1474 What constitutes "trade"?
January 2007 – Issue 89
ITC 1802 (68 SATC 67) essentially required the Court to deal with the "vexed question" (in the words of the Court) of what constitutes "trade".
The facts of the case involved the taxpayer (appellant) appealing against the Commissioner’s 2001 assessment which disallowed:
· an assessed loss brought forward from 2000 on the grounds that the company did not trade and did not derive income; and · certain claimed expenditure on the basis that it was not incurred in the course of trade.The original Annual Financial Statements of the taxpayer showed no income in the 2001 year of assessment. After the disallowance the taxpayer revealed income in the form of interest earned on loans to subsidiaries, which had previously been omitted.
The taxpayer was a company, incorporated in 1985 and converted to a public company and its shares listed on the JSE in 1992. The company claimed its main object to be that of a holding company. The company and its subsidiaries manufactured and marketed luggage and commercial trailers and trailer components. The taxpayer objected to the assessment on the basis that it had traded in the year under review.
The Court, in delivering its judgement, noted that the onus was on the taxpayer to show that an amount is not taxable and that affirmative evidence (as opposed to statements uncorroborated by evidence) is required to discharge this onus.
In seeking to discharge its onus, the taxpayer submitted a multitude of documents in respect of each year of assessment from 1998 onwards (except for 1999). Included in these documents were minutes of meetings, a dealership agreement, minutes of AGMs, statements/reports by the Chairman, Corporate Governance Statements, a Directors Report (2000), Director’s resolutions, etc.
In its judgement the Court first dealt with the interest income which was initially omitted. The Court noted that this had been disclosed in previous years but was omitted in the books in 2001. The income statement in 2000 reflected investment income but none was reflected in 2001. Correspondence between the taxpayer and Commissioner revealed that the taxpayer could offer no explanation as to the nondisclosure of the interest income. As the partner in charge of the former auditors was deceased, as was the former chairman of the taxpayer, this, along with the absence of notation in the minutes, meant that the reason for the failure could not be found.
The Court started its enquiry by setting out the relevant legislation, including that:
· Section 11(a) determines that a taxpayer may deduct any expenditure incurred in the production of income which is not of a capital nature. · Section 20 determines that a taxpayer may set off against any income derived from carrying on his trade, any balance of assessed loss carried forward from the preceding year of assessment.The Court alluded to the following determinations that should be made before a deduction or an assessed loss carried forward will be allowed:
1. Was the taxpayer carrying on a ‘trade’?If the answer to this is in the affirmative then two further issues must be addressed: 2. Was the expenditure (sought to be deducted) in the production of income and not of a capital nature? 3. Did the taxpayer derive income or a loss (in determining whether the assessed loss can be carried forward)?
It was noted by the Court that the moment a company does not carry on a trade in a subsequent year, the assessed loss is forever lost.
The Court, in reaching its conclusion, looked in detail at the evidence presented by the taxpayer in determining whether the taxpayer was carrying on a ‘trade’.
The Commissioner drew the Court’s attention to the absence of any bank account, the erratic interest payments, the failure to declare dividends, and the absence of the making of loans.
The taxpayer argued that it was not merely a passive investor but as the holding company, ensured the continuation of subsidiary operations. It argued along the lines that the interests of the group were served through the taxpayer.
More specifically it was argued that the holding company was responsible for ensuring the continuation of the operations of the subsidiary manufacturing and marketing companies, including ensuring they remained listed on the JSE for the benefit of the entire group, and taking key decisions ranging from arranging finance through to sourcing steel.
Reliance was placed on a number of authorities to submit that both the holding company and subsidiaries each conducted an interconnected and interdependent phase in the total operations:
In support of this reference was made to cases like Solaglass Finance Co (Pty) Ltd v Commissioner for Inland Revenue (53 SATC 1) which stated that …
."it is by no means uncommon, in a large group of companies, for the business of the group to be rationalised in such a way that the activities of each subsidiary are structured with the interests of the group in mind".Reference was also made to the case of Commissioner, South African Revenue Service v Tiger Oats Ltd (65 SATC 281) which, in recognising the contribution made by the holding company to the subsidiary in that case, stressed the importance of the distinction between a passive and active investor.
The taxpayer submitted that it was an active and not a passive investor.
The Court, in dealing with this argument, stated that it must look at the activities of the taxpayer, the functions performed by the taxpayer, the impact which any activities of the taxpayer had on the activities of its subsidiaries to determine whether or not the taxpayer can be said to have been carrying on a trade.
The Court also referred to Solaglass, with specific reference to where the Judge directed attention to the "controlling mind which brought [the wholly owned subsidiary] into operation" and whose "activities were directed…at promoting the interests of the group".
The question before the Court was thus whether or not the promotion of group interests was an integral part of the activities of the taxpayer. The Court had therefore to examine the nature of the activities of the taxpayer, the nature of expenditure and income and any benefit derived by the group from the taxpayers activities.
(The Court noted that there was no authority that requires no more than the existence as a holding company to constitute the "carrying on of a trade".)
Based on the above the Court reached the following conclusion:
1. In determining whether the taxpayer did engage in trade, the onus was on the taxpayer to show that trade had been conducted. 2. The word "trade" was not defined, and it rested on the Courts to provide content. It was most useful to pose the question "What did the taxpayer actually do?" and then to examine the nature of the taxpayer’s activities. 3. Minimal evidence was presented and that which was relevant was little more than circumstantial. 4. The Court concluded that the taxpayer had not evidenced during 2001 any indication of the "controlling mind" referred to in Solaglass. No evidence was presented of activity in respect of the loans, in terms of monitoring or further investments, of involvement in affairs, of control or dominance exercised, of strategic management or direction of policy, of facilitation of the subsidiaries’ activities. 5. The Court accordingly found that they did not carry on a "trade" and therefore that it did not have to proceed further with the enquiry.Deloitte
