Financial implications for selling immovable property – is it classified as capital or revenue?

February 1st, 2021
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Whether a receipt or an accrual is ‘capital’ or ‘revenue’ in nature, in calculating a taxpayer’s taxable income, is probably the most common issue that arises in income tax litigation. With the current financial climate prompting many people to restructure their financial arrangements, for some this has meant contemplating the sale of their immovable property. Due consideration must be given to the tax implications of such a transaction and whether the resulting profits would be subjected to tax by the South African Revenue Service (Sars) as part of the taxpayer’s gross income or capital gains tax calculation. Such a finding can have different financial implications for the taxpayer and their cash flow. The purpose of this article is to provide insight into some of the considerations one should bear in mind when contemplating such a transaction by outlining the test of when such profits will be revenue in nature and form part of the taxpayer’s gross income calculation.

‘Gross income’ definition

The starting point in determining a taxpayer’s taxable income is the definition of ‘gross income’. Section 1 of the Income Tax Act 58 of 1962 (the Act) defines gross income ‘in relation to any year or period of assessment, … –

(i) in the case of any resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident; or

(ii) in the case of any person other than a resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such person from a source within the Republic, during such year or period of assessment, excluding receipts or accruals of a capital nature’.

The question that often arises from the sale of immovable property is whether the resultant profits received or accrued to a taxpayer are receipts or accruals of a capital or revenue nature. The taxpayer bears the onus to prove that the amounts in question are capital and not revenue in nature in terms of s 102 of the Tax Administration Act 28 of 2011.

The capital and revenue divide

As noted, gross income excludes receipts and accruals of a capital nature, as such, capital receipts cannot be included under the taxpayer’s gross income calculation, but could be included under a separate capital gains tax calculation in calculating the taxpayer’s income. The phrase ‘of a capital nature’ is undefined in the Act and one must look to case law for its interpretation.

Proceeds from the sale of an asset

One of the leading authorities in determining whether an amount is of a capital or revenue nature is Commissioner for Inland Revenue v Pick ’n Pay Employee Share Purchase Trust 1992 (4) SA 39 (A). In this case, the then Appellate Division noted that there are a variety of tests to determine whether a receipt is of a capital or a revenue nature. These, however, are only guidelines and there is no single infallible test to apply. Ultimately, whatever guideline is used, the classification of capital or revenue must make sound commercial and good sense. With that said, the court held that the most appropriate test is whether the proceeds were the result of the realisation of a capital asset or whether it was a result of a gain made by the operation of business in carrying out a scheme of profit-making. This is the test regardless of the number of transactions carried out by the taxpayer. As to the meaning of ‘a scheme of profit-making’, the court explained that this means that the profit was designedly sought and worked for by the taxpayer and was not fortuitous. This will be assessed by considering the objectives of the taxpayer and what its purpose was or if there was more than one purpose, what its dominant purpose was. Consequently, the taxpayer must have the intention to trade, in order for a scheme of profit-making to be evident. A scheme of profit-making will be evident when the taxpayer buys an asset intending to sell it at a profit and with the intention to trade in that asset.

The case of Commissioner for the SA Revenue Service v Wyner [2003] 4 All SA 541 (SCA) illustrated the application of the test ‘a scheme of profit-making’. The court applying the Pick ‘n Pay tests evaluated the taxpayers stated intention, her ipse dixit that she was obliged to realise the property in order to salvage what she had invested, against the objective factors to determine whether they supported or disproved the taxpayers stated intention. On the facts, the court found that the profits were not of a capital nature and the taxpayers conduct to be a scheme of profit-making. The court found that the taxpayer had devised a scheme whereby she could make a very large profit, and this was supported by the objective facts that revealed the taxpayer’s intention.

