Judgment was delivered by Acting Judge of Appeal, Boruchowitz AJA in the Supreme Court of Appeal ("SCA") ((132/11)  ZASCA 61) between the Commissioner for the South African Revenue Service ("Commissioner") and Tradehold Limited ("Tradehold") on 8 May 2012.
The respondent, Tradehold, is a South African incorporated investment holding company which is listed on the JSE Limited. Briefly, the facts were that, on 2 July 2002, at a meeting of Tradehold's board of directors in Luxembourg, it was resolved that all further board meetings of the company would be held in Luxembourg. This had the effect that, as from 2 July 2002, Tradehold became effectively managed in Luxembourg. Tradehold, however, remained a resident of South Africa for tax purposes, notwithstanding the relocation of its effective management to Luxembourg, by reason of the definition of the term "resident" in section 1 of the Income Tax Act No. 58 of 1962 ("Act") as it applied at that time, due to its incorporation in South Africa. This definition was amended, with effect from 26 February 2003, resulting in Tradehold ceasing to be a "resident" as envisaged in the definition in section 1 of the Act.
Relying on the provisions of paragraph 12 of the Eighth Schedule to the Act, the Commissioner contended, inter alia, that upon relocation of Tradehold's effective management to Luxembourg on 2 July 2002, or in the alternative, as a result of the amendment of the definition of "resident" on 26 February 2003, Tradehold was deemed to have disposed of all its assets, comprising its shareholding in Tradegro Holdings Limited, its wholly owned subsidiary, resulting in a capital gain being realised in the 2003 year of assessment in an amount of R405,039,083.
Tradehold successfully appealed to the Tax Court against the additional assessment raised by the Commissioner in this regard. The Tax Court relied on Article 13(4) of the Double Tax Agreement entered into between South Africa and Luxembourg ("DTA"), which provides that "gains from the alienation of property other than that referred to in paragraphs 1,2 and 3, shall be taxable only in the Contracting State of which the alienator is resident." The Tax Court held that, since none of the exceptions in Article 13 were applicable, and did not accept the Commissioner's argument that a deemed disposal of property should not be treated as an alienation of property for purposes of Article 13(4). Tradehold's appeal was upheld on this basis.
The issue before the SCA was, inter alia, whether a deemed disposal as contemplated in paragraph 12 of the Eighth Schedule to the Act constitutes an "alienation" as contemplated in Article 13(4) of the DTA.
In upholding the decision of the Tax Court, Acting Judge Boruchowitz stated that a DTA modifies the domestic law and will apply in preference to domestic law to the extent that there is any conflict. In considering whether the term "alienation" as used in the DTA includes gains arising from a deemed (as opposed to actual) disposal of assets, the SCA held as follows:
- the term "alienation" should be given a meaning that is congruent with the language of the DTA having regard to its purpose;
- on the basis that Article 13 of the DTA has a wide ambit and applies in respect of capital gains derived from the alienation of all property, it is reasonable to suppose that the parties to the DTA were aware of the provisions of the Eighth Schedule and must have intended Article 13 to apply to capital gains of the kind provided in the Eighth Schedule;
- it is of significance that no distinction is drawn in Article13(4) between capital gains that arise from the actual or deemed alienations of property; and
- there is no reason in principle why the parties to the DTA would have intended that Article 13 should apply only to taxes on actual capital gains resulting from actual alienations of property.
The SCA accordingly found that the term "alienation" as used in the DTA is not restricted to an actual alienation, but is rather a neutral term having a broader meaning, including deemed disposals of assets giving rise to taxable capital gains. On this basis, the SCA held that from 2 July 2002, when Tradehold relocated its seat of effective management, the provisions of the DTA became applicable and Luxembourg accordingly had exclusive taxing rights to Tradehold's capital gains.
This judgment prompted the Minister of Finance, Pravin Gordhan ("Minister") to issue a statement in respect of the judgment on 9 May 2012. The Minister states therein that the capital gains tax system has, since its inception in 2001, been based on the principle that South African residents were taxed on all of their assets, irrespective of where these assets were located. Therefore, whilst it would be unfair to tax a resident's capital gains accumulated before the taxpayer became a resident, equally, not taxing capital gains accumulated while a taxpayer was a resident would be unfair. He further states that the SCA judgment that a double taxation agreement (DTA) applied to a deemed disposal and thus did not allow for an exit charge, appears to disturb the balance that has been achieved. The Minister concludes by stating that National Treasury is studying the judgment and that, if necessary, it would propose amendments to the tax laws to clarify that a DTA does not apply to exempt capital gains upon a person ceasing to qualify as a "resident". To maintain stability in the tax system, the Minister confirms that he would propose that any amendment take effect from 8 May 2012.
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