Incentive Shares: Capital or Revenue - Pretoria Tax Court ITC 1849
29 July 2011
Posted by: SAIT Technical
The Pretoria Tax Court in ITC 1849 (to be reported in the South African Tax Cases Reports Vol 73 Part 4) had to consider whether certain shares acquired by the taxpayer in an employees’ share incentive scheme were trading stock or a capital asset.
The taxpayer, having exercised his rights in connection with certain share options and having acquired certain shares whose market value had subsequently declined, had taken the view that the shares in issue had constituted ‘trading stock’ in his hands.
The court also had to consider whether the taxpayer’s membership fees paid to the South African Institute of Chartered Accountants could be claimed as a necessary trade expense. The facts were that the taxpayer, during the year of assessment in issue, had been employed by the N Group Holdings (‘N’) as a director and N had introduced a scheme known as the N Employees Share Incentive Scheme to reward and retain the best performing employees. The taxpayer, in furtherance of the objectives of the aforementioned share incentive scheme, had been issued with 100 000 share options in 2003 for R2,67 per share and, again in 2004, he had been issued with a further 75 000 share options by N for R4,36 per share. The taxpayer, during May and June 2007, had exercised his rights in connection with the share options and he had acquired 100 000 shares and also had acquired one tranche of 15 000 issued to him in 2004 and on 1 June 2007 he had acquired a further tranche of 15 000 shares that were issued to him in 2004. At the date of the taxpayer’s acquisition of the shares in issue the market value or share price had been R14,68 and R15,58 per share respectively.
The market value of the shares, at the end of the 2008 year of assessment, had declined and they were trading at R9,57 per share. The taxpayer, in the 2008 year of assessment, in the light of the decline in the share price, had taken the view that the shares in issue had constituted ‘trading stock’ in his hands and, as a consequence of the aforementioned view, he took the market values of the shares at the acquisition date as R14,68 and R15,58 respectively as representing the balance of the opening stock and took the market value at the end of the 2008 tax year (R9,57) as the closing balance of the trading stock and, as a consequence thereof, he claimed as a notional deduction, an amount totalling R677 800, being the difference between the listed share price on the acquisition date (May and June 2007) and the share price at the end of the 2008 tax year.
The respondent, being the Commissioner for SARS, had disallowed the taxpayer’s claim for the deduction of the aforesaid amount on the grounds that he was a salaried employee and did not carry on a trade as a share dealer and, accordingly, he did not incur any loss and the shares were not trading stock.
The Commissioner further contended that even if it were to be held that the shares constituted trading stock, the values that had to be taken into account were the cost price/amount actually paid for the shares at the acquisition date(R2,54 and R4,36) and the values at the end of the tax year, and, accordingly, the taxpayer did not incur any loss. The taxpayer, pursuant to the disallowance of the objection, lodged an appeal to the disallowance of the objection. The taxpayer’s evidence revealed that he had decided to look into the share options offered to him as he was aware that the market was very buoyant at that stage and he considered that he could possibly make a ‘quick buck’ if he bought and sold at the right time and it was common cause that he could have bought them and resold immediately and still have made a profit as he had obtained them at a bargain price.
The taxpayer had also referred to comment in the financial press on the shares’ performance which had indicated ‘that a further growth in price of up to 30% was expected’ and it was due to that sentiment that he had bought the shares in issue and he was very clear in his evidence that he had bought for no other reason than to resell when the shares went up even further and he was expecting them to go up to R18 per share. However, the facts were that almost immediately after he bought the shares the economy and the stock market had crashed and he was not in a position to sell and realise a profit – at least not to the extent that he had expected and it was common cause that he did not sell any of the shares during the rest of the tax year as, in his words, he clearly wanted a higher profit margin.
The taxpayer had also claimed a deduction in respect of his membership fees of the South African Institute of Chartered Accountants (SAICA) on the basis that he undertook outside consulting work, ie beyond his normal employment and in order to be able to do that he had to be a member of SAICA and he claimed his membership fee as a necessary trade expense. The Commissioner for SARS, at the appeal, conceded this claim. RD Claassen J, who delivered the judgment of the court, stated that the court had to decide whether the taxpayer could be classified as a trader for purposes of the transaction in issue. It was common cause between the parties that a once-off venture could classify as a trade for purposes of the definition of a trade or stock in trade and shares per se were certainly capable of being such stock in trade. The court noted that the true nature of each transaction had to be enquired into in order to determine whether it was capital or revenue and the purpose of the expenditure was an important factor and often decisive in assessing whether it was of a capital or revenue nature – BP Southern Africa (Pty) Ltd v C: SARS 69 SATC 79.
The court noted further that the taxpayer was not one who had invested to any relevant measure in shares as capital assets and the evidence was clear that this was a once-off trade where he saw an opportunity to make (a rather big) profit. Moreover, if the Commissioner’s view, viz that because the taxpayer did not sell the shares in that tax year he was not a trader, was to be upheld, it could lead to the assumption that stock must be sold within the same year of acquisition in order to qualify as stock in trade but that could never be the position and, in fact, the Income Tax Act provides specifically how stock in trade, not sold during the year of acquisition, was to be dealt with. In view of the taxpayer’s uncontested evidence, together with the common cause facts, and the fact that a ‘trade’ can consist of a single ‘venture’, it was the court’s finding that the taxpayer’s appeal had to be allowed and that the acquisition of the shares became stock in trade.
The issue as to whether the taxpayer in fact had incurred a trade loss (ie a notional loss) had not been properly aired during the hearing and the matter had to be referred back to the Commissioner to make a revised assessment in view of this judgment.
The taxpayer’s SAICA membership fees were a deductible expense for purposes of income tax. In the result the appeal was upheld.