Monday, 11 August 2014

The Supreme Court of Appeal Admonishes the South African Revenue Service

Under the provisions of the Tax Administration Act, the Commissioner: South African Revenue Service (‘SARS’) is entitled to request that a taxpayer submits relevant material that SARS requires in terms of section 46 of the Tax Administration Act No. 28 of 2011 (‘TAA’).

Section 1 of the TAA in turn defines ‘relevant material’ as meaning:

“any information, document or thing that is foreseeably relevant for the administration of a Tax Act as referred to in section 3.”

Section 3 in turn contains an extensive definition of what constitutes the administration of a Tax Act and in essence encompasses information required for purposes of assessing taxpayers for tax purposes.

Under the general provisions of the TAA a taxpayer bears the onus that an amount is not subject to tax or that a deduction claimed is deductible for tax purposes. Section 102 of the TAA, which replaced the erstwhile onus provision contained in section 82 of the Income Tax Act, provides that a taxpayer bears the burden of proving:

·         ‘that an amount, transaction, event or item is exempt or otherwise not taxable;
·         that an amount or item is deductible or may be set-off;
·         the rate of tax applicable to a transaction, event, item or class of taxpayer
·         that an amount qualifies as a reduction of tax payable;
·         that a valuation is correct; or
·         whether a “decision” that is subject to objection under appeal in the Tax Act, is incorrect.’

However, the burden of proving whether an estimate envisaged in section 95 of the TAA deals with estimation of assessments the burden shifts to SARS which is required to show that the estimate is reasonable. 

Furthermore, where SARS imposes an understatement penalty SARS must prove the facts on which it based the understatement penalty levied under chapter 16 of the TAA.

It must be remembered that where a person is charged with a criminal offence, the state has the obligation to prove that the person committed that offence beyond any reasonable doubt, which is a very high threshold. 

Insofar as discharging of the onus under tax legislation is concerned, the taxpayer must show on a balance of probabilities that the facts or assertions made are correct.

When SARS conducts an audit and requires information to satisfy SARS that deductions have been properly claimed, the question often arises as to the extent of documentary evidence that is required to be submitted by a taxpayer to discharge the onus placed upon the taxpayer under the TAA.

In the Supreme Court of Appeal case of The Commissioner for the South African Revenue Service v Pretoria East Motors (Pty) Ltd, case number 291/12 [2014] ZASCA 91 in which judgment was delivered by Ponnan JA on 12 June 2014 clear guidelines were set out as to what constitutes sufficient proof which should be acceptable to SARS in a taxpayer discharging the onus borne by a taxpayer.

In the Pretoria East Motors case the taxpayer carried on business as a car dealership in Pretoria selling new and used vehicles. During June and July 2003 SARS officials conducted a detailed audit of the taxpayer’s affairs covering the period 2000 to 2004.

In concluding the audit SARS issued additional income tax and value-added tax assessments. 

The taxpayer lodged objections against the various assessments and that having been disallowed by SARS it then appealed to the Tax Court in Pretoria.  Both the taxpayer and SARS were dissatisfied with the decision of the Tax Court and the case proceeded to the Supreme Court of Appeal.

The Court pointed out that much of the evidence presented at the Tax Court took the form of documentary exhibits, including documents obtained or prepared by SARS during the course of the audit.

The Court pointed out that the taxpayer’s ipse dixit will not lightly be regarded as decisive. It is necessary that the taxpayer’s ipse dixit is considered together with all of the other evidence of the case. 

The Court made the point that the interests of justice require that the taxpayer’s evidence and questions of its credibility be considered with great care. 

It is required that the taxpayer’s evidence under oath and that of its witnesses must be properly considered by the court and the credibility of the taxpayer’s witnesses must be assessed no different to any other case that comes before a court.

SARS issued additional assessments on the basis of information obtained from the taxpayer’s records and the court indicated that the SARS official, namely Ms Victor, was to examine the taxpayer’s accounts and where she identified a discrepancy that she did not understand be raised in assessment to additional tax either for income tax or VAT or in some cases both. 

The court pointed out that Ms Victor did not seek to familiarise herself with the workings of the taxpayer’s accounting system even though the information was available to her. Certain of the transactions concluded by the taxpayer were purely internal to the taxpayer’s operations and were being reflected as sales on that internal system did not comprise sales in the true sense for fiscal purposes. 

The court pointed out that Ms Victor ignored the internal character of the transactions of the taxpayer and she levied VAT thereon. At paragraph 11 the court stated as follows:

“As best as can be discerned, Ms Victor’s approach was that if she did not understand something she was free to raise an additional assessment and leave it to the taxpayer to prove in due course at the hearing before the Tax Court that she was wrong. Her approach was fallacious. The raising of an additional assessment must be based on proper grounds  for believing that, in the case of VAT, there has been an under declaration of supplies and hence of output tax, or an unjustified deduction of input tax. In the case of income tax it must be based on proper grounds for believing that there is undeclared income or a claim for a deduction or allowance that is unjustified. It is only in this way that SARS can engage the taxpayer in an administratively fair manner, as it is obliged to do. It is also the only basis on which it can, as it must, provide grounds for raising the assessment to which the taxpayer must then respond by demonstrating that the assessment is wrong. This erroneous approach led to an inability on Ms Victor’s part to explain the basis for some of the additional assessments and an inability in some instances to produce the source of some of the figures she had used in making the assessments. In addition, as a matter of routine, all the additional assessments raised by her were subject to penalties a the maximum rate of 200 per cent, absent any explanation as to why the taxpayer’s conduct was said to be dishonest or directed at the evasion of tax.”

It is clear that the Supreme Court of Appeal has held that in auditing a taxpayer the Commissioner is required to properly consider the documentation provided and to understand that information. It is not sufficient for SARS to merely request information and then disregard it and to issue an assessment as it sees fit.

