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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

JUDGMENT

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

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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 assessment, respondent, the Commissioner for Inland Revenue ("the Commissioner"), disallowed this deduction, added back the amount of R4 15b 937 and assessed Debhold accordingly. An objection to this assessment having been disallowed, 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

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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

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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

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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

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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

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(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 transaction was that Meton would have had problems with undistributed 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

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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

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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 liquidation 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

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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 thereof 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

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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

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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

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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 accounting 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 assessment 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

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stock held and not disposed of at the end of a year of assessment 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 relevant 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

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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,

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R3 997 440, leaving a closing balance of R160. For the reasons already stated, the provisions of sec. 22(1) precluded 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 repeated 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

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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 assessment 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-

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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

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(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 application 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-

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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 nontaxable, but its share of the liquidation dividend subject to tax. On this view, and assuming at least the pro rata

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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 expenditure. 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 reduction 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

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(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

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originally conceived and as actually implemented, was calculated to result, and in the end did actually result, in a commercial 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 figure 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

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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 received 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

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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 income 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

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that Debhold purchased the two EHSA shares not in order to dispose 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 deregistration 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 already 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.

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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

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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 investments it was the intention that the Company, Engelhard (SA), would be liquidated.
MR VAN BREDA: Was it not in order to distribute 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

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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 acquisition.

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

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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 considering 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

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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 considering 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-

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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

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position, did not press the argument - correctly, in my view. Applying what 1 believe to be the correct interpretation 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 conceding 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 representative conceded (rightly, in the view of the Special Court)

/ that

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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 consideration 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

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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 connection 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

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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 expenditure 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 shareholders - 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 produce 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 investments 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 nevertheless 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 permissible 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 nevertheless 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 transaction 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 transactions. 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 absence 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 intention 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 explanation."

(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 transaction from being part of the taxpayer's trade; and correspondingly moneys laid out in a non-profitable transaction 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 expended for the purposes of trade (cf. Nemojim's case, supra,

/at

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 assessment. 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 concerned. The cost of the shares was consequently not a proper deduction in the 1979 tax year and was rightly disallowed 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 dividend, 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 expenditure 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. )

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