IN THE HIGH COURT OF SOUTH AFRICA
(TRANSVAAL PROVINCIAL DIVISION)

Date: 09/05/2008
Appeal No: A93/2006

UNREPORTABLE

In the appeal of:

BC BOS							Appellant

And

THE COMMISSIONER FOR THE
SOUTH AFRICAN REVENUE SERVICE			Respondent

JUDGMENT

HARTZENBERG ADJP:

[1]	This is an appeal against an order of the Income Tax Court. The court found that an amount of R1 000 000 paid to the appellant on 31 January 2002 was income received during the 2002 tax year and directed the respondent to deal with it as such, in the appellant's assessments. The appellant at all stages maintained that the amount received was of a capital nature.

[2]	The amount was paid by PricewaterhouseCoopers ("PWC", "the firm" or "the partnership") in terms of a written agreement ("the separation agreement") as "a compensation amount". The parties were in agreement that the respondent was wrong to treat it as income received during the 2003 tax year and that, if indeed it was income, it was income received during the 2002 tax year.

[3]	The circumstances under which the amount was paid were as follows: The appellant practiced as a chartered accountant since about 1971. He was a partner in a firm known as Theron van der Poel and when that firm, with others, was structured to become Price Waterhouse he became a partner in the latter firm. During 1999 the partners of Price Waterhouse and Coopers and Lybrand entered into a written partnership agreement ("the partnership agreement") in terms of which PWC came into existence and started to practice with effect from 1 February 1999. The partnership agreement provides that a partner is obliged to retire on the last day of the financial year coinciding with his sixtieth birthday. Although a partner is entitled to retire as from age 52, PWC can only terminate a partner's membership in certain specified circumstances: assigning, charging or encumbering his interest in PWC without the necessary consent; insolvency; acting in a manner inconsistent with good faith between partners; committing a material breach of the partnership agreement or misconduct. A partner automatically became a director of a company through which, for tax purposes, certain arrangements were made for the benefit of partners. A substantial portion of a partner's income was paid to him by the company at the end of the financial year when the available funds were allocated to the partners in terms of certain criteria. Seniority and performance were two very relevant considerations when distribution was decided upon.

[4]	There was a restructuring of the finn's operations during 2000. The appellant was placed in the Entrepreneurial Administration Division (''the EAD"). It rendered a one-stop service to clients. The appellant's division was responsible for tax compliance services. The partner in charge of EAD was one Stenekamp. The firm was not satisfied with the profitability of EAD and further restructuring was contemplated. During about May 2001 it was decided that the tax compliance department of EAD was to be moved to another department within the firm and that the firm no longer required the appellant's services. Stenekamp informed the appellant of the decision and invited him to present proposals as to how his services were to be utilized in the firm. The appellant submitted certain proposals to Stenekamp in an e-mail. He indicated that economically he was not in a position to accept early retirement (he was only 55 at that stage), he still had children, whom he had to put through school and university, and had debts that he had to payoff. His attitude was that he had planned to retire at 60 and could not afford to retire at 55. The appellant maintained that he had done nothing giving PWC the right to terminate his rights in terms of the partnership agreement.

[5]	Stenekamp informed him that PWC was not prepared to accept his proposals and wished him to leave the partnership. A departure date of 31 December 2001 was mentioned and Stenekamp indicated that PWC would be prepared to pay damages for the early termination of the partnership agreement. The appellant obtained legal advice from senior counsel who informed him that that PWC had no right to terminate the agreement and had in effect repudiated the agreement. He advised the appellant to accept the repudiation and to claim damages from Pwc. He dictated a letter, along those lines, to the appellant, which was later on formalized and remitted to PWC by the appellant. Thereafter the senior partner, Dunn, had an interview with the appellant. His attitude was that unless the appellant accepted the amount of R1 million, which by then had been mentioned, the appellant would be put into an office and would not be given work, but that his entitlement to share in the distribution of the profits would be taxed according to performance.

[6]	The appellant obtained a tax opinion from the tax department at PWC at the suggestion of Kitshoff.. He was informed that the amount of R1 million would not be taxable as income as the receipt thereof was of a capital nature in terms of the definition of "gross income" in section 1 of the Income Tax Act, 58 of 1962 ("the Act"). In the opinion it was recommended that the payment was to be described as: "Compensation for premature termination of right and expectation to remain a partner until normal retirement date." The members of the top management of PWC, who gave evidence on behalf of the respondent, and negotiated with the appellant about his resignation, stated that they were not aware that he had sought an opinion from the tax department of PWC or what the import thereof was.

[7]	The appellant described his state of mind at that stage roughly as follows: He realized that his position as a partner was in jeopardy for quite some time because there had been rumours in the firm concerning the relevant department since early that year.  He stood to lose his rights in terms of the partnership agreement. He had quantified his expected income as approximately R5,8 million over the remaining 5 years as a partner. If he wanted to establish his claim for that amount against PWC, he as an individual had to take on the firm with all its resources in a court action, the result whereof was by no means a foregone conclusion. He accepted that the receipt of the R1 million would not be subject to income tax. He was exhausted and wanted finality. 