The court made the point that where the SARS auditor issues an assessment based on the taxpayer’s accounts and records but has misconstrued those records then it will be sufficient for the taxpayer to explain the nature of SARS’ misconception, point out the flaws in the analysis and to explain how those records and accounts should be properly understood.

Whilst it is clear from the judgment that the taxpayer did not succeed in all of its challenges to the VAT and tax assessments issued by the Commissioner, the taxpayer did succeed in satisfying the court that SARS had gone too far in reaching the conclusions it did by disregarding information provided to it.

It is clear under the right to administrative justice in section 33 of the Constitution that taxpayers are entitled to fair administrative action and this includes the conduct of SARS officials in concluding an audit into the affairs of the taxpayer. 

The law requires that SARS officials properly evaluate the documentary evidence presented and where taxpayers reach the conclusion that this is not the case they should challenge SARS’ decision or alternatively seek to raise the problem directly with the office of the Tax Ombud which office has been created to deal with abuses of power by SARS and where SARS does not comply with proper procedures in administering the tax laws of South Africa.

SARS, in the case under consideration alleged that insufficient proof had been made available by the taxpayer. 

In fact the taxpayer had offered SARS sight of all of the taxpayer’s ledger accounts and this invitation was declined. It is clear that in the case the SARS auditors had been given access to the documents substantiating the taxpayer’s accounts but chose not to examine them.

Thus, taxpayers who are subject to audit by SARS need to be aware of the rights that they have flowing from the Constitution and also the level and standard by which SARS is required to operate which are enshrined in the Constitution under fiscal laws of the country.

Dr Beric Croome, Tax Executive: Edward Nathan Sonnenbergs Inc.  This article first appeared in Business Day, Business Law and Tax Review, August 2014. Image purchased from www.iStock.com

Monday, 14 July 2014

Should the South African Revenue Service adopt a Taxpayer Bill of Rights?

A Taxpayers’ Charter setting out the rights and obligations of taxpayers in South Africa was published for the first time during 1997. That Charter contained a statement of intent insofar as taxpayers’ rights in South Africa is concerned. On 19 October 2005 the SARS Client Service Charter was released setting out the levels of service that taxpayers could expect in their dealings with the South African Revenue Service (‘SARS’).

Currently, (at date of writing this article), neither the Taxpayers’ Charter nor the SARS’ Service Charter Standards can be located on the SARS website and it would appear to be a matter of ‘out of sight out of mind’.

It is appropriate to revisit the matter in light of the fact that the Internal Revenue Service (‘IRS’) in the United States of America announced on 10 June 2014 the adoption of a Taxpayer Bill of Rights that will become a cornerstone document to provide that country’s taxpayers with a better understanding of their rights. 

The US Taxpayer Bill of Rights consolidates the various existing rights imbedded in the Internal Revenue Code and groups those into ten broad categories making them more visible and easier for taxpayers to find on the IRS website. 

The National Taxpayer Advocate, Professor Nina E. Olson, similar to the Tax Ombud in South Africa, listed the desire to see a Taxpayer Bill of Rights released as a top priority in her most recent annual report to Congress, and stated as follows:

‘However, taxpayer surveys conducted by my office have found that most taxpayers do not believe they have rights before the IRS and even fewer can name their rights. I believe the list of core taxpayer rights the IRS is announcing today will help taxpayers better understand their rights in dealing with the tax system.’

The US Taxpayer Bill of Rights sets out ten rights which taxpayers have in their dealings with the IRS. The first right is that to be informed so that taxpayers know what they need to do to comply with the tax laws of the United States. In addition, taxpayers are entitled to clear explanations of the laws and IRS procedures in all tax forms, instructions, publications, notices and correspondence.

The taxpayer has the right to quality service which entitles them to receive prompt, courteous and professional assistance in their dealings with the IRS and to be spoken to in a way that they can easily understand.

The Bill of Rights lays down that taxpayers have the right to pay only the amount of tax legally due, including interest and penalties and to have the IRS apply all tax payments properly.

Furthermore, US taxpayers have the right to raise objections and provide additional documentation in response to formal IRS actions or proposed actions or to expect that the IRS will consider their timely objections and documentation promptly and fairly and to receive a response where the IRS does not agree with their position.

In addition, US taxpayers are entitled to a fair and impartial administrative appeal of most IRS decisions, including penalties and have the right to receive a written response regarding the Office of Appeals’ decision. Taxpayers also have the right to take their cases to court.

Furthermore, taxpayers have the right to finality and they have the right to know  the maximum amount of time they have to challenge the IRS’ position, as well as the maximum amount of time that the IRS has to audit a particular tax year or collect a tax debt. Related to this, US taxpayers have the right to know when the IRS has finished an audit.

The Taxpayer Bill of Rights sets out that taxpayers have the right to expect that any IRS enquiry, examination or enforcement action will comply with the law and be no more intrusive than necessary and will respect all due process rights.

In the US taxpayers have the right to expect that any information they provide to the IRS will not be disclosed unless authorised by the taxpayer or by law. US taxpayers have the right to expect appropriate action will be taken against employees and others who wrongfully use or disclose taxpayer return information.

In addition, taxpayers have the right to retain an authorised representative of their choice to represent them in their dealings with the IRS. Taxpayers have the right to seek assistance from a Low Income Taxpayer Clinic in the event that they cannot afford representation. 

This is unfortunately something that is lacking in South Africa and consideration should be given to creating non-governmental organisations which can provide assistance to those low income taxpayers who may need assistance in their dealings with SARS.

Finally, the Taxpayer Bill of Rights provides that taxpayers have the right to expect the tax system to consider facts and circumstances that might affect their underlying liabilities, ability to pay or ability to provide information timely. 

Furthermore, US taxpayers have the right to receive assistance from the Taxpayer Advocate Service if they are experiencing financial difficulty or in the event that the IRS has not resolved their tax issues properly and timeously through its normal channels. 

