OCTOBER 2014 ISSUE 181 CONTENTS

Transcription

1 OCTOBER 2014 ISSUE 181 CONTENTS COMPANIES TAX ADMINISTRATION Venture capital Reasonable care Prescription Understatement penalties - before 1 October Preservation orders SARS s power to recover tax DEDUCTIONS VALUE-ADDED TAX Audit fees Zero rating of indirect exports EXEMPT INCOME SARS NEWS Foreign employment Interpretation notes, media releases and other documents 1

2 COMPANIES Venture capital Introduction This article deals with venture capital companies, a tax-favoured investment vehicle regulated by section 12J of the Income Tax Act, 1962 (the Act). The Venture Capital Company (VCC) scheme, introduced in 2009, is a tax-based scheme designed to encourage individual and corporate investors to invest in a range of smaller, higher-risk trading companies by investing through the VCCs. Overview VCCs can provide access to portfolios of potentially high growth companies with the benefit of generous tax concessions. Up to 40% income tax relief on VCC subscription for individual investors. 28% corporate income tax relief on VCC subscription for corporate investors. 40% trust income tax relief on VCC subscription for trust investors. Under certain circumstances, subscriptions to VCCs may be considered as part of retirement planning, particularly in the light of forthcoming retirement funding restrictions. VCC tax relief may be claimed against all forms of income (but not capital gains). Background The 2008 South African National Budget Review identified access to equity finance by small and medium-sized businesses as one of the main challenges to the growth of this sector of the economy. Although South Africa has a well-developed private equity industry, its appetite for start-up, early stage and seed capital type transactions is low. To meet the challenge of access to venture 2

3 capital for small and medium-sized enterprises, government introduced the section 12J of the Act tax incentive for individual investors, corporate investors and venture capital funds in qualifying small enterprises and start-ups. The tax incentive took effect from 1 July Since its inception and despite amendments in 2011 to enhance its attractiveness, the uptake for this tax incentive has been very limited. In the 2014 National Budget Review, Government announced that it will propose one or more of the following amendments to the venture capital company regime: Making tax deductions permanent if investments in the VCC are held for a certain period of time. Allowing transferability of tax benefits when investors dispose of their VCC holdings. Increasing the total asset limit for qualifying investee companies (i.e. companies in which the VCC may invest) from R20 million to R50 million, and from R300 million to R500 million in the case of junior mining companies. Waiving capital gains tax on the disposal of assets by the VCC, and expanding the permitted business forms. This article will give a general overview of the VCC scheme. What is a VCC? A section 12J approved VCC is a company designed to provide individual and corporate investors with access to a range of trading companies which have the potential for growth. The VCC aims to make money by investing in these smaller trading companies. The VCC raises funds by issuing equity shares to investors and the money is then allocated to those businesses that the managers judge to have the best prospects. 3

4 What are the risks of VCC investments? There are significant risks associated with investing in venture capital backed companies. These risks fall into two categories: investment risk and liquidity risk. Investment risk The investment risk will generally be at an earlier stage than more developed quoted companies and will often carry a higher risk of failing than their blue chip counterparts. Although VCCs are long-term investments there is no minimum holding period to take advantage of the upfront income tax relief (which is discussed below). However, a minimum holding period has been proposed to qualify for the permanent tax deduction. Liquidity risk At present an investor may recapture the upfront income tax relief if the VCC shares are sold at a gain. Accordingly, it is proposed that investors must hold VCC shares for a minimum time in order for investors to retain the income tax relief. Even after the holding period, VCC shares may not be easy to sell at full value. Purchasers of second-hand VCC shares will not benefit from upfront income tax relief unless the proposal to transfer tax benefits is implemented and even then it is not clear whether the upfront income tax relief will be one of the transferable tax benefits. Venture capital companies the investment process The diagram below depicts the various role players. 4

5 Overview of the tax treatment VCCs are taxed in the following way: Capital gains on qualifying investments disposed of by the VCC are currently taxable but may become exempt if the proposal in the 2014 Budget is implemented. 5

