Download - S v Gaba 1981 (3) SA 745 (O)
127/85
IN THE SUPREME COURT OK SOUTH AFRICA
(APPELLATE DIVISION)
In the appeal of -
DE USERS HOLDINGS (PTY) LIMITED.... appellant
and
COMMISSIONER FOR INLAND REVENUE .... respondent
Coram: Corbett, Miller et Hoexter, JJA, Galgut et
Nicholas, AJJA.
Date of Hearing: 26 August 1985.
Date of Judgment: 16 September 1985
J U D G M E N T
CORBETT, JA:
Appellant company, which I shall call "Debhold",
is a subsidiary of De Beers Consolidated Mines Limited.
It is a share-dealing company with a large portfolio of
quoted and unquoted shares. In its income tax return
/ for
2
for the year of assessment ended 31 December 1979 (at
all material times Debhold's year of assessment has
coincided with the calendar year) Debhold claimed to
deduct a loss of R4 158 937 sustained on the sale of two
ordinary shares in a company known as Engelhard Hanovia
of Southern Africa (Pty) Ltd ("EHSA") . In determining
Debhold's liability for normal tax for this year of assess
ment, respondent, the Commissioner for Inland Revenue
("the Commissioner"), disallowed this deduction, added
back the amount of R4 15b 937 and assessed Debhold accord
ingly. An objection to this assessment having been dis
allowed, Debhold appealed to the Transvaal Income Tax
Special Court. The Court came to the conclusion that
Debhold's objection was well-founded and accordingly
set aside the assessment and remitted the matter to
the Commissioner for reassessment. The Commissioner
/ appealed
3
appealed against this decision to the Transvaal Provincial
Division("TPD"), which allowed the appeal and altered
the order of the Special Court to one dismissing the appeal.
This latter judgment has been reported (see Commissioner
for Inland Revenue v De Beers Holdings (Pty) Ltd 1984 (3)
SA 286 (T) ). With leave of the Court a quo, Debhold
appeals to this Court, seeking the reversal of the decision
of the TPD and the reinstatement of the order of the
Special Court.
The background facts to the transactions with which
this appeal is concerned may be summarized as follows. In
1967 an agreement was entered into with the late Mr.
Charles Engelhard in terms of which it was arranged that
the Anglo American Corporation ("AAC"),the De Beers
Group and the Rand Selections Corporation Ltd ("Rand
Selections") would acquire interests in the Engelhard
group of companies, both in South Africa and in the
/ United
4
United States of America. This arrangement resulted in
1969 in Debhold, AAC and Rand Selections together acquiring
by subscription 659 940 Class "A" ordinary shares (of 25c
each) in EHSA in the following proportions respectively:
40 per cent, 40 per cent and 20 per cent. Debhold held
its shares directly, whereas AAC and Rand Selections held
their shares through nominee companies. The remaining
shares in EHSA, consisting of 500 000 ordinary shares
(of R2 each) and 1 082 777 preference shares (of R2 each),
were held by the Engelhard Group.
At the time of these share acquisitions it was the
intention of all interested parties to place EHSA into
voluntary liquidation, to dispose of all the assets of
EHSA, amounting in value to some R20m, and to distribute
the funds amongst the shareholders. On 7 August 1970
EHSA was placed in voluntary liquidation by a special
resolution passed at a general meeting of shareholders and
/ thereafter
5
thereafter most of its assets were realised in the course
of liquidation.
For reasons which need not be canvassed (they are
detailed in the judgment a quo at p 289 C - D) it was
decided in March 1971 that all the shares held by Debhold,
AAC, Rand Selections (the latter two through their nominee
companies) and the Engelhard Group in EHSA should be sold
at cost to Meton Investments (Pty) Ltd ("Meton").
Meton was a subsidiary of Turnstone Investments Ltd
("Turnstone"), in which Debhold, AAC and Rand Selections
held the shares in the same proportions of 40 per cent,
40 per cent and 20 per cent.
Difficulties were encountered in the liquidation
owing to the complexity of the share transactions entered
into by EHSA and the failure to keep a banking account
during liquidation. At the same time a recent ruling of the
Commissioner that a company removed from the register in
/ terms
6
terms of sec. 199 of the Companies Act of 1926 would not
be regarded as having been wound up or liquidated within
the meaning of para. (a) of the definition of "dividend"
in sec. 1 of the Income Tax Act 58 of 1962 ("the Act")
made deregistration an unattractive alternative.
In the end the parties concerned decided to take EHSA
out of liquidation, to carry out a measure of reconstruction
and then again to place it in liquidation.
In January 1973 an order of Court was obtained
in terms of which the voluntary winding-up of the company
was terminated. On 31 October 1973 special resolutions
were passed by the members of EHSA resolving -
(1) to distribute the sum of R4 197 379,26, which was
the amount standing to the credit of the company's
share premium account, to the holders of the ordinary
and "A" class shares in the company;
/ (2) to
7
(2) To reduce the authorised capital of the company
from R3 333 854, divided into 500 000 ordinary
shares, 673 2()0 class "A" ordinary shares and
1 082 777 preference shares, to Rl,25, divided
into 5 class "A" ordinary shares (25c each); and
to reduce the issued capital from R3 330 539, divided
into 500 000 ordinary shares, 659 940 class "A"
ordinary shares and 1 082 777 preference shares,
to HI. ,25, divided into 5 class "A" ordinary shares
(25c each), by repaying to the shareholders the
amount of A3 330 539 less R1,25; and
(3) to designate the 5 class "A" ordinary shares
" ordinary shares".
