Commissioner for Inland Revenue v Datakor Engineering (Pty) Ltd (405/1996) [1998] ZASCA 71 (21 September 1998)

2 HARMS JA:

[1] This is an appeal by the Commissioner for Inland Revenue against a judgment

of the Transvaal Income Tax Special Court (Wunsh P) in which it upheld an appeal

by the taxpayer against an assessment for normal tax for the year of assessment which

ended on 31 March 1990. In the assessment the Commissioner had reduced the

taxpayer's assessed loss by R18 807 524,00 by virtue of the provisions of s 20(l)(a)(ii)

of the Income Tax Act 58 of 1962, claiming that the amount represented a so-called

compromise benefit.

[2] The taxpayer, Datakor Engineering (Pty) Ltd, was originally known as GBS

South Africa (Pty) Ltd. It was finally liquidated on 15 August 1989. A scheme of

arrangement in terms of s 311 of the Companies Act 61 of 1973 was thereafter

proposed by a then unrelated company, Datakor Ltd. The scheme was confirmed on

23 January 1990, the taxpayer was discharged from liquidation, its name was changed

to its present name and it became a wholly-owned subsidiary of the proposer, Datakor

Ltd. The latter was obliged, in terms of the scheme, to provide the taxpayer with

certain funds and these, together with some other amounts, were to be applied by the

3 receivers to pay the administration expenses, the net amounts due to secured

creditors, the claims of preferential creditors and, as far as a balance remained, a pro

rata payment to concurrent creditors.

[3] The unpaid balance of the claims of the concurrent creditors claims was to be

capitalised by the taxpayer by the creation of a number of redeemable preference

shares in the taxpayer equal to the face value of the claims. As consideration the

concurrent creditors waived payment of these claims. In the event they received a

dividend of 43,48 cents in the Rand. For every 100 cents of the claims not paid, a

share with a nominal value of one cent was to be issued with a premium of 99 cents.

The shares were to be renounced by the creditors in favour of Datakor Ltd.

Although the evidence is that the scheme was implemented according to its terms,

there are some discrepancies between the requirements of the scheme and the financial

statements of the taxpayer, but these are not of any great moment.

[4] The essence of this type of scheme is that -

"the claims of the creditors, as reduced by a capital amount paid to

them in terms of the scheme, are converted into preference share

4 capital and the creditors are then deemed to have renounced their

entitlement to the issue and allotment of such preference shares in

favour of a person (usually the offeror) nominated by the company.

The rights of all the creditors under such arrangement are confined to

the right to claim payment of the dividends receivable by them under

the arrangement."

[Getz and Jooste Section 311 of the Companies Act: Preserving the Assessed Loss

1995 Acta Juridica 56 at 64]

[5] Before the arrangement the share capital of the taxpayer consisted of 500 000

shares of R1,00 each. A further 100 ordinary shares of R1,00 were issued pursuant

thereto to the proposer with a share premium of R5 736 000,00. The arrangement,

however, obliged Datakor Ltd to subscribe for ordinary shares at an allotment price

of R6 511 000,00. The shortfall of R775 000, it seems, was made up by an interest

free loan from Datakor Ltd to the taxpayer.

[6] The amount waived by concurrent creditors by virtue of the fact that they no

longer had any further claims against the company amounted to R18 997 499,00. In

5 the scheme of things, 18 997 499 cumulative redeemable shares each with a nominal

value of one cent and a share premium of 99c, were issued to the creditors. This gave

rise to a share premium account of R18 807 524,00. The taxpayer's balance sheet

reflects these facts and shows that the taxpayer no longer had any current liabilities.

The cash flow statement demonstrates, furthermore, that the full proceeds of the

issuing of the redeemable preference shares were used to liquidate accounts payable.

The amount credited to the preference share premium account because of the creation

of these shares and which was used to extinguish liabilities to that amount was the

amount which, according to the Commissioner, could not form part of an assessed

loss in terms of sec 20(l)(a)(ii) of the Act.