6 Dividends received from the companies making up the portfolio are exempt from dividends tax. Interest income is taxable. The possible exemption on capital gains is a key exemption shared with other types of investment funds such as Real Estate Investment Trusts (REITs) (another tax favoured investment vehicle regulated by section 25BB of the Act). Currently VCCs are subject to 18.6% capital gains tax (CGT) on shares sold by the VCC. The removal of CGT at the VCC level will improve returns to investors by 18.6%. The dividends tax exemption is a consequence of the provision that dividends paid to SA resident companies are not normally taxable (section 64F(1)(a) of the Act), not by virtue of any special exemption applicable to VCCs. The dividends tax exemption applies regardless of the period for which the investor holds the VCC shares. Dividends paid by the VCC to SA resident individuals remain subject to the dividends tax. Upfront income tax relief An investor which subscribes for VCC shares receives an immediate tax deduction equal to 100% of the amount invested with no annual limit or lifetime limit. The relief is available provided that the investor subscribes for equity shares, as opposed to buying them second hand from other investors. There is no minimum holding period. Unlike shares in REITS there is no statutory requirement for VCC shares to be listed. Thus, VCC shares tend to be highly illiquid. The attraction of the upfront income tax relief is that it effectively reduces the cost of the investment, thereby boosting overall returns. For example, VCC shares priced at R1, have an effective cost of 60c after tax relief for individual investors (or 72c where the investor is a company). The VCC shares only need 6

7 to rise by 20c (or 44c where the investor is a company) and the investor s investment has doubled. Furthermore, the VCC shares need to fall by at least 40c (or 28c where the investor is a company) before a loss is incurred (not counting any dividends). Taxable recoupment The current rules provide for a taxable recoupment of the section 12J deduction if the investor disposes of the VCC shares and recovers the previous deduction. The upfront income tax relief is therefore temporary. According to the 2014 National Budget Review a proposal will be considered making the deduction permanent if the VCC shares are held for a certain period of time. No dividends tax relief Dividends on VCC shares are subject to the 15% dividends tax unless the investor qualifies for an existing dividend tax exemption. For instance, investors which are SA resident companies will enjoy the company-to-company dividend tax exemption. No capital gains tax relief When investors sell their VCC shares, CGT is payable at the rate applicable to the relevant investor (13.3% for individual investors; 18.6% for corporate investors and effective 26.6% for investors which are trusts). However, there is tax relief for capital losses. Capital losses on the disposal of VCC shares can be set off against investors capital gains. It is not possible to set off capital losses against the investors income. No reinvestment relief It is not possible for an investor to defer the gain on another investment by applying the sale proceeds to subscribe for VCC shares. Thus, investors that sell their, say, Sasol or MTN shares in order to reinvest the proceeds in VCC shares 7

8 will be subject to CGT on the sale of the Sasol or MTN shares. The after-tax proceeds from the sale of those shares will be invested in VCC shares. The venture capital scheme is temporary The VCC regime, introduced in 2009 is subject to a 12 year sunset period that ends on 30 June The upfront income tax relief will only apply to VCC shares acquired on or before 30 June ENSafrica ITA: Sections 12J, 25BB, 64F(1)(a) DEDUCTIONS Audit fees On 7th March 2014 the Supreme Court of Appeal delivered judgment in the case of Commissioner for the South African Revenue Service v Mobile Telephone Networks Holdings (Pty) Ltd, [2014] 76 SATC 205 which dealt with the deductibility of audit fees incurred for a dual or mixed purpose and the apportionment thereof for tax purposes in the light of section 11(a) of the Income Tax Act No. 58 of 1962 (the Act ), as amended 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. 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 8

9 other 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, which 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 ITC 1842 [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. 9

10 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 fee 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 allow 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 [1983] 45 SATC 241, Commissioner for Inland Revenue v Standard Bank of SA Ltd [1985] 47 SATC 179 and Joffe & Co Ltd v Commissioner for Inland Revenue [1946] 13 SATC

11 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 therefore 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 relating to the Hyperion system. 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 11

