Court name
Supreme Court of Appeal of South Africa
Case number
509 of 2010

Commissioner for the South African Revenue Services v Founders Hill (Pty) Ltd (509 of 2010) [2011] ZASCA 66 (10 May 2011);

Law report citations
[2011] 3 All SA 243 (SCA)
2011 (5) SA 112 (SCA)
Media neutral citation
[2011] ZASCA 66
Coram
Lewis JA
Harms DP
Nugent JA
Malan JA
Plasket AJA

THE SUPREME COURT OF APPEAL OF SOUTH AFRICA

JUDGMENT

Case
no: 509/10
In
the matter between:

THE
COMMISSIONER FOR THE SOUTH AFRICAN
REVENUE
SERVICE.........................................................................Appellant

and

FOUNDERS HILL (PTY)
LTD..........................................................Respondent

Neutral citation: CSARS v Founders Hill
(509/10) [2011] ZASCA 66 (10 May 2011)
Coram: HARMS
DP, NUGENT, LEWIS and MALAN JJA and PLASKET AJA
Heard: 17
MARCH 2011

Delivered: 10 May 2011

Summary: Proceeds of sale of land sold by
realization company taxable as income: realization company that
acquires land in order
to sell it trades in that land.

___________________________________________________________________

ORDER

___________________________________________________________________

On appeal from: Tax Court (Johannesburg) (Joffe J
sitting with two assessors):

1 The appeal is upheld with costs, including those of
two counsel, but excluding 50 per cent of the costs of preparing,
perusing
and lodging the appeal record.

2 The order of the Tax Court, Johannesburg is set aside.
It is replaced with the following order:

‘The appeal is upheld to the extent only that the
appellant is not liable for the payment of interest in terms of s 89
quat of the
Income Tax Act 58 of 1962.’

JUDGMENT

LEWIS JA (HARMS DP, NUGENT and MALAN JJA and PLASKET AJA
concurring)

[1] In 49 BC when Julius Caesar
crossed the Rubicon – a small river dividing Cisalpine Gaul (a
province of Rome) from Italy
– committing an act of treason in
so doing (for no Roman general was allowed to enter Italy with his
army without the consent
of the Roman Senate), he intended to defy
the Senate and in effect to declare civil war in Rome.1
Little did he foresee (I suspect) that his act would come to be a
symbol of passing a point of no return in the general sense,
and that
it has, in South Africa, become a tax mantra in cases that attempt to
discern the distinction between capital gains and
taxable income upon
a disposal of property.

[2] In Natal
Estates Ltd v Secretary for Inland Revenue2
this court decided (in simplified terms – I shall return to the
decision later) that where a landowner which had held land
for some
time as a capital asset, but then embarked on a project of selling
off the land on a large scale, it had ‘crossed
the Rubicon’
and had not merely sold an investment, the profit in respect of which
would be regarded as capital: it had become
a trader in land such
that any profits it made amounted to taxable income.

[3] The respondent, Founders Hill
(Pty) Ltd (Founders Hill), is described as a ‘realization
company’ since it was formed
for the avowed purpose of
realizing land formerly owned as a capital asset by its holding
company, AECI Ltd (AECI). A realization
company, in the present
context, is one formed
for the purpose of facilitating the realization of property and the
company does no more than act as the means by which the
interests of
its shareholders in the property may be properly realized. Surpluses
made from sales of the property are supposedly
not taxable as trading
profits since such surpluses are capital receipts.
But it is accepted that such a
company, too, might cross the Rubicon and the appellant, the
Commissioner for the South African Revenue
Service, contended that
Founders Hill had indeed crossed the Rubicon when it sold erven on
which it realized profits. (I shall
refer to the erven as such, or to
property or land interchangeably.) Founders Hill maintained that it
had done no more than realize
a capital asset advantageously. The
parties (and the tax court) thus both approached the matter on the
supposition that the property
was a capital asset in the hands of
Founders Hill upon its acquisition, and that the question for
determination was whether Founders
Hill subsequently ‘crossed
the Rubicon’ by starting to trade in the property.

[4] But approaching the matter in
that way begs the question whether the property was a capital asset
in the hands of Founders Hill
in the first place. As will be seen,
Founders Hill purchased the property from AECI for the very purpose
of developing and reselling
it. And so the initial question, in my
view, is whether the property was acquired by it as stock-in-trade,
or whether it was
acquired as a capital asset. It is only if the
property was acquired at the outset as a capital asset that a second
question arises
– the question that was considered by the court
below – which is whether it thereafter ‘crossed the
Rubicon’
by commencing to engage in the business of trading in
the property. The distinction between realizing an investment. on
the one
hand, and carrying on the business of trading, on the other,
is one long recognized. In Commissioner
of Taxes v Booysens Estates Ltd3
Innes CJ, referring to and quoting from Californian
Copper Syndicate v Internal Revenue,4
said that it was well established that where an investment was
realized at a profit, the enhanced value was not taxable, but that

‘where what is done is not merely a realisation or change of
investment, but an act done in what is truly the carrying on
or
carrying out of a business’, the profit made is regarded as
taxable income.

[5] The Commissioner, while initially not assessing the
profits made on sales of land by Founders Hill as income, issued a
revised
assessment in September 2003 for the 2000 and 2001 income tax
years, claiming that the profits were in the nature of income on
which Founders Hill was liable to pay tax. The Commissioner also
assessed Founders Hill for interest in terms of s 89 quat of the

Income Tax Act 58 of 1962.

