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IN THE SUPREME COURT OF APPEAL
OF SOUTH AFRICA
Case Nr: 606/97
REPORTABLE
In the matter
of:
THE COMMISSIONER FOR INLAND
REVENUE Appellant
and
CONHAGE
(PROPRIETARY) LIMITED Respondent
(formerly TYCON
(PROPRIETARY) LIMITED)
Coram: Mahomed CJ, Hefer, Olivier, JJA, Farlam et Madlanga AJJA
Date of hearing: 23 August 1999
Date of delivery: 17 September
1999
Income Tax - tax avoidance- agreements of
sale and leaseback agreements not shown to be simulated transactions - s 103 of
Act 58 of
1962 not applicable
J U D G M E N T
Hefer JA
HEFER JA
[1] Within the bounds of any anti-avoidance provisions
in the relevant legislation, a taxpayer may minimise his tax liability
by
arranging his affairs in a suitable manner. If eg the same commercial result
can be achieved in different ways, he may enter
into the type of transaction
which does not attract tax or attracts less tax. But, when it comes to
considering whether by doing
so he has succeeded in avoiding or reducing the
tax, the court will give effect to the true nature and substance of the
transaction
and will not be deceived by its form. (Erf 3183/1 Ladysmith
(Pty) Ltd and Another v Commissioner for Inland Revenue 1996(3) SA 942 (A)
at 950I-952C.)
[2] At issue in the present case is the true nature and
substance of two sets of agreements between the taxpayer (“Tycon”)
and Firstcorp Merchant Bank Ltd (“Firstcorp”). In form each set
comprises a sale and leaseback of some of Tycon’s
manufacturing plant and
equipment. The Commissioner’s contention is that the agreements are not
what they purport to be.
The dispute arose when Tycon sought to deduct the
rentals paid in terms of the leasebacks as expenditure in the production of
income under s 11(a) of the Income Tax Act 58 of 1962, as amended. When the
Commissioner refused to allow the deductions and in
addition invoked s 103 of
the Act, Tycon appealed to a Special Court. The appeal succeeded and the
matter was remitted to the
Commissioner for re-assessment on the basis that the
rentals were deductible. With the necessary leave the Commissioner has now
appealed directly to this Court. The first issue is the true nature and
substance of the agreements. In the event of a finding
that they are indeed
what they purport to be as the Special Court found, a further question will be
whether the Commissioner correctly
invoked s 103.
The true nature of the agreements
[3] In broad terms the Commissioner’s contention is that,
despite the form of the agreements, Tycon did not sell and lease
back its
equipment, but in substance borrowed the “purchase price” from
Firstcorp. Both in the Special Court and in
this Court his counsel expressly
accepted that the parties did not act in fraudem legis by deliberately
disguising their transactions. In the written heads of argument the agreements
came under attack solely for lack
of what was apparently regarded as essential
elements of a sale (cf McAdams v Fiander’s Trustee & Bell NO
1919 AD 207 at 223-224). On this basis it was submitted that there was no
agreement on a verum pretium nor an intention to transfer and acquire
ownership. At the commencement of his oral argument Mr Rubens for the
Commissioner indicated
that he would not press the argument relating to the
price. When it was pointed out to him that the only remaining point would
then
be that the parties did not intend ownership to pass and that the passing of
ownership is not an essential element of a sale,
he informed us that he would
argue that the agreements should not be applied according to their tenor
because, although Tycon and Firstcorp might honestly have believed that it
would be sufficient to go through the formality of concluding that
kind of
agreement in order to procure tax benefits for themselves, they had no real
intention to enter into agreements of sale and
leaseback. Argument then
proceeded on this basis.