[7] Any person carrying on a trade within the Republic is entitled to set off against

his income any balance of assessed loss incurred within any previous year which has

been carried forward from the preceding year of assessment. This is subject to two

provisos, the second being of relevance, namely that -

"the balance of assessed loss shall be reduced by the amount or value

of any benefit received by or accruing to a person resulting from a

6 concession granted by or a compromise made with his creditors

whereby his liabilities to them have been reduced or extinguished,

provided such liabilities arose in the ordinary course of trade."

[S 20(l)(a)(ii).]

The taxpayer had an assessed loss which was brought forward from previous years

of R8 540 219,00. Its so-called tax loss for the year under consideration amounted

to R15 090 168. It sought to carry the sum of these amounts over to the next tax year

but, as mentioned, the Commissioner reduced this amount by the amount of the share

premium account due to the issue of the preference shares.

[8] The court below and counsel during argument divided the provisions of

subparagraph (ii) into its so-called elements. It is a useful exercise but it may tend to

disguise the interrelationship between the elements and may lead to a failure to

consider the statutory provision as a whole. Bearing this in mind, I nevertheless

intend to do the same. The elements of the quoted paragraph from the section are the

following:

(a) the balance of assessed loss shall be reduced by the amount or value

7

2. of any benefit received by or accruing to a person

3. resulting from a concession granted by or a compromise made with his creditors

(d) whereby his liabilities to them have been reduced or extinguished

(e) provided such liabilities arose in the ordinary course of trade.

The argument was focussed upon the underlined words and phrases. In the court below it was held against the taxpayer that (b) and (c) had not been shown to have been absent. On the other hand, it held that the Commissioner had failed to prove (a) and that he was thus not entitled to invoke the provision in order to disallow the loss. Point (e) was never in issue and little attention was given to point (d), probably because it was common cause that the taxpayer's liabilities to its crditors had been extinguished.

[9] It is convenient to deal first with issue (c), namely whether any alleged benefit derived by the company resulted "from a concession granted by or a compromise made with his creditors". In this regard the court below held that the since the creditors surrendered their rights to the proposer, Datakor Ltd, for no consideration

8 they, in the result, received something less than the face value of their claims. This

can only be ascribed to a concession if not a compromise. Significance was attached

to the fact that s 311 of the Companies Act was invoked in order to facilitate the

rearrangement of the rights of creditors.

[10] This reasoning is not entirely correct. The section does not concern itself with

the relationship between the creditor and some third party, but with that between the

creditor and the taxpayer. A concession granted to a third person (in this case

Datakor Ltd) seems to me to be beside the point. What has to be determined is

whether the creditor granted a concession to the taxpayer.

[11] It is difficult to come to grips with the argument of the taxpayer on this aspect

of the case. Having conceded that the liabilities of the taxpayer to the creditors were

extinguished by means of a contract, counsel was invited to classify the contract, an

invitation he was hesitant to accept. It was not suggested that the agreement was an

innominate contract. The only other possibility that springs to mind is that the contact

was a classic transactio, also known as a compromise. In consideration for a waiver

of their claims the creditors received something different, namely shares. But, said

9 counsel, unless one knows that the shares were worth less than the claims it has not

been established that a concession was granted to the company by the creditors. In

other words, it may be that the shares might have been worth more than their issue

price in which event the creditors relinquished nothing. I cannot accept the argument.