[6] Founders Hill objected to the assessment on the
ground that the proceeds of the sales were capital in nature. The
objection
was disallowed on the basis that Founders Hill was a trader
in land. It appealed against the Commissioner’s ruling. The
Johannesburg
Tax Court (Joffe J and two assessors) upheld the appeal.
Starting from the supposition that Founders Hill had acquired the
land
as a capital asset, it held that the property had remained a
capital asset at the time it was sold, with the result that the
profit
was a capital gain and not taxable income. It referred the
matter back to the Commissioner to revise the relevant assessments on

the basis that no tax was payable on the transactions in issue. It
granted leave to appeal to this court. The total amount in issue
is
some R1 303 588, including the interest.

The history of the property

[7] There is no dispute about the circumstances under
which the sales alleged to attract liability for income tax occurred.
AECI
was formed in 1924 following a merger between the British South
Africa Explosives Company and Cape Explosive Works. AECI acquired

vast tracts of land in the process, including land at Modderfontein
in Johannesburg. The area of the land was some 4 100 hectares
in
extent.

[8] An explosives factory had been built on this land in
1896, and was extended in 1937. Much of the land was vacant, and
constituted
a buffer between the factory and other occupied land. On
portions houses for employees were erected, and there were also
storage
facilities. The land did not form part of any municipality
and was effectively managed by employees of AECI.

[9] By the mid-eighties the legal and technological
environment had changed significantly. Local government had been
decentralized,
town planning responsibilities had devolved on AECI
and the manufacture of explosives had changed such that the buffer
around the
factory was not required to be as extensive as it had once
been. The need for greater urban density in Johannesburg had become
pressing as had the need for housing in the area. Accordingly, the
Johannesburg City Council and AECI engaged in a planning process
to
address these changes. A number of professionals were asked to
produce a strategic plan to deal with future development of the
land,
including proposals as to different land use.

[10] In a memorandum to the AECI board dated 2 March
1989, Mr J C von Solms recommended that the strategic plan that had
been developed
be accepted: that AECI take the decision to sell or
develop the land, and commence the process step by step. The proposal
was accepted.

The formation of Founders Hill

[11] One of the first steps was the formation of
Founders Hill – a wholly owned subsidiary of AECI. It was
incorporated at
the beginning of 1993 and its main business was:

‘To acquire from AECI Limited certain
properties situate at Modderfontein, Johannesburg which are held by
AECI Limited as a capital
asset and which have become surplus to its
needs, for the sole purpose of realising
same to best advantage and within a
period of one year of completion of such realisation to be
voluntarily wound up’ (my emphasis).

The main object of the company was in identical terms.

Sales by AECI to Founders Hill and by Founders Hill
to third parties

[12] On 21 June 1994 AECI sold to Founders Hill erven
283, 301, 302 and 303 Modderfontein Extension 2, and erven 2, 17, 18,
19,
22, 23, 24, 25, 26 and 28 Founders Hill Township. The total price
was R14 229 106, including VAT. Transfer was effected more than
two
years later, on 25 October 1996. Erven 301 and 302 Modderfontein were
subdivided and sold to third parties in the years of
assessment in
question. They constituted part of a township development named
Thornhill. Erven 25 and 28 in Founders Hill Township
(known as
Founders View North and South) were also subdivided. Some of the
subdivided erven in the township were sold in the years
of assessment
to third parties and some to the Edenvale/Modderfontein Metropolitan
Substructure, the local authority in place at
the time.

The properties in Founders View

[13] Erven 25 and 28 Founders View were zoned for
industrial use. Before the transfer by AECI to Founders Hill, AECI
had already
applied to rezone the area for light industrial use, and
had subdivided the land for the purpose of that zoning. Founders Hill
itself engaged professionals to develop these erven and incurred
expenditure in ensuring that each subdivided stand could be sold
with
services such as the supply of water, electricity and sewerage by the
local authority. Most of the erven were sold to third
parties in 1996
and 1997. The last was sold in 2004. Some R11 million was spent by
Founders Hill in developing and marketing these
properties.

The properties in Modderfontein Extension 2:
Thornhill

[14] Erven 301 and 302 formed part of what became the
Thornhill development, forming its southern boundary. As indicated
the erven
had been subdivided by AECI before the transfer to Founders
Hill. Apart from holding costs no expenditure was incurred by
Founders
Hill, and the subdivisions were sold from 2000 to 2002.

[15] A marketing company, Heartland
Properties (Pty) Ltd (Heartland), was introduced into the property
selling activities of AECI
in 1998. It too was a wholly owned
subsidiary of AECI. Its purpose was to promote the selling of the
Thornhill properties. At that
stage, Mr L Van Vugt was appointed as
the new managing director of AECI. He took the view that the surplus
properties owned by
AECI should be sold more aggressively: that if
they were marketed more professionally and extensively they would
achieve higher
prices and that although income tax would be payable
on profits the gains would probably be greater.5
The remaining surplus land at Modderfontein was thus transferred to
Heartland, at market value, and Heartland could deal with it
as it
chose.

[16] Much of the land transferred to Heartland formed
part of the Thornhill Estate – an area designed to provide a
secure
residential environment. Heartland developed, marketed and
sold its property, acquired from AECI, on a grand scale. It also
marketed
and acted as agent for Founders Hill in selling its erven in
the Thornhill Estate. A third entity, Sable Homes, was also tasked

with marketing the Thornhill property, including the erven that
Founders Hill owned.