It is hoped, that in time the Tax Ombud will be conferred the powers available to the Taxpayer Advocate in the USA to direct SARS from taking action against taxpayers until the Tax Ombud has reviewed the particular case.

In the media release published by the IRS it is indicated that the IRS will add posters and signs in the coming months to its public offices so that taxpayers visiting the IRS can easily see and read the information regarding the Taxpayer Bill of Rights. 

Furthermore, a document summarising the rights that taxpayers have under the Bill of Rights will be mailed to taxpayers as taxpayers start to receive follow up correspondence regarding the 2014 filing season. The IRS Commissioner, Mr Koskinen, pointed out that the information contained in the taxpayer Bill of Rights is critically important for taxpayers to read and understand, particularly when they interact with the IRS. 

It's accepted that the US Taxpayer Bill of Rights does not create new rights for taxpayers but rather seeks to highlight and showcase the rights for people to understand and become familiar with those rights and be in a position to enforce them in their dealings with the IRS.

In South Africa, the rights which taxpayers have in their dealings with SARS flow from the Bill of Rights contained in the Constitution of the Republic of South Africa and it is unfortunate that many taxpayers are not aware of the rights which they have in their dealings with SARS officials. It is also unfortunately the case that not all SARS officials are mindful of the rights which taxpayers have under the tax system.

SARS and the National Treasury should consider compiling and publishing a Taxpayer Bill of Rights similar to that in the United States, so as to remind taxpayers of the rights that they have in dealing with SARS and also serve as a useful reminder to SARS officials of the rights which they are required to adhere to in their interactions with taxpayers.

Dr Beric Croome, Tax Executive, ENSAfrica. This article first appeared in Business Day, Business Law and Tax Review, July 2014. Image created from www.irs.gov.

Tuesday, 10 June 2014

Preservation Order Assists SARS in Tax Action

Prior to the enactment of the Tax Administration Act No. 28 of 2011 (“TAA”), the Commissioner: South African Revenue Service (“Commissioner”) was required to apply for a preservation order under the common law, as the Income Tax Act did not itself contain a mechanism whereby the Commissioner could apply for a preservation order under the fiscal statutes to ensure the preservation of assets where there was a concern that a taxpayer may dissipate assets and frustrate SARS’ attempts to recover the tax due.

Section 163 of the TAA regulates the manner in which SARS may obtain a preservation order from the High Court to prevent the dissipation of assets. The High Court was recently required to adjudicate the application of section 163 of the TAA in the case of The Commissioner for the South African Revenue Service v C van der Merwe in re: In the exparte application of: The Commissioner for the South African Revenue Service and G van der Merwe and various others.

The case has as yet not been reported but judgment was handed down by Savage AJ of the Western Cape Division of the High Court on 28 February 2014 in respect of case number 13048/13.

The judgment indicates that Ms C van der Merwe worked as a model declaring taxable income ranging from R20,023.00 in 2009 to R45,366.00 in the 2012 year of assessment. During May 2013  she acquired an Audi R8 and during June 2013 she acquired a Land Rover SD4 coupe. 
The Act prevents dissipation of assets
which SARS may lay claim to in
a tax recovery operation.
Both vehicles were not financed and the purchase price was paid in cash by unknown persons. During May 2013 Standard Bank received the amount of USD$15.3 million for the benefit of C van der Merwe. The person remitting the funds from abroad was identified as a Mr Rawas and the funds were transferred from a bank in Lebanon. C van der Merwe instructed the bank to sell the foreign currency in her favour and gave as the contact details  those of her father and she indicated that the funds constituted a gift received from Mr Rawas. 

On 30 August 2013 a provisional preservation order was granted ex parte by Rogers J on application by the Commissioner under the provisions of section 163 of the TAA. In accordance with the order granted by Rogers J, the respondents were required to show why a final preservation order should not be granted and Savage AJ had to determine whether the provisional preservation order granted should be confirmed.

The judgment reports that C van der Merwe’s father is engaged in various disputes with the Commissioner over a number of years and that her father and various other entities controlled by him are liable to SARS for payment of approximately R291 million in respect of tax, additional tax penalties and interest. Furthermore, criminal charges have been instituted against C van der Merwe’s father.

SARS contends that Mr van der Merwe, together with the assistance of other parties,  intentionally manipulated the value of certain assets owned by non-registered VAT entities which sold second hand goods, comprising aircraft vessels and spare parts  to vendors in order to enable the registered vendors to claim national input tax under section 16(3) of the VAT Act. 

The judgment indicates that payment in terms of the various agreements was largely made by transferring shares, the values of which have been manipulated according to SARS.  The Commissioner  contended that the various transactions undertaken by Mr van der Merwe constituted a scheme as envisaged by section 73 of the VAT Act  and that C van der Merwe, either in her own right owes SARS taxes or holds assets on behalf of her father, or some of the other respondents against which assets SARS may execute in order to ensure the collection of taxes due.

A curator bonis is envisaged in section 163(7)(b) of the TAA, was appointed in accordance with the provisional preservation order to take charge of the assets of the various respondents and to identify assets which can be executed against for the collection of taxes due to SARS.

The van der Merwe family opposed the confirmation of the preservation order on the basis that C van der Merwe has no interest in the business affairs of her father and that the funds received by her were received for her own benefit.

The Commissioner submitted that C van der Merwe’s opposition to the preservation order lacked merit and that she had not raised any bona fide dispute of the fact that she had not adequately explained who Mr Rawas is, nor the rationale for the alleged gift she received of USD$15.3 million.

The Court reviewed the provisions of section 163 of the TAA and confirmed that the preservation order is granted to prevent realisable assets from being disposed of or removed, which may frustrate the collection of the full amount of tax that is due and payable.

Savage AJ indicated that it is not required that the Court determines whether the tax is as a matter of fact due and payable by a taxpayer or other person contemplated in section 163 of the TAA, as that will be determined by a subsequent inquiry. At the preservation stage it is necessary that the Court is supplied sufficient information to determine whether the preservation order should be granted against the persons it is sought. 