12 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. The principles adhered to by the court will apply not only to audit fees but to those costs typically incurred by listed companies as well. On 31 March 2014, MTN applied for leave for the case to be reviewed by the Constitutional Court (case CCT 47/14). Subsequently, on 28 May 2014 the Constitutional Court dismissed MTN s application to review the matter. The Constitutional Court decided that the application should be dismissed as it was not in the interests of justice to hear it. The court s order indicated that the application raised an arguable point of law but that it did not deal with a point of general public importance which should be considered by the Constitutional Court. Thus, all legal avenues to challenge the deductibility of the audit fees have been exhausted. 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. ENSafrica ITA: Sections 11(a), 23(f), 23(g) EXEMPT INCOME Foreign employment In terms of current practice, remuneration derived from services rendered outside of South Africa is, subject to certain requirements, exempt from normal 12

13 tax in South Africa in terms of section 10(1)(o)(ii) of the Income Tax Act, No. 58 of 1962 (the Act). The general rule is that income earned by a tax resident of South Africa from the rendering of services anywhere in the world will be included in 'gross income' as defined in section 1(1) of the Act. Notwithstanding the general rule above, certain exemptions are provided for, inter alia, in section 10(1)(o) of the Act in respect of remuneration which would likely have been subject to the deduction of employees tax under normal circumstances. The exemption provided under section 10(1)(o)(ii) will apply in respect of services rendered outside South Africa for or on behalf of any employer, as long as the individual is outside South Africa for a period or periods exceeding 183 full days (calendar, not working days) in aggregate, during any twelve month period commencing or ending during a tax year. In addition, the exemption will only apply if, during the 183 day period, there was at least a 60 day continuous period of absence from South Africa. The onus is on the taxpayer to prove his absence from South Africa for a period and/or periods complying with the requirements of section 10(1)(o)(ii), as well as the fact that such absence was attributable to him rendering services outside of South Africa. But what about periods spent voluntarily abroad, even where the individual was in full time employment? A situation that often arises is where employees render services on a rotation cycle, for example two weeks offshore and two weeks onshore having regard to the specific type of industry the employer operates in. The employer may require, due to health and safety concerns, that employees take time off (outside of normal leave days), which the employees may decide to spend offshore rather than returning to South Africa. In spending the voluntary days offshore, the employee may ensure that the 60 day continuous period, under section 10(1)(o)(ii), is met. 13

14 Interpretation Note 16 (IN16) specifically provides that "weekends, public holidays, vacation and sick leave spent outside the Republic are considered to be part of the days during which services were rendered during the 183 day and 60 day periods of absence". On the basis that the aforementioned interpretation is correct in calculating the 183 day or 60 day continuous periods, it should be irrelevant as to whether an affected individual decides to spend a voluntary period abroad and, in so doing, complies with the requirements of section 10(1)(o)(ii). Any rest period (whether voluntary or compulsory) will be deemed to be included in the calculation of the 183 day or 60 day continuous periods for purposes of s10(1)(o)(ii). A contrary application of section 10(1)(o)(ii), for example, some form of apportionment methodology for time spent in and outside South Africa on rotation, would likely be incorrect and also against 'practice generally prevailing', having regard to IN16. Taxpayers making use of the exemption under section 10(1)(o)(ii) are reminded to exercise caution in ensuring that all requirements are met and possible future changes are taken cognisance of. Cliffe Dekker Hofmeyr ITA: Sections 1(1) definition of gross income; Section 10(1)(o)(ii) SARS Interpretation Note 16 TAX ADMINISTRATION Reasonable care Judgment was handed down in the case of Harding v Revenue and Customs Commissioners [2013] UKUT 575 (TCC) in the Upper Tribunal (Tax and Chancery Chamber) on 15 November The case revolved around the question of whether an omission by a taxpayer of a severance payment in his tax return amounted to a careless mistake in terms of the United Kingdom Finance Act, 2007 (UK Finance Act). 14