Activities of Founders Hill in selling its property

[17] Founders Hill had no employees. Its sole
shareholder was AECI, and its directors were those of AECI. The erven
in Founders
View were, as I have said, subdivided and developed by
AECI before the transfer to Founders Hill although the profits
accrued to
Founders Hill. And in Thornhill, Founders Hill did not, in
fact, undertake any development or selling itself. Heartland acted on

its behalf. The witnesses for Founders Hill did not attempt to
suggest that there was any difference between Heartland’s

conduct in respect of the land it had acquired from AECI and which
was sold, in effect, as stock-in-trade, thereby realizing profits

that were declared as taxable income, on the one hand, and its
activities for Founders Hill, where the profit was assumed to be
in
respect of a capital asset on the other.

Were the profits made on the sale of Founders Hill’s
property capital or income?

[18] As I have said, the Commissioner impliedly accepted
that Founders Hill acquired the properties as capital assets, but
contended
that having regard to the extent of its activities, it had
crossed the Rubicon because it had started to trade in the land that

it acquired from AECI, and that its profits were accordingly income,
and taxable as such. He argued that Founders Hill’s
intention
was that of AECI since the latter was the controlling mind of
Founders Hill. Although its initial intention may have
been
different, it changed, he argued, as was manifest from the activities
of Founders Hill over the years when the erven were
sold. The sales
during the years of assessment in question could not be viewed in
isolation from those preceding and following
that time. The
realization programme of AECI was vast, and Founders Hill was but one
of six companies formed by AECI to sell its
surplus land throughout
South Africa.

[19] Founders Hill argued, on the
other hand, that its intention at all times was to realize the land
held as a capital asset. That
was the purpose of the company from
inception. That is evident, it contended, from the memorandum of
association, set out earlier.
A taxpayer is entitled to realize an
asset to best advantage, a principle recognized for nearly a century
in South African law.
Founders Hill cited in support of this
proposition the cases of Commissioner
of Taxes v Booysens Estates Ltd6
and Commissioner
for Inland Revenue v Stott7
where Sir John Wessels JA said:

‘Every person who invests his surplus funds in land . . . is
entitled to realize such asset to the best advantage and to

accommodate the asset to the exigencies of the market in which he is
selling. The fact that he does so cannot alter what is an
investment
of capital into a trade or business for earning profits.’

[20] And similarly in John
Bell and Co (Pty) Ltd v Secretary for Inland Revenue,8
P J Wessels JA, after referring to the passage in Stott
cited said:

‘The mere fact, therefore, that a person
deliberately delays the disposal of a capital asset because, upon his
“reading”
of the property market, “the hand of
time” is needed in order to realise the asset to best advantage
cannot, in my
opinion, result in a change in the character of the
asset so as to alter it from a capital asset, held for the purpose of
advantageous
disposal, to stock-in-trade, held for the purpose of
earning income in the course “of an operation of business in
carrying
out a scheme for profit-making” [Natal
Estates at 199A-B].’

[21] This court invoked in support of
the proposition that a taxpayer is entitled to realize property ‘to
best advantage’
the decision in Californian
Copper Syndicate v Internal Revenue9
where Clerk LJ said that it was a settled principle that if the owner
of an investment chooses to realize it, and makes a profit,
the
profit is not taxable as income. But he also said:

‘But it is equally well established that enhanced values
obtained from realisation or conversion of securities may be so

assessable where what is done is not merely a realisation or a change
in investment, but an act done in what is truly the carrying
on, or
carrying out of a business.’

As I have said, on the parties’
formulation of the issue in this case, the question was whether
Founders Hill realized the
erven to best advantage or whether it
embarked upon the business
of selling land.

[22] The Commissioner relied
extensively on Natal
Estates Ltd v Secretary for Inland Revenue10
to which I now
turn. In Natal
Estates the
taxpayer owned vast tracts of land (initially some 21 000 acres, some
of which was expropriated from time to time, but to which
it also
added from time to time) along the coast north of Durban. For decades
it had cultivated sugar cane on the land. In the
late 1950s the board
of directors had contemplated developing townships in the areas of La
Lucia and Umhlanga Rocks. By 1963 the
company that originally owned
the land was taken over by Natal Estates, which established the
townships of La Lucia and Umhlanga
Rocks. Tracts of land were sold to
various developers for township development. Between 1965 and 1970
Natal Estates sold nearly
5 000 acres. The Secretary for Inland
Revenue issued an assessment in 1972 for the years from 1965 to 1972
on the basis that the
profits realized were taxable as income.