The Commissioner argued that the receipt of the R142 million by Mr van der Merwe’s daughter, over which he had signing powers, indicated that Mr van der Merwe had control over his daughter’s funds. 

SARS  argued that the daughter held the assets on behalf of her father or some of the other respondents  and that the assets should be preserved to secure the collection of tax. Furthermore, SARS submitted that receipt of the amount of R142 million by C van der Merwe probably has tax complications itself which need to be investigated. 

The Court therefore decided that reasonable grounds were shown for the preservation order against C van der Merwe to secure tax in relation to assets while the receipt of the funds is being investigated. Savage AJ reached the following conclusion insofar as the receipt of the alleged gifts is concerned:

“the probabilities that a young model, earning in the region of R20,000 per annum, would following a few short visits to a resort in the Seychelles, enjoy the serial generosity of a donor or benefactor on an unparalleled scale I find to be far-fetched and implausible.”

The Court was therefore not prepared to accept the explanation provided by C van der Merwe as to the nature of the funds she received from Mr Rawas. In addition, no details were provided in respect of the donor who purchased the two vehicles which were made available and registered in the name of C van der Merwe.

C van der Merwe asked the Court to dismiss the preservation order, or alternatively to postpone  the matter pending the determination of constitutional and other relevant issues which may be raised by her or the other respondents. 

The Court reached the conclusion that there was no basis on which to grant either order requested by C van der Merwe.

At the end of the day the Court therefore reached the conclusion that the provisional preservation order granted in terms of section 163(3) of the TAA should be confirmed.

In reviewing the judgment it is clear that SARS has the power to apply to the High Court for a preservation order to protect assets where there is a concern that a taxpayer may dissipate  assets which would otherwise be available to SARS to settle tax debts due. 

The Court will also not likely refuse to confirm a preservation order where a taxpayer does not adequately explain the nature of amounts received by them.

Dr Beric Croome, Tax Executive, ENSAfrica Inc. This article first appeared in Business Day, Business Law and Tax Review June 2014. Image purchased from www.iStock.com

Monday, 12 May 2014

Nowhere to Hide

On 21 February 2014 the Convention on Mutual Administrative Assistance in Tax Matters, (‘the Convention’) as amended, by the provisions of the Protocol amending the Convention on Mutual Administrative Assistance in Tax Matters which entered into force on 1 June 2011 was published in the Government Gazette. 

The Convention was approved by Parliament in terms of section 231 of the Constitution and  the  Convention took effect on 1 March 2014 in  South Africa. . 64 Countries have signed either the original Convention or the amended Convention and ultimately the Convention will apply in all 64 member states once  domestic procedures have been completed in the various signatory states to adopt the Convention. 

The purpose of the Convention is to increase the co-operation amongst tax authorities around the world and to combat tax avoidance and tax evasion on an international level.

South Africa has elected that the Convention will apply to the following taxes:
·         income tax
·         withholding tax  on royalties
·         tax  on foreign entertainers and sportspersons
·         turnover tax  on microbusinesses
·         dividends tax
·         withholding tax  on interest, effective from 1 March 2015
·         capital gains tax
·         estate duty
·         donations tax
·         transfer duty
·         value-added tax
·         excise tax
·         securities transfer tax
Chapter 3 of the Convention sets out the forms of assistance which states are expected to provide to each other. Article 4 regulates the exchange of information between states which have adopted the Convention and article 5  deals with the exchange of information on request. Article 6 of the Convention sets out the manner in which information should be exchanged automatically and this is intended to meet the standard set by the Global Forum on Transparency and Exchange of Information for Tax Purposes (‘Global Forum’). 

In addition, the treaty provides for the spontaneous exchange of information and  simultaneous tax examinations whereby a taxpayer residing in states which  have adopted the Convention may simultaneously conduct an examination of the taxpayers’ affairs.

Nowhere to Hide
Article 11 of the Convention regulates the recovery of tax claims by one state on behalf of another. Certain of the double taxation agreements concluded by South Africa with other states have specific provisions allowing for South Africa to request assistance from its treaty partners to assist in the collection of South African tax and allows at the same time for other countries to seek assistance from the South African Revenue Service (‘SARS’) to collect taxes owing to the other state. In the case of HMRC and another v Ben Nevis (Holdings) Ltd the English High Court held that  HMRC was empowered to assist SARS in the collection of tax allegedly due by Ben Nevis. 

More recently, in the case of M Krok v Commissioner: South African Revenue Service the High Court held that SARS was entitled to assist the Australian Tax Office (‘ATO’) in recovering taxes allegedly due by Mr Krok to the ATO.

Under article 11 of the Convention South Africa could seek assistance from other signatories to the Convention to assist in the recovery of taxes due to SARS out of assets owned by a South African taxpayer in a state which is a signatory to the Convention. Similarly, other countries can request that SARS assist in the collection of taxes due to other countries out of assets located in South Africa. The Convention sets out the manner in which signatory states are required to assist each other in the collection and recovery of taxes owing to another state.

The Convention also regulates the service of documents which may emanate from an applicant state which relate to a tax covered by the Convention such that South Africa would be required to assist the other state in the service of those documents.

As indicated above, the Convention entered into force in South Africa on 1 March 2014 and will apply to all those states which have adopted the Convention and have complied with domestic legislative requirements to adopt the Convention.

The purpose of the Convention is to counter global tax avoidance and evasion and to allow for revenue authorities to co-operate and assist each other in the collection and recovery of tax and also in the obtaining of information with  a view to assessing their residents correctly to tax.

The coming into force of the Convention must be viewed in the light of the work of the Global Forum and the intention to ensure that tax information will be exchanged automatically. On 12 October 2013 it was announced that South Africa would join the pilot scheme for the automatic exchange of tax information launched by the United Kingdom, along with France, Germany, Italy and Spain.

