A realisation company is a company which is generally formed with the purpose of facilitating the realisation of properties which are usually transferred to it from a group company. The focus on such a company from a tax perspective is usually whether the proceeds derived from the sale of such properties are of a capital or of a revenue nature. The evaluation of the nature of the proceeds for tax purposes is usually based on the intention of the company, that is, whether the company has sold such property in a scheme of profit making or whether it has merely realised its assets to its best advantage. The operation of such companies has often been seen as contentious from a tax perspective and consequently, much case law exists in relation to realisation companies.
The intention of the taxpayer in realising such property is usually one of the deciding factors in determining the nature of the proceeds derived from such realisations. However, in terms of the judgment recently delivered by the Supreme Court of Appeal in a case between the Commissioner for the South African Revenue Service ("SARS") and Founders Hill (Pty) Ltd ("Founders Hill") (Commissioner for the South African Revenue Service v Founders Hill (Pty) Ltd ( ZASCA 66), the court took a different approach in determining whether the interposition of a realisation company would maintain the intention of a taxpayer in relation to the realisation of capital assets or whether the taxpayer would be seen as conducting a trade in relation to such properties.
Founders Hill's holding company, AECI Ltd ("AECI") historically acquired land on which an explosives factory was built. Much of the land was required as a buffer between the factory and areas where people lived and worked. As technology changed, the extent of the buffer was reduced. Economic and social developments also required that the land be used for housing and industry. AECI took steps to subdivide and develop the land for the purpose of selling it as land for residential, business and light industrial purposes.
AECI formed Founders Hill as a ‘realisation company' with the express purpose of realising the land which AECI sold to it to ‘best advantage'. It commenced doing so and engaged the services of another AECI subsidiary to further develop and market the land.
Both SARS and Founders Hill based their cases on the foundation that Founders Hill acquired land as a capital asset. The arguments diverged from this basis, with SARS contending that Founders Hill had become a trader in land thereby rendering the profits of a revenue nature, and with Founders Hill contending that it merely sold off its capital assets to best advantage.
However, the court did not accept the basis on which both parties had based their arguments. To the contrary, it was held that although AECI may originally have held its surplus land as a capital investment, the business of Founders Hill was to develop these properties and to sell them. This was confirmed by, inter alia, the memorandum of association of Founders Hill and from the minutes of the meetings held by the board of directors.
In focusing on this point, Lewis JA stated that "... an interposed realization company (or other entity) will stand in the shoes of the entity that has transferred assets to it, and hold them in turn as capital assets, only in special circumstances, or where there is a need to protect the assets from the original holder." And that "Special cases do not create general rules."
Founders Hill was not seen to fall within the aforementioned categories. The distinction, it was held, was that there was no real justification for the formation of the company in addition to the purpose of realising the assets. In other words, the basis of Founders Hill's incorporation, its business objectives and operations, and the disposal of the properties by AECI to it broke the chain. The court concluded that the properties were acquired by Founders Hill as stock-in-trade and that Founders Hill then conducted business in trading in the property.
Although the principle that a company may realise its assets to its best advantage is not affected by this case, the interposition of a realisation company to achieve this objective may no longer be a safe bet without fully considering the impact of this case on proposed realisation based activities. Furthermore, routine commercial and administrative factors such as the incorporation of realisation companies and meetings held by directors will also form an important role in forming and upholding a taxpayer's defence.