REPORTABLE
THE SUPREME COURT OF APPEAL
OF SOUTH AFRICA
CASE NO:   620/98
In the matter between
SYFRETS PARTICIPATION BOND MANAGERS LTD
Appellant
and
THE COMMISSIONER FOR SOUTH AFRICAN
REVENUE SERVICE
Respondent
CORAM:
SMALBERGER, NIENABER, MARAIS, PLEWMAN JJA et
MTHIYANE AJA
DATE HEARD:
6 November 2000
DATE DELIVERED:
30 November 2000
Income Tax - whether participations by manager of participation bond scheme in scheme
are “trading stock” - whether any diminution in value by reason of payment of interest in
advance - s 11 (a) and 22 of Income Tax Act 58 of 1962 - Participation Bonds Act 55 of
1987.
JUDGMENT
MARAIS JA
MARAIS JA:

[1]          The first and central issue in this appeal is whether the participations in
participation bonds brought into existence by appellant and offered by it to the
public are “trading stock” within the meaning of that expression in the Income Tax
Act 58 of 1962 (the “Income Tax Act”).  The question arises in this way.
[2]          The Participation Bonds Act 55 of 1981 (“the Act”) consolidates the
laws relating to the securing of the rights of holders of participations in
participation mortgage bonds, the definition of the rights of such participants, and
matters incidental thereto.  In broad, the Act is designed, inter alia, to enable
financial institutions to offer to investors, many of whom may wish to invest
relatively small amounts of money, an opportunity of participating with other
investors in an investment secured by a registered mortgage bond over immovable
property and yielding a competitive rate of interest.  Each participant who holds
such a participation in a participation bond becomes a creditor of the mortgagor
to the extent of the participation.  The debt so created is owed by the mortgagor

to the participant and not to the nominee company in whose name the bond is
registered and the rights conferred by the bond are deemed to be held by the
participants (s 6 (1)).
[3]          The various situations envisaged by the Act are, typically, these.  A
financial institution (the “manager”) will set up a nominee company as defined in
s 1 with a view to the registration of participation bonds in its name in terms of s
2.  The manager will set about finding a borrower and a number of investors who
are prepared to advance sums of money which will match collectively the sum
which the borrower needs.  It may succeed in achieving such a perfect match but
it may not.  It may find that it has accepted money from would-be investors in a
participation bond but that it has no borrower in need of that money.  The Act
obliges it to return the money if a participation is not granted within 60 days (s 3
(1) (a)).  It may also find that it has a borrower but  not enough would-be
participants to fund the loan fully.  The manager may then take up a participation

to cover the shortfall (s 3 (2)).
[4]          In cases in which the required loan is made to the borrower, an
appropriate participation mortgage bond is registered in the deeds registry.  The
names of the participants are not required to be set forth in the bond but the
manager is obliged to keep a register in which must be recorded, inter alia, “the
names of the participants --- and the extent of their participations from time to time
as well  as  all  amounts  repaid  to  participants  in  respect of their participations”
(s 5 (1) (c)).
[5]          Appellant, Syfrets Participation Bond Managers Limited, is such a
manager.  In practice, it is seldom able to achieve perfect matches in point of time
between the needs of borrowers and the needs of would-be investors in
participation bonds.  Business expediency prompts it to frequently put its own
money into the participation bonds which it arranges, until such time as other
participants can be found to take its place.  The need to do so might arise at the

very inception of a particular participation bond or it might arise during the
currency of the bond as a consequence of a participant withdrawing.  At the end
of each of appellant’s tax years there is a very considerable sum of its own money
in the bonds.  That money represents its own provisional or temporary
participations.  It is the true character of those participations for the purposes of
the Income Tax Act which must be determined.
[6]          If the participations so held by appellant are indeed “trading stock”
within the meaning of the definition of that expression in s 1 of the Income Tax
Act as appellant contends, it may be (I express no opinion at this stage) that tax
consequences favourable to it might ensue and those consequences would have
to be considered.  If they are not trading stock, the appeal must fail on that ground
alone.
[7]          The concept is currently defined as follows:
“‘trading stock’ includes -
(a)
anything  -

