Commissioner, South African Revenue Service v Capstone 556 (Pty) Ltd

• Jurisdiction: South Africa
• Judge: Ponnan JA, Bosielo JA, Wallis JA and Mbha JA and Van Der Merwe AJA
• Judgment Date: 09 February 2016
• Citation: 2016 (4) SA 341 (SCA)
• Docket Number: 20844/2014 [2016] ZASCA 2
• Hearing Date: 09 November 2015
• Counsel: AR Sholto-Douglas SC (with MW Janisch SC and H Cassim) for the appellant. L Kuschke SC (with T Emslie SC) for the respondent.
• Court: Supreme Court of Appeal

Van der Merwe AJA (Ponnan JA, Bosielo JA, Wallis JA and Mbha JA concurring): A

[1] During April 2004 the respondent, Capstone 556 (Pty) Ltd (Capstone), disposed of approximately 17 million shares in JD Group Ltd (JDG) and made a profit of nearly R400 million. The principal question B in this appeal is whether Capstone is liable for tax on the amount of the profit on the basis that it constituted income (as the appellant, the Commissioner for the South African Revenue Service (the Commissioner), contends) or a receipt of a capital nature (as Capstone contends). The Tax Court, Cape Town (Davis J presiding), found for the C Commissioner on this issue, but that finding was overturned by the full court of the Western Cape Division of the High Court, Cape Town (Griesel J, Yekiso J and Baartman J), on appeal to it. This court granted leave to the Commissioner to appeal against the order of the full court.

Background

D [2] In the tax court Capstone presented the evidence of several witnesses, whom I shall identify in due course. The Commissioner called no witnesses. The picture that emerged from the evidence was set out in the reported judgments of the tax court (ITC 1867 (2013) 75 SATC 273) and that of the full court (Capstone 556 (Pty) Ltd v Commissioner, South African Revenue Service 2014 (6) SA 195 (WCC) (77 SATC 1)). In the E result I will restrict myself to those facts that I consider material and necessary for a proper understanding of this judgment.

[3] By the end of 2001, Profurn Ltd (Profurn), a JSE-listed company in the retail-furniture industry, had run into serious financial difficulties. F It owed FirstRand Bank Ltd (FirstRand) in excess of R900 million. Profurn also owed between R70 and R90 million to Steinhoff International Holdings Ltd (Steinhoff). Steinhoff was then a major manufacturer and supplier of furniture to the retail industry. Its chief executive officer was Mr Markus Jooste, who was also a major shareholder in Steinhoff. Dr Theunie Lategan, head of the corporate division of G FirstRand, was responsible for Profurn's account. FirstRand also had exposure to other furniture retailers. Profurn risked imminent liquidation in view of its critical financial position. This represented a serious financial risk to FirstRand and Steinhoff, as well as a major threat to the stability of the retail-furniture industry in South Africa as such.

H [4] Dr Lategan, who was under immense pressure to come up with a solution to the Profurn problem, discussed it with Mr Jooste. Mr Jooste referred him to Mr Claas Daun, a wealthy German businessman and director and shareholder of Steinhoff. Mr Daun also indirectly held a 13% shareholding in Profurn, so stood to suffer financially if Profurn I were liquidated. FirstRand had determined that for Profurn to survive, it needed to reduce its debt to FirstRand to some R300 million. Hence Profurn needed a capital injection of approximately R600 million. For this purpose Dr Lategan entered into discussions with Mr Daun early in 2002. Mr Daun was interested but held a firm view that what was required to save Profurn was both an injection of capital and sound J management. He held the managerial skills of Mr David Sussman,

Van der Merwe AJA (Ponnan JA, Bosielo JA, Wallis JA and Mbha JA concurring)

executive chairman of JDG, in high regard. He made it clear that he would A only be prepared to invest if the management of Profurn were taken over by Mr Sussman. FirstRand therefore approached Mr Sussman. Mr Sussman was agreeable but in turn insisted that the investor should be committed to remain on board as a shareholder for as long as it would take to turn the business of Profurn around. Mr Sussman discussed the matter with Mr Daun, who gave the required undertaking. B

[5] These developments were followed by a series of discussions between mainly Dr Lategan, Mr Jooste, Mr Daun and Mr Sussman. They resulted in a plan to rescue Profurn and stabilise the retail furniture industry. All concerned were ad idem, however, that the attempt to C rescue Profurn would be a difficult operation, would involve high risks and would probably require a period of three to five years.

