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22 June 2018
In recent years, taxpayers have frequently been unsuccessful in their disputes with the South African Revenue Service (SARS), especially where the dispute has involved the interpretation or application of the substantive provisions of tax legislation. However, where disputes have involved compliance with the procedural requirements of tax legislation, taxpayers have generally had greater success. This update examines the judgment in Mr A v The Commissioner for the South African Revenue Service (Case IT13726, as yet unreported), which falls into the second category.
The taxpayer had been the chief executive officer of a company for just over 16 years when his employment ended in 2012. When the taxpayer's services came to an end, the company paid him R7,066,530 as an amount equal to a severance package, which was calculated in accordance with the company's retrenchment policies. The taxpayer declared the amount and described it as a "lump sum payment for separation package" in his 2012 income tax return. SARS did not accept that the lump sum payment was taxable as a retrenchment benefit and taxed it as other income instead. The taxpayer also traded as a cattle farmer and in his 2012 income tax return he had claimed farming expenses of R1,781,604 as a deduction, which SARS had disallowed.
SARS issued two additional assessments pursuant to its decisions, which the taxpayer subsequently appealed. The parties agreed that only the following two issues would be argued before the Tax Court:
The parties agreed that the issue pertaining to the deduction of farming expenses would stand over for argument at a later stage. This update focuses only on the first issue argued before the court regarding the audit's validity.
Under Section 40 of the Tax Administration Act (28/2011), SARS may select a person for inspection, verification or audit on the basis of any consideration relevant for the proper administration of a tax act, including on a random or risk assessment basis.
Section 42(1) of the Tax Administration Act states that a SARS official involved in or responsible for an audit under Chapter 5, Part A of the act must, in the form and manner prescribed by the commissioner in a public notice, provide the taxpayer with a report indicating the audit's stage of completion.
Under Section 42(2) of the Tax Administration Act, if an audit or criminal investigation is deemed inconclusive, SARS must inform the taxpayer of this within 21 business days. Alternatively, if an audit identifies potential adjustments of a material nature, SARS must, within 21 business days (or longer, depending on the complexities of the audit), provide the taxpayer with a document containing the outcome of the audit, including the grounds for the proposed assessment or decision referred to in Section 104(2) of the Tax Administration Act.
Section 42(3) states that once a taxpayer has received a document indicating the outcome of an audit and the grounds for the proposed assessment, it must respond within 21 business days of the document's delivery. This period may be extended upon the taxpayer's request and SARS may allow this based on the audit's complexities.
The taxpayer contended that:
The Tax Court held that SARS was not permitted to rely on a procedurally flawed audit conducted without the taxpayer's knowledge as a new ground of assessment in its Rule 31 statement, as this would violate the principle of legality.
The Tax Court explained that an additional assessment constitutes administrative action as contemplated in Section 33 of the Constitution 1996, which protects the right to administrative action that is lawful, reasonable and fair. The section also provides that everyone whose rights have been adversely affected by an administrative action has the right to be given written reasons, meaning that an assessment that is procedurally flawed due to a lack of reasons or failure to give reasons is inconsistent with the principle of legality.
In the Tax Court's view, Sections 40 and 42 of the Tax Administration Act give effect to Section 33 of the Constitution. The breach of the legality principle was compounded by SARS's failure to comply with Section 42(1) of the Tax Administration Act, as it had:
SARS also flouted Section 42(2)(b) of the Tax Administration Act, as it deprived the taxpayer of the opportunity to respond to any of the issues raised by SARS, particularly the question of the circumstances surrounding the taxpayer's resignation and the nature of the lump sum paid to him.
Notably, the Tax Court also held that if the taxpayer had been afforded an opportunity to explain his position regarding the nature of the lump sum payment, he could have informed SARS that his services had come to an end during a retrenchment process as contemplated in the definition of 'severance benefit' in Section 1 of the Tax Act. The Tax Court stated that if SARS had conducted the audit with due regard to Sections 40 to 42 of the Tax Administration Act, the outcome of the audit may have been different. The same considerations applied to the farming expenses that had been claimed as a deduction and disallowed.
As SARS's non-compliance with Sections 40 and 42 of the Tax Administration Act had contravened the Constitution and the principle of legality, the Tax Court concluded that:
The taxpayer's appeal was therefore upheld and SARS was ordered to pay the taxpayer's appeal costs.
The judgment sets out important principles regarding the relationship between SARS's compliance with the Tax Administration Act's audit provisions and the effect of an invalid audit on any subsequent assessment issued. This case reiterates the rights of taxpayers in tax dispute resolution proceedings and confirms that they can insist on SARS's compliance with the act's audit provisions. Where SARS issues an assessment without complying with Sections 40 and 42 of the act, such an assessment can be set aside.
For further information on this topic please contact Louis Botha at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email (email@example.com). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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