[23] The Special Income Tax Court, to
which Natal Estates appealed, found that it had traded in land and
dismissed the appeal against
the assessment. Holmes JA, on appeal to
this court, after stating that it was clear that a taxpayer may
realize an asset once owned
as capital to best advantage, held that
in this matter there had been a change in the intention of the
taxpayer: it had become
a dealer in land and was taxable on the
income that it made from trading. The court rejected the contention
that its business operations
in regard to the sales of land in
Umhlanga Rocks and La Lucia amounted only to the realization of a
capital asset to best advantage
and that it was not using its land as
stock-in-trade in a profit-making business. Holmes JA said:11

‘In deciding whether a case is one of
realising a capital asset or of carrying on a business or embarking
upon a scheme of selling
land for profit, one must think one's way
through all of the particular facts of each case. Important
considerations include, inter alia,
the intention of the owner, both at the time of buying the land and
when selling it (for his intention may have changed in the
interim);
the objects of the owner, if a company; the activities of the owner
in relation to his land up to the time of deciding
to sell it in
whole or in part; the light which such activities throw on the
owner's ipse dixit
as to intention; where the owner sub-divides the land, the planning,
extent, duration, nature, degree, organisation and marketing

operations of the enterprise; and the relationship of all this to the
ordinary commercial concept of carrying on a business or
embarking on
a scheme for profit. Those considerations are not individually
decisive and the list is not exhaustive. From the totality
of the
facts one enquires whether it can be said that the owner had crossed
the Rubicon and gone over to the business, or embarked
upon a scheme,
of selling such land for profit, using
the land as his stock-in-trade.’

[24] But even looking at the totality
of facts, and the taxpayer’s intention, discerning where the
Rubicon lies gives rise
to difficulty. As E B Broomberg said of Natal
Estates:12

‘The uncertainty created by the judgment is manifest in the use
of the picturesque “crossing the Rubicon”, which
has
become the trade-mark, so to speak, of this judgment. But to what
“Rubicon” are we directed? Is it the objective
conduct of
the taxpayer which converts what was a mere realization into an
observable trade? Or is it a purely mental turning point
relating to
the attitude of the taxpayer to his asset?’

[25] Assuming that a taxpayer
acquires an asset with the intention to hold it as capital, a change
in that intention (if such be
proved) on the part of the owner who
realizes it, should not be the only determinant of the nature of the
profits made. Were it
to be otherwise a number of difficulties arise.
Whose intention is relevant? And at what stage? If the taxpayer is a
realization
company wholly owned by the original owner of the asset
in question, is it the intention of the subsidiary or its controlling
mind
that counts? In my view, although this need not be decided at
this point, the question should be whether the taxpayer is actually

trading, or carrying on a business, at the time of assessment, and
not merely whether or not it has changed its mind. Of course
the
intention of all concerned must be considered, but intention cannot
be conclusive in the enquiry. As Schreiner JA said in Commissioner
for Inland Revenue v Richmond Estates (Pty) Ltd:13

‘The decisions of this Court have recognised the importance of
the intention with which property was acquired and have taken
account
of the possibility that a change of intention or policy may also
affect the result. But they have not laid down that a
possibility
that a change of policy or intention by itself effects a change in
the character of the assets.’

[26] The difficulties attendant on
invoking the intention of a taxpayer as the litmus test which
determines whether the proceeds
of an asset sold are of a capital or
income nature are made plain too in Malan
v Kommissaris van Binnelandse Inkomste14
where E M Grosskopf J said that intentions by their nature are
changeable and often not fully formulated; and evidence after the

event, however honest, is not always reliable, sometimes being
reconstructed.15
And of course in Natal
Estates, in the
passage cited, Holmes JA said clearly that one must ‘think
one’s way though all the facts’16
and thus not rely only upon what the taxpayer claimed had been its
original and continuing intention.

[27] Naturally the Commissioner in this matter contended
that Founders Hill had crossed the Rubicon. And Founders Hill
maintained
that it was still in Gaul, having realized capital assets
it held for that sole purpose. Joffe J in the tax court, starting on
the supposition that the land had been acquired by Founders Hill as a
capital asset, found that the Rubicon had indeed not been
crossed.
But he did not explain why. Founders Hill, on appeal, relied chiefly
on the fact that its sole purpose was to sell off
the land which AECI
had held for decades: its intention, it said, was to realize capital
assets to best advantage. That, as I have
said, begs the question
whether it acquired capital assets or stock-in-trade in the first
place. The tax court apparently concluded
(and before us Founders
Hill contended) that because AECI had transferred surplus land in
Modderfontein to a subsidiary company,
Founders Hill, in order for
the latter to realize the land, there was an intention to realize
what was a capital asset to best
advantage. Founders Hill bought no
additional land, and it did not become a trader in property. The
interposition of the realization
company was thus of great
significance. I shall deal with realization entities and their
purpose in due course. But I shall deal
first with the question of
intention.

The intention of Founders Hill

[28] Founders Hill was formed as a ‘realization
company’ on legal advice. Its witnesses were very conscious of
two principles:
that it was entitled to ‘realize the property
to best advantage’; and that in so doing it should not ‘cross
the
Rubicon’. The problem lies in the fact that they had
failed to appreciate that the realization of property to best
advantage
applies to the realization of a capital asset only and the
fact that a taxpayer refers to an asset as a capital asset does not
make it one. It had acquired the erven with the express intention of
selling them – carrying on the business of selling land.
The
view taken that the interposition of a realization company would in
some way enhance the intention to realize capital assets,
rather than
to trade, requires greater scrutiny.

Realization entities

[29] The principal progenitor of
cases in South Africa dealing with realization companies17
is Berea West
Estates (Pty) Ltd v Secretary for Inland Revenue,18
also a judgment of Holmes JA in this court, where the profit on the
sale of land by a company formed for the purpose of realizing
land
held for many years by different family members, was found to be
capital in nature. The Special Income Tax Court had held
that the
company had traded in land, a finding reversed on appeal. Holmes JA
held that a court, when determining whether a company
was merely
selling the property as an asset held as capital, or was trading for
profit, was entitled to look at the facts leading
to its
incorporation, to its memorandum and articles of association, and to
its subsequent conduct.