As a result of this reconstruction Meton, as holder of all
the shares, received an amount of R4 197 379 from the share
premium distribution and an amount of R3 330 538 from the
/ reduction
8
reduction of capital
It was thereafter decided that, before proceeding
with the liquidation of EHSA, Meton should sell at cost its
5 ordinary shares in EHSA to the beneficial owners thereof,
viz. Debhold, AAC (through the medium of a nominee, Marjoram
(Pty) Ltd) and Rand Selections, in the appropriate proportions.
This was done on 27 December 1973. Debhold received 2 such
ordinary shares for which it paid R4 158 937,60. This was
the purchase that has given rise to the dispute between
Debhold and the Commissioner. The reason for this trans
action was that Meton would have had problems with undis
tributed profits tax had it been the beneficiary of further-
distributions by EHSA.
At this stage EHSA still had revenue reserves
amounting to about R300 000 and capital reserves of R9 994 186.
On 24 December 1973 the directors resolved to distribute the
revenue reserve as a dividend of R60 000 per share, payable
/ o n
9
on 31 December 1973. This was done and Debhold received
as dividend an amount of R120 000. This dividend fell
within para. (a) of the definition of "dividend" in sec. 1 of
the Act and consequently constituted "gross income" in Debhold's
hands (see para. (k) of the definition of "gross income" in
sec. 1 of the Act). Because, however, sec. 10(1)(k) of the Act
exempts such a dividend from tax when it is received by or
accrues to a company, the dividend did not constitute "income",
as defined in the Act, in Debhold's hands; and accordingly
it did not give rise to an income tax liability on Debhold's
part.
At that stage the intention was still to proceed
with a new liquidation of EHSA and with a distribution, by way
of a liquidation dividend, of the capital reserves of the
company. Debhold's share of such a distribution would have
been R3 997 674. The definition of "dividend" in the Act
provided, in effect, that in relation to a company being
/ wound
10
wound up or liquidated any profits distributed which were
of a capital nature were excluded from the definition. Thus
it was considered that Debhold's share of the proposed liqui
dation dividend, being derived from capital reserves, would
not constitute a dividend in Debhold's hands and therefore
would not be exempt from tax; whereas, on the other hand,
because Debhold was a shareholder, the distribution would
have accrued to it as income and the amount thereof would
have been subject to income tax.
At this point the law was changed in two important
respects. Firstly, in terms of sec. 75(1)(b) of the new
Companies Act 61 of 1973, which came into force on 1 January
1974, a company having/share capital, if so authorized by
its articles, was empowered by special resolution to increase its
share capital constituted by shares of no par value by, inter
alia, transferring reserves to the stated capital without a
distribution of shares. Secondly, sec. 4(1)(e) of the
/ Income
11
Income Tax Act 85 of 1974 amended the definition of "dividend"
in the Act in such a way Chat where there had been a transfer
of capital reserves to share capital, a distribution there
of to shareholders by way of a reduction of capital would in
effect be regarded as the distribution of a dividend. This
amendment was deemed, in terms of Act 85 of 1974, to have
taken effect as from the commencement of years of assessment
ending on or after 1 January 1974. The combined effect of
the the two enactments, in/case of Debhold and its co-shareholders
in EHSA, was that it became possible to transfer the capital
reserves of the company to stated capital without an issue
of shares (thereby saving a substantial amount in stamp duty);
and thereafter to return the capital to the shareholders in
cash by way of a reduction of capital in which case the
amount received by each shareholder would constitute a
dividend. Since all the shareholders were companies, this
/ dividend
12
dividend would be exempt from tax in their hands. This
procedure, therefore, had obvious advantages over the initial
liquidation proposal, which for convenience I shall call "the
first scheme".
In due course the shareholders in EHSA opted for
the procedure involving a transfer of the capital reserves
to stated capital and a distribution thereof by way of a
reduction in capital. I shall call this "the second scheme".
And on 23 December 1975 special resolutions giving effect to the
second scheme were passed by the members of the company. In
pursuance thereof there was distributed to shareholders an
amount of Rl 998 720 in cash in respect of each share held.
Debhold received a payment of R3 997 440, which constituted
gross income, but in terms of sec. 10(1)(k), read with the
definition of "income", not income in its hands.
Upon the completion of (the second scheme there were
no assets left in EHSA. An application was made for the
/ deregistration
13
deregistration of the company in August 1977 on the ground
that it had no assets and no liabilities and that it had
ceased to carry on business. In January 1978 application
was made to halt the deregistration proceedings. On 31
December 1979 Debhold sold its two shares in EHSA to Tarl
Investments Limited for Rl. Tarl Investments Limited is owned
partly by Debhold and partly by AAC. In January 1980 there
was a re-application for the deregistration of EHSA and in
May 1980 the company was deregistered.
That completes the factual story. I come now to
the fiscal side of the matter. Being a dealer in stocks and
shares, Debhold, as a matter of practice, included in its
financial statements attached to its annual income tax returns
schedules reflecting its holdings of, and dealings in, shares
in listed and unlisted companies. These schedules, compiled
in accordance with the provisions of sec. 22 of the Act
relating to trading stock, deal individually with each
/ company
14
company in respect of which Debhold held or acquired shares
during the year in question. They indicate in each case an
opening balance (if any) of shares held, purchases, sales,
transfers by way of exchange, and a closing balance (if any).
