Secretary for Inland Revenue v John Cullum Construction Co (Pty) Ltd

• Jurisdiction: South Africa
• Judge: Steyn CJ, Van Blerk JA, Holmes JA, Williamson JA and Wessels JA
• Judgment Date: 01 October 1965
• Citation: 1965 (4) SA 697 (A)
• Hearing Date: 20 August 1965
• Court: Appellate Division

C Steyn, C.J.:

This is an appeal, by consent, directly from the Transvaal Special Court for hearing income tax appeals. The respondent, a private company with two equal shareholders, John Cullum and George Raymond, carried on business during the year of assessment ended 30th June, 1961, as a building contractor. It built and sold houses. The majority of its D customers were unable to provide more than 10 per cent. of the purchase price, and for the balance they had to raise loans on mortgage of the property purchased, but building societies would not advance more than 75 per cent. of the value of the property, unless the repayment of the amount in excess thereof was guaranteed by an acceptable surety and a deposit of half that amount was made. The respondent accordingly found E it necessary to seek an arrangement with a building society. The respondent itself was not acceptable to the building society as a surety, but Cullum was. In the result, the respondent entered into an agreement with Cullum, trading as John Cullum Finance Corporation, on F 5th January, 1954, in terms of which Cullum would furnish the guarantees to the building society and make the deposits.

By this agreement the respondent bound itself to offer to the Corporation, for a period of ten years, all business in which such financial facilities were required by a purchaser, and the Corporation had the right to renew the agreement for a further period of ten years. In every case in which the respondent approached the Corporation for G assistance to a purchaser, it had to pay the Corporation R30 on submission of the application and thereafter, upon acceptance, the sum of R120, if the amount to be guaranteed by the Corporation did not exceed R1,700, or if it exceeded R1,700 then ten per cent. of the amount to be guaranteed less the R30 deposited at the outset. If an application was refused, the R30 had to be refunded to the respondent. The maximum H amount which the Corporation undertook to guarantee in any one case was R2,000.

In addition to these payments, the respondent had to deposit with the Corporation one-half of the amount to be guaranteed to the building society. In respect of a period of five years as from the date of the deposit, the Corporation was entitled to retain the interest paid by the building society on these deposits, and thereafter the interest accrued

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for the benefit of the respondent. In the normal course the deposit would be returned to the respondent when the amount owing by the purchaser to the building society had been reduced to two-thirds of the value then placed upon the property by the building society. In practice A this meant that the deposit would be retained for a period of ten to fourteen years, depending upon the original period of the loan.

At a later stage the Corporation ceded its rights and obligations under this agreement to Marnold Investment Co. (Pty.) Ltd., to which I shall B refer as 'Marnold'. Cullum was the sole shareholder of this company and in practice he continued to act personally as surety for the loans to the respondent's customers. He did so for the benefit of Marnold.

According to the stated case, the agreement was a valuable asset for Marnold and at one stage also for the respondent, but about 1960 the building trade became more competitive, Raymond complained that the C agreement had become onerous for the respondent, and on 7th December, 1960, Marnold released the respondent from its obligation 'to place all future business with the Finance Company', i.e. the John Cullum Finance Corporation, and authorised the respondent to place its future business with any firm, company or person as it may deem fit, in consideration of D a cash payment of R16,000, that being the amount agreed upon as 'a fair purchase price for this right'. This amount was based upon the income which Marnold could have expected to receive under the original agreement over a period of two years.

Raymond found, however, that no more favourable financial accommodation was obtainable from any other source, and on 3rd May, 1961, he concluded E a new agreement on behalf of the respondent with Marnold, more favourable to the respondent, in terms of which the respondent would, inter alia, be required in each case to make a deposit of 15 per cent instead of 50 per cent of the amount to be guaranteed.

Having set out these matters, the stated case continues to mention the following as part of the facts either admitted or proved:

F '(20) The objects with which these arrangements were concluded were to reduce the deposits on the Company's business so that more capital became available and to ease the financial strain under which the company had been operating, thus enabling it to extend its activities, build a greater number of houses and thereby earn a greater income.