[30] The facts of Berea
West, in summary,
were these. Hermann Konigkramer (K) married his wife, Elise, in
community of property. In 1890 they entered into a
postnuptial
contract excluding the community. K owned a farm in Berea West, in
the Durban area. It was some 620 acres in extent.
Elise died in 1912,
leaving her rather small estate (since community was excluded) to
their 13 children, subject to a usufruct
in favour of K. The validity
of the postnuptial agreement was contested by some of the children.
In order to settle the litigation
that might ensue K formed an inter
vivos trust, the children being the beneficiaries.

[31] In terms of the trust deed, executed notarially in
1922, an undivided half share of the farm was donated in trust for
his 13
children and was transferred to the trustees after K’s
death in 1927. In terms of K’s will, the remaining undivided

half share of the property was also left to his 13 children. The
administration of the trust and K's estate proved to be difficult
and
protracted and it took some ten years before the estate liabilities
were fully paid. In the meantime some of the beneficiaries
of the
trust, who were also heirs, had died, with the result that others
became beneficiaries and heirs by representation.

[32] The beneficiaries and other interested parties
agreed that a company be formed to acquire the assets of the deceased
estate
and of the trust, and that shares be issued as consideration
for the interests of the heirs and beneficiaries in the company in

proportion to their respective entitlements. An agreement to this
effect was executed in 1950. In the preamble to the agreement
it was
stated that its object was that in due course the company might
complete the realization of the property and from time to
time
distribute the net profits from such realization among the
shareholders, thus relieving the executors and the trustees of
their
obligations. The Master of the Durban and Coast Local Division, and
the court itself, approved the creation of the company
which was
registered in March 1950.

[33] The land, valued then at £120 000, was
transferred to the company. Prior to the company's acquisition of
the land, K’s
estate had received approval for the conditions
of establishment of various townships, and these were proclaimed
after the company
had acquired the land. The conditions of
establishment of the townships included stipulations that the owner
was responsible for
road making, water supply and certain physical
surveys. The conditions had to be complied with before lots in the
townships could
be marketed. From 1950 to 1970 the company spent R95
496 in developing the land, being expenditure on roads, water supply
and surveys.
The company carried out no other development of the
land. The directors of the company considered that the only way in
which the
company would ever be able to repay its share and debenture
holders would be by selling building sites or lots in an established

township and not land in blocks. The company disposed of the land by
first developing and selling lots in one area and then, using
the
funds so acquired, developing and selling lots in another area.

[34] The amounts due in respect of debentures were fully
paid in 1968 and dividends were paid to shareholders for the first
time
in 1969. Throughout its existence the company had rendered
annual returns of income to the Receiver of Revenue in the same
manner
as an ordinary commercial company but received an assessment
in respect of taxable income for the first time for the year ended
30
June 1965. For the year ended 30 June 1967 the company was assessed
on a taxable income of R43077. Its objection to the assessment
was
rejected. It appealed to a special income tax court which held that
the profits from the sale of its land by the company constituted

taxable income and not a capital accrual.

[35] On a further appeal to this court Holmes JA
concluded that the special court's finding of a changed intention was
based on
the objects in the company’s memorandum; the
similarity of the directors' approach to that of a trading company;
the method
of operation in the disposing of the property; the long
period over which the farm was subdivided and realized; the fact that
it
was realized gradually in different areas; the expenditure of a
substantial sum in developing the property over 20 years; the failure

by the company to object to an assessment that it was liable to pay
tax on profits of the sale of land in one year of assessment;
the
fact that the heirs and beneficiaries realized their interests in the
estate and the trust when shares and debentures were
issued to them;
the separate identity of the company, which was not the alter ego of
the beneficiaries; and the view that the events
leading to the
formation of the company were only remotely relevant.

[36] Holmes JA concluded19
that the basis of the finding that the company had become an ordinary
company, trading for profit, was that after inception it
had deviated
from its original intention. He held otherwise:20

‘The corner-stone of the argument on behalf of the respondent
[the Secretary] was that, basically, if a company buys land
with the
object of selling it, and does so at a profit, the latter is regarded
as income. Counsel for the appellant did not collide
with this
proposition: he sought to turn its flank by contending that it did
not apply because the appellant acted merely as a
realisation company
and therefore any profit was of a capital nature. It is accordingly
necessary to refer to the concept of a
realisation company in
relation to income tax. As will appear later, in general the
authorities sanction a proposition which may
be illustrated along the
following lines:

Suppose, for example, A and B and C own a tract
of land, not having acquired it with a
view to sale, and they wish to realise
this capital asset; and they promote a company and become the
exclusive shareholders; and they transfer
the land to the company for
the purpose of realising the asset; and, when it has been sold, the
company is to be wound up and its
assets distributed among the
shareholders. The company would be regarded as a realisation company,
and not a company trading for
profits, and the surplus would be
regarded as a capital receipt; unless, of course, the company
conducted itself as a business
trading for profits, using the land as
its stock-in-trade.

The position is well put in Simon’s Taxes, 3rd ed at p B 1. 214
-

“If a company is formed for the purpose of facilitating the
realisation of property and the company does no more than act
as the
means whereby the interests of its shareholders may be properly
realised in the property, surpluses made from sales of the
property
are not taxable as trading profits since such surpluses are capital
receipts.”’