A change of intention

The Appellate Division in Commissioner for Inland Revenue v Stott 1928 AD 252, shed clarity on the determination of intention and the possibility of a change in intention. In this case, the court had to determine whether the taxpayer had been carrying on a business as a person who trades in land and so treats the land as their trading stock. This would make the proceeds revenue in nature. In applying the test, the court noted that when it comes to individuals, a certain level of continuity is required for a scheme of profit-making to be evident. Furthermore, everyone is entitled to realise their investment asset to their best advantage, consequently, the mere sale of an asset at a profit is not enough to indicate a scheme of profit-making; one would need a special act to convert an asset from capital to revenue. When the court examined intention in more detail, it held that intention at the time of purchase is conclusive unless some other intervening factors show that the asset was sold in a scheme of profit-making.

In Natal Estates Ltd v Secretary for Inland Revenue 1975 (4) SA 177 (A) the Appellate Division was once again faced with the issue of whether proceeds from the sale of immovable property were capital or revenue in nature and whether there was a change in intention. The court held that the original intention of the taxpayer is important but not conclusive and the court will look at the totality of facts in considering whether the taxpayer was involved in a scheme of profit-making. This would take into account –

  • the intention of the taxpayer at the time of purchase and sale of the asset;
  • the objects of the taxpayer as a company;
  • the activities of the taxpayer in respect of the land up to the time of sale either in whole or in part; and
  • where land was subdivided; the planning, extent, duration, nature, degree, organisation and marketing operations of the enterprise.

On the facts before it, the court found that the taxpayer had done more than merely realising an asset as the best advantage. The taxpayer had crossed the Rubicon and had gone into the business of township development, construction and sale. The court further held that generally whether the taxpayer had crossed the Rubicon was a question of degree and a taxpayer’s property dealing with one property cannot automatically extend to every transaction of the taxpayer, as every transaction must be considered on its own merits.

In African Life Investment Corporation (Pty) Ltd v Secretary for Inland Revenue 1969 (4) SA 259 (A) and Commissioner for Inland Revenue v Nussbaum 1996 (4) SA 1156 (A), the court made it clear that where a taxpayer has a main and secondary purpose, equal weight will be given to both purposes. These purposes will be evaluated considering the totality of circumstances to determine their capital or revenue nature. A secondary purpose does not mean a subordinate purpose.

A summary of the position in our law

From the above it is clear that when determining a taxpayer’s gross income, only income of a revenue and not of a capital nature will be included in the taxpayers’ gross income calculation. Income is of a revenue nature when it is the result of a gain made by operation of business in carrying out a scheme of profit-making, having been designedly sought and worked for by the taxpayer and is not fortuitous. This is determined by evaluating the taxpayers stated intention against objective factors to determine whether they support or disprove of the taxpayers stated intention. As everyone is entitled to realise their investment asset to best advantage, the mere sale of an asset at a profit is not enough to indicate a scheme of profit-making and a special act is required to convert an asset from a capital to a revenue asset. Furthermore, although the original intention of the taxpayer is important in this inquiry it is not conclusive, as the court will look at the totality of facts. Where there is a main and secondary purpose, both purposes will be evaluated considering the totality of circumstances to determine their capital or revenue nature.

Final remarks

A finding of whether a receipt or an accrual from the sale of immovable property is capital or revenue in nature in calculating a taxpayer’s gross income can have different financial implications for the taxpayer and its cash flow. This can often be the determining factor of whether the taxpayer can weather the current financial climate, especially for those taxpayers struggling to get by. Consequently, it is imperative that before any decision to sell immovable property is taken, due consideration must be had to the tax implications of such a transaction. One such consideration being whether the resulting profits would be subjected to tax by Sars as part of the taxpayer’s gross income or capital gains tax calculation in determining the taxpayer’s taxable income.

Lulama Lobola BA LLB (UCT) is currently an LLM (Tax Law) candidate and a legal practitioner at Gunston Strandvik Attorneys in Cape Town.

This article was first published in De Rebus in 2021 (Jan/Feb) DR 11.

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