Personal rights play an important role in the determination of capital gains and losses. They may comprise assets in their own right for CGT purposes and play a role in establishing proceeds and base cost. Unfortunately, they impose a layer of complexity on the Eighth Schedule which cannot be avoided.
What is it?
A personal right (jus in personam) is a right in or against a particular person or group of persons. Personal rights are of two types:
jus in personam ad rem acquirendam, a right to claim delivery of a thing; and
jus in personam ad faciendum, a right to claim performance or an act.
Put differently, a personal right is a right against another person for performance of an obligation under which the counterparty must do or refrain from doing something.
Examples of personal rights include an heir's right to claim an inheritance, a beneficiary's right to require the trustee to administer the trust in accordance with the trust deed, a claim for damages and a creditor's right to require a debtor to settle a debt.
In contrast, a real right (jus in rem) is a right in a thing, which is enforceable against all persons. It is the badge of ownership.1 Examples include corporeal things such as motor vehicles, plant and machinery as well as registered real rights, such as a registered lease of at least ten years,2 a registered usufruct over immovable property, servitudes and a life right in a retirement village.3
Is a personal right an asset for CGT purposes?
The answer to this question is yes. The definition of 'asset' in paragraph one of the Eighth Schedule includes 'property of whatever nature, whether movable or immoveable, corporeal or incorporeal … and a right or interest of whatever nature to or in such property'.
CIR v Estate CP Crewe & another in relation to the determination of estate duties, Watermeyer CJ said the following:4
'One would expect that when the estate of a person is described as consisting of property, what is meant by property is all rights vested in him which have a pecuniary or economic value. Such rights can conveniently be referred to as proprietary rights and they include
jura in rem, real rights such as rights of ownership in both immovable and movable property, and also
jura in personam such as debts and rights of action.'
In 2004 Prof Julie Cassidy, then with Deakin University, Australia, compared the Australian CGT provisions with those of South Africa and questioned whether personal rights were assets
for CGT purposes primarily on the basis that they were not capable of transmission.5 Professor Gerrie Swart (then with Unisa) responded to her criticism in 2005, pointing out that the Eighth Schedule was replete with examples of personal rights being recognised for CGT purposes, among them financial instruments, options and debt claims.6
It would be surprising if personal rights were not assets for CGT purposes, especially given the numerous references to them in the Eighth Schedule, such as paragraph 56 (disposal by creditor of debt owed by connected person), 58 (exercise of option), 59 (compensation for personal injury, illness or defamation), 64A (awards in terms of land restitution programmes and land reform measures), among others.
Recently, the question whether a personal right was an asset arose in an unreported case7 in which the appellant (Massmart Holdings Ltd), a holding company, sought to claim capital losses incurred in the 2007 to 2013 years of assessment by its employee share incentive scheme trust.
On instruction from the appellant, the trust would grant selected employees options to acquire shares in that company at a strike price. When an employee exercised an option to acquire the shares, the appellant would purchase the shares on the trust's behalf at market value and debit the trust's loan account, as the trust did not have a bank account. When the employee paid the appellant, the appellant would credit the trust's loan account with the strike price and the shares would be given to the employee. Usually there would be a shortfall in the trust because the strike price would be less than the price paid by the trust. Under the trust deed, the appellant was liable for the shortfall and would credit the trust's loan account and debit 'share expense cost' on its balance sheet with the amount for which it was liable. That meant the expense did not go through the income statement but directly against retained income.8 Since the trust had recovered the shortfall from Massmart, its base cost in the shares was reduced under paragraph 20(3)(b), with the result that it did not suffer any capital losses.
The appellant argued that it acquired an asset in the form of a claim for performance against the trust. This personal right comprised the right to require the trustees to make offers to the employees and deliver the shares upon exercise of the options. The base cost of the right was equal to the amount of the shortfall and, when the right was disposed of through performance, there would be no proceeds, resulting in a capital loss. Adams J dismissed the appeal, noting that a personal right was not an asset as defined in the Eighth Schedule.