This move flows from a decision taken by the G20 countries to enhance transparency and exchange of tax information to benefit both developed and developing countries. On 13 February 2014 a common reporting standard for the automatic exchange of information between tax authorities was unveiled. The standard requires jurisdictions to obtain information from their domestic financial institutions and to exchange that information automatically with other tax jurisdictions on an annual basis.

The South African Revenue Service has entered into negotiations with the United States Department of the Treasury to conclude an Inter-Governmental Agreement (‘IGA’) with respect to the United States of America’s Foreign Account Tax Compliance Act (‘FATCA’). It has been confirmed that the wording of the draft IGA has been agreed upon and will be signed at governmental level shortly. Once the IGA has been signed the United States Treasury will regard South African financial institutions as being generally compliant with FATCA.

South Africa’s financial institutions will be required to report certain specific information to SARS which will then exchange that information with the United States under the legal framework provided by the double taxation agreement in place between South African and United States. The first reporting period is 1 July 2014 to 28 February 2015 and the required information will have to be submitted to SARS by June 2015.

Financial institutions will be required to submit information to SARS annually for every tax year ending February of each year. SARS has proposed a business requirements specification (‘BRS’) to deal with the automatic periodical reporting of specified information by financial institutions. SARS will publish a Public Notice in terms of section 26 of the Tax Administration Act requiring a return as specified in the BRS requiring the record keeping of the required information. 

It must be noted that South Africa will be entitled to exchange information with any other party that has adopted the Convention referred to above even where no double taxation agreement exists with that country. SARS will therefore require information from financial institutions for purposes of exchange of tax information under the IGA and the Convention based on the OECD common reporting standard on financial accounts and to obtain information that will be used by SARS under domestic statutes to tax  source based income  derived by non-residents.

Taking account of developments in the international arena, those taxpayers whose tax affairs are not in order should seek to regularise their position under the Voluntary Disclosure Programme available under the Tax Administration Act, failing which such persons will in all likelihood be identified by SARS as a result of the international initiatives under way to enhance tax compliance.

Dr Beric Croome Tax executive ENSafrica This article first appeared in Business Day, Business Law and Tax Review, May 2014. Image purchased from www.iStock.com

Monday, 14 April 2014

The Deductibility of Audit Fees

On 7th March 2014 the Supreme Court of Appeal delivered judgment in the as yet unreported case of Commissioner for the South African Revenue Service v Mobile Telephone Networks Holdings (Pty) Ltd, (966/2012) [2014] ZASCA 4 (7 March 2014) which dealt with the deductibility of audit fees incurred for a dual or mixed purpose and the apportionment thereof for tax purposes in light of section 11(a) of the Income Tax Act 58 of 1962, as amended (‘the Act’) read with sections 23(f) and 23(g) of the Act.

Mobile Telephone Networks Holdings (Pty) Ltd (‘MTN’) is the holding company of five directly held and a number of indirectly held subsidiaries and joint ventures. MTN in turn is a subsidiary of MTN Group Limited and the collective business of the operating companies within the group is the operation of mobile telecommunication networks and the provision of related services to customers in South Africa and other African states.

The Commissioner contended that the audit fees should be apportioned
and only that part relating to the generation of taxable income
MTN derived its income primarily in the form of dividends from its subsidiaries but also loaned funds to its various subsidiaries to finance working capital in the other working countries on an interest-free basis. In addition, MTN borrowed funds by issuing debentures and on loaning those funds to group companies at a higher rate of interest. Thus, MTN had two sources of income, namely dividends received from subsidiaries and interest received from subsidiaries.

MTN employed auditors as it was required to do to undertake the statutory audit of its annual financial statements for each of the 2001, 2002, 2003 and 2004 tax years. The audit fees incurred by MTN for each of those years was R365,505, R647,770, R427,871, and R233,786 respectively. Furthermore, during the course of the 2004 tax year MTN paid an amount of R878,142 to KPMG, its auditors, in relation to what was described as the ‘Hyperion’ computer system. In the tax returns submitted by MTN to the Commissioner: SARS the company claimed as a deduction the audit fees incurred by it as well as the fee paid to KPMG regarding the computer system .

The Commissioner disallowed the deduction of the KPMG fee in full and apportioned the annual audit fees by only allowing a deduction of between 2% and 6% of the audit fees incurred. The apportionment ratio adopted by the Commissioner was based on the ratio of MTN’s interest income as a proportion  of its total revenue, that is the revenue derived in the form of dividends and interest.

MTN lodged an objection against the disallowance of the audit fees and the KPMG fee and appealed against the Commissioner’s decision to disallow the objection.  MTN’s appeal was  heard by the South Gauteng Tax Court and was reported as ITC1842 [2010] 72 SATC 118.

The Tax Court decided that a 50/50 apportionment of the audit fees was just and equitable and therefore allowed the company to claim 50% of the audit fees against the income derived by it in each of the four years of assessment. Furthermore, the Tax Court reached the decision that the KPMG fee of R878,142 constituted an expense of a capital nature and was therefore not deductible for tax purposes.

MTN was dissatisfied with the decision of the Tax Court and appealed to the South Gauteng High Court where Victor J in Mobile Telephone Networks Holdings (Pty) Ltd v Commissioner for South African Revenue Service [2011] 73 SATC 315 allowed MTN’s appeal regarding the KPMG in allowing the expenditure in full. Furthermore, the High Court overturned the 50/50 apportionment of the audit fees decided on by the Tax Court and directed that the Commissioner allows 94% of the audit fees as a deduction for tax purposes.

The Commissioner was dissatisfied with the decision of the High Court and therefore appealed to the Supreme Court of Appeal with the leave of that Court. 

The Commissioner contended that the audit fees should be apportioned and only that part relating to the generation of taxable income, which in the instant case constituted interest, should be allowed for tax purposes with the balance of the expenditure not being allowed.

The Commissioner also contended that no deduction regarding the KPMG fee should be allowed or alternatively that the fee should be subject to apportionment on the same basis as the audit fees.