The Act is not concerned with the benefit received by the creditor, but with the benefit

received by the debtor. The mere substitution of a creditor's claim with a share, even

a redeemable preference share, amounts to a concession. An enforceable obligation

is replaced with something of a completely different nature. In the case of debts, all

the assets of the company are available to satisfy the claims of creditors whereas, in

the case of redeemable preference shares, only profits available for dividends or the

proceeds of a fresh issue of shares may be used to redeem the shares (s 98 (1) of the

Companies Act 61 of 1973). The right to redeem vests in the company and the

creditor cannot enforce a "right" to redemption. In this regard the dictum of

Nicholas AJA in AA Mutual Insuranc Association Ltd v Century Insurance Co Ltd

1986 (4) SA 93 (A) at 101C-H is instructive:

"The right to redeem under the special resolution is one solely for the

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benefit of the company. It was not created in the public interest. Until

the enactment of s 43 [of the Companies Act 46 of 1926, now s 98 of the 1973 Act] (which was introduced into our companies legislation by s 21 of Act 23 of 1939 (as amended by s 23 of Act 46 of 1952)), it was considered that the public interest required that shares should not be redeemable - the general rule was that a company could not issue redeemable preference shares, because redemption would amount to an illegal purchase by the company of its own shares. See Trevor v Whitworth (1887) 12 AC 409; Pennington's Company Law 4th ed at 192. The interests of creditors cannot be affected by a waiver by the company of its right to redeem - on the contrary their interests are best served if there is no redemption. The company may redeem none or all or any of the redeemable preference shares, as it pleases and as determined by the board of directors. No member, nor anyone else, has grounds for complaint if the company decides not to redeem any shares. Nor can the rights of any person other than the

11

company be affected if the company enters into an agreement by

which it renounces pro tanto its right to redeem any particular shares.

There is nothing in s 43 ... or in the common law, which obliges the

company to redeem or which prohibits an agreement not to exercise

the right of redemption, unless, possibly, the effect of the agreement

is to deprive the shares concerned of their character of redeemable

preference shares, eg by providing that they are under no

circumstances to be redeemed."

[12] I now turn to deal with the second question, question (b), namely whether any

benefit was received by or accrued to the taxpayer. In finding against the taxpayer,

Wunsh P first traced the chequered history of arrangements of this sort. (It can be

found in the quoted article of Getz and Jooste. See also Ex parte De Villiers and

Another NNO: In re Carbon Development (Pty) Ltd (In liquidation) 1993 (1) SA

493 (A).) He then held that any arrangement or dispensation by which a company is

protected from action by its creditors so as to enable it to continue with its business,

whether by means of a subordination agreement or the capitalisation of the claims,

12 must redound to its benefit. The company is discharged from liquidation. Its

creditors are replaced by a shareholder, who, as the holder of redeemable preference

shares, cannot sue the company for repayment of the capital when redemption

becomes due.

[13] The taxpayer joins issue with these findings, relying mainly on the arguments

advanced by Getz and Jooste at 67-68. Their basic premise is that the conversion

of a debt into redeemable preference shares is merely a change in the form of the

company's liability because the extent of the obligation, and the obligation to repay,

remain as before. Counsel shied away from this proposition, but relied upon the

statement of the authors (at 68) following upon the said premise, namely that it is -

"arguable that in substance, if not in form, a redeemable preference

share is analogous to an obligation to repay a debt in that a company

has either an actual (if the shares are redeemable on or before a fixed

date) or a contingent (if the shares are redeemable at the option of the

company) obligation to repay to the holders of the shares the issue

price thereof"

13 [14] The views of Wunsh P are similar to those of RDJ Schemes of Arrangement-

A New Development(1989) 28 Income Tax Reporter 7 at 10-11 who argued that the

effect of the scheme is to rid the company of its creditors and that the fact that the

ownership of the company has been altered in that the capital structure has been

changed does not detract from the fact that the creditors' claims no longer exist in any

form. The author also pointed out that there are vital differences between, on the one

hand, a preference share and, on the other, a creditor's claim. These differences are

highlighted by Prof Blackman in 4 (1) LAWSA par 103 (reissue):