15 Background The Appellant held a senior position in a company forming part of a leading accounting practice. He entered into a compromise agreement with his employer whereby his contract of employment was terminated and he received approximately 110, in severance payments (payment). The amount included performance-related bonuses in relation to his work. The Appellant omitted to include this payment in his tax return. However, his previous employer submitted a tax return to Her Majesty s Revenue and Customs (HMRC), which included the payment. Consequently, he was assessed by HMRC and a penalty was imposed on him for careless inaccuracy in his return due to the understatement of his income. First-tier Tribunal The Appellant appealed against the penalty to the First-tier Tribunal (FTT) on the grounds that his failure to include the payment in his return was not careless, as he genuinely believed that the payment would not be subject to tax because it was made after the termination of his employment. The Appellant s employment was terminated on 31 October 2008 and his payment was only received later in November In support of his argument, the Appellant submitted evidence regarding an article from a tax website purportedly stating that severance payments such as the one received by him, were not taxable when they were paid after termination of employment. The FTT dismissed the appeal stating that they were satisfied that the Appellant entertained considerable doubt as to whether the amount was in fact taxable, but failed to take steps to ascertain the correct position. Furthermore, there was no evidence that the Appellant took appropriate advice from an independent source or the HMRC. 15

16 Upper Tribunal The Appellant subsequently appealed to the Upper Tribunal. The Upper Tribunal examined the article on which the Appellant relied as well as the compromise agreement entered into with his employer and found that: The compromise agreement contained a paragraph headed Taxation which provided that the first 30, of the payment was not subject to tax, but that any remaining balance shall be subject to deductions in respect of tax at the appropriate rate. The article made it clear that any payment received in connection with the termination of employment is taxable, but that in some circumstances the first 30, of such payment is tax free. The Upper Tribunal consequently held that the decision of the FTT be upheld for the following reasons: The Appellant admitted that he considered that the payment was possibly subject to tax. The Appellant is an intelligent person, who held a senior position in a company forming part of an accountancy practice. It was not credible to propose that he could conclude that there was no possibility of the payment being taxable. The self-assessment the Appellant made contained an inaccuracy which led to an understatement of his liability to tax. That inaccuracy was careless, since it was due to the failure of the Appellant to take reasonable care. The Appellant failed to take reasonable care because he knew, or should reasonably have known, that there was at least a possibility that the payment was liable to tax. 16

17 Relevance for South African taxpayers Schedule 24 to the UK Finance Act contains provisions largely similar to those of the Tax Administration Act No. 28 of 2011 (TAA) in that it provides that a penalty may be levied on an understatement of tax liability, where the understatement was the result of an inaccuracy in a return due to a failure by the taxpayer to take reasonable care. Reasonable care implies that the taxpayer knew or should reasonably have known that the given outcome could occur. Section 223 of the TAA contains the understatement penalty percentage table. In terms of item (ii) of the table, where reasonable care was not taken in completing a return, a penalty percentage of 15% must be applied in respect of standard cases, and 50% where the taxpayer s behaviour has been obstructive or if the matter was a repeat case. In a South African context, in determining whether reasonable care was taken, one would test the conduct in question against the objective criterion of the reasonable person. This means that conduct will be seen as negligent, or that reasonable care was not taken, if it is not in accordance with the conduct expected of the reasonable person who finds himself in the same situation. Conduct will be negligent where the reasonable person would have acted differently under the same circumstances, in that he would have reasonably foreseen the consequences of his actions, and taken steps to avoid such consequences. This test was laid down in Kruger v Coetzee [1966] (2) SA 428. If the facts in the Harding case were to be tested against the TAA, and the reasonable person test was applied, then it is submitted that the South African Tax Court would likely have come to the same conclusion as that reached by the Upper Tribunal. One could however speculate whether the same set of facts would be considered by the South African Revenue Service (SARS) to fall within the ambit of item 17

