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Few topics in taxation have resulted in as much debate as that of the distinction between capital and revenue. Although South African fiscal legislation does make a distinction between gains and loss of a capital or revenue nature, it does not provide a definition of these terms. Thus it has been left to the judiciary, in the numerous cases brought before it, to lay down the principles governing what constitutes capital and revenue. This executive summary examines the relevance of this distinction between capital and revenue in South Africa and the uncertainty created by the vague and subjective nature of these terms.
There are two major schools of thought as to what constitutes taxable income. The ‘traditionalist approach' makes a distinction between gains and losses of a capital or revenue nature. Income is likened to the fruit of the tree while capital is viewed as the tree itself. Maritz J in CIR v Visser 17 TPD 77 explained that
‘if we take the economic meaning of capital and income, the one excludes the other. Income is what capital produces, or is something in the nature of interest or fruit as opposed to principal or tree'.
The ‘modernist approach', as opposed to the traditionalist one, takes a more comprehensive view of income. It defines income as all increases in the economic power of the taxpayer, whether exercised or not, to consume goods or services. As explained in Part 1 of the report of the Carter Commission (Canada 166),
‘a dollar gained through sale of a share, bond or piece of property bestows exactly the same economic power as a dollar gained through employment or operating a business'.
Thus using this approach, the distinction between capital and revenue becomes irrelevant.
The South African tax authorities, like their counterparts in many other countries, have adopted the traditionalist approach in differentiating between gains and loss of a capital or revenue nature. S 1 of the Income tax act exempts amounts from gross income if they are of a capital nature. Similarly S 11(a) disallows the deduction of expenditure and losses if they are of a capital nature. The recently inserted Eighth Schedule of the Income Tax Act sets out the distinct tax treatment of capital gains and losses. Thus the distinction between capital and revenue is relevant to South African tax law.
Despite the significance of this distinction, South African fiscal legislation provides no definition of what constitutes capital or revenue. Thus our courts have been forced to develop tests, in the many cases tried before them, to distinguish items of a capital and revenue nature. These tests include, inter alia considering the intention of the taxpayer, determining the length of time the asset was held by the taxpayer, examining the frequency of similar types of transaction and evaluating these aspects in the context of the taxpayer's business.
The judiciary has often found the application of these tests difficult due to their subjective nature. As Maritz J in the Visser case stated,
‘ for what is principal in the hands of one man may be interest in the hands of another. Law books in the hands of a lawyer are a capital asset; in the hands of a bookseller they are a trade asset. A farm owned by a farmer is a capital asset; in the hands of a land jobber it becomes stock-in-trade.'
Thus the commission of inquiry into the tax structure of the Republic of South Africa (the Margo commission) found that the criteria used to distinguish items of a capital and revenue nature are unsatisfactory.
Many people argued that the introduction of capital gains tax in South Africa would alleviate the problem. But as the Margo commission pointed out in their report, capital gains are taxed at different rates to revenue gains. Thus the distinction between capital and revenue is still relevant to South African tax legislation and taxpayers still require certainty in distinguishing between the two.
Objective criteria are needed in South Africa to give taxpayers and the judiciary guidance on how to differentiate between items of a capital and revenue nature. This would promote uniformity in the treatment of taxpayers and alleviate the unnecessary uncertainty of the current situation.
Reference list
Cases
· Barnato Holdings Ltd v SIR 178 () SA 440 A, 40 SATC 75
· CIR v Middleman 1 (1) SA 00 (C), 5 SATC
Books
· Arendse J A, Jordaan K, Kolitz M A and Stein M L (00) ‘income and capital' Chapter Silke South African Income Tax Durban Butterworths.
Other
· Chapter 1 of The report of the commission of inquiry into the tax structure of the Republic of South Africa (the Margo report)
Legislation
· Income Tax Act 58 of 16
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