Trading stock acquired for no consideration (ITC 1851 73 SATC 241)
30 September 2011
Posted by: SAIT Technical
Trading stock acquired for no consideration
By Adv J Silke
In ITC 1851 73 SATC 241 the Eastern Cape Tax Court had to consider whether trading stock had been acquired for no consideration as envisaged in s 22(4) of the Income Tax Act 58 of 1962.
The facts were that the appellant company had purchased ABC (SA) (Pty) Ltd, a company that had been established in South Africa in 1937 and had initially specialised in the manufacturing of square, zinc batteries but which was not generating the anticipated return.
The appellant purchased the ABC zinc battery business for a purchase consideration of R80 million and in terms of the agreement of sale concluded between the parties as reflected in Schedule 6 thereof the inventory relating to that part of the business had been allocated a nil value. Section 22(4) of the Income Tax Act provided that if any trading stock has been acquired by any person for no consideration or for a consideration which is not measurable in terms of money, such person shall be deemed to have acquired such trading stock at a cost equal to the current market price of such trading stock on the date on which it was acquired by such person.
The appellant, in its income tax and financial statements for the year of assessment ended 30 June 2004, had contended that trading stock with a market value of R105 532 719 had been acquired from the seller for no consideration and accordingly claimed a deduction of the amount as aforesaid in terms of s 22(2) read with ss 22(3) and 22(4) of the Act.
The respondent, being the Commissioner for SARS, had initially allowed no deduction in respect of trading stock although he subsequently had allowed a deduction of R21 562 918, not in terms of s 22(4) of the Act but in respect of what he contended was the consideration given and, in addition, he had imposed interest in terms of s 89quat(2) of the Act in the amount of R7 750 628, 17. The respondent had disallowed the appellant’s objection to its assessment, hence its present appeal to the Port Elizabeth Tax Court.
The only issues which fell for adjudication in the Tax Court were –
• Whether the trading stock acquired by the Appellant from the seller in terms of the aforementioned agreement had been acquire for no consideration as envisaged in s 22(4) of the Act; and
• Whether, in the event of a finding adverse to the appellant on the first issue, it had nonetheless established reasonable grounds as envisaged by s 89quat(3) of the Act to be absolved from paying interest levied in respect of the underpayment of provisional tax in terms of s 89quat(2) of the Act.
The respondent, in response to the appellant’s request for reasons following the disallowance of the deduction claimed in the sum of R103 532 719, and in conformity with its obligations in terms of Rule 3(1)(a) of the Rules regulating objections, had articulated its position under the rubric ‘A. Inventory Deduction Disallowed.’
The respondent contended that s 22(4) of the Act was not applicable to ABC in the circumstances as the trading stock had not been acquired ‘for no consideration or for a consideration which is not measurable in terms of money’ and, furthermore, the liabilities assumed by ABC represented the consideration given for the trading stock. The appellant contended that ex facie the agreement itself, it was manifestly clear that no consideration had been given for the trading stock and, furthermore, Schedule 6 to the agreement constituted irrefutable proof that no such consideration had been given.
The respondent contended, however, that on a proper analysis of the agreement, it was clear that the ‘inventory’ to which Schedule 6 allocated no value, in fact constituted the trading stock. Moreover, certain clauses in the agreement clearly established that the inventory constituted the trading stock, e.g. that the parties will cause a stocktaking to be conducted on the day prior to the effective date of all the inventories and display inventories in accordance with certain specific provisions and the value of the inventories shall be determined on the basis of the lower of market value or cost as was consistent with previous practice.
The appellant tried to adduce oral evidence relating to the negotiations that preceded the conclusion of the agreement of sale in order to place a particular interpretation thereon, i.e. it attempted to establish that ABC was so desirous of disposing of its South African operations that it concluded the sale of the business irrespective of the substantial losses that it would incur and hence the trading stock was in effect donated to the appellant. Chetty J, who delivered the judgment of the court, stated that on a proper analysis of the agreement of sale the ‘inventory’ to which Schedule 6 thereto allocated no value in fact constituted the trading stock and certain clauses of the agreement clearly established that the inventory constituted the trading stock, i.e. clauses 1.2.17, 5.5, 8, 11 and 12 provided further indiciae that a proportion of the R80 million and a proportion of the liabilities in respect of the purchase of the trading stock constituted consideration for the acquisition of the stock.
The court continued that the entire edifice of the appellant’s case was predicated upon Schedule 6 which had assigned a nil value to inventory and display inventory but such assignation was of little probative value and the arbitrary allocation of the purchase price did not establish that no consideration was given for the trading stock and the sale agreement itself proved the contrary. Moreover, appellant’s reliance on the judgment in KPMG Chartered Accountants (SA) v Securefin Ltd and Another 2009 (4) SA 399 (SCA) was entirely misplaced in that the parol evidence rule remained part of our law even though it is frequently ignored by practitioners and seldom enforced by trial courts; If a document was intended to provide a complete memorial of a jural act, extrinsic evidence may not contradict, add to or modify its meaning and in casu the parol evidence rule prevented the appellant from adducing oral evidence relating to the negotiations which preceded the conclusion of the agreement of sale.
Accordingly, upon a proper analysis of the agreement consideration had been given for the trading stock as contended for by the respondent and the appellant’s reliance on the provisions of s 22(4) of the Act was entirely misplaced. Objectively, the appellant’s conduct was reasonable and consequently no interest was to be payable for claiming the deduction as envisaged in s 89quat(3) of the Income Tax Act.