[4] Despite the reference to the
parties’ honest belief, it seems to me that the logical effect of the
submission is precisely
what the Commissioner has constantly been disavowing,
viz that they dishonestly concealed the true nature of their
transactions. Certain dicta in cases like McAdams v
Fiander’s Trustee & Bell NO supra, Goldinger’s
Trustee v Whitelaw & Son 1917 AD 66, Bank Windhoek Bpk v Rajie en `n
Ander 1994(1) SA 115 (A) (the minority judgment) and Nedcor Bank Ltd v
Absa Ltd 1998(2) SA 830 (W) support the proposition that the true nature of
a transaction will prevail where the parties enter into an agreement
in the
honest belief that they will achieve a particular purpose by doing so, but
do not actually intend it to have effect according to its
tenor. In McAdams
eg the real transaction was found to be a loan even though the parties had
deliberately cast their agreement in the form of a sale
in the bona fide
belief that it would provide security to the “purchaser”. But even
in such a case the agreement is plainly a simulation;
and it may be a dishonest
simulation depending on what use the parties want to make of it. In the
present case Tycon required
capital to expand its business. Firstcorp was
prepared to make the funds available. Both parties were aware of the tax
benefits
to be gained from sales and leasebacks and decided to follow that
course. If they did not genuinely intend ownership of the merx to pass
upon signature of the agreement as each agreement of sale stipulated, the
agreements would have been simulations and could
only have been signed with the
object of deceiving the Commissioner. The conclusion that this would indeed be
a case of fraus legis cannot be avoided.
[5] This is not the
only problem that I have with the submission. Although Mr Rubens assured us
that the Commissioner’s
case was conducted on the same basis in the
Special Court, he candidly confessed that he never suggested in his
cross-examination
of Tycon’s witnesses that the agreements had been
signed under the impression that the mere formality would be sufficient,
or that
the actual intention was that the agreements would not have effect according to
their tenor. The record leaves one with
the firm impression that the
cross-examination of Tycon’s witnesses turned on the effect of the
agreements rather than on the
signatories’ actual intentions.
Tycon’s case might well have been conducted differently had the argument
in this Court
been raised in the Special Court and in fairness we should really
decline to entertain what is essentially a new point.
[6] I will
nevertheless deal with the argument because I am of the view that it is in any
event not supported by the facts.
In view of the analysis of the evidence and
the submissions for the Commissioner in the Special Court’s reported
judgment
(ITC 1636 in 60 (1998) SATC 267) only a brief discussion is required.
[7] The Special Court found (on the strength of the presumption in s 82
of the Act) that the onus was on Tycon to prove the authenticity
of the
agreements and that the onus had been discharged. The signatory on
Tycon’s behalf and two Firstcorp officials who
had negotiated the
transactions testified that the parties intended to give effect to the
transactions according to their terms.
The Special Court accepted their
evidence on the point.
[8] The Court’s judgment was vigorously
criticized in the written heads of argument for the Commissioner. In some
respects
the criticism is valid; in others not; and in still others it is no
longer relevant in view of the limited scope of the argument.
It is not
necessary to go into the details because it is quite clear to me that Mr Rubens
is clutching at straws. The real point
of his submission is that neither Tycon
nor Firstcorp actually intended to enter into agreements of sale and leaseback.
One way
of testing its validity is to ask: If the parties did not intend to
deceive, how did it come about that they entered into agreements
which they knew
would have no effect inter se as sales and leasebacks? The problem
facing the Commissioner is that he has discarded the possibility that the
agreements were deliberately
disguised. The only other explanation which he
is able to suggest is that the parties might have believed that the formal
instruments
would gain them the desired tax benefits. But this is sheer
speculation which finds no support in the evidence and is against the
probabilities. I say this particularly in view of
the consideration which Tycon’s staff and financial director in consultation with the financial directors of affiliated companies gave to the advantages and disadvantages of sales and leasebacks;
the fact that the disadvantage which the loss of the ownership of part
of Tycon’s plant would bring about, was
expressly mentioned and
considered;
the fact that offers by other banks to make funds
available by way of sales and leasebacks were received and considered
by the
company;
the extensive negotiations which were conducted at arms
length with Firstcorp; and
the expertise of the people involved
in the negotiations and the signing of the agreements.