[37] Holmes JA discussed the cases on
which the editors of Simon’s
Taxes had relied,
and concluded that they were authority for the proposition that where
a company was formed solely for the purpose of
facilitating
the realization of property which could not otherwise be dealt with
satisfactorily,
then the profit achieved on sale would be of a capital nature and not
taxable. In none of the cases discussed in Simon’s
Taxes and evaluated
by this court was there but a single owner who interposed a
‘realization company’ where it could satisfactorily
have
realized the capital asset itself.

[38] The court concluded that Berea
West had not traded in land and was not taxable on the profits that
it made on its sales over
time. Holmes JA held that the beneficiaries
had set up the company ‘for the purpose of facilitating the
realisation of the
land, and that the company, in which they became
the shareholders, was merely the machinery for realising their
interest in the
land’.21
On the special court’s reasoning, he said, all realization
companies would be taxable on their profits.

[39] What, then, is the difference
between Natal
Estates, on the one
hand, and Berea West
on the other? Some writers have assumed that the mere interposition
of a realization company makes the difference. Silke
on South African Income Tax22
states:

‘An important exception to the general rule that if a company
acquires an asset with the express object of reselling it the

proceeds are income is to be found in the concept of a realization
company, which is applied when the transaction is not undertaken
as a
scheme of profit-making.’

[40] Similarly, R C Williams Income
Tax in South Africa: Law and Practice23
states that ‘it is well established that . . . realisation to
best advantage may be effected by means of a company or trust
(a
so-called “realisation company” or “realisation
trust”)’. Both Silke
and Williams cite Berea
West as authority
for the proposition. It is possible that counsel who advised AECI
took the same view, hence the transfer of the erven
in question to
Founders Hill. Yet Holmes JA in Berea
West24
made it quite clear that if a realization company ‘so conducts
its affairs that it can be said to be carrying on the trade
or
business of making profits from the sale of land, using the latter as
its stock-in-trade, the profits will be “revenue
derived from
capital productively employed”
25.’

[41] Founders Hill relied also on ITC
148126
where a company had been formed for the sole purpose of acquiring
land, subdividing and selling it. The court found that the company

had not embarked on the business of township development and selling
land for profit. The court held that Natal
Estates was
distinguishable because of the extent of the development, the
marketing, and construction of houses. In my view, the test whether

the taxpayer is engaged in the business of selling, and therefore
taxable on profits, cannot depend only on the degree of its
activities. The case is not in line with the cases on realization
entities discussed in Berea
West and below, and
was based on the supposition that the land was capital in the hands
of the realization company. It is thus of no
assistance in
determining the matter before us.

Where the interposition of realization entities does
not change the capital nature of the property sold

[42] Calling an entity a ‘realization
company’ (and limiting its objects and restricting its selling
activities in respect
of the assets transferred to it), is not itself
a magical act that inevitably makes the profits derived from the sale
of the assets
of a capital nature. Silke
recognizes this when it states that it is conceivable that a
realization company can change its intention and start trading in
the
assets. But this assumption begs the question whether, in
circumstances where the original holder of the assets could, without

the interposition of a subsidiary company (the sole purpose of which
is to realize what was in the former owner’s hands a
capital
asset), realize the assets itself, there could ever be an intention
on the part of the interposed entity to realize the
property it has
acquired as a capital asset. If the sole purpose of the transfer to
the realization company is so that it can realize
the property, on
what basis can it be said that it ever held it as capital?

[43] Referring to companies formed
for the purpose of realizing property Clerk LJ stated the general
rule in Californian
Copper Syndicate:27
in such cases ‘it is not doubtful that where they make a gain
by a realisation, the gain they make is liable to be assessed
for
income tax’.28
The import of this statement is that when an entity is formed for the
sole purpose of realizing property, profits achieved amount
to income
made from trading.

[44] In my view an interposed
realization company (or other entity) will stand in the shoes of the
entity that has transferred assets
to it, and hold them in turn as
capital assets, only in special circumstances, exemplified in Holmes
JA’s judgment in Berea
West (where A, B
and C hold shares in property and require a vehicle to sell them as
advantageously as possible, as was the case in
Berea
West), or where
there is a need to protect the assets from the original holder.
Malone Trust v
Secretary for Inland Revenue29
is an illustration of the latter situation.

[45] In 1917 Mrs J F Malone acquired a farm in Beacon
Bay, East London. She lived there with her family for many years. The
land
was not suitable for farming. From time to time small portions
of it were sold off to provide for the maintenance of her family.
She
died in 1933 and her husband inherited the property and continued to
live on it. He died in 1948, and their son, Joseph Malone,
acquired
the farm and also lived on it. In 1952 he sold off some ten morgen,
on which the purchaser established a township. When
he was fifty he
married a younger woman and they had three children. His wife, in the
words of Trollip JA, was ‘financially
irresponsible’ and
his money was rapidly dissipated.

[46] In 1962 Joseph Malone and his wife executed a joint
will, bequeathing their joint estate to their children, subject to a
usufruct
in Mrs Malone’s favour. Their attorney and financial
adviser, Mr Orsmond, was the executor of the estate. Some years
later,
on Orsmond’s advice, Malone decided to establish a
township on what remained of the land. Orsmond took the steps
necessary
to do so. But before this was finalized Mrs Malone had
spent all the family money and had taken up with a younger man. Again
on
Orsmond’s advice, Malone established a trust, the purpose of
which was not only to establish a township but also to ensure
that
the proceeds from any sales would go to the trust and not to Mrs
Malone.

