Erf 3183/1 Ladysmith (Pty) Ltd and Another v Commissioner for Inland Revenue

• Jurisdiction: South Africa
• Judge: Hefer JA, Nestadt JA, Howie JA, Schutz JA and Plewman AJA
• Judgment Date: 28 March 1996
• Citation: 1996 (3) SA 942 (A)
• Docket Number: 527/94
• Hearing Date: 07 March 1996
• Counsel: H V Vorster (with him E Brinckler) for the appellants. P J van R Henning SC (with him P J Venter) for the respondent.
• Court: Appellate Division

Hefer JA:

This appeal in terms of s 86A(2)(b) of the Income Tax Act 58 of 1962, as amended, is against a decision of a Special Court upholding two additional assessments I for normal and additional tax issued by the respondent ('the Commissioner') during 1990 in respect of income allegedly omitted from the appellants' returns for the 1985 year of assessment. Each appellant was originally assessed to normal tax towards the end of 1985 on a comparatively small amount of rent reflected in its return as its only income from the lease of a stand in Ladysmith. In the financial statements submitted in support of the respective returns each stand was reflected at cost. What was not revealed, was that a J factory had

Hefer JA

A since their acquisition been erected on both stands. Almost four years later, having been apprised of the true position and being of the view that the erection of the factory occurred in circumstances which brought about an accrual of income to the appellants under para (h) of the definition of 'gross income' in s 1 of the Act, the Commissioner B issued the additional assessments.

In view of the first proviso to s 79(1) of the Act, the appellants' initial stance was that it was no longer open to the Commissioner to issue additional assessments. They abandoned this contention in the Special Court and the main remaining issue is whether, on the facts of the case, para (h) of the definition of 'gross income' is applicable. The C Special Court decided this issue in the Commissioner's favour. If the decision were to be upheld, there is an end to the matter and the appeal falls to be dismissed; if not, other issues will have to be considered.

To demonstrate the relevance of para (h) it is necessary to refer briefly to the facts as related to the Special Court by appellant's witnesses, Mr H T D Drury and Mr M H E D Wimble. At the relevant time the former was the auditor of the group of companies to which I am about to refer, and the latter a director of one of the companies within the group.

During 1983 the directors of Pioneer Seed Company (Pty) Ltd ('Pioneer') and its subsidiary, Pioneer Seed Holdings (Pty) Ltd ('Holdings'), decided to establish a furniture E factory which Pioneer would operate in Ladysmith. Although industrial stands were apparently freely available the directors, instead of negotiating with the town council for the acquisition of a suitable site, approached Mr F A Krause who had at that stage already formed the appellant companies. Details of the bargain subsequently struck with F him were not disclosed to the Special Court; but according to Mr Wimble, an erstwhile director of Holdings, the upshot was that Krause purchased one stand in each appellant's name acting as 'nominee' of that company. Later, on a date which cannot be ascertained with certainty from the evidence, Holdings acquired the entire shareholding in both companies. (The group consisting of Pioneer, Holdings, and the two appellants will G henceforth be referred to as 'the group'.)

On 27 March 1984 eight separate but interrelated written agreements, comprising two practically identical sets of four, were simultaneously concluded. One set relates to the stand owned by first appellant and the other to the stand belonging to second appellant. H Each set consists of the following:

(1)

An agreement of lease ('the main lease') in terms of which the appellant in question lets its stand to Board of Executors Pension Fund ('the Fund') for the period 1 April 1984 to 31 July 1991. The leased premises are described as 'the land and any buildings or other improvements which may be effected on I the land by the lessee'. Clause 7 provides that:

'7.1

The lessee shall be entitled at its expense to erect such buildings and other improvements on the land as it may determine. . . .

7.2

All buildings and other improvements erected on the land by the lessee shall become the property of the lessor and the lessee shall have no claim against the lessor for compensation in J respect thereof.'

Hefer JA

(2)

A An agreement of sub-lease in terms of which the Fund sublets the property to Pioneer for the period 1 August 1984 to 31 July 1991. The leased premises are described as the land and buildings, and the buildings as 'the buildings which are to be erected on the land for the purpose of accommodating the B sub-lessee'. Other relevant provisions are to the effect that the Fund will cause buildings to be constructed on the land in accordance with plans approved by it and Pioneer; and that Pioneer will pay the Fund, in addition to monthly rent, and on the date of the final completion of the buildings, a premium 'in consideration for the sub-lessor having agreed to erect the C buildings on the land and to lease the property to the sub-lessee'.

(3)

A building contract between the Fund and Terwell Investments (Pty) Ltd ('the contractor') providing for the construction of a factory on each stand. The completion date is 31 July 1984.

(4)

A variation agreement between the relevant appellant and the Fund. Clause 3 D reads as follows:

'3.1

. . .

3.2

The lessee's liability to the lessor in respect of rent due in terms of the lease for the period 1 April 1984 to 31 July 1984 shall be discharged only from rent accruing to the lessee in terms of the sub-lease.

3.3

E To the extent necessary to give effect to this agreement the lessor waives its right to recover rent due in terms of the lease for the period 1 April 1984 to 31 July 1984 from the lessee.'

(The lease and sub-lease referred to are stated to be those listed in (1) and (2) supra.)

F These agreements, as will presently appear, are the source of the dispute. Before I deal with the conflicting contentions it is necessary to revert to the facts.

I referred earlier to the uncertainty about the precise date on which Holdings acquired the shares in the appellants. Appellants' attorney conceded, however, that the question of the G applicability of para (h) must be decided on the basis that his clients were subsidiaries of Holdings at the time of the conclusion of the agreements. Since the land on which the factory was to be erected thus belonged to the group (I speak in practical terms), one is immediately struck by the cumbrous arrangements for its construction. Affiliated H companies are of course at liberty to structure their mutual relationships in whatever legal way their directors may prefer; but when, for no apparent commercial reason, a third party is interposed in what might equally well have been an arrangement between affiliates, it is not unnatural to seek the motive elsewhere.

I When the appellants' witnesses were questioned in this regard it came to light that the agreements were concluded pursuant to a scheme first mooted by the group's banker and subsequently devised on the advice of a tax consultant by the directors of Pioneer and Holdings. Its aim, so both witnesses claimed, was to procure the benefit of a deduction under s 11(f) of the Act for Pioneer. (In terms of s 11(f) a deduction from gross income is J allowed 'in respect of any premium or consideration in

Hefer JA

A the nature of a premium paid by a taxpayer for . . . the right of use or occupation of land or buildings used or occupied for the production of income or from which income is derived'.)

This was plainly not the only result sought to be achieved. The problem facing the directors after the stands had been acquired, was that a factory to accommodate Pioneer B had to be constructed at considerable cost on land which, in practical terms, belonged to two of its subsidiaries. What the situation called for was an arrangement regulating the rights and obligations of the companies inter se. To achieve this various options were available. An obvious solution would have been a lease between the appellants and Pioneer providing for the construction of the buildings by the latter for its own account. C Another would have been a lease between the same parties with a provision imposing the obligation to erect the factory on the appellants. Each of these courses - and other conceivable ones - required careful consideration because, apart from other matters, there was the ever present problem of tax. It was in this connection that the group's banker put D forward the possibility of the interposition of a third party as the appellants' lessee and Pioneer's sub-lessor. Expert advice was taken and the outcome was that the inter-company relationship was formalised along the lines of the agreements...