Tax Talk  – Intention determines tax treatment

LAST time I indicated that your intention regarding the assets that you hold determines the taxability of amounts that you receive when selling them.

So what does this mean? The tax courts, which we rely on to determine whether an amount is capital or revenue, have laid down various tests. One of these tests has emerged as the dominant test – the taxpayer’s intention.In 1928 the tax court had to decide whether the proceeds received on the sale of land was subject to income tax or not.The court held that the taxpayer’s intention at the time of buying the land had to be established.The court also held that it is possible that the taxpayer’s intention can change in the intervening period before the sale of the land.A person may, for example, acquire land with the intention of using it for his domestic dwelling (a capital intention).If he does in fact use it for the original purpose intended, the subsequent sale will be of a capital nature.The taxpayer may of course become aware of the economic potential of the property during the time he holds the land and, in an attempt to maximise this potential, he sets about dealing with the property as a land dealer would.When this Rubicon is crossed, the proceeds on the sale of the property become potentially subject to tax.In this particular case, the taxpayer acquired an asset with the intention to hold it forever.By the actions of the taxpayer the Receiver wanted to tax the proceeds on the sale of the asset because, so the Receiver argued at the time, the asset had been converted into trading stock.The mere fact that an asset is sold at a profit does, however, not in itself indicate that the taxpayer’s intention has changed.Something more is required to indicate that the owner of the asset is engaged in a scheme of profit making.It is therefore important to establish whether it is the profit that motivates the sale or whether it is the sale of the asset that results in the profit.The judge in the above-mentioned case said that every person who invests surplus funds in land or any other asset is entitled to realise such asset to best advantage.The fact that the taxpayer sells an asset cannot alter what is an investment of capital into a trade or business for earning profits.In this case the taxpayer was able to satisfy the court that he had not crossed the Rubicon and he was only disposing of his asset to the best advantage.It therefore requires something more than the mere decision to sell (even at a substantial profit) to result in a change of intention.The ‘something more’ refers to the taxpayer’s actions while he holds the asset.Clearly, the intention of the taxpayer will be supported by his actions and behaviour.It is therefore the way the taxpayer goes about selling his asset that determines whether the proceeds are taxable or not.In a more recent case, a taxpayer acquired land with the intention to farm.When the land was sold, the method used by the taxpayer to sell the land had all the features of a business similar to those one would expect to find in the activities of a land dealer.The judge held that the taxpayer had crossed the Rubicon and had gone over to carrying on a business of land dealing.The land had become trading stock and the income received was of a revenue nature and therefore taxable.Your intention must always be supported by your actions to have a watertight argument should the Receiver challenge you on the nature of the income you receive.Remember the onus is always on you to prove that income is not subject to tax.And burden of proof is not always that easy to discharge successfully.* Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com.One of these tests has emerged as the dominant test – the taxpayer’s intention.In 1928 the tax court had to decide whether the proceeds received on the sale of land was subject to income tax or not.The court held that the taxpayer’s intention at the time of buying the land had to be established.The court also held that it is possible that the taxpayer’s intention can change in the intervening period before the sale of the land.A person may, for example, acquire land with the intention of using it for his domestic dwelling (a capital intention).If he does in fact use it for the original purpose intended, the subsequent sale will be of a capital nature.The taxpayer may of course become aware of the economic potential of the property during the time he holds the land and, in an attempt to maximise this potential, he sets about dealing with the property as a land dealer would.When this Rubicon is crossed, the proceeds on the sale of the property become potentially subject to tax.In this particular case, the taxpayer acquired an asset with the intention to hold it forever.By the actions of the taxpayer the Receiver wanted to tax the proceeds on the sale of the asset because, so the Receiver argued at the time, the asset had been converted into trading stock.The mere fact that an asset is sold at a profit does, however, not in itself indicate that the taxpayer’s intention has changed. Something more is required to indicate that the owner of the asset is engaged in a scheme of profit making.It is therefore important to establish whether it is the profit that motivates the sale or whether it is the sale of the asset that results in the profit.The judge in the above-mentioned case said that every person who invests surplus funds in land or any other asset is entitled to realise such asset to best advantage.The fact that the taxpayer sells an asset cannot alter what is an investment of capital into a trade or business for earning profits.In this case the taxpayer was able to satisfy the court that he had not crossed the Rubicon and he was only disposing of his asset to the best advantage.It therefore requires something more than the mere decision to sell (even at a substantial profit) to result in a change of intention.The ‘something more’ refers to the taxpayer’s actions while he holds the asset.Clearly, the intention of the taxpayer will be supported by his actions and behaviour.It is therefore the way the taxpayer goes about selling his asset that determines whether the proceeds are taxable or not.In a more recent case, a taxpayer acquired land with the intention to farm.When the land was sold, the method used by the taxpayer to sell the land had all the features of a business similar to those one would expect to find in the activities of a land dealer.The judge held that the taxpayer had crossed the Rubicon and had gone over to carrying on a business of land dealing.The land had become trading stock and the income received was of a revenue nature and therefore taxable.Your intention must always be supported by your actions to have a watertight argument should the Receiver challenge you on the nature of the income you receive. Remember the onus is always on you to prove that income is not subject to tax.And burden of proof is not always that easy to discharge successfully.* Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com.