This taxpayer wanted a capital loss treated as revenue, to get a higher tax deduction


A CONCERN that is often raised by investors in shares is that they run the risk that should they make the odd sale in order to rebalance their portfolios, the South African Revenue Service (SARS) is lurking behind the bushes waiting to pounce and declare them to be share-dealers.

If you are in fact regarded as being a share-dealer for tax purposes, your pro-fits will be taxed at your marginal rate, which is higher than that applicable to capital profits.  However, should you incur losses, you will be able to claim a deduction.

But this case from the Tax Court was dealing with the sale of shares from the other side of the fence.  In this case, the taxpayer wanted to be classified as a share-dealer.

The brief facts of this case are as follows.  As at the beginning of 1994, the taxpayer (referred to in the case transcript as ‘A Ltd’—the identity of taxpayers is not disclosed in Tax Court cases) had a 98% interest in ‘B Ltd’ via its 60% controlling interest in C Limited (‘C Ltd’).

This 98% shareholding in B Ltd was a strategic long-term investment of a capital nature.

On 1 June 1994, A Ltd acquired a 15.6% direct shareholding in B Ltd for just under R301 million.  Four years later, the B Ltd shares were sold to C Ltd for around R141 million.  When completing its 1999 tax return, A Ltd claimed a loss of R160 million on the sale of the B Ltd shares.

Because Section 82 of the Income Tax Act provides that whenever a loss is claimed, the burden of proving such loss rests with the taxpayer, SARS asked A Ltd to motivate the deductibility of the loss.  A Ltd stated that the stated that the loss was of a speculative nature, and therefore deductible.

This SARS did not accept, responding by disallowing the loss on the grounds that the loss is actually of a capital nature and as such did not qualify for deduction under Section 11(a) of the Income Tax Act.  An objection to the assessment was duly lodged, which was also disallowed by SARS on the same grounds for which the original deduction was disallowed.

When the case came before the Tax Court, the issue at hand was the taxpayer’s original intention: Were the shares acquired as a long-term investment, or were they acquired for speculative purposes?

The taxpayer argued that the intention concerning these shares was always speculative, and would be disposed of on one of three ways, i.e. by selling the shares after the listing of B Ltd on the JSE Securities Exchange; by placing such shares privately with a foreign investor, or by disposing of such shares to C Ltd.

However, the Tax Court found that a document dealing with the possible methods of disposal emphasised the long-term capital appreciation potential of the shares concerned.

In addition, the annual reports of A Ltd directly contradict the suggestion of any intention to list and sell the shares in B Ltd.  These reports show that A Ltd had intended at all relevant times, to continue to build on B Ltd’s position in the domestic market with regard to branded food products.

The Tax Court also noted that when A Ltd had disposed of other shares, resulting in a profit which SARS had attempted to tax, A Ltd responded to SARS by stating that:

  • the shares in the companies were disposed of as a result of the company’s decision to unbundle;
  • the profits on their disposal did not arise in the ordinary course of business but rather as a result of the forced disposal due to the unbundling of A Ltd; and
  • the profits were deemed to be capital.

The Court was particularly unimpressed with the fact that when A Ltd had realised a profit after disposing of its asset, it “conveniently asserts that such disposal is of capital”, but when a loss had been incurred, A Ltd “wants everyone to believe that it was disposing of its stock in trade, or that it was in the ordinary course of business”.

It seems that you can’t have your cake and eat it.  When you are claiming to be a share-dealer, your actions must support your claim.  A Ltd’s fatal flaw in its argument was the fact that the B Ltd shares were never shown as “stock in trade”, which would normally be the case of A Ltd was operating as a share-dealer.

The final nail in A Ltd’s coffin was its argument that previous disposals were of a capital nature.  Nothing had happened in the interim to conclusively indicate that A Ltd’s intention concerning its share investment had changed.

In finding in favour of SARS, the Court indicated that “[i]t is patently clear that the disposal of the B Ltd shares to C Ltd was not fortuitous or in the course of any share jobbing or profit-making scheme, as the appellant would like us to believe”.

While this case does not lay down any definitive classification of an investment as being either long-term or speculative, the intention of the taxpayer, as evidenced by previous actions, proved to be conclusive.


Steven Jones is a registered SARS tax practitioner, a practicing member of the South African Institute of Professional Accountants, and the editor of Personal Finance and Tax Breaks.