"Although there are similarities with debt, the redeemable preference

share is not debt. The right to redeem is not created in the public

interest, and is solely for the benefit of the company. The interests of

the creditors cannot be affected by a waiver by the company of its

right to redeem; on the contrary, their interests are best served if there

is no redemption. The company may redeem none or all or any of the

redeemable preference shares, as it pleases and as determined by the

board of directors. No member, or anyone else, has grounds for

14 complaint if the company decides not to redeem any shares. Nor can

the rights of any person other than the company be affected if the

company enters into an agreement by which it renounces pro tanto its

right to redeem any particular shares. There is nothing in the section,

or in the common law, which obliges the company to redeem, or which

prohibits an agreement not to exercise the right of redemption, unless,

possibly, where the effect of the agreement is to deprive the shares

concerned of their character of redeemable preference shares, for

example by providing that they are under no circumstances to be

redeemed.

Where the redeemable preference shareholder has a right that the

company redeem his shares and the company does not have available

profits or is in fact unable to issue fresh shares to cover the

obligations, the redeemable preference shareholder will not be able to

enforce his right, and his only remedy is an order for the winding-up

of the company."

15

[15] This, and the quoted dictum of Nicholas AJA, I believe, support the reasoning

of Wunsh P set out in par [12] above and at the same time dispose of the taxpayer's argument. The obligation to repay is not the same in each instance. And without wishing to imply that it would have made any difference, there is in any event no evidence that the shares in question were redeemable on a fixed date. Also, the argument appears to miss the point because it is rather related to the quantification of the benefit, something I shall deal with. The provision in question concerns itself with "any benefit", words of a wide and indeterminate meaning. Whether the benefit is affected or reduced by other factors is, for this part of the investigation at least, of no consequence. The benefit, in the words of the Act, is to be found in the reduction or extinction of the debt, something which and the extent of which, as said before, is common cause. Indeed, the concession by the creditors (to waive the balance of their exigible claims against the taxpayer in return for a nebulous "right" of redemption of redeemable preference shares) must of necessity translate into a benefit to the taxpayer. [16] As far as (a) is concerned, the Special Court made a number of findings which

16

can be summarized as follows. The trigger for the application of the provision is the

"amount or value" of the benefit. That implies an amount ascertainable in monetary terms. The Commissioner bore the onus of proving that an ascertainable money value can be ascribed to the benefit. It is not possible in this case to quantify the amount or value of the benefit because the benefit was not derived without any cost since the preference shares carry a dividend and have to be redeemed. [17] Wunsh P was conscious of the provisions of s 83(7)(c) of the Act, although he did not make specific reference to its exact terms. It provides that at any appeal against a decision of the Commissioner, the objector "shall be limited to the grounds stated in his notice of objection". The Commissioner may agree to an amendment of such grounds and the Special Court may, on good cause shown, permit an amendment - neither of which occurred in this case. The grounds upon which the case went against the Commissioner were, in the words of Wunsh P, "not advanced as such in the letter of objection nor, indeed, articulated in the submissions advanced" during argument. But, he held, the matter had been sufficiently indicated in the letter of objection and that he had raised the issue during argument. The fact that the court

17 raised the matter during argument is, in the light of the wording of the subsection,

irrelevant. The correct test is to look at the substance of the objection without being

unduly technical or rigid (Matla Coal Ltd v Commissioner for Inland Revenue 1987

(1)SA 108(A) 125I-J).

[18] Unfortunately, the learned President did not state where in the notice of objection the point was raised. The experienced legal representatives representing the taxpayer did not realise that they had raised the point - a strong indication that it had not been raised, Neither party offered any evidence nor asked any question concerning the issue. As I read the notice of objection, the point was not raised. Counsel did not submit otherwise. The notice, no doubt, dealt with the question of the "value" of the benefit but, contrary to the approach of the Special Court, stated that the benefit had to be found in the financial statements of the taxpayer - the taxpayer remained indebted to the same extent as before and, recognising the accounting principle of substance above form, the financial statements disclosed "no benefit accruing in consequence of the arrangement." (The underlining appears in the original.) This was not the issue considered by Wunsh P.