(i)
produced, manufactured, purchased or in any other manner
acquired by a taxpayer for purposes of manufacture, sale or
exchange by him or on his behalf; or
(ii)
the proceeds from the disposal of which forms or will form
part of his gross income;  or
(b)
any consumable stores and spare parts acquired by him to be used
or consumed in the course of his trade,
but does not include a foreign currency option contract and a forward exchange
contract as defined in section 24I (1).”
(The emphasis in this and all other provisions quoted in this judgment has been
supplied by me.)
[8]          In De Beers Holdings (Pty) Ltd v Commissioner for Inland Revenue
1986 (1) SA 8 (A) at 32 E - F this court considered that the definition as it then
stood fell into two parts -
“(1)
anything produced, manufactured, purchased or in any other manner
acquired by a taxpayer for purposes of manufacture, sale or
exchange by him or on his behalf, or
(2)
anything the proceeds from the disposal of which forms or will form
part of his gross income.”
As will have been noticed, the definition has been expanded since by amendments
the effect of which is to add yet a third part, but the third part is of no relevance

given the facts of this particular case and appellant did not contend otherwise.
[9]          In the Cape Income Tax Special Court from which the appeal emanates
it was contended by appellant that its own participations should be regarded as
falling within the first part of the definition of trading stock.  In this court, without
abandoning that contention, counsel for appellant preferred to contend that they
fell within the second part.  In my view, they fall within neither and even if,
contrary to what was said in the case of De Beers Holdings (Pty) Ltd at 33 C, the
definition is not exhaustive and other examples of what would in ordinary parlance
be regarded as trading stock could be conceived of, the participations which
appellant holds cannot be so regarded.
[10]          In appellant’s written heads of argument the case sought to be made
was that the participations held by it were trading stock;  that the cost to appellant
of those participations was deductible in terms of s 11 (a) of the Income Tax Act;
that the value of the participations still held and not disposed of by appellant at the

end of each tax year fell to be added back in terms of s 22 (1) (a) of the same Act;
and that, in terms of the latter sub-section, that value consisted of the cost price
to appellant of the participations less the amount which the Commissioner might
think just and reasonable as representing the amount by which the value of the
participations had been diminished by a decrease in their market value.  The
consequence, so it was submitted, was that appellant was entitled to a substantial
deduction in terms of s 11 (a) because the cost price of the participations
exceeded by far the diminished value of the undisposed of participations which
had to be added back.  Whether there was in fact any such diminution in value is
yet another question which would have to be answered affirmatively before
appellant could enjoy any success in this appeal.  To that question I shall return.
[11]          The rationale which underlies s 22 was explained in Richards Bay Iron
and Titanium (Pty) Ltd and Another v Commissioner for Inland Revenue  1996
(1) SA 311 (A) at 316 F - 318 C.  It is unnecessary to repeat the explanation. It is

critical to appellant’s case that it be shown at the outset that the participations
which it holds are held to be sold or exchanged or, if they are not, that a
“disposal” of them takes place “the proceeds ..... of which forms or will form part
of (its) gross income”.   In my opinion, appellant has failed to do so.
[12]          In order to forge a link to the word “sale” in the definition of “trading
stock”, appellant has attempted to characterise as sales transactions which are not
capable in law of being so characterised.  The transaction which a participant in
a participation bond scheme enters into can by no stretch of imagination be
regarded as a sale.  The participant lends to the mortgagor a sum of money in
return for which the mortgagor will pay interest until the loan is repaid to the
participant.  Appellant, as  manager of the scheme, will be rewarded for its efforts
by a commission which it deducts from the interest payable by the mortgagor.  It
is the earning of that commission for the rendering of its management services
which is appellant’s principal object.  It is not intended to operate primarily as a

