Johannesburg - A profit of almost R400 million made by Capstone 556 from the sale of about 17 million shares in the JD Group was of a capital nature and not a revenue nature despite Capstone paying for and taking transfer of the shares less than a year earlier, the Supreme Court of Appeal has found.
In dismissing an appeal by the SA Revenue Service (Sars) and upholding the cross-appeal of Capstone against an order of the Western Cape Division of the high court in Cape Town, the court also held that the R55 million tax liability undertaking by Capstone to Daun et Cie Aktiengesellschaft that flowed from the original acquisition transaction formed part of the base cost of the shares in JD Group.
The shares that formed the subject of the dispute were acquired by Capstone during a corporate restructuring of JSE-listed furniture business Profurn, which by the end of 2001 was in severe financial difficulty. Profurn also owed between R70m and R90m to Steinhoff International Holdings, which was then a major manufacturer and supplier of furniture to the retail industry.
Profurn risked imminent liquidation, which represented a serious financial risk to FirstRand and Steinhoff apart from posing a major threat to the stability of the retail furniture industry in South Africa.
Claas Daun, a wealthy Germany businessman and director of Steinhoff, also indirectly held a 13 percent shareholding in Profurn and stood to suffer financially if Profurn was liquidated. The turnaround strategy adopted involved the merger of Profrun with listed furniture business, the JD Group, in return for JD Group shares.
Revenue vs capital
In terms of the restructuring, the shares were initially issued to FirstRand Bank, which then sold them in various quantities to Capstone, a special-purpose vehicle, and others. The shares were eventually paid for and transferred by FirstRand to Capstone in December 2003 and sold in April 2004 for a profit of almost R400m.
Sars argued this profit must be taxed as being of a revenue nature. Capstone claimed it was of a capital nature.
The Supreme Court of Appeal reaffirmed the test for determining whether a profit must be treated as revenue was whether it was a gain made by operation of a business in carrying out a scheme of profit-making, and if not, it was of a capital nature. It held that where the profit was the result of the sale of an asset, the intention of the taxpayer when acquiring and holding the asset was of great importance. The shares were sold less than a year after Capstone acquired ownership of them, which would ordinarily suggest a short-term transaction.
Risk and reward
But the court said the risk and reward in substance was acquired by Capstone much earlier in June 2002 when a binding memorandum of understanding was signed by the various parties setting out the turnaround strategy and fixing the price at which Capstone would acquire the shares.
The court said Capstone and its controllers in June 2002 expected the turnaround to take between three and five years and viewed the enterprise as an investment to rescue the business of Profurn.
The potential sale of shares at some point in the future was one of many options and not the dominant purpose behind the acquisition and therefore the nature of the profit fell to be treated as capital, it found.
BUSINESS REPORT