All this goes to show
that the parties were not merely going through the motions of concluding
agreements. And if they were not,
the very foundation of the submission
crumbles.
[9] The fact of the matter is that the evidence that the
parties had every intention of entering into agreements of sale and
leaseback
and of putting the agreements into effect was not contradicted. The result was
that the Special Court had no option but
to accept it unless the witnesses were
not reliable, or all the available information and such inferences as might
justifiably be
drawn, were cogent enough to cast sufficient doubt thereon. I
have not been persuaded that the Court erred in finding the witnesses
reliable;
or that there is sufficient reason to doubt the authenticity of the agreements.
Mr Rubens referred us to certain provisions
of the agreements which, he
submitted, are not usually found in agreements of sale and agreements of lease
and militate against an
intention to buy and sell and to lease back. But it is
by no means unusual to find provisions in a sale and leaseback which do
not
typically appear in a contract of purchase and sale or in a contract of lease.
On the contrary, as Professor Nereus Joubert
points out in “Asset-based
financing, contracts of purchase and sale, and simulated transactions”
109 (1992) SALJ 707 at 708,
“[d]espite the fact that new asset-based financing transactions are often carefully drafted to reflect contracts of purchase and sale or contracts of letting and hiring, they almost invariably contain provisions which are not typically found in such types of contract ...” (Emphasis added.)
Moreover, although a sale and leaseback comprises an
agreement of sale as well as an agreement of lease, it must be treated as one
composite transaction. This is why Mr Rubens’s reliance on the fact that
Tycon could not do without the equipment sold to
Firstcorp because it was in
daily use in Tycon’s factory, is misplaced. If we were to look at the
agreement of sale separately
this would be a valid point, but, viewed in the
context of the whole transaction, the argument loses its sting: as lessee Tycon
would be assured of the use of the equipment for the duration of the lease. It
is really the provisions dealing with their fate
at the end of the lease that
count. In this regard Mr Rubens stressed clause 5 of the each lease. It is
to the effect that the
equipment would on the expiry date remain
Firstcorp’s property. But there is also clause 10 which grants Tycon
the option
to renew the lease on that date and annually thereafter. In effect
the company was entitled to the indefinite use of the equipment.
Admittedly it
lost its ownership. But this was a considered and accepted disadvantage for
which the capital generated by the
transactions more than compensated. All in
all the transactions made perfectly good business sense.
[10] In my view
the Special Court was correct in deciding the first issue in Tycon’s
favour.
Did the Commissioner correctly invoke s 103?
[11] Although s 103 was no doubt designed to enable the Commissioner to deal effectively with tax avoidance schemes, it operates only in the circumstances stipulated in the section itself. As Watermeyer CJ observed in Commissioner for Inland Revenue v IHB King 1947(2) SA 196 (A) at 209,
“if a transaction is covered by the terms of the section its provisions come into operation, if it is not then its provisions cannot be applied.”
Broadly speaking the section empowers
the Commissioner to determine a taxpayer’s liability for income tax and
other taxes by disregarding any
abnormal transaction which the latter has
entered into for the purpose of avoiding or postponing his tax liability or
reducing the
amount thereof. I need not list all the requirements that must
co-exist before the power may be exercised because we are only concerned
with
the abnormality requirement and the purpose requirement. A transaction is
regarded as abnormal if it was entered into or carried
out by means or in a
manner which would not normally be employed in the entering into or carrying out
of a transaction of the nature
of the transaction in question; or has created
rights or obligations which would not normally be created between persons
dealing
at arms length under a transaction of the nature of the transaction in
question. An abnormal transaction may be disregarded if
it was entered into
or carried out solely or mainly for the purposes of the avoidance
or the postponement of liability for the payment of any tax or the reduction of
the amount of such
liability.
