Question:

The taxpayer received a horse as an inheritance. He continues to let the horse race, he makes bets and recevies prizes and winning. When he sells the horse realising this asset (the horse) to his best advantage, is there a change in intention of the taxpayer? if so has the asset change from capital to revenue nature?

Answer:

The enquiry as to whether a profit is one of a capital or revenue nature is extremely complex and the intention of the taxpayer is of utmost importance when the tests or rules laid down by the courts are applied. The most important “test” employed by the courts in deciding whether the proceeds arising upon disposal of an asset are in the nature of income or capital is the test of “intention”. Accordingly, reference to the taxpayer’s intention is at the time of acquisition and disposal of the asset.

It has been said that the “usual badge” of a fixed, capital investment is that it is acquired “for better or for worse, or, relatively speaking, for ‘keeps’ (ie only to be disposed of if some unusual, unexpected, or special circumstances, warranting or inducing disposal, supervene[s]” ( Barnato Holdings Ltd v SIR 1978 (2) SA 440 (A)). It must therefore be established that the intention was to retain the asset on a capital basis. The test of intention is subjective and its application involves a consideration of all the circumstances surrounding the acquisition of and method of dealing with an asset. The taxpayer’s intention must be investigated not only at the time he acquired the asset but during the whole period over which he held the asset. It has even been suggested that the taxpayer’s intention at the time he disposes the asset is an important consideration. However, the “test” of intention, although important, is not conclusive, and there are other objective factors which constitute additional means of establishing or testing the intention of the taxpayer.

One further has to consider whether there was a change in intention when the taxpayer realized that the sale was inevitable, namely that the taxpayer at that point entered into a scheme of profit making.

Another factor is the length of time the asset was held for. Therefore, the timeline from acquisition to disposal is relevant.

The above are just a few salient principles applicable in order to determine whether a transaction is capital or revenue in nature. It is a contentious area of law and the onus ultimately rests on the taxpayer to discharge his burden of proof. To this extent, if a taxpayer claims a transaction is capital in nature, then there must be sufficient evidence to support same. This must be borne in mind when compiling the facts surrounding the transaction as well as the standard of enquiry which must be met in order to prove a transaction is capital in nature.

There is unfortunately no simple answer but one has to first collate a comprehensive set of facts which meticulously sets out inter alia the history of the matter, chronology of events and all surrounding circumstances, including the taxpayer’s “intention”. Thereafter, once there is a better understanding of the matter, one can present the arguments in accordance with the legal principals and only then, arrive at a finding.

The following extract appears from a scholarly article written on the subject of breeding and racing horses. However, the quote must be seen in the context of the points raised above:

“The profit from the sale of a horse in the racing activity, on the other hand, should not be taxable as this horse is a capital asset.
The breeding of horses is a farming operation, while the racing of horses is not.”

In addition, the horse was inherited. Case law supports the contention that when you immediately dispose of an asset inherited (unless part of trading stock) it tends to be a capital transaction, unless the asset is sold in pursuance of a profit-making scheme. Here the fact that you first used the asset to generate some income by betting and looking to gain winnings should not detract from the capital realisation argument. However, the mere fact that property is acquired by inheritance is not of itself sufficient in law to justify a decision that no part of the proceeds arising on its realization is subject to tax

At the end of the day, the manner in which you present the evidence of your actions will go a long way towards convincing SARS and the courts that the transaction was of a capital nature. Please seek practical guidance from our professional team at that stage to create a detailed defence file for you.