Deducting A Trading Loss
01 November 2009
Posted by: Author: Steven Jones
Deducting A Trading Loss
In what appears to be a complex set of facts, intention once again emerges as the dominant factor
When it comes to the whole "capital vs. revenue” argument, one of the main factors that are taken into account is the taxpayer’s intention at the time of acquisition.This means that, for example, if you make an investment with the intention that such investment is for the long term, the proceeds upon eventual disposal thereof will be treated as capital.
In the event of a loss, the investor would be left with a capital loss which can only be set off against any future capital gains.The trader would however want to deduct the loss against their normal taxable income. Unfortunately for many taxpayers, whenever a particular tax treatment of a transaction puts the taxpayer in what appears to be a better position,tax-wise, than an alternate treatment thereof, you can be sure that the South African Revenue Service (SARS) will raise their eyebrows.
A recent court case (Anglovaal v SARS (411/08)  ZASCA109), in which judgement was delivered on 22 September 2009,highlighted this particular problem.In 1994 the taxpayer, which was then known as Anglovaal Limited,had a mining division, as well as an industrial division which included a 60% shareholding in Anglovaal Industries Limited (AVI). One of AVI’s subsidiaries was National Brands Limited in which it had a 97.7% shareholding.
In addition to its mining and industrial interests, the taxpayer was an active trader in shares, such shares not being regarded as strategic long term assets, and the object thereof being to make money by speculative investment.On 21 April 1994 NBL purchased a snack food business trading as ‘Willards Foods’,funding the acquisition by acquiring a 15.6% shareholding in NBL for the amount of R300 million. It in turn acquired the funds by issuing ordinary shares to foreign investors.
In early 1998 an investment bank advised Anglovaal Limited to separate the mining from the industrial companies. This was implemented by changing its name to Anglovaal Mining Limited and transferring its shares in AVI to another holding company.At the same time the taxpayer decided to sell the NBL shares held by it to AVI.
The sale, which took place during the 1999 tax year, left the taxpayer as a purely mining investment company. It also resulted in a loss of R159 702 919 which the taxpayer sought to deduct as a loss against its trading income.The reason for claiming such a deduction was that the NBL shares were originally acquired for speculative purposes. NBL was at the time ear marked for a separate listing on the Johannesburg Stock Exchange, and the taxpayer was hoping to make a profit from such listing.
However, NBL’s profit performance after acquiring Willards Foods deteriorated so sharply that the planned listing did not take place.For this reason, the taxpayer argued, the loss arising from the sale of NBL to AVI should be allowed as a deduction.Naturally, SARS saw things differently and disallowed AVI’s claim.
The taxpayer’s argument was based on the fact that AVI had along history of acquiring certain shares for speculative purposes—a practice that dated right back to the group’s formation in 1933.At each executive committee meeting, there was an agenda item covering the possible purchase and sale of investments for speculative purposes.
The taxpayer (being Anglovaal Mining) also claimed that it was not their normal practice to acquire direct investments in a subsidiary—this normally took place within AVI. However, the fact that this transaction took place shortly before South Africa’s first democratic election made this an opportunity too good to pass up,what with the prospect of improved international sentiment towards South Africa.This, together with the intended listing of NBL, made a decent short-term profit a distinct possibility.
A further reason for housing the transaction within Anglovaal Mining was that as South Africa’s investment prospects became more attractive, international investors would be looking to acquire mining assets rather than those indiversified industrial companies.This would make access to funds to finance the transaction easier than if it was done via AVI.The fact that NBL’s profits took a severe turn for the worse was the reason why the proposed listing did not take place.
On the other hand, the Tax Court relied on what it saw as certain pointers to the transaction being of a capital nature. One of these was that the fact that the taxpayer’s 98% shareholding in NBL in 1994 (when it was still Anglovaal Limited) was a "strategic long-term investment of a capital nature”. That may be so,argued the taxpayer, but even though the shares now housed within AVI after the 1998 restructure were seen as a long-term strategic investment by AVI,this did not mean that the direct holding of shares in NBL by the taxpayer (now Anglovaal Mining)represented the same long-term intention.On the contrary, argued the taxpayer, there was never any intention for Anglovaal Mining to hold shares in NBL on a long-term basis.
The fact of the matter is that the taxpayer, prior to the acquisition of Willards, had held all of its long term strategic interests in AVI.Any direct holdings (apart from its 60% holding in AVI at the time)were considered to be speculative,short-term investments.SARS then further argued that,if it were to concede that the loss were to be allowed, it should have been in the 1994 year of assessment, being the year that the shares were originally acquired.
The mechanisms surrounding this argument are however beyond the scope of this article, but suffice to say that the SCA rejected this argument by SARS.The SCA therefore found, on a balance of probabilities, that the facts presented point to the investment in NBL by the taxpayer being of a short-term, speculative nature, and ordered SARS to revise the 1999 assessment on the basis that the loss of R159 702 919 should be allowed as a deduction from the taxpayer’s taxable income.
Source: By Steven Jones (Tax breaks)