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. )