[47] Malone died in June 1968. As executor of the
estate, Orsmond had considerable difficulty in dealing with the
property and proceeding
with the establishment of a township. He thus
transferred the land to the trust so that he could see to the
establishment of the
township in his capacity as a trustee. For the
tax years 1970 and 1971, sales of erven in the township achieved
profits which the
Secretary taxed as income. An appeal against the
assessment to a special income tax court failed.

[48] On a further appeal to this
court, Trollip JA held that Malone, had he established the township
himself, would have been doing
no more than realizing his property to
best advantage. When his executor transferred the land to the trust
it did not engage in
land trading. In forming the trust Malone merely
‘set up the necessary machinery to implement that intention [to
realize
to best advantage] on his behalf more efficiently in order to
protect the interests of himself, his wife, and more especially his

children.’30
Trollip JA, also relying on Simon’s
Taxes31
and on Berea West
said that the principle to be distilled was that:32

‘[I]f a trust is formed for the purpose of
facilitating the realization of property and the trust does no more
than act as the means
whereby the interests of its beneficiaries may
be properly realized in the property, surpluses made from sales of
the property
are not taxable as trading profits since such surpluses
are capital receipts. That statement is particularly apposite to the
present
case. In other words the trust here was purely a realization
trust to which the principles expounded in the Berea
West case are applicable.’

[49] The distinction between cases
where an asset is transferred to a company from a single source for
the sole purpose of realizing
it, on the one hand, and Berea
West and Malone
on the other, is that in each of the latter cases there was a real
justification for the formation of the company or trust (in
addition
to the purpose of realizing the assets). First, more than one person
transferred the assets to the interposed entity (as
in Holmes JA’s
example of A, B and C); and second, without the interposition of a
company or trust, realization would have
been difficult if not
impossible.

[50] So too, the cases discussed in
Simon’s Taxes,
referred to by Holmes JA in Berea
West33
are instances of interposition of another entity in order to achieve
a purpose over and above the realization of property. In Rand
v Alberni Land Co Ltd34
a new entity was required to facilitate the sale of property
previously held by different people. In Inland
Revenue Commissioners v Westleigh Estates Co Ltd35
the purpose was to consolidate and conveniently administer the
interests of beneficiaries under different wills. In Commissioner
of Taxes v The Melbourne Trust Ltd36
a company was formed to facilitate the sale of assets belonging to
three banks for the benefit of their respective creditors. These
are
but examples.

[51] In a more recent case in the
Supreme Court of Canada, Balstone
Farms Limited v Minister of National Revenue,37
an elderly couple
had owned farm land, let under crop leases, for many years. They
decided to sell the land, at a profit, to a company
for the purpose
of selling it, though it was anticipated that it would continue to be
farmed for a period and this object was set
out in the letters patent
of the company. The court held that on the evidence, the real purpose
in incorporating the company was
to acquire the farm land with a view
to selling it.

[52] The company gave several options
on the lands to prospective purchasers: when these were not exercised
the company retained
option payments. In due course the property was
sold. The Minister assessed both the receipts of option payments and
the proceeds
of sale for tax. The company, on appeal to the Supreme
Court, relied inter alia on Rand
v Alberni Land Co Ltd,38
arguing that it had been formed as a realization company for the
purpose of disposing of capital assets. The court rejected the

argument.39
That case, it said, quoting from the judgment of Rowlatt J, had ‘done
no more than provide the machinery by which the private
landowners
were enabled under the peculiar circumstances of their divided title,
to properly realise the capital of the property
. . . and that is not
income or proceeds of trade’.

Judson J in Balstone40
added:

‘In none of these realization cases was there an out and out
transfer by former owners for a cash consideration. . . . [Balstone]

was not “realizing” or selling these properties for the
benefit of prior owners or the creditors of prior owners. The
facts
speak for themselves and fully justify the finding of fact of the
learned trial judge. The company was selling on its own
behalf to
make a profit . . . .’

Did Founders Hill acquire capital assets or
stock-in-trade?

[53] Founders Hill was not merely
AECI’s alter ego. It was formed solely for the purpose of
acquiring the property and then
developing and selling it at a profit
and I see no reason then why the property was not stock-in-trade.
This is apparent from
the terms of the memorandum of association and
was confirmed by the minutes of the board of directors and the
witnesses as well
as the manner in which it dealt with the
properties. As I have said, the mere fact that Founders Hill said
that it acquired the
properties as capital assets did not make them
such. Founders Hill was no different, I think, from Balstone. Its
business was
to develop the erven and sell them. Its intention in
acquiring was different from that which AECI had had, at least
originally,
to hold its surplus land as a capital investment.
Founders
Hill’s profits were gains ‘made by an operation of
business in carrying out a scheme for profit-making’
and
therefore revenue derived from capital productively employed and must
be taxable income.
Counsel for Founders Hill could not explain why it was formed, and
AECI assets sold to it, other than on the basis that AECI had
taken
legal advice to this end. That is not an explanation. And the case
does not fall within the exception recognised on the special
facts of
Berea West
where the realization of the property was not the main purpose of the
interposition of the trust but a subsidiary one, or where,
in the
example of Holmes JA, three parties form a company to enable them to
realize their properties to their best advantage. Special
cases do
not create general rules.