The Court reviewed various leading cases regarding the deductibility of expenditure such as Commissioner for Inland Revenue v Nemojim (Pty) Ltd, Commissioner for Inland Revenue v Standard Bank of SA Ltd and Joffe & Co Ltd v Commissioner for Inland Revenue. 

The Court recognised that the audit fees were laid out for a dual or mixed purpose in that it related to the receipt of dividends and interest and was of the opinion that the audit fees should therefore be apportioned. The Court indicated that apportionment of expenditure is essentially a question of fact depending upon the particular circumstances of each case and the Court therefore referred to the summary of MTN’s trading for the various tax years which set out the quantum of dividends received and interest received and the audit fees as a proportion of its income.

The Court indicated that the audit function involved the auditing of MTN’s affairs as a whole, the greater part of which related to the consolidation of the subsidiaries results into MTN’s results. 

The Supreme Court of Appeal expressed the view that any apportionment of the fees must be heavily weighted in favour of the disallowance of the deduction taking account of the primary role played by MTN’s equity and dividend operations compared to its more limited income earning operations. The Supreme Court of Appeal therefore reached the conclusion that a 50/50 apportionment was too generous to MTN and decided that only 10% of the audit fees claimed by MTN for each of the tax years in question should be allowed.

The Court  reviewed the nature of the KPMG fee and referred to the evidence heard by the Tax Court regarding the rationale for the services rendered by KPMG to MTN insofar as the ‘Hyperion’ system is concerned. The Court indicated that it was difficult to establish whether the KPMG fee could legitimately be deducted by MTN. Thus, the Supreme Court of Appeal reached the conclusion that the deduction of the KPMG fee must be disallowed in full.

It is accepted that MTN was required to undertake an audit of its affairs to comply with its statutory obligations. However, the courts will take account of the income derived by a taxpayer to determine what portion of the audit fees should be deductible and in MTN’s case it was decided that only 10% of the audit fees could be justified as relating to the production of the interest income which was taxable and that the remaining 90% of the audit fees was related to the receipt of dividends which are exempt from income tax.

It is also important that taxpayers establish the nature of expenditure reflected by the particular entity so that it can be shown that the expense relates to that specific entity and  not to any other entity in the group. The Court experienced difficulty in establishing the true nature of the KPMG fee and whether that related to MTN itself or other entities in the group and for that reason decided that the fee was not deductible by MTN.

Dr Beric Croome, Tax Executive, Edward Nathan Sonnenbergs Inc. This article first appeared in Business Day, Business Day Law and Tax Review, April 2014. Image purchased from iStock

Sunday, 30 March 2014

Mutual Assistance in Collection of Tax: South Africa and Australia

South Africa and Australia concluded a convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains on 1 July 1999. The agreement was subsequently amended by way of a Protocol signed on 31 March 2008. The agreement and the Protocol were entered into by the South African government in terms of section 108(2) of the Income Tax Act, No 58 of 1962, as amended (“the Act”) read with section 231(4) of the Constitution of the Republic of South Africa. The Protocol was duly published in the Government Gazette on 23 December 2008. Article 25A which deals with the mutual assistance in the collection of taxes took effect from 1 July 2010.

South Africa and Australia concluded a convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains on 1 July 1999. 
The amendments to the treaty concluded by South Africa and Australia by way of the Protocol referred to above deal with, inter alia, the exchange of information regulated by article 25 and with mutual assistance in the collection of taxes which is catered for in article 25A.

Article 25A of the treaty provides that the South African Revenue Service (“SARS”) and the Australian Tax Office (“ATO”) shall assist each other in the collection of taxes. Article 25A provides that the competent authorities of South Africa and Australia, may, by mutual agreement settle the mode of application of article 25A.

Article 25A refers to any amounts owed in respect of taxes of every kind and description imposed on behalf of South Africa and Australia or of their political subdivisions or local authorities, so long as the taxation in question is not contrary to the tax treaty or any other instrument to which the two countries are parties, as well as interest, administrative penalties and the cost of collection or conservancy relating to such tax.

The tax treaty provides that, where a tax debt is enforceable under the laws of South Africa, and is owed by a person who cannot under the laws of South Africa prevent its collection, that tax debt shall at the request of the Commissioner: SARS be accepted for purposes of collection by the competent authority of Australia. 

Similarly, the ATO is empowered to request that the Commissioner: SARS assists the ATO in collecting tax due to Australia.

Article 25A(3) has the result that the tax debt shall be collected by SARS in accordance with the provisions of South African law applicable to the enforcement in collection of taxes as if the debt were an amount due to SARS. The treaty also requires Australia to assist South Africa in collecting tax due by South African taxpayers from assets they may have in Australia. Prior to the insertion of article 25A into the tax treaty, SARS was unable to assist the ATO in the collection of taxes due to it from assets of Australian taxpayers located in South Africa and similarly, the ATO was unable to assist SARS in recovering taxes due to SARS from assets located in Australia belonging to South African taxpayers.

The application of an article regulating mutual assistance in the collection of taxes under a tax treaty was considered in the United Kingdom’s Court of Appeal in the case of Ben Nevis (Holdings) Ltd & Anor v Commissioner for HM Revenue and Customs [2013] EWCA Civ 578. In that case the United Kingdom court held that article 25A of the tax treaty concluded between South Africa and United Kingdom was valid and applied to the tax debts in issue in that case.

More recently, the North Gauteng High Court was required to finalise a provisional preservation order in terms of the provisions of section 163 of the Tax Administration Act, No 28 of 2011 (“TAA”) which related to a request made by the ATO to SARS to assist in the collection of tax due by an Australian taxpayer out of assets located in South Africa.

