News / Legal Brief
Apr 7,2016
In our November 2014 edition of Legalwerks, we discussed the decisions of the Full Bench of the High Court of the Western Cape regarding the capital or revenue nature of the disposal proceeds of shares owned for a relatively short time period, and the meaning of “farming” for tax purposes.
Both High Court decisions were taken on appeal and both were recently confirmed by the Supreme Court of Appeal (“SCA”) in the taxpayers’ favour. In addition, the taxpayer’s cross-appeal in the first case was decided in its favour.
Click here for our November 2014 Legal Brief.
Very briefly, it will be recalled that:
The Supreme Court of Appeal (SCA) in Commissioner: SARS v Capstone 556 (Pty) Ltd, handed down a strong judgment in favour of the capital nature of the disposal proceeds of the shares and concluded that the indemnity payment formed part of the base cost of the shares.
The SCA gave clear guidelines to determine the capital or revenue nature of the proceeds derived from the sale of an asset.
It confirmed that where a profit is the result of the sale of an asset, the intention with which the taxpayer acquired and held the asset is of great importance. The mere intention to profit from an acquisition and holding of an asset is not conclusive – it is only when a profit motive is coupled with ‘an operation of business in carrying out a scheme for profit-making’ that the proceeds would be revenue in nature.
Apart from the taxpayer’s intention, other relevant factors to consider when categorising sales proceeds as either capital or revenue include:
The SCA confirmed the High Court’s approach to scrutinise the taxpayer’s intention in acquiring the shares at the time it entered into the binding commitment (in June 2002), which was approximately 18 months prior to the formal acquisition/transfer of the shares. Such an approach takes into account the commercial transaction as a whole.
The SCA strongly expressed the view that the directing mind of the taxpayer, in both its acquisition and sale of the shares, was that of its consortium partner. In analysing the “directing mind”, the SCA took into account the following:
The above factors led the SCA to believe that “all of this was consistent with an investment of a capital nature that was realised sooner than initially expected because of skilled management and favourable economic circumstances“.
In relation to the indemnity payment made by the taxpayer the SCA found that the payment qualified as ‘expenditure actually incurred’ in respect of the acquisition of the shares and should form part of their base cost, notwithstanding the fact that the payment was incurred after the sale of the shares. This is so because the indemnity payment was incurred in substitution for an earlier contingent obligation which was clearly related to the acquisition of the shares. On this basis, the acquisition of the shares remained the causa causans of the indemnity payment.
In the second case of Commissioner: SARS v Kluh Investments (Pty) Ltd, the SCA, on 1 March 2016, dismissed SARS’ appeal and confirmed the decision of the full bench of the Western Cape High Court, to the effect that the taxpayer was carrying on farming operations.
The brief facts were:
If the taxpayer qualified as a “farmer”, the sale proceeds are deemed, under tax legislation, to be revenue in nature. The legislation provides that a farmer is a person carrying on farming operations.
The SCA agreed with the High Court’s finding that the taxpayer’s involvement was limited to the acquisition of bare ownership of the land and the timber, which did not amount to the carrying on of farming operations.
The SCA considered the further branches of SARS’ argument, namely that:
The SCA dismissed these arguments on the following grounds:
The provision which deems the proceeds of the disposal of a plantation as gross income cannot in itself determine who qualifies as a farmer. SARS’ contention is thus fallacious, as a deeming provision that will only apply if Kluh is a farmer cannot be applied to determine whether Kluh is a farmer.
The relevant tax legislation simply provides that the proceeds on disposal of a plantation by a farmer must be included in the farmer’s gross income. That cannot be interpreted to mean that a disposal of a plantation is tantamount to farming.
Thirdly, even if Steinhoff in some sense acted on behalf of Kluh, that would not make Kluh a farmer, given that Kluh did not have the right to the yield of the plantation nor the use of the land or the plantation and Kluh did not derive any income from the land and the plantation, as the use thereof was granted to Steinhoff to farm for its own benefit. Thus the only entity which could be regarded as a ‘farmer’ in relation to the plantation owned by Kluh, was Steinhoff.
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