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

• Jurisdiction: South Africa
• Citation: 1996 (3) SA 942 (A)

Erf 3183/1 Ladysmith (Pty) Ltd and Another v Commissioner for Inland Revenue
1996 (3) SA 942 (A)

1996 (3) SA p942

Citation	1996 (3) SA 942 (A)
Case No	527/94
Court	Appellate Division
Judge	Hefer JA, Nestadt JA, Howie JA, Schutz JA and Plewman AJA
Heard	March 7, 1996
Judgment	March 28, 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.

Flynote : Sleutelwoorde

G Revenue — Income tax — Scheme for the avoidance of — Interaction between principle (1) that taxpayer entitled to arrange his affairs so as to remain outside of provisions of particular statute and (2) that courts of law not to be deceived by form of transaction but should examine its substance — No reason why both principles should not be applied in same case — Court only becoming concerned with H substance rather than form of transaction when having to decide whether party concerned succeeded in avoiding application of statute by an effective arrangement of its affairs — Thus applied, two principles not in conflict.

Revenue — Income Tax — Income — Gross income in terms of para (h) of definition of I 'gross income' in s 1 of Income Tax Act 58 of 1962 — Appellants and other parties entering into arrangement structured in form of series of agreements which included two lease agreements — Leases providing that lessee entitled to erect improvements on land 'as it may determine' — Applicability of para (h) — Appellants (lessees) contending that right as envisaged in para (h) not accruing to them in J terms of leases because agreements

1996 (3) SA p943

A entitling but not obliging lessor to effect improvements and, in absence of obligation enforceable by them, no right to have improvements accruing to them — Court holding that para (h) but a discrete application of principle that accrued right, capable of being valued in money, also included in 'gross income' — On B analysis of agreements forming part of arrangement, clear that parties seeking to give each agreement semblance of self-sufficiency which it did not in reality possess — Certain anomalies consistent with wider, unexpressed agreement or tacit understanding between parties — Agreements bearing stamp of simulation — Appellants failing to discharge onus of proving that agreements reflecting actual C intention of parties thereto and thus failing to show that right to have improvements effected as envisaged by para (h) did not acrue to them.

Headnote : Kopnota

The appellant companies appealed against a decision of the Income Tax Special Court upholding two additional assessments issued by the respondent ('the Commissioner') in D respect of income allegedly omitted from the appellants' returns for 1985. Although each appellant was originally assessed to normal tax on a comparatively small amount of rent reflected in its return as its only income from the lease of a stand, it later came to light that a factory had been erected on both stands. The Commissioner, being of the view that the building of the factory brought about an accrual of income to the appellants under para (h) of the definition of 'gross income' in s 1 of the Income Tax Act 58 of 1962, proceeded E to issue the additional assessments.

Paragraph (h) of the definition of 'gross income' ('para (h)') provides that a taxpayer's gross income includes the benefit accruing to him from the right to have improvements effected on his land. This benefit must accrue in terms of an agreement relating to the grant to any other person of the right to use or occupation of land and equals the amount F stipulated in the agreement as the value of or the amount to be expended on the improvements.

It appeared that the appellant companies had each concluded a series of agreements with various other parties ('the agreements'). These consisted of two identical leases, one in respect of each of the stands ('the leases'). Each lease was coupled with a sub-lease and a building contract. The lessee in both cases was a certain pension fund and the sub-lessee the company operating the factory established on the stands. A subsidiary of this company owned the entire shareholding in each appellant. Clause 7.1 of the leases, on which the G appellants' case rested, provided that 'the lessee shall be entitled at its expense to erect such buildings and other improvements on the land as it may determine . . . '.