18 (iv) of the penalty percentage table, being gross negligence. Generally the reasonable person test is also applied when testing for gross negligence, however, in terms of SARS s Short Guide to the TAA, gross negligence calls for a disregard of the consequences of one s actions and recklessness. Conceivably, SARS could consider such an omission on a return as intentional tax evasion in terms of item (v) of the penalty percentage table. However, the concept of intention generally requires a person to direct his will at achieving a particular result while being aware that the conduct in question is wrongful (Dantex Investment Holdings (Pty) Limited v Brenner [1989] (1) SA 390). SARS s Short Guide to the TAA describes intention in terms of item (v) of the table as acting wilfully or with a guilty mind. The relevance of the Harding case for South African taxpayers is that the fact that one genuinely believes that a particular tax position is correct will not absolve one from penalties where reasonable steps were not taken to make sure that the position taken is indeed correct. It is therefore crucial that taxpayers obtain the necessary tax advice, especially in circumstances where the facts raise some doubt. Cliffe Dekker Hofmeyr TAA: Section 223 SARS Short Guide to the TAA Prescription Many taxpayers are generally aware that there is a prescription provision contained in our tax law. However, it is not always understood that the prescription provisions apply only if certain statutory requirements are met. In this regard it is not uncommon for SARS to assess taxpayers beyond the prescription period of three years. It is therefore necessary for taxpayers to 18

19 understand the circumstances in which prescription will apply and also the relevant statutory provisions dealing with prescription. Section 79 of the Income Tax Act No. 58 of 1962 (the Act) contained the prescription provisions prior to the enactment of the Tax Administration Act No. 28 of 2011 (the TAA). These provisions are now contained in section 99 of the TAA. There is some debate about when the new prescription provisions apply It seems that the new provisions pertaining to prescription as contained in section 79 should apply where the relevant years of assessment have been concluded and the taxpayer s tax return submitted prior to the date that the TAA came into effect, namely, 1 October However, it should be noted that in certain circumstances SARS is applying the prescription provisions contained in the TAA to years of assessment which ended prior to the enactment of the TAA. In terms of the proviso to section 79(1) of the Act, the Commissioner may only issue revised assessments after the expiry of the three year period, where the Commissioner is satisfied that the fact that the amount which should have been assessed to tax was not so assessed was due to fraud or misrepresentation or non-disclosure of material facts. In order for the Commissioner to raise additional assessments in terms of section 79(1), there are two elements in respect of which the Commissioner must be satisfied. Firstly, he must be satisfied that there was fraud, misrepresentation or non-disclosure of material facts. If he is so satisfied, then secondly, he must also be satisfied that the fact that the full amount of tax chargeable was not assessed, was due to such fraud, misrepresentation or nondisclosure of material facts. 19

20 Misrepresentation The Dictionary of Legal Words and Phrases states that a misrepresentation is: a false statement of fact made by one party to another before a contract is entered. Such a statement may be innocent or fraudulent The meaning of the term misrepresentation therefore refers to an expression of facts as opposed to a mere expression of opinion or interpretation of law, i.e. it requires a positive statement to have been made by the taxpayer which is false. Non-disclosure of material facts In the case of SIR v Trow [1981] 43 SATC 189, the Appellate Division had to consider whether the prescription period in section 79 applied to an additional assessment issued by the Secretary to the taxpayer in circumstances where the taxpayer had, in reply to the question in his tax return whether he had sold any property during the tax year in question, answered no, when in fact he had realised a capital profit upon the sale of certain land. The court stated that: It follows, in the circumstances of this case, that the additional assessment could only have been raised if the Commissioner were to have satisfied himself (1) that there had been a non-disclosure of material facts by the taxpayer, and (2) that the fact that the profit in question was not assessed to tax prior to the expiration of the relevant period of three years was due to such non-disclosure, i.e., that the non-assessment was causally related to the non-disclosure of material facts. In terms of this case, not only must the Commissioner be satisfied that there was non-disclosure but such non-disclosure must have caused the Commissioner not to assess that amount. 20

21 In other words, there must be a causal link between the non-disclosure by the taxpayer and the non-assessment of that amount by the Commissioner. It should be noted that the court in ITC 1459 [1988] 51 SATC 142, dealing with the issue of the disclosure of material facts, stated that the question to be considered is whether the Commissioner had all the material facts when he issued all the original assessments. This is an important point since taxpayers are often subject to a tax audit by SARS after the relevant tax returns have been assessed. Any disclosures made during the course of the tax audit may therefore not be relevant in determining whether prescription applies. Section 99 of the TAA Section 99(1) provides that: SARS may not make an assessment in terms of this Chapter - (a) three years after the date of assessment of an original assessment by SARS In terms of section 99(2)(a), section 99(1) does not apply to the extent that: in the case of assessment by SARS, the fact that the full amount of tax chargeable was not assessed, was due to - fraud; misrepresentation; or non-disclosure of material facts In terms of section 99(2), the Commissioner may issue revised assessments after the expiry of the three year period, where the fact that the full amount of tax chargeable was not assessed was due to fraud or misrepresentation or nondisclosure of material facts. In light of the above, the test pertaining to prescription as contained in the Act remains largely unchanged subsequent to the introduction of the TAA. The most 21