During January 2012, that is, before the Tax Administration Act took effect, SARS received a request from the ATO for assistance with tax collection and conservancy of the assets of Mr Krok pending collection of the amount which was alleged to be due by him under the tax laws of Australia. Subsequently, this request was renewed by the ATO during February 2013, which is after the Tax Administration Act took effect. The request made by the ATO was accompanied by a formal certificate issued by the Australian Commissioner indicating that Mr Krok was liable to the ATO in the amount of R235,705,169.19. SARS agreed to assist the ATO in accordance with the Protocol to the tax treaty concluded between South Africa and Australia and particularly article 25A.

Section 185 of the TAA sets out the process which SARS must adhere to where a request has been received from a foreign government, in terms of a tax treaty, to assist in the recovery of tax payable to that government. As a result of SARS being requested by the ATO to assist in the collection of tax allegedly due by Mr Krok, SARS applied for an order for the preservation of Mr Krok’s assets in accordance with section 163 of the TAA. 

Fabricius J delivering judgment in the Krok case referred to a Memorandum of Understanding between the two competent authorities of South Africa and Australia concerning assistance in the collection of taxes under article 25A of the treaty in place between the two countries. It does not appear that SARS has published this Memorandum of Understanding for use by taxpayers and it is interesting to note that in the Ben Nevis case the English Court expressed reservations about that the fact that there appeared to be documents in existence setting out the practical application of the tax treaty concluded by South Africa and United Kingdom which had not been made available to taxpayers in either country.

Mr Krok’s counsel contended that on a proper interpretation of the double tax agreement between South Africa and Australia and indeed the Protocol that SARS and the ATO could only rely on the mutual assistance provisions in respect of taxes owing which arose during the income years commencing from 1 July 2009. It was therefore argued that the taxes claimed by the ATO from Mr Krok fell outside of the scope of article 25A of the treaty. 

Similar arguments were raised in the Ben Nevis case and that was dismissed by the English Court. Similarly, in South Africa the High Court reached the conclusion that article 25A could be invoked from the date on which it took effect in respect of taxes which might have arisen since inception of the underlying tax treaty, that is during 1999.

The Court also examined the structure created by Mr Krok and related entities pursuant to his emigration from South Africa and the manner in which those structures were implemented. The Court was satisfied that the assets in issue remained under the control of Mr Krok and therefore confirmed the provisional preservation order sought by SARS in order assist the ATO in the collection of taxes due my Mr Krok.

Thus, taxpayers who have assets located in multiple jurisdictions need to be aware that should they not settle their tax liabilities payable to the tax authority where they reside, that tax authority may seek assistance from other revenue authorities around the world to assist in the collection of tax under double taxation agreements.

In addition, many countries have assented to the Multilateral Convention on Mutual Administrative Assistance on Tax Matters, as amended by the Protocol (“the Convention”). On 21 February 2014, Government Gazette 37332, indicated that all constitutional formalities required to give effect to the Convention had been finalised and that the Convention would take effect in South Africa from 1 March 2014. 

Currently there are 64 countries which have adopted the Convention and are in the process of finalising assent thereto in terms of domestic constitutional requirements. This means that South Africa can request assistance from numerous countries in collecting taxes payable by South African residents with assets located in countries which have assented to the Convention. Similarly, various other countries can call on South Africa to assist in the collection of taxes due to those other countries. 

Historically, it was possible for a taxpayer to argue that it was not legally competent for one government to assist another government in the collection of taxes due to that other government as it undermined the principle which recognised the sovereignty of nations. 

Those principles have changed by virtue of the inclusion of mutual assistance articles in numerous double taxation agreements and indeed in the Convention referred to above.



DR BERIC CROOME Tax Executive Edward Nathan Sonnenbergs Inc. This article was first published in Business Day, Business Law & Tax Review (March 2013). All information was correct at date of publication.

Monday, 10 February 2014

Income Tax and Vat Consequences of E-Tolls

Introduction

The levying of tolls for the use of certain highways in Gauteng, the so called e-tolls, took effect on 3 December 2013.  

It is therefore appropriate to consider the income tax consequences arising from the payment of e-tolls in those cases where an employee is reimbursed for business travelling or is provided with a vehicle owned by their employer or where an employee receives a travelling allowance to finance the expenditure incurred whilst travelling on the employer’s business.  

In addition, brief reference will be made to the income tax consequences facing fleet owners and cartage contractors.


Reimbursement at prescribed rate

An employer may decide not to provide an allowance for travelling to their employees nor a company owned vehicle and instead reimburse staff for the actual distance travelled on the business of the employer.  

Where an employee travels on the employer’s business and does not exceed 8 000 kilometres during a year of assessment and the employee does not receive any other compensation from the employer in the form of a further allowance or reimbursement, the prescribed rate per kilometre, which may be paid without attracting income tax,  is R3.24.

The rate per kilometre was set before e-tolls became effective and future regulations governing the amount payable by an employer to an employee for travelling on the employers business should be clarified to provide that the employer may reimburse the employee in respect of the cost of e-tolls.  

Currently, the rate per kilometre fixed for purposes of section 8(1)(b)(iii) of the Income Tax Act, No. 58 of 1962 (‘the Act’) provides that the amount of R3.24 may only be paid without any adverse tax consequence arising when no other compensation in the form of a further allowance or reimbursement is payable by the employer to the recipient of the reimbursement at the specified rate.  

The payment of the allowance is also not subject to VAT as a fringe benefit in terms of section 18(3) of the VAT Act.

Company Owned Vehicle

Where the employer owns or leases a motor vehicle and makes that available to an employee the employee will be subject to fringe benefits tax on the value and usage of that vehicle in the manner set out in paragraph 7 of the Seventh Schedule to the Act.

In principle, the employee is subject to fringe benefits tax at a rate of 3.5% of the determined value of the motor vehicle for each month for which the employee is provided with the use of the vehicle by their employer.  

The determined value of the vehicle for fringe benefits tax purposes is normally the cash cost thereof, including VAT.  In the event that the motor vehicle, at the time of acquisition, is the subject of a maintenance plan, the rate of fringe benefits is reduced to 3.25% of the determined value of the motor vehicle on a monthly basis.