On appeal in
Massmart Holdings Ltd v C: SARS,9 the Supreme Court of Appeal (SCA) found in favour of SARS, on the following grounds:
- The evidence of the three witnesses appeared to bolster SARS's argument that the notion that the so-called right constituted an asset was illusory and an
ex post facto reconstruction to establish a basis by Massmart for a claim for capital gains.
- Even if it were accepted that the right to require the trustees to grant the options was an asset, the expenditure in respect of that asset was incurred after the asset was disposed of and hence did not qualify to be added to the base cost under paragraph 4(a).
- Since the loans to the trust were unpaid, they comprised an asset for Massmart, so it had not incurred any loss. Instead, Massmart had sought to account for the trust's losses in its books.
Unfortunately, the court's reasoning in dismissing the appeal is unsatisfactory in a number of respects.
Firstly, the court should not have relied on the opinion of witnesses to determine a question of law, namely whether a personal right to claim performance was an asset for CGT purposes.
Secondly, the court's statement that the expenditure on the personal right could not give rise to a capital loss because it was incurred after the asset was disposed of is incorrect. The appellant sought to use paragraph 4(b) and not paragraph 4(a). Paragraph 4(b) specifically permits a capital loss to be claimed in respect of expenditure incurred after an asset has been disposed of.
Thirdly, the court was wrong to conclude that the loans were unpaid and therefore no loss had been incurred by Massmart. The unpaid loans related to the small stock of shares held by the trust at year end, not to the amounts claimed by Massmart in making good the trust's losses.
Despite the court misdirecting itself on these issues, it would have been difficult to persuade it that the personal right to require performance from the trustees was an asset with pecuniary value related to the ZAR 1 billion that the company had spent over the period in making good the trust's losses. Massmart's argument was that the loans did not give rise to capital losses in the trust because the trust acquired a counter claim against Massmart in respect of the losses. In Massmart, the debit loan arising on the acquisition of the shares less the amount paid by the employee was set off against the credit loan arising from the counter claim. The fact is that Massmart incurred expenditure when it became indebted to the trust in respect of the losses. The court therefore did not address the identity of the true asset, if any, to which this expenditure related.
Massmart was unable to claim the expenditure under s 11(a), since it related to the employees of its subsidiaries and was not incurred in the production of income. The problem could easily have been avoided if Massmart had simply recovered the cost from its subsidiaries, which in turn could have claimed it under s 11(a) as an employment-related expense.
The case raises the issue of how expenditure incurred by a holding company on behalf of its subsidiaries should be dealt with. If it can be proven that the expenditure was incurred in enhancing the value of the shares in the subsidiaries, the expenditure may qualify to be added to the base cost of the shares under paragraph 20(1)(e). In the United States case of
Eskimo Pie Corp v Commissioner of Internal Revenue, the court stated the following:10
'Payments made by a stockholder of a corporation for the purpose of protecting his interest therein must be regarded as additional cost of his stock and such sums may not be deducted as ordinary and necessary expenses.'
The Internal Revenue Service (IRS) has treated the payment of bonuses to employees of subsidiaries by the holding company as a capital contribution to the subsidiaries and a constructive deduction by the subsidiaries.11 However, this treatment would be impermissible in South Africa, since the subsidiaries would not be regarded as having actually incurred an
expense. Section 40CA does not deal with capital contributions, only with the issue of shares in exchange for an asset.
Personal rights play an essential role in determining capital gains and losses and the tax court was clearly wrong to conclude that all personal rights are not assets for CGT purposes. It is a pity that the SCA did not address the question whether a personal right to require performance is an asset. Despite the court's prevarication on the issue, it would probably be going too far to conclude that all such personal rights have pecuniary value and comprise property and hence assets for CGT purposes. In any situation involving CGT, it is important to identify the true asset.
This article was first published in
ASA October 2021.