[8]	The finance partner of PWC, Kitshoff, on 28 October 2003, addressed a letter to the appellant in which he was informed that the tax returns submitted on behalf of PWC reflected a partnership taxable income accruing to him of R102 232. The letter continued:

"In addition you were paid an amount of R1 000 000 as compensation for your withdrawal from the partnership".  "Please ensure that a copy of this letter accompanies your tax return and that the taxable income reflected above is returned therein."

The letter is ambiguous in the sense that it informs the appellant that the PWC returns indicate a taxable income of R102 232 and an additional payment of R1 million as 6compensation. It does not state clearly what the status of the R1 million is. It does not require a strained interpretation to understand the letter as indicating that the R1 million was received as something other than taxable income.

[9]	The respondent does not seem to have interpreted the letter as unambiguous because, the relevant portion of a letter, dated 7 February 2005, written by Kitshoff on behalf of PWC to the respondent reads as follows:

"I refer to your facsimile transmission dated 13 December 2004 and our telephone discussion earlier today. 

I confirm that Mr. B C Bos was allocated taxable income from the PwC partnership totaling R1 102 232 for the financial year ended 30 June 2002. The allocation represented R102 232 pro‑rata income for the 7 months up to his withdrawal on 31 January 2002 as well as an additional amount of R1 000 000 as a settlement in respect of his withdrawal from the firm. Both these amounts were treated as normal taxable distributions from the firm in the 2002 financial statements.

I have attached a detailed income statement, which shows the total taxable income of the partnership for the year and a schedule setting out the allocation of taxable incomes to individual partners.

You will note that Mr. Bos had been allocated R1 102 232 as per the schedule."

One presumes that once the RI million has been allocated out of the partnership's taxable income to the appellant, to be taxed in his hands, that the partnership's tax liability is reduced to a taxable income of R1 million smaller than what it would have been, had the R1 million been paid for a capital acquisition.

[10]	According to Dunn the wording of the written agreement that was signed by the parties was the wording that had been used on a number of occasions, also in the case of other partners, to say ''that we will pay a compensation amount if you will agree to leave the firm”. If one looks at the actual written agreement the following provisions are relevant: In paragraph 3.1. it is stated that the parties have reached agreement on the withdrawal of the appellant from the partnership. In paragraph 4 it is stated that the withdrawal date will be 31 January 2002 and in paragraph 5 it is stated that in lieu of the separation agreement the appellant shall be paid a compensation amount of R1 000 000.  It is contended on behalf of the respondent that the wording of the agreement differs from what was suggested to be the wording in PWC's opinion. If there is a difference it is more apparent than real. Read in context the agreement states that there is a premature termination of the appellant's right to remain a partner for which he is paid the compensation amount. It is clear that the appellant, who did not draft the agreement, was at all relevant times under the impression that the amount had been paid to him as compensation for the early termination of his partnership agreement. It is not so clear what PWC's state of mind at all relevant times had been. As has been indicated, the letter of 28 October 2003 was at least ambiguous and did nothing to indicate to the appellant that PWC would later on inform the respondent that he had received the amount as income. The subjective state of mind of one or even both of the partnership and the appellant cannot change the nature of the payment. The nature of the payment must be inferred from the objective circumstances that prevailed when it was made:

10.1	The appellant agreed to forego his right to receive drawings from the partnership and to share in the profits of the partnership. The value of what he relinquished was realistically not less than R5 million over the next five years.

10.2	Both parties were aware thereof.

10.3.	The partnership regarded the appellant as a liability because of the provisions of the partnership agreement.

10.4.	The appellant regarded his rights in terms of the partnership agreement as an asset.

10.5.	The appellant would have preferred to remain a partner until he reached the age of sixty and so to have a virtually guaranteed income, of the order of R1 million per annum, for the next five years.

10.6.	If the partnership could buy off the appellant's rights in terms of the partnership agreement for less than R5 million discounted over five years each individual partner stood to gain the difference between the appellant's expected income as a partner reduced by what the partnership had to pay to get rid of him and what the appellant could generate for the firm after expenses.

10.7.	The firm put the appellant before an ultimatum which, if implemented, would have reduced his income drastically if he insisted on staying on, to compel him to accept their offer.

10.8.	The appellant did not see his way open to take on PWC in a lawsuit. 

10.9.	The once-off payment of R1 million is considerably less than what the appellant would have received as income had he stayed on.

10.10.	Although the appellant had written the letter in which he indicated that the firm had repudiated the agreement and that he accepted the repudiation the parties did not conduct themselves as if the appellant had divorced himself from the partnership. He went to work and Dunn's threat to him was that unless he accepts the R1 million he would not be given work to do and would be paid on his performance. In my view the fact that he wrote the letter does not give an indication, either way, as to the nature of the payment.

10.11	The court a quo relied on the fact that the appellant, on being questioned by it, indicated that he wanted the money because he stood to lose his income from the firm and in order to make up for the loss. Again in my view that is a neutral factor.

