Capital Gains Tax (CGT) is payable on the disposal of capital assets that were in the seller’s possession on, or were acquired after, 1 October 2001.
In the recent Supreme Court of Appeal (“SCA”) judgement of The Commissioner for the South African Revenue Service v Stepney Investments (Pty) Ltd, the SCA considered the various valuation methods available in determining the value of a capital gain, namely the discount cash flow method (“DCF”) and the net asset value method (“NAV”).
The court considered whether Stepney Investments had discharged the onus of proving the base cost of its 4.37% shareholding in Emanzini Leisure Resorts; a shareholding it had disposed of during the 2002/3 tax years. Stepney Investments bore the onus of proving the value of those shares (on or after 1 October 2001, when capital gains tax came into force) so as to establish the taxable gain made when they disposed of the shares.
Stepney Investments had elected, in terms of para 26(1) of the Eighth Schedule to the Income Tax Act 58 of 1962 (“the Act”), to use market value as the method of valuing the shares, which, according to para 31(1)(g) of the Eighth Schedule to the Act is ‘the asset sale price that could have been obtained between a willing buyer and a willing seller dealing at arm’s length in an open market’. Stepney Investments contended that the DCF valuation method was the most appropriate method for valuing shares. The DCF method values the business in question on the basis of its forecast future cash flow, discounted back to present-day values through the application of a discount factor.
SARS, on the other hand, contended that the NAV valuation method was the most appropriate method. TheNAV method considers the value of the company’s assets less the value of its liabilities at the relevant time. The net asset value can then be divided by the number of shares the company holds to arrive at the value per share. By using this method, for base cost purposes, SARS adjusted the value of the Emanzini Leisure Resorts shares to nil. SARS was of the opinion that the taxpayer had overstated the value of the shares, which in turn resulted in an “inflated valuation.”
The SCA found that SARS’ preferred approach, based on the NAV method, was incorrectly utilised, as it was clear that the shares were not worth nil on the valuation date. The SCA emphasised that the onus is on the taxpayer to prove that the valuation of an asset is reasonable and in doing so, the taxpayer or an expert must accurately assess the valuation. Even though the Act does not state who must conduct the valuation, it does emphasise the responsibility upon the taxpayer to substantiate that its valuation is reasonable, even if experts and not the taxpayer itself conduct it. The SCA found that, although the DCF method could be used in the valuation, the expert assisting the taxpayer had used incorrect dates, disregarded important risks, and used forecasts that were unreasonably optimistic.
“A court is entitled to reject a valuation if it is not satisfied with the investigations underpinning it: ‘For instance, if the expert added up his figures wrongly, or took something into account which he ought not to have taken into account, or conversely, or interpreted the agreement wrongly, or proceeded on some erroneous principle – in all these cases, the court will interfere’. The Tax Court was wrong in upholding that valuation. As a consequence, Stepney has failed to discharge its onus of proving the paragraph 29 market value and thus also the aggregate base costs of the relevant shares. But counsel for the Commissioner very properly conceded that the value of the shares cannot be nil.
The appeal was upheld and the SCA ruled that it would be in the interests of justice for a proper valuation to be completed. The matter was therefore remitted to SARS for further investigation.