In Tax Case IT 13726, as yet unreported, the Tax Court in Port Elizabeth had to determine if the 2012 assessment issued to the taxpayer was valid. The taxpayer claimed farming expenditure amounting to R 1 781 604 and reflected an amount of some R 7 million as a retrenchment payment which the taxpayer contended should have been taxed not at the normal marginal rate of tax but at the special rate applicable to retrenchment lump sums.
SARS issued an additional assessment for 2012 on 31 January 2013 disallowing the farming expenditure and treating the retrenchment lump sum as normal income. The taxpayer lodged objections to the adjustments made to the assessment by SARS. The objections were disallowed and the taxpayer filed an appeal against SARS’ decision to disallow the objections.
On 25 May 2017 the Registrar of the Tax Court was informed that the parties would only argue the following points:
· As a point in limine, whether the audit conducted by SARS before the issue of the additional assessment was valid and if the additional assessment was itself valid;
· Whether the lump sum received by the taxpayer upon his termination of employment constituted a ‘severance benefit’ as envisaged in the Income Tax Act.
The taxpayer argued that the amount of R 7 million should have been taxed according to the tax tables applicable to retrenchment and retirement lump sums. SARS contended that it conducted a personal income tax audit on the taxpayer during January 2013 and came to the conclusion that the amount was incorrectly reflected in the 2012 tax return as a retrenchment lump sum on the basis that the amount was paid because the taxpayer was dismissed and not retrenched.
The court indicated that if the taxpayer’s point in limine is upheld and the assessment is held to be invalid that will resolve the dispute without needing to determine if the payment was a retrenchment lump sum or not.
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The court decided that SARS could not rely on a procedurally flawed audit conducted without the taxpayer’s knowledge as a new ground in its Rule 31 statement and is thus mpermissible as this would violate the principle of legality.
The court stated that the issue of an additional assessment is administrative action as dealt with in section 33 of the Constitution which confers the right of just administrative action on taxpayers. That section also requires that any person whose rights have been adversely affected by administrative action is entitled to be supplied written reasons for the decision made. The court indicated that an assessment was issued and SARS’ failure to provide reasons therefore offends the principle of legality as dealt with in various court decisions.
Section 40 of the Tax Administration Act (‘TAA’) provides that SARS may select a taxpayer for inspection, verification or audit. Section 42 of the TAA places a legal obligation on SARS to keep the taxpayer informed as to the status of the audit. Furthermore, upon conclusion of the audit SARS must, within 21 business days, issue a document which is generally referred to as the letter of audit findings whereby SARS should advise the taxpayer of the adjustments to be made to the taxpayer’s assessment and provide reasons in writing for those adjustments.
In the case at hand SARS failed to provide a report on the status of the audit and also did not provide reasons as required by the TAA. Thus, the court decided that SARS had violated section 42(2)(b) of the TAA and as a result the taxpayer was denied the opportunity to respond to the issues raised by SARS, especially regarding the circumstances giving rise to the lump sum of R 7 million.
The court also reviewed the law dealing with severance benefits in order to establish if the lump sum of R 7 million was in fact a retrenchment lump sum. Revelas J stated in the judgment that had SARS granted the taxpayer the opportunity to explain the nature of the payment it would have satisfied SARS that the lump sum was related to a retrenchment process as required by the Income Tax Act.
SARS argued that the taxpayer had not been retrenched but that the payment related to the taxpayer’s dismissal which meant the lump sum would be taxed as normal income. SARS relied on a letter issued by the taxpayer’s employer that the payment was for dismissal and not retrenchment. The court stated that SARS reliance on the letter in question was selective and decided that the payment was made for termination of employment as a result of retrenchment.
The court was also critical of the manner in which SARS decided to disallow the farming expenditure. The judgment states that had SARS conducted a proper audit there would have been a different result, that is, the expenditure would not have been disallowed.
Revelas J decided that the audit was invalid and SARS non-compliance with section 40 and 42 of the TAA offends the Constitution and the principle of legality. Thus, the court set the additional assessment aside as it did not comply with the law.
In the result the entire 2012 additional assessment was set aside and the interest levied on the tax reflected as due was remitted. Furthermore, the court ruled that SARS must pay the taxpayer’s cost of the appeal. It must be noted that in the Tax Court, costs are not always awarded to the successful part as is the case in other courts. Section 130 of the TAA prescribes when costs should be awarded by the Tax Court but the court did not refer to those requirements. Costs can be awarded where, for example, the taxpayer’s grounds of appeal are unreasonable or SARS grounds of assessment are unreasonable.
This case is important for taxpayers as it serves as a useful reminder of the rights taxpayers have when SARS conducts an audit into their affairs. Taxpayers are entitled, by law, to be advised as to the status of an audit and more importantly when an audit is completed they are entitled to a letter of audit findings setting out the adjustments made to the taxpayers assessment as well as the reasons for those assessments. If SARS fails to adhere to its statutory obligations the court will set any such additional assessment aside and more likely than not award costs against SARS for not complying with the law.
Dr Beric Croome is a Tax Executive at ENSafrica. This article first appeared in Business Day, Business Law and Tax Review, March 2018.