(21) The arrangements and agreements had the effect and result contemplated.

(22) Both the payment of the consideration in the agreement and of the sum of R16,000 was to the advantage of the company's trade and was G incidental to the performance of the income-producing activities of the company and this expenditure was not incurred for the equipment of the income producing machine.'

In his determination of the respondent's liability for normal tax for the year of assessment in question, the Commissioner for Inland Revenue H (as he then was) had declined to allow the amount of R16,000 paid to Marnold as a deduction from the respondent's income. On appeal the Court a quo reversed this decision.

In the course of its judgment (which, of course, forms part of the stated case) the Court referred to the 'test' in New State Areas Ltd v C.I.R., 1946 AD 610, in the following terms:

'. . . the true nature of the transaction must be ascertained as a matter of fact, and the test is whether the operation in respect of which the expenses are incurred is incidental to the performance of the income-producing activities of the taxpayer or for the equipment of the income-producing machine'.

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This, no doubt, is a reference to the oft-quoted passage at p. 627 of that case, where, in relation to the important factor, the purpose of the expenditure, the distinction is drawn between expenditure incurred for the purpose of acquiring a capital asset for the business and expenditure which is

'in truth no more than part of the cost incidental to the performance of A the income-producing operations, as distinguished from the equipment of the income producing machine'.

Thereupon the Court stated its conclusion to be

'that the agreement (i.e. the agreement of release of 7th December, 1960) was to the advantage of the appellant's trade and was incidental B to the performance of the income-producing activities of the company'.

In apparent amplification of this finding, the judgment proceeds:

'From the point of view of Marnold Investment the contract, of course, was a valuable asset, although intangible. It was also at one stage a valuable contract from the point of view of the appellant and in a sense constituted an asset. The question is whether this can detract from its primary purpose, namely, to ensure that Marnold Investment would continue to go surety for the additional 15 per cent of the bond. It C seems to us that the purpose of the contract was to ensure this continuity and thus to make sure that the company could offer 90 per cent bonds to prospective buyers. In other words it was a precautionary measure in the course of the company's income-producing activities.

Viewed in this light the buying off of the contract, once it became onerous and when a financially more satisfactory arrangement could be made, was part solely of the income-producing activities of the appellant and cannot properly be described as expenditure incurred for D the 'equipment of the income-producing machine'. It should therefore be allowed as a deductible expenditure.'

Although in this last paragraph, which is not happily worded, it is not expressly stated that the expenditure incurred in buying off the contract was part of the cost of the income-producing activities, that I E think, is nevertheless what the language used is intended to convey, as is demonstrated by the statement that the buying off

'cannot properly be described as expenditure incurred 'for the equipment of the income-producing machine''.

The words

'once it became onerous and when a financially more satisfactory arrangement could be made',

describe the circumstances giving rise to the buying off. The advantageous 'precautionary measure' described in the preceding F paragraph had turned into a disadvantage, and the taxpayer was able to make a more satisfactory arrangement. While it is not correct that the respondent was able to make any such arrangement at the time of the buying off, these words do not indicate in any way that what the Court here has in mind is not expenditure incurred as part of the cost of the G income-producing activities. In the context of this case, the word 'structure' or 'concern' would, no doubt, have been more appropriate than the word 'machine', but the latter word is obviously not used in a literal sense. It is part of a quotation, presumably from the above-mentioned passage in the New State Areas case.

H In terms of secs. 11 (2) (a) and 12 (g) of the Income Tax Act, 1941, which applies in this case, the taxpayer, in claiming the deduction of the amount in question, had to show that it is expenditure incurred in the production of his income, that the expenditure is not of a capital nature, and that the amount was wholly or exclusively laid out or expended for the purposes of his trade. Before this Court counsel for the appellant relied solely on the contention that the expenditure is of a capital nature and on that ground not deductible. He conceded the other

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requirements for deductibility...