If there have been dealings in the shares during the year the
profits or losses made on these transactions are also reflected
in the schedules. In the schedules two sets of figures are
shown in respect of these various items. One set, termed
"tax amount", shows the figures for tax purposes; while the
other set, termed "book amount", shows the figures for account
ing purposes. The main reason for differences in these
figures lies in the fact that for tax purposes Debhold is
required by sec. 22 to value trading stock held and not
disposed of at the beginning and end of each year of assess
ment at cost, whereas for accounting purposes the value
of such stock is sometimes written down from cost at the end
of the year. Sec. 22(1) stipulates that the value of trading
/ stock...
15
stock held and not disposed of at the end of a year of assess
ment shall be the cost price -
"... less such amount as the Commissioner
may think just and reasonable as representing
the amount by which the value of such trading
stock, not being shares held by any company
in any other company, has been diminished by
reason of damage, deterioration, change in
fashion, decrease in the market value or for
any other reason satisfactory to the
Commissioner". (My italics.)
(I quote the subsection in its present form. The only
difference in the wording of the section between now and as it was
in 1975 is that the Commissioner was then called the Secretary.)
In its income tax return for the year of assessment
ended 31 December 1973 Debhold treated the purchase of the
EHSA shares as an acquisition of trading stock and the rele
vant entry in its share dealing schedules, under EHSA, shows
in the tax amount column a nil opening balance, purchases in the
sum of R4 158 937,60, nil sales or transfers and a closing
/ balance
16
balance of the same amount. In the book amount column,
however, an amount of R120 000 figures against transfers
(this obviously relates to the dividend received) and the
shares are written down by an amount of R41 337,60,
leaving a closing balance of R3 997 600. (This latter figure
is approximately equivalent to Debhold's share of the capital
reserves still left in EHSA.) I shall later refer again
to this writing down figure of R41 337,60.
The schedules for the 1974 tax year simply reflect
under EHSA opening and closing balances of R4 158 937,60
in the tax amount column and of R3 997 600 in the book amount
column. In the tax amount column of the schedules for the
1975 tax year the same opening and closing balances are given
as for the previous year; but in the book amount column
there is an item "sundry realisations" (which is explained
in a note to relate to the reduction of capital) amounting to
/R3 997 440,
17
R3 997 440, leaving a closing balance of R160. For the
reasons already stated, the provisions of sec. 22(1) pre
cluded Debhold from similarly reducing or writing down the
closing balance in the tax amount column.
In the following year (1976) opening and closing
balances of R4 158 937,60 and of R160 appear in the tax
amount and book amount columns respectively. This is re
peated in the schedules for the 1977 and 1978 tax years.
In the schedules for the 1979 tax year the tax amount column
shows an opening balance of R4 158 937,60, sales of R1,00,
a loss of R4 158 936,60 and a nil closing balance.
The corresponding figures in the book amount column are
R160, R1,00, R159 and, of course, a nil closing balance.
It is this loss in the tax amount column amounting to
R4 158 936,60 in the 1979 tax year which was added back by
the Commissioner when assessing Debhold to income tax for that
year and which forms the subject-matter of this appeal.
/ Debhold's
18
Debhold's case in regard to this claimed loss,
as presented to us on appeal, may be summed up as follows:
(1) The two EHSA shares which Debhold acquired in the
1973 tax year constituted trading stock in its
hands.
(2) The expenditure incurred by Debhold in paying the
purchase price of the shares was a proper deduction
in terms of secs. 11(a) and 23 (f) of the Act for
that tax year since the purpose of the acquisition
was to earn income in the form of a liquidation
dividend paid out of EHSA's capital reserves;
and this deduction was properly allowed by the
Commissioner when issuing Debhold with an assess
ment for that tax year. In argument Debhold's
counsel, Mr Welsh, conceded that since the
purpose of the acquisition was partly in order to
obtain a relatively small dividend from revenue re-
/ serves
19
serves, which constituted exempt income in Debhold's
hands, the Commissioner might have been entitled to
apportion the expenditure in accordance with the
principles laid down in the recent decision of this
Court in the matter of Commissioner for Inland
Revenue v Nemojim 1983 (4) SA 935 (A); but he
pointed out that this had not been done and argued that
it was too late for the Commissioner to re-open the
1973 assessment.
(3) As a matter of principle each year of assessment
has to be treated as an independent and distinct
unit. Income tax is assessed on an annual basis
in respect of taxable income received by or accrued
to the taxpayer during the period of assessment and
determined in accordance with the provisions of
the Act. Thus expenditure or losses incurred in
a particular year must be claimed in that year.
/ (4) The
20
(4) The EHSA shares, being trading stock in Debhold's
hands, had to he dealt with in terms of sec. 22,
which is cast in imperative terms. Debhold duly
reflected the shares in its returns for the 1973 to
1979 tax years (inclusive) in accordance with sec.
