D-Day coming for South African taxpayers

A case now before the Supreme Court of Appeal could significantly affect taxpayers’ rights by determining the level of certainty they are entitled to when challenging SARS assessments.

A recent judgment of the Tax Court, Commissioner for the South African Revenue Service (SARS) v Oakleaf Investments Holdings 79 t/a Lesedi Power Company, is now on appeal to the Supreme Court of Appeal.

According to Shepstone & Wylie Attorneys’ Tax Executive Johan Kotze, this case raises an important procedural question in South African tax litigation – to what extent may SARS reformulate its case during the appeal process without issuing a revised assessment?

“Although the underlying dispute concerns the deductibility of pre-trade expenditure, the significance of the matter lies elsewhere,” Kotze said.

“The appeal turns on the proper interpretation and application of Rule 31 of the Tax Court Rules, and on the balance it seeks to strike between SARS’ powers in litigation and the taxpayer’s entitlement to procedural certainty.”

Kotze stressed that the appeal’s outcome may have implications beyond the facts of the particular case.

The Tax Administration Act, which establishes a structured framework for resolving tax disputes, is critical to this case.

“Once an assessment has been issued, a taxpayer may object to it and, if dissatisfied with the outcome, may appeal to the Tax Court,” Kotze explained.

“Rule 31 regulates the stage at which SARS delivers its statement of grounds of assessment and opposing appeal.”

The purpose of the rule is to crystallise the issues that fall to be determined by the Tax Court. Rule 31(3) permits SARS to include a new ground of assessment, unless that ground –

• Constitutes a novation of the whole of the factual or legal basis of the disputed assessment
• Requires the issue of a revised assessment

“The rule, therefore, allows a degree of flexibility, while at the same time imposing limits designed to ensure procedural fairness and certainty,” Kotze said.

The Oakleaf case

The dispute in the Oakleaf case arose when the taxpayer, an independent power producer, incurred substantial expenditure prior to commencing trade in developing a solar photovoltaic facility.

In its 2014 year of assessment, it claimed deductions for this expenditure, described as “development fees”, under section 11A read with section 24J of the Income Tax Act.

In its finalisation of audit letter and the additional assessment that followed, SARS disallowed the deduction on the basis that –

• The expenditure was capital in nature
• The authorities relied upon by the taxpayer, including CSARS v South African Custodial Services and ITC 1870, only applied to the now defunct section 11(bA) of the Income Tax Act, which were applicable to preproduction interest and related finance charges, but were not applicable to section 24J
• The expenditure did not arise “in terms of” the relevant financial arrangements, notwithstanding any close connection to the raising of finance

“When SARS later delivered its Rule 31 statement, it maintained its opposition to the deduction but advanced a different basis for doing so,” Kotze said.

“SARS accepted that ‘related finance charges’ under section 24J may have a wide ambit, and that costs not directly incorporated into loan agreements could, in principle, qualify.”

Kotze explained that the focus of the taxman’s opposition shifted instead to an alleged lack of factual particularity.

SARS contended that the taxpayer had not adequately demonstrated the necessary nexus between the expenditure and the relevant financial arrangements. The Tax Court held that SARS’ Rule 31 statement did not comply with Rule 31(3).

“In the court’s view, SARS had not merely elaborated on the grounds set out in the assessment, but had abandoned the legal foundation of that assessment and replaced it with a materially different factual case,” he noted.

“The court emphasised that the comparison required by Rule 31(3) is between the Rule 31 statement and the assessment itself, rather than the objection decision.”

The court also held that letting SARS introduce a fundamentally different factual and legal basis at the Rule 31 stage would be prejudicial to the taxpayer and inconsistent with the structure of the objection and appeal process.

“On that basis, the court concluded that the new grounds advanced by SARS required the issue of a revised assessment and granted relief in favour of the taxpayer,” Kotze said.

The appeal

SARS has appealed the judgment to the Supreme Court of Appeal, Kotze said. The appeal raises, in broad terms, two related questions –

1. Whether SARS’ Rule 31 statement constituted a novation of the factual or legal basis of the assessment, or whether it amounted to a permissible elaboration of the existing grounds of disallowance
2. What the appropriate consequence is if a contravention of Rule 31(3) is established

“The appeal is therefore not concerned with the substantive deductibility of the expenditure, but with the procedural limits applicable to SARS once an assessment has been issued,” Kotze said.

According to Kotze, the appeal highlights an issue that arises with some frequency in practice. On the one hand, SARS is entitled to defend an assessment and to require a taxpayer to discharge the burden of proof.

However, on the other hand, taxpayers are also entitled to know the case they are required to meet and to object meaningfully to the grounds upon which an assessment is based.

“If SARS were permitted to substitute the basis of an assessment during litigation, the objection process would be undermined, and Rule 31 would lose much of its intended effect,” Kotze explained.

“Conversely, an unduly restrictive approach could impede SARS from properly articulating its case where an assessment has been imperfectly expressed.”

Kotze added that the Supreme Court of Appeal’s decision may therefore provide important guidance on the balance to be struck between these competing considerations.

“The Oakleaf appeal affords the Supreme Court of Appeal an opportunity to clarify the scope and purpose of Rule 31(3), and to reaffirm the role of procedural certainty and fairness in the resolution of tax disputes,” he said.

“Whatever the outcome, the judgment is likely to be of interest to taxpayers, practitioners and SARS alike, and may influence the conduct of tax litigation going forward.”