The appellants relied on the principle that '(e)very man is entitled if he can to order his affairs so that the tax attaching under the appropriate Act is less than it would otherwise be'. They argued that effect had to be given to the agreements according to their tenor, H and that, whatever their purpose might have been, a right as envisaged in para (h) did not accrue to the appellants in terms of the leases because clause 7.1 of the main lease entitled but did not oblige the pension fund to build, and in the absence of an obligation enforceable by the appellants, no right to have the buildings erected accrued to them: the obligation of the lessor (ie the pension fund) to build on the leased properties stemmed from the sub-leases and was enforceable by the sub-lessee/factory operator, not by the I appellants. The Commissioner in turn relied on the principle that the Courts should not be deceived by the form of a transaction but should examine its substance. He contended that the agreements did not reflect the real intention of the contracting parties: inasmuch as the entire purpose of the transaction had been to evade tax, the agreements had been concluded in a form which concealed the fact that the appellants did acquire the right to have the improvement effected. The Special Court held in favour of the Commissioner, finding that para (h) was indeed applicable. On appeal

J Held, that one was immediately struck by the cumbrous arrangements made for the

1996 (3) SA p944

A construction of the factories: although affiliated companies (such as the appellant companies, the sub-lessee/factory operator, and its subsidiary, the sole shareholder in the appellants) were at liberty to structure their mutual relationships in whatever legal way their directors chose, it was not unnatural to seek the motive elsewhere when, for no apparent reason, a third party (such as the pension fund/lessee) interposed in what could B equally have been an arrangement between affiliates. (At 948G/H-I.)

Held, further, that although the general principle of the Act was that a taxpayer was taxed on the total amount in cash or otherwise received by or accrued to him, accrued rights capable of being valued in money were generally included in the definition of 'gross income'. Paragraph (h), inasmuch as it dealt with the accrual of a right (to have improvements effected), was but a discrete application of this principle. (At 950B/C-E.)

C Held, that as to the interaction between the two principles mentioned above, that the South African approach has always been that 'a transaction was in fraudem legis when it is designedly disguised so as to escape the provisions of the law, but falls in truth within these provisions', viz that the law had to have regard to the substance rather than the form of things. (At 951I-952A/B.)

Dadoo Ltd and Others v Krugersdorp Municipal Council1920 AD 530 applied.

Held, further, that, provided that each principle was confined to its recognised bounds, D there was no reason why both could not be applied to the same case; the Court only became concerned with the substance rather than the form of a transaction when it had to decide whether the party concerned had succeeded in avoiding the application of a statute by an effective arrangement of its affairs. Thus applied, the two principles were not in conflict. (At 952A/B-C.)

Held, further, that the appellants' argument that once it was found that the parties to the E agreements actually intended to structure their arrangement in the form of a lease coupled with a sub-lease and a building contract, that was the end of the matter as effect had to be given to the arrangement according to its tenor, was fundamentally flawed: the real question was whether they actually intended that each agreement would inter partes have effect according to its tenor. If not, effect had to be given to what the arrangement really was. (At 953A/B-C/D.)

Held, further, that by virtue of the provisions of s 82 of the Act, the onus was on the F appellants to show that any amount was exempt from tax, and accordingly that the agreements indeed reflected the actual intention of the parties thereto. (At 953C/D-E/F.)

Held, further, that the agreements could not be regarded separately: they were all signed simultaneously and were plainly interdependent to the extent that none of them would have been concluded without the others. Accordingly, each one had to be considered in the context of all the others to discover their total effect. (At 954C-D.)

G Held, further, on an analysis of the agreements, that the impression was irresistible that the parties deliberately sought to give each agreement a semblance of self-sufficiency which it did not in reality possess. Certain anomalies were consistent with a wider, unexpressed agreement or tacit understanding, the terms of which were not divulged. As such they bore significantly on the question whether the accrual to the appellants of a right to the improvements was concealed. (At 954B/C, 954I-I/J; and 955A-A/B.)

H Held, further, that the evidence did not exclude a real likelihood that the agreements did not reflect the true or full intention of the parties. Appellants' entire case rested on clause 7.1 of the main lease, but it was that very provision which, on the Court's analysis of the agreements, bore the stamp of simulation, the purpose of which could...