22. In its return for 1979 appellant was obliged
by sec. 22 to take into account the cost price of
the EHSA shares in its opening stock values and to
reflect a nil value for these shares in its closing
stock figure. The resulting loss, taking into
account the R1,00 for which the shares were sold
to Tarl, resulted inevitably from a proper applica
tion of the relative provisions of the Act. There
was accordingly no basis for the Commissioner's
disallowance of this loss as a deduction.
(5) The facts of this case are clearly distinguishable
from those in Nemojim's case, supra, and the prin-
/ ciples
21
ciples there enunciated are not applicable here.
Consequently the Court a quo erred in relying on
Nemojim's case when coming to its decision.
Before considering the validity of this argument,
I wish to make certain preliminary observations.
Although the recital of the facts has been a
fairly lengthy one, the basic nature of the transaction in
issue may be simply and shortly stated. In essence Debhold
and its two co-shareholders purchased their shares in EHSA
with the common intention of immediately (a) distributing
the revenue reserves of the company by way of an ordinary
dividend, and (b) liquidating the company and distributing
its capital reserves by way of a liquidation dividend. In
Debhold's view its share of the ordinary dividend would be non
taxable, but its share of the liquidation dividend subject to
tax. On this view, and assuming at least the pro rata
/ deductibility
22
deductibility of the cost of the shares (which would have
exceeded the total proceeds thereof), this transaction
would not have produced any taxable income in Debhold's hands.
Substantially income received would have been balanced by ex
penditure. This was the first scheme, which was implemented
only as regards the ordinary dividend.
EHSA's capital reserves, which embraced the vast
bulk of its remaining assets, devolved upon the shareholders
in terms of the second scheme, which was implemented in 1975.
In the result Debhold received in terms of the capital reduc
tion an amount of nearly R4m, which because of amendments
to the law was not income (as defined) in its hands.
Thus, taking a broad and approximate view of the
transaction, what Debhold actually achieved by it was to
outlay approximately R4m and to receive back approximately R4m.
From the commercial point of view, Debhold suffered no loss.
/(I ignore
23
(I ignore for the moment the relatively small excess of
expenditure over receipts.) From the taxation point of view,
Debhold expended approximately R4m and received amounts of
approximately R4m, which did not constitute income (as defined)
in its hands; and yet Debhold claims that the expenditure is
deductible in terms of sec 11(a) as having been incurred
"in the production of the income" and that its deductibility
is not prohibited by sec. 23(f), which denies deduction in
respect of an expense incurred in respect of "amounts received
or accrued which do not constitute income as defined". Thus,
in a broad sense, the allowance of such a deduction would
appear to be an anomalous result, both commercially and
legally. Mr Welsh acknowledged this, but contended that the
proper application of the provisions of the Act, especially
sec. 22, led inescapably to such a result.
There is a further observation to be made about this
transaction. According to the figures placed before the
Court, the transaction in regard to the EHSA shares, as
/ originally
24
originally conceived and as actually implemented, was calcu
lated to result, and in the end did actually result, in a com
mercial loss, in Debhold's case, of some R41 000. This is
the excess of the cost of the shares to Debhold over the
amounts receivable or received by it, to which I have already
alluded. And this no doubt explains the aforementioned fi
gure of R41 337,60 by which the shares were written down in
the book amount column of Debhold's trading schedules for
the 1973 tax year.
It is a corner-stone of Debhold's case that the
acquisition of the EHSA shares was an integral part of its
activities as a dealer in stocks and shares and that the
shares, once acquired, formed part of Debhold's trading
stock. But is this so? The normal way in which a dealer
in shares operates is to buy shares and re-sell them at a
profit. They constitute his stock-in-trade, as do groceries
in a grocer's business. Unlike groceries, however, shares,
if held long enough, may also yield income in the form of
/ dividends
25
dividends; and such dividends would constitute part of the
return which a share-dealer might expect possibly to receive
in his share-dealing transactions. Indeed, as in the
dividend-stripping type of case (exemplified by Commissioner
of Inland Revenue v Nemojim, supra) the dividend to be re
ceived may constitute the major component of the dealer's
return. But in all these cases the dealer acquires the
shares with the intention of ultimately disposing of them as
part of a scheme of profit-making. This distinguishes his
trade from that of an investor in shares who buys shares to
hold them as a capital asset and reap a return in the form
of dividends. Exceptionally, a dealer in shares may make
his profit not by reselling, or receiving a dividend and
re-selling, but by putting the company whose shares he has
acquired into liquidation (cf. Commissioner for Inland Revenue
v Rand Selections Corporation Ltd 1956 (3) SA 124 (A) ) or,
as in the case of Overseas Trust Corporation Limited v
/ Commissioner
26
Commissioner for Inland Revenue 1926 AD 444, buying shares in a
company which is in the process of being liquidated. If
such a transaction is embarked upon as a profit-making scheme,
then the proceeds of the liquidation will constitute gross in
come in the dealer's hands.
Of course, the attainment of a profit is not
necessarily the hallmark of a trading transaction. A trader
may for commercial reasons be compelled to re-sell goods at
a loss. Conceivably also he may elect to resell goods at
a loss in order to gain some other commercial advantage for
his business. The practice of putting on sale the so-called
"loss leaders" by some merchants would fall into this category;
and there seems little doubt that merchandise so sold would
constitute stock-in-trade and the proceeds thereof gross
income.
