In recent times, taxpayers have often been unsuccessful in their disputes with the South African Revenue Service (SARS), especially where the dispute 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. The judgment in Mr A v The Commissioner for the South African Revenue Service (Case No. IT13726) (as yet unreported), falls into the second category and is the subject of this article.
The taxpayer, Mr A, had been the chief executive officer of a company for just over 16 years, when his employment with the company 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 calculated in accordance with the company’s retrenchment policies. He 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 claimed farming expenses of R1,781,604 as a deduction, which SARS disallowed.
SARS issued two additional assessments (Assessments) pursuant to its decisions and the taxpayer subsequently objected and appealed against the Assessments. The parties agreed that only the following two issues would be argued before the Tax Court:
- As a point in limine (preliminary point), whether the audit conducted prior to the additional assessment was valid, and whether the subsequent additional assessment was valid; and
- Whether the lump sum payment received by the taxpayer at the termination of his employment was a “severance benefit” as defined in the Income Tax Act, No 58 of 1962 (Act).
The parties agreed that the issue pertaining to the deduction of farming expenses would stand over for argument at a later stage. In this article, we will focus only on the first issue argued before court, regarding the validity of the audit.
In terms of s40 of the Tax Administration Act, No 28 of 2011 (TAA), 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 a risk assessment basis.
Section 42(1) of the TAA states that a SARS official involved in or responsible for an audit under Chapter 5 Part A of the TAA must, in the form and in the manner as may be prescribed by the Commissioner by public notice, provide the taxpayer with a report indicating the stage of completion of the audit.
In terms of s42(2) of the TAA, once the audit or criminal investigation has been concluded and it was inconclusive, SARS must inform the taxpayer of this within 21 business days. Alternatively, if the audit identified 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 s104(2) of the TAA.
Section 42(3) states that once the taxpayer has received a document indicating the outcome of the audit and the grounds for the proposed assessment, he must respond within 21 business days of delivery of the document. The period of 21 business days may be extended upon request by the taxpayer and SARS may allow this based on the complexities of the audit.
The taxpayer contended that in its Rule 31 Statement of Grounds of Assessment, SARS referred to a personal audit conducted in respect of the taxpayer and that this was the first time that he (taxpayer) had heard of such an audit. 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 it would violate the principle of legality.
The Tax Court explained that an additional assessment constitutes administrative action as contemplated in s33 of the Constitution of the Republic of South Africa, 1996 (Constitution), 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 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, s40 and s42 of the TAA give effect to the provisions of s33 of the Constitution. The breach of the legality principle was compounded by SARS’s failure to comply with s42(1) of the TAA, as it did not keep the taxpayer informed of the status of the audit, made no written conclusions or findings at the end of the audit, did not discover any audit file for 2012 and failed to conduct a financial inspection prior to issuing an additional assessment. SARS also flouted s42(2)(b) of the TAA in that 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.
Interestingly, the Tax Court also held that if the taxpayer was afforded an opportunity to explain his position regarding the nature of the lump sum payment, he could have informed SARS that his services came to an end during a retrenchment process as contemplated in the definition of “severance benefit” in s1 of the Act. The Tax Court stated that if SARS had conducted the audit with due regard to s40, s41 and s42 of the Act, the outcome of the audit may have been very different. The same considerations apply to the farming expenses that were claimed as a deduction and disallowed.
The Tax Court concluded that as SARS’s non-compliance with s40 and s42 of the TAA contravenes the Constitution and the principle of legality, SARS’s decision to issue an additional assessment without notice must be set aside and the assessment is invalid (presumably the Tax Court meant that both Assessments should be set aside). The taxpayer’s appeal was therefore upheld and SARS was ordered to pay the taxpayer’s costs of the appeal.
The judgment sets out important principles regarding the relationship between SARS’s compliance with the audit provisions of the TAA and the effect of an invalid audit on any subsequent assessment issued. This case re-iterates the rights of taxpayers in tax dispute resolution proceedings and is confirmation that a taxpayer can insist on SARS’s compliance with the audit provisions of the TAA. Where SARS issues an assessment without complying with the provisions in s40 and s42 of the TAA, such an assessment can be set aside.