moneylender and, to the extent that it does in fact lend its own money to a
mortgagor, it does so only because it is expedient to do so for the reasons I have
explained.  Those loans by it are bridging loans made only because another
participant cannot be found at a time when money is required either to make up,
or to maintain, the full amount required by the mortgagor.  As soon as another
participant can be found appellant’s participation will cease pro tanto or altogether
as the case may be.
[13]          Attempts to classify the acquisition of these participations (whether
participations by third parties or participations by appellant) as sales are
confronted, in my view, by insuperable obstacles.  It is of the essence of a sale
that there be an identifiable merx and pretium.  What could conceivably qualify as
the merx?  Nothing other than a secured right to be repaid at a future date the same
sum of money which the participant has paid and to be paid interest in the
meantime.  That is hardly a merx in the ordinary sense of that word.  If that is to

be regarded as a merx then hundreds of thousands of South Africans are
unwittingly “buying” daily from the post office, banks, and other financial
institutions the right to be repaid the money they deposit with such institutions in
savings accounts, short, medium and long term deposits, and the right to receive
interest in the interim.  The sum of money deposited would have to be regarded
as the pretium even although it has to be repaid in due course to the “purchaser”.
That cannot be right.  Transactions such as those are quite unlike, say, factoring
transactions in which debts are sold at a discount to their face value.  The latter are
plainly sales.  There is an identifiable merx (a debt due to the seller by a third
party) and an identifiable pretium (the discounted face value of the debt) which is
the product of negotiation.
[14]          When, and if, appellant succeeds in arranging a perfect match at the
outset and has no need to advance any part of the loan itself, it has not “sold” any
participations.  It may loosely, but inaccurately, be said have “sold” its managerial

services, the “price” to be its commission on the interest paid, but it is not that
which is contended to be the trading stock; it is the participations themselves.
When a participant subsequently withdraws and is replaced by a new participant
found by appellant what is happening in law?  There is no sale by the outgoing
participant of his participation to the incoming participant.  The former will not
even know who the latter is.  The incoming participant makes a payment to the
manager in his representative capacity; the sum so paid is employed by the
manager to reduce pro tanto the debt of the mortgagor; a new debt is thereupon
created in the same amount which the mortgagor then owes the new participant.
The outgoing participant is repaid the sum which he lent the mortgagor.  The
mortgagor’s debt to that participant is discharged and the register is amended to
reflect that.  There is nothing left to “sell” to the incoming participant and there is
no identifiable pretium.
[15]          The fact that the incoming participant’s payment to appellant in its

capacity as manager of the scheme may be used to fund payment of the debt due
to the outgoing participant does not make it a payment by the incoming participant
to the outgoing participant.  The incoming participant’s payment remains what it
was intended to be:   a direct investment by the incoming participant in the scheme
- in legal parlance a secured interest-bearing loan by the incoming participant to the
mortgagor.  If that be so where the outgoing participant is a third party, why
should it be any different when the outgoing participant is appellant?  No good
reason suggests itself.  On the contrary, all the same considerations apply mutatis
mutandis.
[16]          The provisions of the Act are, as one would expect, entirely consistent
with the classification of participations as secured interest-bearing loans by the
participant to the mortgagor, and inconsistent with their classification as the
intended subject of sales by the managers of participation bond schemes.
[17]          A “participant” is defined as “a person who holds a participation in a

participation bond”;  a “participation” as “a share of, or all, the rights secured
under a participation bond”.  Such a bond must be registered in the name of a
“nominee company” to fall within the definition of “participation bond”.  A
nominee company is also defined and inter alia, must have “as its principal object
to act as nominee for or representative of any person or persons in the holding of
property in trust for such person or persons”.  These definitions are all to be
found in s 1 of the Act.
[18]          S 2 requires a participation bond clearly described as such to be
registered as such in a deeds registry in the name of a nominee company “as
nominee for or representative of the participants” in the bond.  The names of the
participants do not have to be set forth in the bond (s 2 (2)).  They are deemed to
hold their participations subject to the provisions of the Act (s 2 (3)).  Whenever
a participation in a bond is “granted”, the participant must be notified in writing of
the particulars of the bond, the extent of the participation granted, and the

