Most Read Contributor in South Africa, September 2016
The definition of gross income, as defined in section 1 of the
Income Tax Act, 58 of 1962 ("the Act"), specifically
excludes an amount, received or accrued to a person, which is
capital in nature. The Act is silent on the term 'capital
nature', and in cases of uncertainty it is left to the courts
to decide whether a receipt is of a capital or revenue nature.
The Supreme Court of Appeal ("SCA") delivered judgment
in favour of the South African Revenue Service ("SARS")
on 10 May 2011 in the case of CSARS v Founders Hill (509/10)
 ZASCA 66, where the court was tasked with deciding
whether proceeds from the sale of land sold by a realisation
company is taxable as income. In short, Founders Hill was a
realisation company formed by AECI Limited ("AECI")
specifically to acquire property that had become surplus to the
needs of AECI 'for the sole purpose of realising same to
the best advantage and within a period of one year of completion of
such realisation to be voluntarily wound-up.'
In her judgment, Lewis JA concedes the well established
principle, that a taxpayer is entitled to realise a capital asset
to its best advantage. However, she stated that calling an entity a
realisation company (and limiting its objects and restricting its
selling activities in respect of the assets transferred to it), is
not in itself a magical act that inevitably makes the profits
derived from the sale of the assets of a capital nature.
In the case of Founders Hill supra the court held that
there was never a change of intention as Founders Hill's
original intention was always to acquire and deal with the land as
its trading stock. This statement has a profound impact on the
classification of proceeds on capital or revenue account, and is
important for taxpayers who own property on capital account and
decide to realise it to its best advantage. The question whether a
taxpayer is the business of selling cannot only depend on the
degree of its activities, and the extent of marketing and
construction of houses can now no longer be decisive.
The courts have established special principles over time
applicable to the disposal of assets, and in the case of Berea
West Estates (Pty) Ltd v SIR  38 SATC 43, the
court decided that disposals by a realisation company and by merely
calling an entity a realisation company does not result in the
profits derived from the sale of assets constituting an amount of a
capital nature. However, in the Founders Hill supra
decision, the court held that Founders Hill could never have
acquired the property on capital account to the extent that it had
the stated intention to realise same, and failed to state that one
should consider objectively whether the taxpayer is actually
trading or carrying on a business.
Following the decision in Founders Hill supra, taxpayers will
now find themselves in a position where they may not dispose of a
capital asset, that was acquired as an investment, without
incurring income tax on such disposition, if they had an intention
to dispose of the asset in the future with the hope of making a
The impact of the judgment will have far-reaching effect
that is not limited to realisation companies. It will also affect
the tests which have been established over many years by case law,
which are applicable in determining the general nature of the
proceeds of the sale of assets, and reducing intention and
activities of the taxpayer to one of the many factors that will be
taken into account in the determination of the nature of the
Thus, as a result, if the taxpayer is actually trading or
carrying on a business, any disposal of a capital asset shall bear
income tax implications when it can be proven by SARS that the
taxpayer had an intention to dispose of the asset upon acquisition
The impact can be illustrated by way of the following
If a taxpayer purchases property as an investment, but intends
to realise the property (at a later stage) at a profit, such
realisation will be considered to be of a revenue nature due to the
fact that the taxpayer had acquired the property with the intention
to realise it for a profit. Accordingly, such a property will be
deemed to be trading stock and, as a result, any profit derived
will be included in the taxpayer's taxable income.
From the judgment it is not clear whether it was the court's
intention that the tests applied in this case must be applied to
all transactions or whether it only applies to realisation
companies. However, until this is clarified, taxpayers are bound by
the precedent set down in the judgment and need to be mindful of
the potential impact thereof when structuring their affairs.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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