[11]	The appellant was involved with PWC and its predecessors for more than 30 years, the last 17 of which he was a partner. Seniority plays an important role when profits are distributed. There must of necessity be much greater security for an individual to be a partner in an internationally known firm of accountants with an established practice and many corporate clients than at the age of 55 to open a practice. In a big firm there is continuity. When a 55 year old accountant gets forced to retire prematurely because of alleged non profitability he is certainly not going to be lapped up by other big firms. It means that he will have to open a one man or other small practice with, in all probability, a limited life span. Such a firm will not appeal to big corporate clients.

[12]	Both PWC and the appellant realized that he was paid the RI million to surrender his rights in terms of the partnership agreement. In cross-examination Dunn admitted that fact:

Question: "It was not meant as a reward for services."
Answer: "That is certainly as you say, an offer to ask him to go early."

Both parties realized that those rights were worth a lot more than the million Rand paid for it. They also realized that in all probability the appellant would not be able, on his own, to earn income remotely in the region of what he was earning as a senior partner.  They also realized that in all probability that what the appellant would be able to earn, supplemented by the R1 million, profitably invested and spread over 5 years, would be substantially less than what he would have been able to earn as a senior partner. That was the reason why PWC wanted to get rid of him.  In my view it means that the appellant was forced to relinquish his profitable contractual rights in terms of the partnership agreement, knowing full well that it would be impossible for him to get the same benefits in any other way. If one wrongfully damages a taxi to such an extent that it has to be written off, the owner stands to lose income. If he claims compensation from the wrongdoer to replace the taxi, that is clearly a payment of a capital nature. If the taxi is out of operation for some time the taxi owner may over and above his capital loss suffer a loss of income during the period that the taxi cannot operate. The appellant's situation can be equated with that of a taxi owner whose taxi could carry twelve passengers and who was forced to substitute it with one that can carry no more than six passengers. He cannot earn the same income with the smaller vehicle but has to accept the difference in value between the two vehicles as compensation. Although he can still operate his taxi his income will in all probability be less than what he could generate with the bigger one. That in my view does not change the position that his capital consisted of the value of the big taxi and was reduced to the value of the smaller one and that he suffered a capital loss equal to the difference between the values of two vehicles.

[13]	It was not only through his education, training, skill and intellect that the appellant was able to receive a good income before termination of the agreement. Surely those aspects were essential for him to have become a partner, but his position in the firm as entrenched in the partnership agreement was primarily responsible for what he took home during a tax year. The terms of the partnership agreement were the real foundation of his income earning structure.

[14]	Where it is common cause that the appellant received the amount of R1 million the onus was on the appellant to prove that the amount was of a capital nature.  There is no definition of what constitutes receipts or accruals of a capital nature in the Act. The courts have not attempted to give such a definition and have accepted that the question whether an accrual is to be categorized as capital or income has to be decided on the facts of each particular case3. It is generally accepted by our courts, on the strength of Burmah Steam Ship Co. Ltd. Vs IRC4, that in each case it is to be ascertained whether the accrual was received to fill a hole in the taxpayer's income or to fill a hole in his capital assets. It is evident that in order to answer that question it sometimes becomes necessary to decide whether some intangible assets form part of the taxpayer's income producing structure or not. If it does, the accrual in all probability will be held to be of a capital nature, and the position is not changed even if there was only a partial sterilization of the taxpayers income producing structure and for a limited period5.

[15]	Instances of findings that intangible rights formed part of the taxpayer's income producing structure are relinquishment of a portion of its right to contract freely6; relinquishment of a permanent appointment as a director of a company7; a partner's right to share in the partnership's profits8 and the right to trade freely9. Where it has already been found that the appellant's rights in terms of the partnership agreement formed the very foundation of his income producing structure10 it follows that the remuneration for his relinquishment thereof was an accrual of a capital nature and that the appellant has discharged the onus of proving it. It follows further that the appeal must succeed, unless the accrual of the amount can on another basis be categorized as "gross income".

[16]	From the outset the appellant dealt with proviso (d) of the definition of income and contended that the proviso is not applicable as the appellant did not resign from any office or employment or appointment and that he merely agreed to accept the termination of his rights in terms of a partnership agreement. The respondent did not rely on the proviso, in this court or in the court a quo. Mr. Stevens made it clear that the respondent had abandoned reliance thereon already at an early stage in the court a quo. It is therefore not necessary to pursue this aspect any further.

The following order is made: 

1.	The appeal against the respondent's contention, that the R1 million received by the appellant pursuant to the separation agreement was "income" received by the appellant during the 2003 tax year, succeeds with costs.

2.	The assessment in respect of the appellant for the 2003 year of assessment is set aside and referred back to the Commissioner for reconsideration on the basis that the R1 million received in terms of the separation agreement was not part of the appellant's gross income.

W J HARTZENBERG
ACTING DEPUTY JUDGE PRESIDENT OF THE HIGH COURT

I agree,

W L SERITI
JUDGE OF THE HIGH COURT

I agree,

P Z EBERSOHN
ACTING JUDGE OF THE HIGH COURT.

Representation:
For the Appellant:		Adv. C van Breda.
Attorneys: 			Weavind & Weavind
For the Respondent:	Adv. G Stevens
Attorneys:			The State Attorney