In the present case the evidence shows firstly
/ that
27
that Debhold purchased the two EHSA shares not in order to dis
pose of them but with a view to receiving an ordinary dividend
and, having put the company into liquidation, a liquidation
dividend. The sale of the shares for Rl in 1979 was never
contemplated when they were acquired in 1973. In fact the-
application for deregistration in 1977, the halting thereof in
1978, the sale in 1979 and the re-application for deregistra
tion in 1960 would seem to indicate that the idea of selling
the shares was conceived, as an afterthought, in 1978. Mr
L A Lincoln, a director of Debhold and the only witness to
give evidence (on Debhold's behalf) before the Special Court,
as much as conceded this. Secondly, the evidence shows that
Debhold purchased the shares knowing that it would not make
any profit from the transactions. In fact, as I have al
ready pointed out, on the figures reflected in EHSA's
accounts Debhold must have known that the transaction would
produce a loss of some R41 000.
/ These
28
These two features immediately take the acquisition
of the EHSA shares out of the ordinary run of Debhold's business
as a share-dealer and also prompt the question: what was the
purpose of the transaction? ' As Mr Welsh had to concede,
in this regard the evidence is meagre. In evidence Lincoln
maintained that Debhold's intention was "to acquire the shares
as stock-in-trade"; but the features to which I have alluded
tend to negative this. Under cross-examination by the
Commissioner's representative Lincoln was asked about the
purpose behind the acquisition:
"The whole purpose was that the appellant
would acquire the assets of Engelhard - the purpose behind the liquidation was that the appellant company would acquire the assets of Engelhard?— No, that is not true. We bought an asset - shares in the company Engelhard Hanovia - for the proper price and this was part of an acquisition. We did not intend to acquire the assets which were contained in Che company. Was that not the real purpose behind the liquidation of the company?— No, the shares were portfolio shares and other / assets
29
assets which were sold, some on the market
and elsewhere. 1 do not think that we
have any of those shares in our portfolio
now, or since 1969.
I do not think that I quite follow.
What was the reason for the appellant
company wanting to liquidate Engelhard
Hanovia?— It was part of the arrangements
that had been made with Mr Engelhard when the
other investments that we spoke about - the
American investments - were bought, and
seeing that they were South African invest
ments it was the intention that the Company,
Engelhard (SA), would be liquidated.
MR VAN BREDA: Was it not in order to distri
bute the assets in kind to shareholders?--
No, that was not the purpose at all."
Bearing in mind the background history to this acquisition
— the original scheme in 1970 to put EHSA into voluntary
liquidation, the distributions to Meton (in which Debhold
held a 40 per cent interest) of the amount standing in
share premium account and by way of a reduction of capital,
and, after Debhold had acquired its shares in EHSA from Meton,
the first and second schemes for the dismantling of EHSA —
I find this evidence somewhat unconvincing. The facts
/ speak
30
speak too strongly for themselves. At any rate, in my
view, Debhold on whom the onus rests has not shown that a
distribution of the assets of EHSA in cash to the shareholders
was not, as it appears to have been, the purpose of the acqui
sition.
In the circumstances, did the EHSA shares, once
acquired by Debhold, constitute trading stock in its hands?
"Trading stock" is defined in sec. 1 of the Act, unless the
context otherwise indicates, as including:-
".... anything produced, manufactured,
purchased or in any other manner acquired
by a taxpayer for purposes of manufacture,
sale or exchange by him or on his behalf,
or the proceeds from the disposal of which
forms or will form part of his gross
income."
The corresponding definition, in the Afrikaans text of the Act,
of the word "handelsvoorraad" reads:
"Tensy uit die samehang anders blyk, beteken
hierdie Wet —
'handelsvoorraad' ook enigiets deur 'n
belastingpligtige vir doeleindes van
/ vervaardiging...
31
vervaardiging, verkoop of ruil deur of
ten behoewe van horn geproduseer, ver-
vaardig, gekoop of op ander wyse verkry,
of enigiets waarvan die opbrings uit die
van die hand sit daarvan deel van sy bruto
inkomste uitmaak of sal uitmaak". (My
italics.)
The repetition of the word "enigiets" (italicised by me)
has no counterpart in the more elliptical English text.
The repetition makes the definition clearer; and in con
sidering the English definition (the Act was signed in English)
I shall interpolate the word "anything" after the word "or".
The definition falls naturally into two parts:
(1) anything produced, manufactured, purchased or in
any other manner acquired by a taxpayer for
purposes of manufacture, sale or exhange by him
or on his behalf, or
(2) anything the proceeds from the disposal of which
forms or will form part of his gross income.
/ Mr Welsh
32
Mr Welsh conceded that the EHSA shares did not fall within
part (1) of this definition, but contended that they did fall
within part (2) . The concession is clearly well-founded:
the EHSA shares were unquestionably not purchased by Deb-
hold for the purpose of manufacture, sale or exchange.
But, in my opinion, the contention is not well-founded.