conditions upon which the participant may transfer, cede or encumber his rights
(s 4).
[19]          A register must be kept in which must be recorded, inter alia, the
particulars of each participation bond; the amount owing from time to time by the
mortgagor; and “the names of the participants in such bond and the extent of their
participations from time to time as well as all amounts repaid to participants in
respect of their participations (s 5 (1)).  The rights of a participant are spelt out in
s 6:
“(1)
The debt secured by a participation bond shall to the extent of the
participation granted to any participant be a debt owing by the
mortgagor to such participant and not to the nominee company,
and the rights conferred by the registration of any such bond shall,
notwithstanding the registration of the bond in the name of the
nominee company, be deemed to be held by the participants.”
[20]          The circumstances in which a participant may enforce his rights against
the mortgagor are set forth in s 6 (2).  Where the nominee company itself takes
action to recover money from the mortgagor any money recovered “shall be the

property of the participants proportionately to the extent of their participations”
(s 6 (4)).  Money received from would-be participants in a participation bond, or
money paid in reduction of the principal debt owing under a participation bond,
must be deposited “in the name of the nominee company on behalf of the
investor” with a registered banking institution and must “remain so deposited until
the investor is granted a participation --- or until the money is repaid to the
investor” (s 10 (5)).
[21]          Provision is made in the Act for the appointment by the nominee
company of a manager in terms of an “irrevocable agreement --- in terms of which
[the manager] has undertaken to pay all the expenses of and incidental to [the
nominee company’s] formation, operations, management and liquidation”.  (See
the definitions in s 1 of “manager” and “nominee company”.)  A manager may also
hold a participation in a participation bond (s 3 (2)).
[22]          What all these provisions show, to my mind, is that the legislature set

out to create for the public at large opportunities for the making of even relatively
modest interest-bearing loans secured by a mortgage bond over immovable
property.  (A minimum amount of R1000,00 is all that s 3 (1) (b) of the Act
requires.)  For someone with only a modest amount available for investment the
expense of registering a mortgage bond to secure so modest an investment would
be prohibitive if a separate bond reflecting the investor as the mortgagee would
have to be registered.  There is not the slightest indication anywhere in the
legislation that the granting of these participations by the manager of a participation
bond scheme is, or is to be regarded as, the entering into of sales or exchanges.
[23]          The evidence adduced by appellant in the court a quo to bolster its
contentions fell far short of doing so.  If anything, it reinforces the conclusions I
have reached.  I see no need to review it in any detail.  What emerges clearly from
it is this.  These participations were referred to by appellant in its promotional
literature as “investments”.  Its own role was that of a facilitator and manager of

the scheme.   It referred to participants as “investment clients”.  It took from
would-be participants what amounted to a power of attorney to make participation
bond investments and reinvestments “on his behalf”.  Interest paid by the
mortgagor to it was received by it as agent for the participant.  Nothing in the
contractual documentation existing between it and a participant suggested that
anything was being sold.  The period of time for which a client would be a
participant was (subject to a prescribed minimum period) potentially open-ended.
Its own financial statements were difficult to reconcile with its own participations
being regarded as trading stock in that no sales thereof were reflected, and in those
statements the existence of any “turnover in the generally accepted sense” was
specifically disclaimed.
[24]          The terms “bond stock”, “stock on hand”, and “office pool” which
were used internally by appellant to describe the participations held by itself count
for little in the face of all that.  They are equivocal expressions which do not

