Defy Limited v The Commissioner for the South African Revenue Service

Defy Limited was an investment company whose shareholders decided to dispose of its business to Clidet No 553 (Pty) Ltd and wind up the company. Defy held shares in several subsidiaries, including Defy Appliances (Pty) Ltd (Appliances), the main operating company. Defy sold shares in other subsidiaries directly to Clidet for R550,298,138. However, regarding Appliances, the parties structured the transaction differently: Appliances sold its entire business as a going concern to Clidet and then distributed the proceeds (R426,152,780) to Defy in anticipation of winding up. Of this amount, R82,341,323 was repayment of a loan, R68,811,457 was reduction of share premium, R68,919,490 was revenue profits, and R206,080,510 was capital profits. Defy then distributed R498,000,000 to its shareholders as a dividend. The Commissioner assessed Defy for secondary tax on companies (STC) of R28,811,074 on R230,488,595 of this dividend. Defy objected, arguing that R343,811,457 received from Appliances, after deducting its original cost of acquiring Appliances (R28,451,459), constituted a capital profit of R315,359,998 that it had earned and was exempt from STC under s 64B(5)(c)(ii) of the Income Tax Act.

• Whether moneys distributed by Defy constituted 'profits of a capital nature' as contemplated in s 64B(5)(c)(ii) of the Income Tax Act and were thus exempt from secondary tax on companies
• Whether a company can earn a capital profit without disposing of a capital asset
• Whether a dividend received by a holding company from a subsidiary can itself constitute a capital profit earned by the holding company
• The proper interpretation of 'profits of a capital nature' in the context of s 64B(5)(c)(ii)

The appeal was dismissed with costs, including costs of two counsel. The Commissioner's assessment of STC in the sum of R28,811,074 for the dividend cycle 16 May 2004 to 27 January 2005 was upheld.

The binding legal principle is that 'profits of a capital nature' in s 64B(5)(c)(ii) of the Income Tax Act means the pecuniary gain earned upon disposal by the company of a capital asset—the proceeds after deduction of the cost of acquiring the capital asset. A company cannot earn a capital profit for STC exemption purposes without actually disposing of a capital asset. The character of money for exemption purposes is determined by the nature of the transaction that yielded it. Money received as a dividend payment does not constitute a capital profit earned by the recipient company, even if the dividend represents capital profits earned by the company that declared it. Moneys cannot be exempt from STC when received by one company and also exempt when received by another company unless the nature of the transaction that yielded the money on each occasion is the same.

Nugent JA made several non-binding observations: (1) He expressed difficulty with the idea that construction of the parts of a statute can produce one result but construction of the sum of its parts can produce another, stating that a statute is not merely a policy statement leaving detail to be filled in by courts—it is policy translated into law. (2) He criticized the Tax Court's conclusion that the provisions read 'contextually and purposively as a whole' could override the plain meaning of individual provisions to avoid 'double favourable treatment,' suggesting this approach strikes at the heart of the rule of law. (3) He noted that if a statute has not been adequately drafted to reflect legislative policy, it is not for courts to rewrite it. (4) He commented that an appeal lies against an order made by a court rather than its reasons, acknowledging that while the Tax Court's reasoning did not withstand scrutiny, its order was nonetheless correct. (5) He explained the mechanics of STC as a withholding tax and illustrated how the exemption and deduction provisions operate to prevent double taxation while ensuring that capital profits are ultimately taxed when distributed beyond the corporate group.

This case is significant for establishing the proper interpretation of 'profits of a capital nature' in the context of secondary tax on companies under s 64B(5)(c)(ii) of the Income Tax Act. It clarifies that: (1) a capital profit for STC purposes can only be earned through the actual disposal of a capital asset; (2) the exemption depends on the character of the money as determined by the nature of the transaction that yielded it, not on whether the money has the 'effect' of a capital profit; (3) a dividend received by a holding company from a subsidiary, even if that dividend represents capital profits earned by the subsidiary, does not constitute a capital profit earned by the holding company; and (4) courts should not adopt a purposive or contextual approach that effectively rewrites statutory provisions to achieve a desired policy outcome. The case demonstrates the importance of formalistic distinctions in tax law and the limits of anti-avoidance interpretation.