She would buy a residential property and live in it while she refurbished it and put it back on the market a few months later. Having sold it at a gain, she would buy another property and repeat the process. This went on to the point where she had bought, refurbished and sold five properties in four years, in each case using the primary residence exclusion to avoid paying tax on her gains. In each instance both the purchase price and selling price were below R2 million.

Her new tax consultant was concerned when she saw the taxpayer’s property dealing history and warned her that SARS could decline to allow her the primary residence exclusion on the grounds that her conduct amounted to a trade. The taxpayer was adamant that so long as she ticked the primary residence box on her annual tax return, which she was entitled to do because she at any particular time owned only one property, in which she resided, it was axiomatic that the exclusion applied. Therefore whenever she sold a property it was her primary residence and she was entitled to the exclusion.

The tax consultant said she would decline to tick the primary residence box on the taxpayer’s tax return, because she was concerned that this was an offence under the Tax Administration Act (TAA). It was possibly fraud, certainly misrepresentation, and non-disclosure of material facts. She was concerned about being seen to collude with the taxpayer in committing a tax offence. Not only would she be exposed to sanctions by SARS, but her Recognised Controlling Body (RCB) would be likely to take a dim view of her action. She warned the taxpayer that, should SARS at any time challenge her claim for the primary residence exclusion, SARS could reopen previous assessments for as far back as the taxpayer been conducting this activity. The three year prescription period for assessments does not apply where there has been fraud, misrepresentation, or non-disclosure of material facts.

The taxpayer poured scorn on the tax consultant’s opinion, which she described as off the wall, misguided and ill-informed. In her view, SARS was the tax expert, not the tax consultant, and if SARS accepted her claim for the exclusion it was no business of the tax consultant to second guess SARS. Needless to say, the taxpayer and the tax consultant parted ways.

Who is correct in this situation? Has the tax consultant acted correctly in terms of the tax legislation?

Gross income is defined in section 1 of the Income Tax Act as the total amount, in cash or otherwise, received by or accrued to or in favour of a person, excluding receipts or accruals of a capital nature. When we consider whether a receipt or accrual is capital in nature, and then potentially subject to the provisions of the Eighth Schedule, it is necessary to consider case law, and in particular the question of the intention of the taxpayer. For example, in CSARS v Capstone 556 (Pty) Ltd [2016] 78 SATC 231 ZASCA the Supreme Court of Appeal held that in order for a profit to be revenue in nature “the gain must be acquired by an operation of business in carrying out a scheme for profit-making”. In so finding, the court drew on a long line of decisions. A good example relevant to the taxpayer is Natal Estates Ltd v SIR [1975] 37 SATC 193, where the court found that in determining whether any particular case is one of realising a capital asset or carrying on a business of selling land for profit, the totality of the facts of the case must be considered in their relation to the ordinary commercial concept of carrying on a business or embarking upon a scheme for profit. Considerations will include, inter alia, the intention of the taxpayer both when acquiring and selling the land; the owner’s activities in relation to the land prior to decision to sell, and the light that these considerations throw on the owner’s statements of intention.

In the present matter the taxpayer set about using the primary residence to her advantage and proceeded to acquire, refurbish and sell her primary residences five times in four years. She argued, correctly, that at any particular time she owned one residence and used it as her primary residence. However, paragraph 45 of the Eighth Schedule, after providing in subparagraph (1)(b) that the gain on disposal of a primary residence is excluded from CGT if the proceeds do not exceed R2 million, then provides in subparagraph (4)(b) that subparagraph (1)(b) does not apply to the disposal of a primary residence where the taxpayer “used that residence or a part thereof for the purposes of carrying on a trade”. It is submitted that the tax consultant was correct to conclude that the taxpayer was conducting a trade in acquiring, refurbishing and selling residential properties. It did not avail the taxpayer that at each material time whichever property she then owned was her primary residence. Subparagraph (1)(b) prohibited the exclusion. And the tax consultant was wise to decline the appointment. SARS could report the tax consultant to her RCB under section 241(2) of the TAA, which provides that a senior SARS official may lodge a complaint with an RCB “if a registered tax practitioner has, in the opinion of the official-

• Without exercising due diligence prepared or assisted in the preparation, approval or submission of any return, affidavit or other document relating to matters affecting the application of a tax Act;
• Unreasonably delayed the finalisation of any matter before SARS;
• Given an opinion contrary to clear law, recklessly or through gross incompetence, with regard to any matter relating to a tax Act;
• Been grossly negligent with regard to any work performed by a registered tax practitioner;
• Knowingly given false or misleading information in connection with matters affecting the application of a tax Act or participated in such activity; or
• Directly or indirectly attempted to influence a SARS official with regard to any matter relating to a tax Act by the use of threats, false accusations, duress or coercion, or by offering gratification as defined in the Prevention and Combating of Corrupt Activities Act 2004 (Act 12 of 2004)”

The tax consultant would be vulnerable under all but the last of these if she permitted the taxpayer to claim the primary residence exclusion, on the facts before her. She has therefore acted correctly in declining to act for the taxpayer.

The following facts, published in the tax court judgment as ITC 1867 [2013] 75 SATC 273, were not set out in the High Court judgment but are necessary to an understanding of the matter.

Profurn was a listed company which by 2001 faced imminent liquidation. R600 million of its debt was converted into equity, after which the bank held about 78% of the shares in Profurn. Daun, a German businessman, was introduced in or about June 2002 as a person with the ability to turn the fortunes of Profurn around. He insisted on doing this through the JD Group (JDG), which agreed to take Profurn over in exchange for issuing JDG shares to the bank. The bank received the JDG shares in April 2003, and then sold nearly all of them in equal parts to the taxpayer, which was a special purpose vehicle whose sole function was to hold the shares, and one of Daun’s German companies.