[6] In essence, the solution agreed upon was the following. FirstRand would underwrite a R600 million rights issue by Profurn, thereby converting R600 million of the debt owed to FirstRand into equity. This D would be followed by a merger between Profurn and JDG, whereby the Profurn shares would be exchanged for JDG shares. FirstRand would then sell the JDG shares so acquired by it for R600 million to a South African special-purpose vehicle, to be created in due course when needed (Capstone). Daun et Cie Aktiengesellschaft (Daun et Cie), a E German private holding company controlled by Mr Daun, would invest R300 million in Capstone, which would be used to pay half of the purchase price. R200 million of the purchase price would be settled by the issue, by Capstone to FirstRand, of redeemable preference shares, and the balance by a participating loan by FirstRand to Capstone. In this manner the required capital injection and management would be achieved. F

[7] Most of this was reflected in a memorandum of understanding (MOU) signed by Mr Daun on 26 June 2002 at Rastede in Germany. In terms of the MOU it was naturally envisaged that final written agreements would be entered into and that the requisite regulatory approval be obtained. G It was nevertheless accepted by all relevant parties that the MOU gave rise to a binding commitment by Mr Daun and his associates via the proposed special-purpose vehicle to purchase the JDG shares from FirstRand, and that the risk and reward in respect of the shares passed with effect from 26 June 2002, which was the express effective date of the MOU. H

[8] Despite some efforts by FirstRand to encourage existing shareholders of Profurn to take up the rights offer, only a handful did so, raising less than R1 million. This was an indication of the desperate position of Profurn, as was the fact that after the MOU was signed, Profurn's share price fell even further. As a consequence FirstRand acquired a 78,8% I shareholding in Profurn. Thereafter JDG and Profurn merged and FirstRand acquired approximately 42 million JDG shares.

[9] In the agreements and amended agreements entered into following on the MOU, the rescue plan was varied in two material respects. First, FirstRand determined to retain one-sixth of its JDG shares. In the result J

Van der Merwe AJA (Ponnan JA, Bosielo JA, Wallis JA and Mbha JA concurring)

A five-sixths of the JDG shares would be transferred to Capstone. This translated to approximately 35 million JDG shares and a 20,9% interest in JDG. Second, Mr Daun invited Mr Jooste to participate in the transaction, which required some restructuring of the special-purpose vehicle to keep Mr Daun's financial interests separate from those of B Mr Jooste. As a result, half of the 35 million shares were sold to Daun et Cie for R250 million and the other half to Capstone for the same purchase price. In terms of these agreements the purchase price of the shares was fixed as at 26 June 2002 and the purchasers had to pay interest on the purchase price calculated from that date. Daun et Cie eventually paid R262 725 131 (R250 million plus interest) to FirstRand C in cash. This constituted a significant foreign investment in South Africa. The funding of the purchase price payable by Capstone was of course the responsibility of Mr Jooste. Daun et Cie and Capstone thereby committed themselves to a significant investment of indefinite duration, the ultimate profitability of which depended upon the ability of Mr Sussman D to turn around the operations of Profurn and integrate them profitably into those of JDG.

[10] Capstone was incorporated on 2 April 2003. It was wholly owned by another special-purpose vehicle, Business Ventures Investments No 687 (Pty) Ltd (BVI). The financial interest in BVI was held by Mr Jooste E and his associates. Genbel Securities Ltd (Gensec) advanced the amount of R150 million to BVI on condition that it be utilised to enable Capstone to acquire the JDG shares. BVI thereafter made a shareholder's loan to Capstone in the amount of R150 million on the same terms and conditions as those contained in the loan agreement between Gensec and BVI. The balance of the purchase price was settled by the issue by F Capstone of three year and one day redeemable preference shares to FirstRand. For this reason Capstone was required to comply with FirstRand's standard terms and conditions in respect of preference shares. In the result Capstone took a number of registered special resolutions. One of these inter alia provided that a special condition be G inserted in Capstone's memorandum of association that, until the date on which the preference shares have been redeemed in full, Capstone shall not —

'be entitled to conduct any business whatsoever, enter into any contract or undertake any obligation whatsoever, other than in respect of the sale H and subscription agreement and a voting pool agreement relating to its shares in JD Group Limited, provided however that this shall not prevent the company from acquiring any additional shares in the share capital of the JD Group Limited from time to time . . . without the express prior written consent of FirstRand'.

The effect of this and other terms and conditions was that for the period I of three years and a day from 30 May 2003, Capstone was prohibited from disposing of its JDG shares without the consent of FirstRand.

[11] Two additional liabilities were attached to the acquisition of the JDG shares by Capstone. First, a due-diligence investigation, performed in respect of Profurn at the instance of JDG, revealed contingent liabilities of J Profurn in respect of tax. FirstRand...