In this article, which is the first of a series of three that focusses on the judgement in CSARS v Founders Hill (“Founders Hill”)[1], we consider the importance of the intention of a taxpayer at the time of acquiring an asset when assessing whether amounts realised from the disposal of the asset, are of a capital nature, or of a revenue nature.
In essence, the courts have consistently emphasised that the taxpayer’s intention and whether it constitutes a “profit making scheme”[2], evaluated considering all relevant and objective surrounding circumstances, is central to the enquiry.
Although the Act does not define “capital,” section 1 of the Act provides a detailed definition of “gross income”. In summary (and as interpreted by the courts), gross income comprises the total amount, being an amount not of a capital nature, in cash or otherwise, received by or accrued to a taxpayer for their own benefit. For a resident (as defined for tax purposes), [3] gross income encompasses worldwide receipts and accruals. By contrast, for a non-resident, only amounts received by or accruing from a South African source are included.[4]
Importantly, only amounts not of a capital nature are included in gross income,[5] unless specifically included by a paragraph under the “gross income” definition.
In Founders Hill, the Supreme Court of Appeal was again required to determine whether the receipts in the hands of Founders Hill (Pty) Ltd (“Founders Hill”), the respondent, were of a revenue or capital nature. Founders Hill was a wholly owned subsidiary of AECI Limited (“AECI”) and had been incorporated as a ‘realization company’ to dispose of “excess vacant land” subdivided by AECI before its transfer to Founders Hill. The narrow question before the court was whether Founders Hill, as a ‘realization company’, had merely realised the erven to the best advantage (in which case the amounts would be capital in nature) or whether it had in fact embarked upon the business of selling land (in which case the amounts would be revenue in nature and be included in gross income).[6]
In evaluating the facts, the court drew[7] on the remarks of Schreiner JA in Commissioner for Inland Revenue v Richmond Estates (Pty) Ltd (“Richmond Estates”)[8], where the following was stated:
“The decisions of this Court have recognised the importance of the intention with which property was acquired and have taken account of the possibility that a change of intention or policy may also affect the result. But they have not laid down that a possibility that a change of policy or intention by itself effects a change in the character of the assets.”
Relying on these remarks, the court concluded that “the legal question should be whether the taxpayer (Founders Hill) is actually trading, or carrying on a business, at the time of assessment, and not merely whether or not it has changed its mind.”[9]
The court further emphasised that intention alone cannot be conclusive in determining the nature of a receipt.[10] Having weighed the evidence, it held that the income derived from the sale of the erven constituted revenue income and was therefore taxable.
In this three-part article, the facts, as considered by court, will be re-evaluated to establish whether the court made the correct decision in respect of the classification of the amounts received by Founders Hill. Specifically, the following three issues will be revisited: (1) the initial intention of Founders Hill, (2) whether a change of intention occurred; and (3) whether the nature of the assets (the erven) changed as a consequence of any such change of intention.
The first issue will be addressed below, while the remaining two issues will be considered in follow-up articles.
Issue 1: The initial intention
As noted by the court, Founders Hill was a ‘realization company’, formed for the sole purpose of disposing of land previously held as a capital asset by its holding company, AECI. In this context, a realisation company is understood to be an entity “formed for the purpose of facilitating the realization of property and the company does no more than act as the means by which the interests of its shareholders in the property may be properly realized.”[11]
In paragraph 10 of the judgment,[12] the court observed:
“The respondent was incorporated at the beginning of 1993 and its main business was: ‘To acquire from AECI Limited certain properties situate at Modderfontein, Johannesburg which are held by AECI Limited as a capital asset and which have become surplus to its needs, for the sole purpose of realising same to best advantage and, within a period of one year of completion of such realisation, to be voluntarily wound up’ (emphasis added).”
On the face of this, a preliminary conclusion would be that Founders Hill was incorporated with the clear intention of realising AECI’s surplus capital assets to the best advantage. However, as the courts have consistently emphasised, a taxpayer’s stated intention, while relevant, cannot be treated as conclusive. In Commissioner, South African Revenue Service v Smith[13], the court endorsed the dictum of Miller J in ITC 1185[14], which underscores the importance of an objective enquiry:
“It is often very difficult, however, to discover what [the taxpayer’s] true intention was. It is necessary to bear in mind in that regard that the ipse dixit of the taxpayer as to his intent and purpose should not lightly be regarded as decisive. It is the function of the court to determine on an objective review of all the relevant facts and circumstances what the motive, purpose and intention of the taxpayer was. Not the least important of the facts will be the course of conduct of the taxpayer in relation to the transactions in issue, the nature of his business or occupation and the frequency or otherwise of his past involvement or participation in similar transactions.”
The facts with regard to those matters will form an important part of the material from which the court will draw its own inferences against the background of the general human and business probabilities. This is not to say that the court will give little or no weight to what the taxpayer says his intention was, as is sometimes contended in argument on behalf of the Secretary in cases of this nature. The taxpayer’s evidence under oath and that of his witnesses must necessarily be given full consideration and the credibility of the witnesses must be assessed as in any other case which comes before the court. But direct evidence of intent and purpose must be weighed and tested against the probabilities and the inferences normally to be drawn from the established facts.”[15]
Against this backdrop, Founders Hill’s stated purpose at incorporation appears to have been readily established, based on which one could argue that the amounts realised by Founders Hill from the disposal of the erven should be treated as being of a capital nature. Nevertheless, as will be explored in the subsequent articles, one must consider more than the stated intention of a taxpayer in these assessments, as the consequences Founders Hill faced ultimately stemmed from the court’s findings on whether a change of intention occurred after its formation.
The analysis of this second issue will be addressed in the follow-up article.
[1] (509/10) [2011] ZASCA 66.
[2] CIR v Pick-n-Pay Employee Share Purchase Trust 54 SATC 271.
[3] Refer to the definition of “Resident” as contemplated in section 1 of the Act.
[4] Refer to part (ii) of the definition of “Gross Income” as contemplated in section 1 of the Act.
[5] Per CIR v Pick-n-Pay Employee Share Purchase Trust 54 SATC 271, the onus of proving that any receipt is of a capital nature is upon the taxpayer.
[6] Founders Hill at paragraph 21.
[7] Ibid at paragraph 25.
[8] 1956 (1) SA 602 (A) at 610C–D.
[9] Founders Hill at paragraph 25.
[10] Founders Hill at paragraph 25.
[11] Founders Hill at paragraph 3.
[12] Founders Hill.
[13] 2002 (6) SA 621 (SCA) at 629C–E.
[14] 35 SATC 122 at 123–124.
[15] Anglovaal v SARS (2009) SCA 109 at paragraph 25.