[12] From the judgment in Secretary for
Inland Revenue v Geustyn, Forsyth & Joubert 1971(3) SA 567 (A) at 571E-H
and other reported judgments of this Court the following emerges:
(a) Although the Commissioner may invoke the section whenever he is satisfied of the presence of its requirements, a Special Court may re-hear the whole case and, if necessary, substitute its own decision for that of the Commissioner. When Geustyn was decided appeals against decisions of Special Courts were limited to questions of law. The Act has since been amended to do away with this limitation and this Court may now exercise the same powers as a Special Court.
(b) The effect, purpose and normality of a transaction are essentially questions of fact. The onus is on the Commissioner to prove that its effect was to avoid or postpone the liability for tax or to reduce the amount thereof. Upon proof that this was the case it is presumed (in terms of ss (4)) that the effect of the transaction was also its sole or main purpose.
(c) What has
to be determined in every case is the subjective purpose of the
taxpayer.
[13] In the present case the Special Court found that the
Commissioner had not established the abnormality of the sales and leasebacks
and
that Tycon had established the absence of the purpose requirement. Both
findings were attacked in this Court, but a decision
in Tycon’s favour on
either will dispose of the appeal. I proceed to deal with the purpose of the
transactions.
[14] The enquiry is limited to a single question. I have
already mentioned that Firstcorp was prepared to make the capital available
which Tycon needed to expand its business. The financing could be structured
either as a loan or as a sale and leaseback; but
from an income tax point of
view the latter was preferable and mainly for this reason Tycon decided on a
sale and leaseback. The
Commissioner’s contention is that this is all
that counts; the sole purpose of the transaction was to reduce the
company’s
tax liability; and it matters not that Tycon needed the capital
to finance its expansion programme. Tycon’s argument is precisely
the
opposite: the purpose of the whole exercise was to obtain capital, not to
reduce tax; and if the reduction of its tax liability
can be regarded as a
purpose of the transactions as envisaged in s 103 at all, it was not the main
purpose.
[15] I share the Special Court’s view that the
agreements of sale and leaseback served the dual purpose of providing Tycon
with
capital and to take advantage of the tax benefits to be derived from that type
of transaction. The following passage in the
Court’s judgment (at 393)
neatly describes the situation:
“[The raising of finance] was the fons et origo of the transactions and it remained the underlying and basic purpose thereof ... This whole arrangement ... was to achieve the predominant purpose of raising finance but, because of the welcome by-product of the tax benefit, the vehicles chosen were the sale and leaseback transactions.”
It is
submitted on behalf of the Commissioner that the only reason why sales and
leasebacks were preferred to a straightforward loan
was that a loan would not
bring about such advantageous tax deductions. This is not entirely correct
because there were other commercial
reasons too. But, even if the particular
type of transaction was chosen solely for the tax benefits, it would be wrong to
ignore
the fact that, had Tycon not needed capital, there would not have been
any transaction at all. Tycon did not approach Firstcorp
in order to alleviate
its tax burden; it did so because it was in need of capital and this plainly
remained the main purpose of
the transactions. It is not necessary to deal
with the case of Commissioner of Taxation of the Commonwealth of Australia v
Spotless Services Limited [1996] 186 CLR 404 on which the Commissioner
relies because it is clearly distinguishable both on the facts and in respect of
the applicable legislation.
[16] In view of this conclusion it is not
necessary to deal with the Special Court’s finding that the abnormality of
the
transactions had not been established. Suffice it to say that what the
Commissioner had to establish, was the abnormality of the
transactions as
sales and leasebacks. To decide whether he had done so, the Court
rightly took all the circumstances of the case into account and did not content
itself with an examination of the
typicality of the terms of the
agreements.
[17] I conclude therefore that the Special Court correctly
found in Tycon’s favour on the second issue as well.
The appeal is accordingly dismissed with costs including the costs of two counsel.
_________________
HEFER JA
Concurred:
Mahomed CJ
Olivier JA
Farlam
AJA
Madlanga AJA
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