necessarily connote that they were being used as the equivalent of trading stock
within the meaning of s 1 of the Income Tax Act or indeed within the ordinary
meaning of trading stock.  But even if they were being so used, if their use was
inaccurate and not a true reflection of the real nature of the participations, that
usage cannot advance appellant’s case.
[25]          The Court a quo seems to have regarded instances of appellant being
succeeded as a participant by a third party as cessions by appellant to the third
parties of its rights against the mortgagor.  While such transactions are notionally
conceivable (subject to the limitations to be found in the Act), it was not
appellant’s case that any such cessions occurred.  A cessionary’s right against a
debtor is a derived right which he acquires by virtue of the contract of cession.
It would be inherent in such a cession that the mortgagor’s debt to the cedent has
not been discharged.
[26]          There is no provision made in the Act for the registration of a

cessionary as a participant in lieu of the cedent.  A cedent will therefore remain
registered as a participant and the debt due to him, her or it by the mortgagor will
continue to be reflected as owing. When appellant replaces itself as a participant
by admitting a new participant to the scheme it reflects itself in  the register as
having been repaid and enrols the new investor as a participant.  The new
investor’s rights are the original rights of a new investor; they are not  rights
acquired from appellant.  If they were, and if it is so that appellant had the right to
withdraw from participation at any stage as it asserts it had (a question upon which
I refrain from expressing any opinion), it would follow that a  cessionary would
have the same right.  If the rights acquired are not those of a cessionary, but those
of a new investor, all the restrictions upon withdrawal from the scheme applicable
to a new investor would apply.  Appellant’s entire case was predicated upon the
latter being the position.  There is no basis in fact for any finding that appellant is
ceding its rights against the mortgagor when it replaces itself with a new investor.

[27]          Neither in the written heads of argument nor during oral argument was
it argued that any such substitution of a new participant for appellant’s
participation amounted to an “exchange” within the meaning of the definition of
“trading stock”.  Nor could it have been for, even if it could be said that such a
transaction involves an exchange, the exchange takes place between participant
and mortgagor and not between participant and appellant.  In exchange for the
participant’s loan to the mortgagor, the mortgagor makes a commitment to the
participant to repay the loan in due course and to pay interest on it in the interim.
[28]          As I have said, during oral argument in this court counsel for appellant
sought to bring such transactions within the second part of the definition.  In order
to do that it must show that there have been “disposals” of something, that there
were demonstrable “proceeds” of those disposals, and that those proceeds
formed part of its “gross income”.  The concept of “gross income” is also
defined in s 1 of the Income Tax Act.  The definition is extensive.  It is not

necessary to quote it in full.  It is sufficient to say that while it excludes in general
“receipts or accruals of a capital nature”, it contains a list of particular receipts or
accruals which are to be included irrespective of whether or not they are of a
capital nature.  None of the receipts or accruals so listed would comprehend the
sums of money invested by participants in appellant’s participation bond scheme.
That is so irrespective of whether any such sum is or is not a sum which has
enabled appellant to withdraw either wholly or partially from participations in its
own scheme.
[29]          If such sums are to be classified as gross income, they will have to fall
within the general rubric of receipts or accruals which are not of a capital nature.
Here again appellant faces an insuperable hurdle.  Such sums are not received by
appellant in its own right, nor are they sums accruing to appellant in its own right.
They are sums received by appellant and held by it on behalf of would-be
participants preparatory to the investment of those sums in participation bonds by

appellant in its capacity as agent for the participants.  They do not constitute
income received by or accruing to appellant at all. On this view of the matter it is
irrelevant whether or not those sums are of a capital nature.
[30]          That is not the only obstacle in the way of appellant.  What ranks as a
“disposal” and what ranks as the “proceeds” of the disposal within the meaning
of the definition of trading stock?   As was explained in paragraph 12 above,
appellant does not dispose of anything nor are there any proceeds of a disposal.
In exiting from the scheme either partially or wholly appellant is simply receiving
payment from the mortgagor of part or the whole of the debt due to it.  It is not
disposing of its right to be paid by the mortgagor to the incoming investor nor is
what the latter lends to the mortgagor the “proceeds” of any such disposal.  But
even if those difficulties could be overcome, it would be far from clear that they
would be receipts not of a capital nature.  The appellant is not “trafficking” in
participations; it is not “purchasing and selling” participations in order to generate