18

[19] The question of onus was also not argued in the court below and the judgment

on this point was given without the benefit of counsel, although before us the taxpayer did seek to support the findings in this regard. It is useful to start with s 82 of the Act:

"The burden of proof that any amount is . .. subject to any ... set-off in terms of this Act, shall be upon the person claiming such . . . set-off

The taxpayer claims that the amount reflected in its financial statements as representing the share premium consequent upon the issuing of the preference shares and which was used to extinguish its liabilities, should be set off against its income. In other words, the financial statements show a fixed amount in respect of which the taxpayer wishes to claim the advantages of s 20 of the Act. (Cf Ochberg v Commissioner for Inland Revenue 1931 AD 215 220 in fine - 221.) The Commissioner disallowed that amount as being a benefit. The amount was fixed, it was ascertained [20] The court below relied upon Commissioner for Inland Revenue v Butcher

19 Bros (Pty) Ltd 1945 AD 301 319 (although I think that pp 322-323 were intended)

and De Koker Silke on South African Income Tax par 18.27 for its conclusion

summarized in par [16] above. The latter work does not support the finding and

appears to the contrary -

"It would seem that the Commissioner is entitled to tax any receipt or disallow any claim for deduction, set-off or exemption and leave it to the taxpayer to prove that he is wrong."

In Butcher at 322 in fine, Feetham JA is reported to have said the following:

"The assessment in dispute, made by the Commissioner under sec. 7 (1) (d) [of the Income Tax Act, 1925], can only be allowed to stand if some "amount" accrued to or was received by the company in the tax year ended 30th June, 1935, by virtue of its rights under the building clauses in the lease, and it is essential for the Commissioner, in order to support his assessment, to show that some amount has accrued to or been received by the company by virtue of such rights.

20

[21] The reference to Ochberg has been given. There this Court, per Roos JA, was

called upon to deal with the precursor of the present s 82 which was to all intents and purposes identical to it. The argument considered by Roos JA raised the issue whether there was an initial onus upon the Commissioner to prove that the amount taxed is income liable to taxation. Somewhat tersely, he held that the contention would make the section meaningless and useless and that the section "means that an amount received by the taxpayer, on which an assessment has been made by the Commissioner, is taxable unless the taxpayer shows that it is not income." [22] To return to Butcher. The question was whether an amount had been received or had accrued as a premium or like consideration in respect of the grant of a right of the use or occupation of certain premises in a particular tax year as part of the taxpayer's gross income. The taxpayer had entered into a lease of fifty years' duration. The tenant was obliged to erect a building on the property to the value of not less than 655 000. The building was erected and the Commissioner contended that the erection of the building to that value constituted the receipt by the taxpayer of that amount as a premium in the year the building was erected. It is obvious that the taxpayer had

21

received no "amount", but only the right to the return, after fifty years, of the property

with the building thereon. In this context it was held that the Commissioner had to show the receipt of an amount during the tax year under consideration. In the present instance, as I have shown, the amount is a fixed amount and not an assessed amount. The dictum is, therefore, of no assistance in answering the present question. I therefore conclude that the court below erred in placing the onus on aspect (a) in the circumstances of this case upon the Commissioner.

[23] Because the issue was not raised in the notice of objection, the question whether on a proper interpretation of the provision the "benefit " to the taxpayer should be valued with reference to the alleged cost of or the liability created by the redeemable preference shares, or, for that matter, the pre-compromise value of the creditors' claims against the taxpayer, does not require consideration and 1 prefer to say no more on the subject.

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[24] In the result the appeal is upheld with costs and the order of the Special Court

is altered to read : "The appeal is dismissed".

LT CHARMS JUDGE OF APPEAL

NIENABER JA )

ZULMAN JA ) Concur

MELUNSKY AJA )

NGOEPE AJA )