Page 760 - SAIT Compendium 2016 Volume1

CASE DIGEST 2013–2014
revenue amount to be included in gross income. SARS is also cross-appealing against the same court’s nding that the amounts paid for the ‘equity kicker’ and ‘indemnity’ in respect of the share transaction constituted amounts deductible from the taxpayer’s gross income.
Facts
The taxpayer is a special purpose vehicle company and 50 per cent member of a consortium which purchased shares in Profurn Ltd as part of a ‘business rescue operation’ initiated by FirstRand Ltd as the main creditor. The restructure was subject to the condition that JD Group Ltd would be taking over management control of Profurn Ltd, subject to approval of that arrangement by the Competition Commissioner. The rescue plan by the FirstRand Ltd entailed converting R600 million of the R900 million debt owed to the FirstRand Ltd by Profurn Ltd into equity, whereupon the equity in Profurn Ltd was exchanged for shares in JD Group Ltd. Thereupon, 5/6 of such equity interest was sold to the consortium as a strategic investment by them in the furniture industry for R500m. The consortium was, however, required to retain the shares for a minimum time period.
The taxpayer partly funded its share of the acquisition price through loan nance of R150m obtained from its 100 per cent holding company BVI, who in turn obtained the nance from a German company, Gensec. The loan was subject to interest but also contained an ‘equity kicker’ provision whereby Gensec would be entitled, in addition to interest, to a portion of any pro ts yielded by the share investment. The taxpayer was liable to BVI for this amount in consequence of BVI’s liability to Gensec. The remaining portion was nanced by FirstRand Ltd through the issue of preference shares by the taxpayer to the FirstRand Ltd for R100m.
To address concerns by JD Group Ltd on certain identi ed tax risks identi ed in Profurn Ltd by the auditors during the due diligence, FirstRand Ltd provided a tax warranty as part of the conditions of the share subscription and exchange. FirstRand Ltd in turn required the consortium to take up a 5/6 obligation to it in respect of the tax warranty provided by FirstRand Ltd in respect of the shares sold to them.
Profurn Ltd recovered substantially faster than anticipated under the new management and after holding the shares for only ve months the consortium partner was ‘fortuitously’ advised by Citibank how to dispose of the shares to institutional investors. After getting approval for the premature disposal of the shares, the shares were to be disposed of to Citibank. The taxpayer was compelled to sell the shares in terms of the consortium agreement which provided for such sale if the other consortium partner elected to sell its shares. However, FirstRand Ltd intended retaining some of the proceeds after the sale to provide cover for the tax warranty. To address this, the consortium parties agreed amongst themselves that the appellant would assign its obligations under the tax warranty to the other consortium partner for an amount of R55 million for full indemnity of its warranty obligation to the FirstRand Ltd irrespective of the amount of the actual warranty claim. The consortium partner then after the sale renegotiated the original indemnity to apply only to it and not to the taxpayer. The amount payable by the taxpayer to the consortium partner was done on loan account with set-off in future against any other claims between the parties.
The taxpayer disclosed the amount in its 2005 return as a capital amount but SARS reassessed the amount as being revenue in nature and issued an additional assessment for R200 million.
SARS contended that the amount from the sale of shares was revenue and not capital in nature. This conclusion was based on the fact that the taxpayer had at the time of acquisition of the shares not intended to hold them as capital assets or for earning dividends, but rather to dispose of them for short-term pro t in a scheme of pro t making. SARS based their conclusion on the fact that the shares were only held for ve months, the shares were nanced from external sources and that the dividends that were payable on the shares were earmarked to repay the short-term shareholder loan. SARS furthermore disallowed the expenses for the ‘equity kicker’ and ‘indemnity’ payment.
Held
Capital vs revenue of proceeds from sale of shares
The court approached this question by rst concluding in overview that though the onus of establishing the facts is on the taxpayer, in the current matter the majority of facts were common cause and merely the inferences from such facts were in dispute. The court stated that SARS have in their approach oversimpli ed the transaction by focusing too closely on the bare facts and that to evaluate the question properly the bare facts must be evaluated in the broader context of the evidence as a whole.
In addressing the legal question of capital vs revenue the court reaf rms the approach that no single litmus test can make the determination and it usually is a matter of degree depending on the circumstances. The court, in applying the intention of acquisition test, con rms that the intention and statement of intention by the taxpayer is not conclusive of the actual intention as the latter must be determined with critical scrutiny and weighing it against the objective facts. In determining the intention the court clari es that it is not what the taxpayer contemplated to do that is relevant but what was his actual purpose or object was.
In reviewing the facts the court found that the effective date of the transaction preceded the actual acquisition date as used by SARS by nearly 15 months. It furthermore found that that the motivation for the transaction was well documented in the Competition Commission application made prior to the effective date, which evidence was not challenged by SARS; it was indicated that the taxpayer intended to acquire the shares as capital and not in a scheme of pro t making. The court concluded that the overwhelming evidence supports this statement of intention on acquisition that the taxpayer intended to make a strategic capital investment which was to last for a period of at least three years. The court disagreed with the nding of the tax court and held that the nding was contrary to the same facts concluded on by that court. The court also held that the tax court had erred in holding that the taxpayer had to prove de nitively its intention on acquisition, as the onus threshold was met merely on a balance of probability. The court also held that the evidence presented did not indicate a mixed intention on acquisition as held by the tax court. The court found that other objective factors such as the disclosure of the asset as a non-current asset in the nancial statements and that no trade was conducted, thus eliminating the existence of oating capital supported the nding of the shares being held on capital account.
752 SAIT CompendIum oF TAx LegISLATIon VoLume 1