tons of maize.

(c)

Interest would be payable on the capital sum at a fixed rate of 15,41 % per annum, payable every six months. To this end NWK D would issue ten promissory notes with a total value of R74 686 861.

(d)

To fund the loan Slab would discount the notes (sell them for an amount less than their face value) to FNB. NWK, on due date, would pay FNB.

(e)

Slab would sell its rights to take delivery of the maize at the end of the E five-year period to First Derivatives, a division of FNB. This 'forward sale', for the sum of R45 815 776, would enable FNB to pay the full amount of the loan to NWK.

(f)

First Derivatives would sell to NWK the right to take delivery of the same quantity of maize for the sum of R46 415 776, payable immediately on the conclusion of the contract, but delivery to take F place only five years hence. This contract would neutralise the risks associated with delivery in the future.

(g)

Slab would cede its rights to a trust company to relieve Slab of the 'administrative burden' of the transaction. (This transaction did not G eventuate.)

[12] The proposal indicated that the series of transactions would enable NWK to deduct the interest paid on the capital sum in the year it was payable under s 11(a) of the Act. Barnard submitted the proposal to NWK's board of directors for approval which was granted on 30 March 1998. Contracts envisaged in the proposal were signed by Barnard on H behalf of NWK on 1 April 1998 and by Slab and FNB on 2 April. I shall, for convenience, refer to the date of the contract as 1 April 1998.

The contracts between NWK and FNB and its subsidiary or division

The loan I

[13] The contract provided that Slab would lend R96 415 776 to NWK. 'Repayment', to take place on 28 February 2003, would be effected by the delivery to Slab of 109 315 tons of 'dried white maize intended for human consumption'. (Although the transaction was, in my view, a sale and not a loan, I shall refer to it for convenience as a loan.) The delivery J was to be effected by representatives of the parties meeting in the

Lewis JA (Harms DP, Cachalia JA, Shongwe JA and Bertelsmann AJA concurring)

presence of a notary, when appropriate certificates would be signed — a A recognised means of constructive delivery in the industry.

[14] The parties agreed that Slab would be entitled to cede its right to delivery of the maize, or to delegate any of its obligations under the contract, to a company within the FNB group, without the consent of NWK. NWK, on the other hand, was not permitted to cede any right or B delegate any obligation, but it undertook to effect delivery to any cessionary.

[15] The capital amount of the loan was subject to interest at a fixed rate of 15,27 % per annum, compounded monthly in arrear. The interest was payable every six months. In respect of each payment NWK was to (and C did) issue promissory notes, the face value of the total being R74 686 861. This is the amount that NWK claimed as a deduction over the five-year period in terms of s 11(a) of the...