In the case of an employer owned vehicle, the vehicle will be owned by the employer and thus the employer will be liable to pay the e-tolls to the extent that the motor vehicle in question travels on tolled highways.

The employer will be entitled to deduct the cost of e-tolls as an expense incurred in the production of income in that it relates directly to the provision of the motor vehicle by an employer to an employee for purposes of its business. 

The employer will, so long as the travelling was for the purpose of making taxable supplies and they receive a valid tax invoice which complies with the provisions of section 20 of the Value-added Tax Act, Act No. 89 of 1991,(‘VAT Act’), be entitled to recover the VAT paid on the e-tolls as an input credit when submitting its VAT returns to SARS. 

Where the employee retains accurate records of business distance travelled it will be possible to reduce the taxability of the fringe benefit by taking account of the ratio of business kilometres to total kilometres travelled by the employee. 

Furthermore, where the employee pays for certain expenses relating to the motor vehicle, the value of the taxable fringe benefit may be reduced by taking account of the business kilometres travelled as a proportion of the total kilometres travelled during the tax year. 

In accordance with the provisions of the Fourth Schedule to the Act the employer is required to deduct PAYE on 80% of the value of the fringe benefit arising from the use of the employer owned vehicle unless the employer is satisfied that at least 80% of the employee’s travel is related to the business of the employer. In these cases the PAYE deduction is based on 20% of the value of fringe benefit in question.

Employee Owned Motor Vehicle

In this case the employee will receive an allowance as part and parcel of their remuneration package with the result that the travelling allowance received will be subject to PAYE such that 80% of the allowance paid per month will attract PAYE.  

Where the employer can be satisfied that 80% or more of the travelling undertaken by the employee is for business purposes only 20% of the allowance paid will attract PAYE.

It is essential for the employee to retain a log book recording distance travelled on the business of the employer and the nature thereof so that they may determine the total business kilometres travelled during the tax year and that portion of travelling with constitutes private travel for which no deduction is available.

When the employee completes their annual tax return they will be entitled to claim expenditure regarding the motor vehicle against the allowance received by taking account of actual business kilometres travelled during the tax year.  

The taxpayer is entitled to use either actual costs incurred in respect of operating the motor vehicle during the tax year or alternatively may rely on the table of costs prescribed by the Minister of Finance.

Where the employee chooses to claim expenditure based on actual expenditure incurred they will be entitled to take account of the cost of insurance, maintenance and other direct costs relating to the operation of the motor vehicle including fuel, depreciation on the motor vehicle and the cost of e-tolls.  

The table of costs prescribed by the Minister takes account of the fixed cost attributable to the motor vehicle which is an attempt to recognise the depreciation in the value of the a motor vehicle depending on the cost thereof as well as the fuel cost and maintenance cost.  

The table of costs currently in existence does not take account of the cost of e-tolls. 

The table of costs is unlikely to be amended because e-tolls are only applicable on certain highways in Gauteng and not in South Africa generally. 

The alternative for the employee is to seek the reimbursement of the actual e-toll costs incurred from the employer in respect of business travelling. 

This will be neutral for tax purposes from the employee’s point of view. 

The employer should be entitled to claim the reimbursement of e-toll costs as a deduction for income tax purposes under section 11(a) of the Act.

Where an employer reimburses an employee who travelled for taxable business purposes for e-toll costs that employer will be entitled to recover the VAT relating thereto even though the tax invoice will be issued in the name of the employee and not in the name of the employer. 

This is based on the provisions of sections 16(2)(a) and 54 of the VAT Act which regulates the position of input tax borne by an agent on behalf of their principal.  

Also, section 20(5) of the VAT Act does not require that the name, address and VAT registration number of the employer be reflected on a tax invoice where the consideration for the supply does not exceed R5 000.

Fleet owners and cartage contractors

Those businesses which own a large number of vehicles, such as the car rental companies will face an increase in their operating costs as a result of the introduction of e-tolls. 

Similarly, the transport contractors will experience an increase in their costs of moving goods around the country as a result of the imposition of e-tolls. 

The cost of e-tolls are directly related to the business conducted by such taxpayers and will be deductible under section 11(a) of the Act.

Where the affected businesses are registered for VAT, they will be entitled to recover the VAT incurred on the e-tolls if the vehicles were used in the course of making taxable supplies and so long as they are in possession of a valid tax invoice which meets the requirements of section 20 of the VAT Act.

The introduction of e-tolls will no doubt result in an increase in the cost of goods transported by road which will ultimately be carried by the consumer in South Africa. 

Conclusion

Where an employee receives a reimbursement of travelling at a rate not exceeding the amount specified by the Minister of Finance it may be possible to seek the reimbursement of e-toll costs without adverse tax consequences. 

However, it would be preferable if the rules regulating such reimbursement are clarified in this regard. 

In the case of a company or employer owned vehicle, the employer will be liable to pay the e-tolls and should be entitled to deduct that cost as a deduction for tax purposes.  

No adverse tax consequences should arise in so far as the employee is concerned who is subject to fringe benefits tax on the usage of the motor vehicle in any event.

In those cases where an employee receives a travelling allowance to finance the cost of travelling on the employer’s business a decision will need to be made whether to claim the actual expenditure incurred regarding the motor vehicle, including the cost of e-tolls or to rely on the table of prescribed costs as set out by the Minister of Finance from time to time.

Those businesses which own a fleet of vehicles for renting out to clients or which own trucks to transport goods around the country will face an increase in costs which will, no doubt, be recovered from their clients. 

The cost of e-tolls will be deductible for tax purposes in terms of section 11(a) and the VAT element should be recoverable where the business is registered for VAT purposes and the vehicle is used for taxable business purposes. 

Dr Beric Croome, Tax Executive, Edward Nathan Sonnenbergs Inc. This article first appeared in Business Day, Business Law and Tax Review, February 2014.