Part (2) of the definition is somewhat cryptic and
in its application may lead to circuitous reasoning (e.g.
often the question as to whether the proceeds of the disposal
of an article constitute gross income is answered by con
sidering whether the article was trading stock, or stock-
in-trade, in the hands of the seller). Be that as it may, in
my view, this part of the definition (like part (1) ) relates
to articles or things which (a) are disposed of (so as to
produce proceeds) or (b) will be so disposed of in the
future. Category (a) would cover things held at the begin-
/ ning
33
ning of the tax year and disposed of during the tax year;
and category (b) would cover things held throughout the
tax year but to be disposed of thereafter. Mr Welsh
argued that category (b) related to, or at any rate included,
things the proceeds of which would form part of the taxpayer's
gross income if he were to dispose of them, notwithstanding
the fact that he had no intention of disposing of them at the
time of acquisition or at any other time during the relevant
tax year, ie. postulating a notional disposal of things not
to be disposed of. To my mind, the argument is unsound.
Such an interpretation would do violence to the plain meaning
of the words used: words simply denoting futurity would be
stretched to cover at the same time not only futurity but
also a hypothetical state of affairs which in fact did not
and would not come to pass. Mr Welsh also submitted
tentatively that the first scheme constituted a "disposal"
of the EHSA shares, but in the end, as I understood the
/ position
34
position, did not press the argument - correctly, in my
view. Applying what 1 believe to be the correct inter
pretation of the definition, 1 am satisfied that the EHSA
shares did not fall within its terms. Moreover, although
the definition is prefaced by the word "includes", I am
of the opinion, bearing in mind the principles stated in
R v Debele 1956 (4) SA 570 (A), at pp. 575-6, and the
fact that the definition would seem to comprehend what is
ordinarily understood by the term trading stock (cf. Hex v
McKenzie 1938 TPD 469, at p. 471), that the definition is
intended to be exhaustive.
At the beginning of the hearing in the Special
Court, the Commissioner's representative, although con
ceding that Debhold was a share-dealing company, did not
concede that the EHSA shares form part of the stock-in-
trade. At the argument stage, the Commissioner's represen
tative conceded (rightly, in the view of the Special Court)
/ that
35
that the EHSA shares were held by the appellant as trading
stock. And in the Court a_ quo counsel for the Commissioner
did not contest this.
In argument in this Court, however, counsel for
the Commissioner submitted that the concession was not
supported by the undisputed facts and was wrongly made.
He submitted further that the fact that it was made, does
not preclude this Court from dealing with the matter on the
basis of the facts. Mr Welsh, although contending that the
concession was rightly made, did not suggest that it
stemmed from anything other than an erroneous appreciation
of the legal position. He therefore could not submit that
this Court was precluded from dealing with the matter on the
basis of the undisputed facts. Accordingly there is no
reason why this Court should not give what it considers to be
the right decision on the facts. Cf. Paddock Motors (Pty)
Ltd v Igesund 1976 (2) SA 16 (A) at 23 D _ G. I proceed
therefore on the basis that the EHSA shares did not constitute
trading stock in Debhold's hands.
/ One
35 (A)
One of the consequences of this finding is that
the EHSA shares were not governed by the provisions of sec.
22. In my opinion, the term "trading stock" in sec. 22
means "trading stock" as defined. There is no considera
tion of context to lead to the conclusion that the definition
does not apply in sec. 22. And furthermore the fact that
the definition of "trading stock" was introduced into the
income tax legislation in 1956 by the same Act (the
Income Tax Act 55 of 1956) that introduced the statutory
provisions equivalent to the present sec. 22 indicates
cogently that the definition was intended to apply
to sec. 22 (and its predecessor).
/ The
36
The finding that the EHSA shares did not constitute
trading stock in Debhold's hands does not, of course,
conclude the enquiry as to whether the cost of the shares
was deductible in terms of the Act in the 1973 year of
assessment or in any other relevant year of assessment.
This question must be separately determined in the
light of the relative statutory provisions. In this con
nection counsel directed their argument before us mainly
at secs. 11(a) and 23(f), the general effect of which
was fully considered in Nemojim's case, supra, at
pp. 946 B - 948 A. No reference was made to sec.
23 (g) until the applicability of this paragraph
was raised by a member of this Court during the hearing.
/ Sec
37
Sec. 23 (g) provides that —
"No deductions shall in any case be made in
respect of the following matters namely —
(g) any moneys claimed as a deduction
from income derived from trade, which
are not wholly or exclusively laid out
or expended for the purposes of trade;
In Joffe & Co Ltd v Commissioner for Inland Revenue
1946 AD 157, at pp. 162-3, WATERMEYER CJ discussed the
meaning and effect of secs. 11(2) and 12(g) of the Income
Tax Act 31 of 1941 (which are virtually identical with secs.
11(a) and 23(g) of the Act) in relation to a deduction claimed
in respect of damages paid by the taxpayer and in the course
of doing so stated (at p 163):
"The damages which were paid are, therefore,
only deductible if they constitute expendi
ture not of a capital nature, which was
incurred in producing the income in respect
of which the tax was levied. Sec 12(g)
which, in the case of income derived from
trade, prohibits the deductions of any
/ moneys
38
moneys 'which are not wholly or exclusively
expended for the purposes of trade', makes
it clear that such expenditure, in order to
be deductible, must not only be connected
with the production of income but must have
been paid out for the purposes of trade.
'These words', said Lord DAVEY, in
the case of Strong & Co., Ltd. v.
Woodifield (1906 A.C. 448 at p. 453),
when speaking of similar words in the
English Income Tax Act of 1842,
'appear to me to mean for the purpose
of enabling a person to carry on and earn
profits in the trade, etc. I think the
disbursements permitted are such as are
made for that purpose. It is not enough
that the disbursement is made in the
course of, or arises out of, or is
connected with the trade or is made
out of the profits of the trade. It
must be made for the purpose of earning
the profits'.
