Gross income tax case

The taxpayer was a pensioner who had been a member of a Pension Fund and then transferred by investing the relevant amount in a retirement income option with another fund. Gross income ITC 1797, 67 SATC 377 Paragraph a of the definition of gross income in s 1 of the Income Tax Act 58 of 1962 provided at the relevant time that any amount received or accrued by way of annuity, including any amount contemplated in the definition of annuity amount in s 10A1 was to be included in gross income whether of a capital nature or not. The facts of the case were briefly: The taxpayer was a pensioner who had been a member of a Pension Fund and then transferred by investing the relevant amount in a retirement income option with another fund. The taxpayer entered into an agreement with the other fund in terms of which he would invest an amount just in excess of R6 million in a life annuity with the fund with effect from 1 September 1998 which would give him an initial guaranteed income of R41 666 per month and this could be revised annually at appellants instance within certain limits. The aforementioned agreement also provided that the taxpayer could instruct the fund to vary the investments and for which purpose he was to employ a financial adviser for whose decisions he accepted full liability. The taxpayer was responsible for paying the fund an upfront investment fee as well as an annual investment fee and he was not allowed to make any withdrawals from his investment save for certain specified amounts. The monthly income which appellant would receive would be taxable and the fund would deduct PAYE there from. The Commissioner for SARS had taxed appellant on the basis that the periodic amounts paid to him by the fund in terms of the aforementioned agreement was an annuity and thus gross income. The taxpayer contended that he should not have been taxed but that he should rather have been taxed on the basis that only the income generated on the capital amount invested by him constituted gross income and that the capital portion of his monthly receipt from the fund was not taxable income. The crisp issue to be determined by the Tax Court was whether the periodic payments paid to appellant by the fund constituted an annuity for purposes of paragraph a of the definition of gross income in s 1 of the Income Tax Act 58 of 1962 and, in particular, whether the capital ceases to exist and is converted into an annuity. The taxpayer contended that he had, in effect, made a loan to the fund and had been receiving repayments on the loan and not an annuity and consequently that the capital amount of approximately R6 million was paid to the fund by the Pension Fund on behalf of and for the benefit of appellant and in determining the nature of the periodic payments regard must be had only to the terms of the agreement. The taxpayer contended further that in terms of the agreement the fund undertook to act as taxpayers agent in investing the capital in such units as appellant chose and the fund had no proprietary or financial interest in the capital sum, the capital sum and the income earned being held solely for the benefit of the taxpayer and after his death that of his dependants until both the income and capital was exhausted. The Commissioner for SARS contended that the funds invested with the fund did not vest in the taxpayer but vested first in the pension fund and subsequently in the other fund. He contended further that the taxpayer was not the true owner of the investment because he could not draw the money at will. The Tax Court held That even though the agreement in issue between appellant and the other fund bore a likeness to an annuity and it was clear that the taxpayer at all times thought that he was buying an annuity, the real question to decide was therefore whether the terms of the agreement were such that it in fact constituted an annuity and in doing so it must be borne in mind that the cases suggest that the main distinguishing feature is that in the case of an annuity the investor forgoes his capital in return for annual payments. That the distinction between the payment of a capital debt in instalments and an annuity is not easy to draw and, generally, if what is being repaid is a debt, it is not an annuity whereas if the periodical payment is not in respect of a debt owing or in liquidation of a debt it is an annuity. That the mere fact that the taxpayer could not draw the money at will is not decisive of whether the agreement in issue gave rise to an annuity as there are many types of investments which are not annuities where the investor can only access his/her funds after a certain period or under certain specified circumstances and in this case appellant and B agreed that his capital would be repaid in a specified manner. That the decision in Kommissaris van Binnelandse Inkomste en n Ander v Hogan 55 SATC 329 supports appellants case in that firstly it adopts with approval the dictum in Commissioner for Inland Revenue v Milstein 11 SATC 279 at 287 which makes it clear that the crucial question is not whether the investor can access his/her funds but whether the capital ceases to exist and is converted into an annuity and, secondly, it gave consideration to the distinction between a lump sum payable in instalments which reduce and in time extinguish the principal sum owing, and the obligation to make periodic payments without reference to any principal sum. That it was evident that although the taxpayer had agreed to tie up his capital in order to obtain payment from his Pension Fund, in effect, the agreement provided for the return of all his capital plus the income derived there from until the capital was exhausted and accordingly it was not an annuity. The taxpayer won his appeal. 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