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Realisation of trading stock is not capital

12 June 2012   (1 Comments)
Posted by: SAIT Technical
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By Dirk Kotze (MoneyWebTax)

A recent Supreme Court of Appeal case decision once again brought the use of "realisation companies" in selling capital assets to the fore. Much has been said and written about the judgement, however, is the whole argument relating to a realisation company not mooted by the definition of trading stock in the Income Tax Act?

In the past, the courts held that realisation companies that dispose of assets do not do so in a scheme of profit making and therefore the income generated was not subject to tax (pre-capital gains tax). The reasoning was that realisation companies would normally acquire an asset from a related party who held the asset as a capital asset, with the intention of selling it to its best advantage.

However, where realisation companies did more than just realise the sale of the capital asset its profits were regarded as gross income. This was where the realisation company entered into transactions and steps to aggressively market and develop the asset to attract buyers, i.e. the realisation company did more than just sell the asset as best it could but started trading with the asset.

In the recent case, the realisation company acquired the property with the express purpose of selling it to its best advantage. It then subdivided and developed the land and disposed of the subdivided portions to third parties.

The court found in favour of Sars which taxed the company on the sale as being gross income, whereas the company argued that the gains made are capital in nature.

Sars apparently accepted that the company was a realisation company, but contended that it did more than just realising the asset by subdividing and developing the land to the extent that it did.

Sars' argument would seem to suggest that it would still accept an argument involving a realisation company if it acted within the parameters that Sars would consider acceptable, and did not cross over into a scheme for making profit.

Section 1 of the Act contains the definition of trading stock, which expressly contains the provision that trading stock includes anything purchased, or in any manner acquired, for the purpose of sale.

What else does a realisation company do? It acquires something for the purpose of resale. Surely, by definition that ‘something' will therefore meet the definition of trading stock as defined in section 1 of the Act.

There can also not be an argument of interpretation as that part of the definition is probably one of the most understandable passages in the whole Act, and contains the least ambiguity.

In conclusion, a realisation company cannot be said to acquire anything other than trading stock if what it acquires is for the purpose of resale. Tread carefully therefore if a realisation company forms part of your immediate or planned future structure, as the arguments in favour of a realisation company may be nipped in the bud.


Stephene Sathiga says...
Posted 15 June 2012
I strongly suggest that the ITA should be reviewed to address the loophole around realisation companies. It is confusing because what would be regarded as selling to the best advantages without aggresively markerting the asset to lure best selling price? if realisation company frequently do just that, then to me it is embarked in a scheme of profit making and revenue is thus subject to nomal income tax


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