The taxpayer acquired its JDG shares on 5 December 2003, and funded the acquisition of the JDG shares through the issue of preference shares to the bank and by borrowings from shareholders.

By April 2004, five months after the taxpayer had acquired the JDG shares, it sold them to a purchaser.

In the 2005 year of assessment SARS assessed the taxpayer to tax on about R201 million arising from the disposal of shares in JDG Ltd. In addition, SARS disallowed as deductions an amount of about R45 million in respect of an “equity kicker” and R55 million in respect of an indemnity obligation. Finally, SARS imposed interest of over R50 million for underpayment of provisional tax [Para 1]. The tax court had found against the taxpayer on the R201 million but in its favour on the other two issues and directed SARS to remit the interest. Both parties appealed to the extent that they had been unsuccessful.

SARS contended that the taxpayer had not intended to hold the shares in question (shares in JDG) as capital assets and/or for purposes of earning dividends, but rather to dispose of them in the short term in pursuance of a scheme of profit-making. In support, SARS pointed out that the taxpayer had held the shares for less than five months; that the taxpayer had financed the purchase from external sources; and that the taxpayer could not benefit from the dividends from JDG, as these had been earmarked for other purposes. While these are generally among the conditions often invoked to support of profit-making inference, it was open to a taxpayer to rebut this inference in the light of all the circumstances. The court then discussed the circumstances.

The likely liquidation of Profurn threatened to destabilise the whole furniture industry in South Africa. It would also have harmed Steinhoff, a major creditor of Profurn and member of the furniture industry. Profurn’s banker approached Daun to mount a rescue operation. Crucially, as it transpired, in his affidavit to the Competition Commission, which was dated nine days before the taxpayer acquired the shares in JDG, Daun stated that the whole purpose of the scheme was a rescue operation, not a profit-making scheme. This contention was not challenged in cross-examination and was supported by the surrounding facts, these being the parlous state of the retail furniture industry and Daun’s readiness to commit his money and efforts to restoring stability to the industry. Daun insisted on doing so through JDG because it was in his opinion the only competent professional manager in the industry.

It was anticipated that the rescue operation would take three to five years to achieve; there was no short-term intention on the part of anyone involved. A R125 million five-year indemnity was concluded, of which the taxpayer bore R62,5 million; and attempts to raise finance for the transaction were based on a three to five year period. The court saw these factors as indicating a large-scale rescue operation anticipated to require both capital and management expertise, and to take three to five years to complete. Thus the court found, in summary, that the taxpayer’s intention when it acquired the JDG shares was to make a strategic investment in a leading company and to hold them for however long it took to bring Profurn back to health, which was anticipated to take three to five years.

The High Court noted that the arrangement had in fact been implemented in June 2002, even though the taxpayer had acquired its shares in JDG only in December 2003, so the period of the arrangement had commenced on the earlier date. However, in about 2003/2004 the world economy “miraculously” turned around. This fact, together with the takeover by JDG and the “unique turnaround strategy” which was an unqualified success, meant that Profurn recovered far earlier than had been expected.   At the same time, however, the Rand lost value at an alarming rate and Daun decided to reduce his investments in South Arica. Fortuitously, at this time an opportunity arose to dispose of the JDG shares and they were duly sold. The taxpayer, as a junior partner in the arrangement, had no say in this decision.

In respect of the taxpayer’s 2005 year of assessment, the taxpayer accounted for the proceeds on the disposal of the JDG shares as being of a capital nature.

The High Court took the approach that, despite the objective facts pointing to the taxpayer having sold the JDG shares shortly after acquiring them, and by making use of short-term finance, “[T]he taxpayer’s explanation of the events, including his or her intention in respect of the transaction in question, is therefore relevant and must be tested in the light of all the other circumstances”. “[I]t would be an over-simplification to focus too closely on the bare facts…in drawing an inference as to the intention of the taxpayer”.

The court noted further objective factors that pointed in the direction of the taxpayer having acquired and held the shares as capital assets:

• as a special purpose vehicle, the taxpayer was contractually precluded from doing anything other than acquiring and holding the shares;
• in its financial statements the taxpayer reflected the shares as non-current assets; and
• the taxpayer conducted no trade and did not even hold board meetings.

The taxpayer’s appeal, on this point, was accordingly upheld.

The taxpayer’s liability for the “equity kicker” arose from an agreement between the taxpayer’s holding company and Gensec, which had provided the funding for the arrangement. Gensec was entitled, in addition to interest on the loan, to a share of any profit yielded by the investment. SARS opposed the deduction of this expense by the taxpayer on the grounds that it was the holding company’s obligation, not that of the taxpayer. The High Court rejected this submission and concurred with the tax court’s finding that it was actually the taxpayer that had incurred the obligation.   Based on its finding that the shares had been capital assets in the hands of the taxpayer, the High Court then categorised the expense as a “borrowing cost”. Because JDG was a listed company, the court applied the provisions of paragraph 20(2) of the Eighth Schedule to the Act and concluded that one third of the expense should be added to the base cost of the shares.

The court then turned to the indemnity payment. The taxpayer had in July 2004 assumed an unconditional liability to one of Daun’s companies in an amount of R55 million. This was recorded in the taxpayer’s books as a loan. The question to be answered was whether this obligation could be seen as part of the cost of acquiring the JDG shares. The High Court agreed with the tax court’s conclusion that this was a different matter unrelated to the acquisition of the shares. The expense was therefore disallowed.