an income from such activity.  Its own involvement in participations is temporary
and incidental to its true vocation which is to administer the scheme in return for
its agreed commission.  As such its “holding” of participations is prima facie of
a capital and not of a revenue nature.  However that may be, in as much as the
point was not addressed during argument, I refrain from expressing a more definite
opinion.
[31]          To the extent that there are expressions of opinion in the “Guidelines
and Explanatory Notes” issued by appellant as to what is happening in law, and
to the extent to which they are incompatible with what I consider to be the correct
juristic analysis of what actually happened and was intended to happen, they must
be taken to be erroneous.
[32]          In view of these conclusions it is not really necessary to consider
whether, if the participations could be classified as trading stock, there was in fact
any diminution in their value within the meaning of s 22 of the Income Tax Act,

whether that was in fact so decided by the Commissioner, and if so, whether that
finding is open to attack in this appeal.  Had it been open to this court, and
necessary, to consider the first question, I would have answered the question in
the negative.
[33]          An elaborate argument to the contrary was advanced in the written
heads of argument by appellant and repeated during oral argument.  Parallels were
sought to be drawn between the well-known fluctuations in intrinsic value of traded
stock and debentures carrying particular interest rates as market conditions
change.  In my opinion, the argument is fallacious.   The intrinsic value of stock
and debentures traded at any given date depends primarily upon the relationship
between the fixed rate of interest payable throughout the life of the instrument and
prevailing interest rates and current expectations as to how rates may move.  In the
case of these participation bonds there is no fixed rate of interest.  It is variable
and there is no “floor rate” below which it cannot fall.  The intrinsic value of the

participation is therefore not under threat by virtue of it bearing a fixed interest rate.
The risk of the borrower being unable to repay the loan is theoretically a factor
which may adversely affect the intrinsic value of the participations but it is not
suggested that any such risk existed here.
[34]          The way in which appellant sought to demonstrate a depreciation in
value was this.  Interest is payable quarterly in advance on participations.  The
case was postulated of an investor who becomes a participant during a quarter and
after interest for that quarter has already been paid to the outgoing investor.  The
incoming investor will therefore be deprived of interest for the remainder of that
quarter.  That will “impair the price” which he is prepared to pay for the
participation.  The extent to which the “price” will be diminished will depend on
how long the new investor will have to endure the non-payment of interest.  In
practice this means, so the argument runs, that the value of such a participation is
diminished by an amount equivalent to the interest which the incoming participant

will not get.
[35]          The fallacy in the argument is shown by what appellant does in such a
case.  It does not give the incoming participant a discount representing the interest
which the participant will not receive for the remainder of the relevant quarter.  It
accepts from the incoming participant a sum equal to what has been repaid to it
(appellant).  It then pays the participant a sum by way of interest on his investment
for the remainder of the quarter.  The position is plain:  appellant, in its capacity
as a participant, has received a quarter’s interest in advance in anticipation of it
remaining invested for the coming quarter.  If it does not in fact remain invested
for the whole of the quarter, it disgorges the interest attributable to the period for
which it was not in fact invested and uses it to pay interest to the new investor who
was in fact invested for that period.  This is purely and simply a recognition of the
facts of economic life.  A lender cannot insist upon being paid interest in respect
of a period during which he lent nothing and a lender at interest cannot be

expected to forego the payment of interest in respect of a period during which his
money was in fact made available to the borrower.  The “value” of the
participation as such is unchanged.  What will have to be advanced to acquire it
remains constant.
[36]          The appeal is dismissed with costs, such costs are to include the costs
of two counsel.

R M MARAIS
JUDGE OF APPEAL
SMALBERGER JA)
NIENABER        JA)
PLEWMAN        JA)
MTHIYANE    AJA)      CONCUR