[54] I therefore consider that Founders Hill acquired
the property as stock-in-trade and then conducted business in trading
in the
property and that the profits made were taxable as income. The
Commissioner’s assessments in the tax years 2000 and 2001 were

thus correct. I see no reason, however, to impose penalty interest in
terms of s 89 quat of the Act. Founders Hill acted on legal
advice
and in the mistaken belief that as a realization company it was doing
no more than selling its property to best advantage.
It disclosed all
the facts in its tax returns. And in previous tax years the
Commissioner had not assessed it for tax on the profits
made on sales
of erven.

Costs

[55] The appeal record did not comply with the rules of
this court, and at least half of it was not necessary for the
determination
of the appeal. The Commissioner may not, therefore,
recover 50 per cent of the costs of preparing, perusing and lodging
the record.

Order

[56] 1 The appeal is upheld with costs, including those
of two counsel, but excluding 50 per cent of the costs of preparing,
perusing
and lodging the appeal record.

2 The order of the Tax Court, Johannesburg is set aside.
It is replaced with the following order:

‘The appeal is upheld to the extent only that the
appellant is not liable for the payment of interest in terms of s 89
quat of the
Income Tax Act 58 of 1962.’

_____________

C H Lewis

Judge of Appeal

APPEARANCES:

APPELLANTS: A R BHANA SC (with him C DREYER)

Instructed by

The State Attorney

Johannesburg

The State Attorney

Bloemfontein

RESPONDENTS: S F DU TOIT SC (with him H V VORSTER)

Instructed by

Vorster Perreira Attorneys

Sandton

Naude’s Attorneys

Bloemfontein

1
C Suetonius Tranquillus ‘The Lives of the
Twelve Caesars’ XXXI and XXXII (trans Alexander

Thomson).

2
Natal Estates Ltd v Secretary for Inland
Revenue 1975 (4) SA 177 (A).

3
Commissioner of Taxes v Booysens Estates Ltd
1918 AD 576 at 580. See also Overseas
Trust

Corporation Ltd v Commissioner
for Inland Revenue 1926 AD 444 at
452-3, and Commissioner for

Inland Revenue v
Pick ‘n Pay Employee Share
Purchase Trust [1992] ZASCA 84; 1992 (4) SA 39 (A) at
46A-52B,

where there is a comprehensive
analysis of the cases dealing with the distinction.

4
Californian Copper Syndicate v Internal Revenue (1904) Sc
(Court of Session) LR 691 at 694.

5
The transactions in question did not attract
capital gains tax, introduced by the Taxation Laws

Amendment Act 5 of 2001.

6
Commissioner of Taxes v Booysens Estates Ltd
1918 AD 576 at 595.

7
Commissioner for Inland Revenue v Stott
1928 AD 252 at 263. See also Commissioner
for Inland

Revenue v Malcomess Properties
(Isando) Pty Ltd [1990] ZASCA 163; 1991 (2) SA 27 (A) at
34H-I.

8
John Bell and Co (Pty) Ltd v Secretary for
Inland Revenue 1976 (4) SA 415 (A) at
428E-F.

9
Californian Copper Syndicate v Internal
Revenue (1904) Sc (Court of Session)
LR 691 at 694.

10
Natal Estates Ltd v Secretary for Inland
Revenue 1975 (4) SA 177 (A).

11
At 202G-203B.

1212
1975 Annual Survey
of South African Law p 517.

13
Commissioner for Inland Revenue v
Richmond Estates (Pty) Ltd 1956 (1) SA
602 (A) at 610C-D.

13

1414
Malan v Kommissaris van Binnelandse Inkomste
1981 (2) SA 91 (C) at 96E-G.

15 See also ITC 1185 35
SATC 122 at 123-4, where Miller J said much the same: his dicta were
relied

on by E M Grosskopf J in Malan.

16 For criticism of
reliance on intention alone see Gavin Urquhart ‘Capital v
Revenue: Some Light in the

Darkness?’ 1979 Acta
Juridica p 299.

15

16

17
There are earlier decisions in the Southern
Africa tax courts, most notably Realisation
Company v

Commissioner of Taxes
1951 (1) SA 177 (SR), referred to by this court in Berea
West, below.

18
Berea West Estates (Pty) Ltd v Secretary for
Inland Revenue 1976 (2) SA 614 (A).

19
At 627H.

20
At 628A-E.

21
At 634F.

22
Para 3.16.

23
Page 176.

24
At 631E-G.

25
A quotation from Overseas
Trust Corporation Ltd v Commissioner for Inland Revenue
1926 AD 444

at
453.

26
ITC 1481 52 SATC 285 (Eastern Cape Special
Court).

27
Above at 694.

28
See the analysis of the passage by Nicholas AJA
in CIR v Pick ‘n Pay Employee
Share Purchase

Trust
[1992] ZASCA 84; 1992 (4) SA 39 (A) at 49E-I.

29
Malone Trust v Secretary for Inland Revenue
1977 (2) SA 819 (A).

30
At 828A-C.

31
Third edition pB1.214.

32
At 828B-D.

33
At 628D-629H.

34
Rand v Alberni Land Co Ltd
(1920) TC 629 (KB).

35
Inland Revenue Commissioners v Westleigh
Estates Co Ltd [1924] KB 390.

36
Commissioner of Taxes v The Melbourne Trust
Ltd 1914 AC 1001 (PC).

37
Balstone Farms Limited v Minister of National
Revenue [1968] SCR 205.

38
Above.

39
The Chief Justice, Cartwright CJ, dissented.

40
At 212-213.