Far reaching judgement may cause upsets for property sales
05 June 2011
The Supreme Court of Appeals recently delivered two far-reaching judgments, with detrimental consequences for the taxpayer. The latest case, delivered in May has far reaching consequences for companies wanting to sell unused land.
The first, on 1 December 2010, was the NWK case and the most recent on May 10 2011, was the Founders Hill case. Neither judgment was in the taxpayer's favour, and there is a growing fear that a new trend has started at the Supreme Court of Appeal against the taxpayer. In the NWK case, more than a century worth of good precedent was strangely interpreted to arrive at a judgement against the taxpayer.
In the Founders Hill case, alarm bells should be ringing for companies that want to sell off tracts of land they've historically owned. Sars successfully taxed the proceeds on sale of the property as income and not capital, with dire consequences for the taxpayer.
In the latest case, the long-standing principle that if a company sets up a so-called realisation company in order to sell off land or property, the proceeds of the sale will be capital in nature, and thus subject to capital gains tax, if any, was overturned. But worse, the court said that the formation of a realisation company was as good as ensuring the proceeds upon sale of the property would be revenue in nature and taxed at the full corporate tax rate.
The facts of the case are that the company, AECI, owned large portions of land in the Modderfontein area in Johannesburg, where it also operated an explosives factory. Because of changes in technology and processes, the company no longer needed so much land. So it formed a so-called realisation company, Founders Hill, to which the properties were sold with the purpose of re-selling them for housing purposes. SARS taxed the proceeds of the sale of the properties as income, not capital, and AECI appealed to the Supreme Court of Appeals.
What the court had to decide is whether the formation or use of a realisation company for the sale of property results in the proceeds being of a capital nature. There are many examples in history where realisation companies were used to sell land and thereby ensured that the proceeds would be of a capital nature. The most famous of the realisation company cases is Berea West Estates read in 1976, in which the court of appeal found that the use of a realisation company in the circumstances did ensure that the proceeds on sale of property were of a capital nature.
Some academic writers have also created the impression that the use of a realisation company should secure the income from the sale of property as capital. Legal and tax advisors have also followed suit, advising clients to set up realisation companies when companies need to sell land owned by them, which would secure the proceeds as capital in nature.
But Founders Hill has changed all that. What the court said is that the use of a realisation company will only ensure that the proceeds of a sale are of a capital nature in limited circumstances. In all other cases, the use of a realisation company is likely to give rise to income of a revenue nature and therefore would be fully taxable. In fact, the judgment went so far as to say that if the sole purpose of the transfer to a realisation company is so that it can realise property, on what basis can it be said that it ever held it as capital?
In other words, if not carefully considered and contrary to what was commonly accepted as the position until this case, the use of a realisation company by taxpayers to sell land can destroy any argument that the property was sold for capital account.