All expenditure, therefore, necessarily
attached to the performance of the operations
which constitute the carrying on of the income-
earning trade, would be deductible and also
all expenditure which, though not attached
to the trading operations of necessity, is yet
bona fide incurred for the purpose of carrying
them on, provided such payments are wholly
and exclusively made for that purpose and
are not expenditure of a capital nature."
/Often
39
Often expenditure incurred in the production of the income
(not being of a capital nature) is also wholly and exclusively
laid out or expended for the purposes of trade; but not
necessarily so. To be deductible expenditure must pass
both tests.
Was the purchase price of the EHSA shares moneys
wholly or exclusively laid out or expended for the purposes of
trade? I have already analysed what I conceive to be the
normal modus operandi of a dealer in shares like Debhold;
and 1 have pointed to various features of the EHSA share
transaction - the intention not to resell the shares, the
contemplation that the implementation of the first scheme
would produce no profit, in fact a loss of R41 000, and the
possible inference that the object of the transaction was
merely to transfer the cash assets of EHSA to its share
holders - which cause it to stand apart from Debhold's
normal trade as a dealer in shares.
/ Mr Welsh
40
Mr Welsh submitted that profit-making was not of
the essence of trading and he cited in this connection the
following cases: Modderfontein Deep Levels Ltd and Another
v Feinstein 1920 TPD 288; Weinstock and Another v Commissioner
of Taxes 1962 (3) SA 543 (PC); Commissioner of Taxes v
BSA Co Investments Ltd 1966 (1) SA 530 (SR.AD); and
Commissioner of Inland Revenue v The Incorporated Council of
Law Reporting (1888) 3 TC 103. In my opinion, none of these
cases assists, him in regard to the particular facts of the
instant case.
In the Modderfontein case the question arose as to
whether a mining company which sold articles of clothing to its
employees from a store (which was open daily) at cost, was
"carrying on a trade or business" within the meaning of
certain mining legislation. The Court held that it was,
DE VILLIERS JP remarking -
/"No
41
"No doubt as a rule a trade or business is
carried on for the purpose of making a profit,
but profit-making is not of the essence of
trading."
The Modderfontein case, apart from relating to different
words in entirely different statutes, is, in my view, wholly
distinguishable. The mining company there was carrying on a
non-profit-making trade or business. In the instant case the
taxpayer, Debhold, carries on a business of share-dealing
which is obviously designed to produce profits; and the
question is whether an unusual transaction designed to pro
duce a loss was part of its trading operations and whether
the cost of the shares could be regarded as moneys wholly
or exclusively laid out or expended for the purposes of
trade. And here one must consider the question in relation
to the trade actually conducted by Debhold. The same or
similar comment would apply to the last of the cases quoted by
Mr Welsh.
/ Weinstock's
42
Weinstock's case is, in my view, not relevant.
There the taxpayer entered into various share dealings and
other transactions in carrying out what was clearly, and
was found to be, a scheme of profit-making. In the BSA
Company case the taxpayer, an investment dealing company,
purchased from another company a whole portfolio of invest
ments as a package deal and these investments formed the
taxpayer's opening stock-in-trade. Included amongst these
investments was a certain Kariba loan which was a "bad buy"
and could not be sold at a profit. It was held that never
theless the Kariba loan, along with the other investments
purchased, constituted the taxpayer's stock-in-trade and that
the expenditure incurred in the purchase of the Kariba loan was
deductible as being "expenditure... wholly and exclusively
incurred... for the purposes of (the taxpayer's) trade" in terms
of sec 13(2)(a) of the Rhodesian Income Tax Act of 1954. In his
judgment (which was the judgment of the Court) BEADLE CJ
/ emphasized
43
emphasized that the Kariba loan was purchased as part of a
package and held that in such a package deal it was not per
missible to distinguish between the two types of stock and
call the stock which can be profitably sold stock-in-trade,
while branding the rest assets of a capital nature.
He said (at p 532 E-G) :-
"As 1 see the situation, the case is no
different from that of a merchant who, in
order to assist a fellow merchant in the
same line of business, buys the stock-in-
trade of that merchant, intending to sell
as much of that stock as he can at a profit
and to cut his losses as best he can on
that part of the stock which he knows he
cannot sell at a profit, but who neverthe
less hopes on the transaction as a whole
to show a profit. The stock which cannot
be sold at all or which can only be sold at
a loss is, in the circumstances of such a
transaction, just as much the merchant's
stock-in-trade as that stock which can be
sold at a profit."
In my opinion, the instant case is wholly distinguishable.
It does not appear from the evidence that the EHSA shares
were purchased as part of a package deal;
they were not purchased for re-sale; they were
/ purchased
44
purchased very possibly as part of a scheme for distributing
the assets of EHSA in cash to its shareholders; the trans
action was calculated from the start to show an overall loss.
The present case is in fact closer to an English
case, Petrotim Securities Ltd v Ayres (1964) 41 TC 389,
distinguished by BEADLE CJ in his judgment. In the Petrotim
case the taxpayer company, a dealer in securities, sold
some investments which it held as trading stock to R Ltd,
of which the taxpayer was almost a wholly-owned subsidiary,
at prices very much below cost and market value (referred
to as the "X" transaction). The taxpayer also purchased
some stock and immediately resold it to another subsidiary
of R Ltd at about one-tenth of its cost and market value
(referred to as the "Y" transaction). In the Court of the
Special Income Tax Commissioners the issue was as to whether
the taxpayer was entitled to tax relief in respect of the
/ losses
45
losses incurred on these transactions, which the taxpayer
contended had been carried out in the course of its trade.
The Commissioners concluded that they were not trading trans
actions. The Commissioners, having referred to a dictum of
Lord SIMONDS in a previous case to the effect that a trader's
job is to make profits, said at (p. 395):-
"In the present case it appears, in the ab
sence of evidence to the contrary, that the
Company deliberately set out to make a very
substantial loss. We, of course, recognise
that, in the course of his trade, a trader
may make sales at much less than cost or
even make free gifts of the goods in which
he deals: e.g., when advertising. We
have no evidence that the transactions
in the present case in any way resemble such
sales or gifts. The agreements relating
to the X transactions support the fact of
a purchase or sale, but not the quality of the
sale. The profit-seeking motive, which is
normally important, was absent, and in its
place there appears to have been an inten
tion to make a loss for a reason which was
not explained. It therefore seems a fair
inference to draw that in relation to those
transactions the Company, at the time of the
sales, was no longer acting as a dealer
or financier and accordingly the sales were
not made in the course of the Company's trade.
/ A fortiori,....
46
A fortiori, the position is the same with regard
to the Y transaction as neither the purchase
nor the sale, it seems to us, was made in the
course of the Company's trade."
The decision of the Commissioners was upheld in successive
appeals to the Chancery Division and the Court of Appeal.
In the Chancery Division UNGOED-THOMAS J remarked that
(at p 400) :-
"All these transactions were completely out
of character with the rest of the Company's
trading operations and the way in which it
conducted its trade These transactions,
when seen in their context of the Company's
trading operations, cry aloud for an expla
nation."
(See also Skinner (Inspector of Taxes) v Berry Head Lands
Ltd [l97l] 1 All ER 222.)
It is true, as I have already indicated, that the
absence of a profit does not necessarily exclude a trans
action from being part of the taxpayer's trade; and
correspondingly moneys laid out in a non-profitable trans
action may nevertheless be wholly or exclusively expended
/ for
47
for the purposes of trade within the terms of sec. 23(g).
Such moneys may well be disbursed on grounds of commercial
expediency or in order indirectly to facilitate the carrying
on of the taxpayer's trade (see in this regard the remarks
of JENKINS LJ in Morgan v Tate & Lyle Ltd, 1953 Ch 601,
at pp 637-8; and Boarland v Kramat Pulai Ltd [1953] 2 All
ER 1122). Where, however, a trader normally carries on
business by buying goods and selling them at a profit,
then as a general rule a transaction entered into with the
purpose of not making a profit, or in fact registering a
loss, must, in order to satisfy sec. 23(g), be shown
to have been so connected with the pursuit of the taxpayer's
trade, e.g. on ground of commercial expediency or indirect
facilitation of the trade, as to justify the conclusion
that, despite the lack of profit motive, the moneys paid
out under the transaction were wholly and exclusively ex
pended for the purposes of trade (cf. Nemojim's case, supra,
/ a t
48
at pp. 947 H - 948 A ) . Generally, unless the facts speak
for themselves, this will call for an explanation from the
taxpayer.
In the present case there was, as I have indicated,
no satisfactory explanation of the EHSA share transaction
from Debhold. It was not a normal share-dealing transaction.
It stood apart from Debhold's normal method of trading.
It was not a profit-making scheme; on the contrary, it was
entered into in the contemplation of registering a loss
and ultimately, in terms of the second scheme, it did
result in a commercial loss. It may well have been
a procedure merely to distribute in cash the assets of
EHSA. In my opinion, Debhold did not establish that the
deduction claimed in respect of the cost of the EHSA shares
passed the test of sec. 23 (g).
It follows from this that the cost of the EHSA
shares was not a proper deduction in the 1973 year of assess
ment. Furthermore, since the shares did not constitute
/ trading
49
trading stock, sec. 22 did not require the cost of the
shares to be reflected in Debhold's returns of the value of
trading stock in the 1973 and subsequent tax years. The fact
that Debhold erroneously did so cannot alter the true legal
position as far as the 1979 year of assessment is con
cerned. The cost of the shares was consequently not a
proper deduction in the 1979 tax year and was rightly dis
allowed by the Commissioner.
The consequences of the finding that sec. 23 (g)
precluded the deduction of the purchase price of the shares-
on the 1973 assessment do not arise for decision. Nor
need consideration be given to what the income tax position
might have been had the first scheme been implemented,
and to such questions as to whether the liquidation divi
dend, not being the product of a profit-making scheme,
would or would not have constituted gross income in Debhold's
hands; whether the EHSA shares were capital assets; or
/ whether
50
whether, as argued by counsel for the Commissioner before us,
the purchase price of the shares constituted capital ex
penditure by Debhold.
In the result I agree with the conclusion reached
by the Court a quo, though for different reasons. The
appeal is dismissed with costs, including the costs of
two counsel.
M M CORBETT
MILLER, JA. )
NICHOLAS, AJA. )