22 significant amendment being that the test as to whether the presence of the elements listed in section 99(2)(a) caused the non-assessment of the taxpayer, now requires an objective consideration and does not have regard to the subjective satisfaction of the Commissioner. Therefore, in order for the Commissioner to raise additional assessments in terms of section 99(1), the presence of two elements must objectively be determined. Firstly, the presence of fraud, misrepresentation or a non-disclosure of material facts must be demonstrated. Secondly, it must, in accordance with an objective fact-based approach, be evidenced that the fact that the full amount of tax chargeable was not assessed was due to such fraud, misrepresentation or non-disclosure of material facts. ENSafrica ITA: Section 79 (now repealed) TAA: Section Understatement penalties before 1 October 2012 The promulgation of the Tax Administration Act No. 28 of 2011 (the TAA), which came into effect on 1 October 2012, brought into effect a basis for the imposition of penalties in respect of understatements. An understatement arises where a return is not submitted, amounts are omitted from or deductions are erroneously claimed in a return submitted to SARS. The understatement penalty is a percentage-based penalty applied to the shortfall. The shortfall is defined in the following terms in section 222(3): (3) The shortfall is the sum of (a) the difference between the amount of tax properly chargeable for the tax period and the amount of tax that would have been chargeable for the tax period if the understatement were accepted; 22

23 (b) (c) the difference between the amount properly refundable for the tax period and the amount that would have been refundable if the understatement were accepted; and the difference between the amount of an assessed loss or any other benefit to the taxpayer properly carried forward from the tax period to a succeeding tax period and the amount that would have been carried forward if the understatement were accepted, multiplied by the tax rate Prior to 1 October 2012, the various acts that imposed taxes contained their own rules for the imposition of penalties. With the advent of the TAA, these were repealed. Issues concerning the imposition of understatement penalties have arisen as a result of the original assessment after 1 October 2012 of returns filed with SARS prior to 1 October 2012 or adjustments made after 1 October 2012 as a result of audits of assessments issued in respect of returns filed before 1 October 2012 (which assessments may have been issued before 1 October 2012). Taxpayers have argued three fundamental issues regarding these penalties. First, the issue of additional assessments was made after 1 October 2012, but the audit or investigation relating to the understatement had been completed before that date, and they should therefore have been subject to the penalty regime under the relevant tax act that applied before 1 October Secondly, they submitted the returns at a time when the law did not expose them to the penalty regime now in place, and therefore were unable to avail themselves of certain safeguards afforded in the TAA. Thirdly, the TAA does not contain provisions for remission of the penalty for understatement if there were extenuating circumstances, whereas 23

24 provisions in the Income Tax Act No. 58 of 1962 (the Act), prior to their repeal by the TAA, had made such provision. SARS, to its credit, has recognised the inequity of this switch in penalty regimes and has sought to provide for a more equitable basis for the transition from the previous legislation to the new legislation through amendments incorporated in the Tax Administration Laws Amendment Act No. 39 of 2013 (the TALAA), which came into effect on 16 January The relevant amendments were made retroactive to 1 October The relevant amendments were effected to section 270, which provided for the transition from the previous legislation to the current legislation. Delay in issuing additional assessments Section 270(6) was substituted and section 270(6A) was inserted by the TALAA to deal with this issue. Section 270(6)(a) provides that additional tax, penalty or interest which could have been imposed but for the repeal of the relevant provisions in the tax act may be imposed as if the relevant provisions in the tax act had not been repealed if the additional tax, penalty or interest would have been capable of being imposed. Section 270(6A) provides that an amount is regarded as having been capable of being imposed if the verification, audit or investigation necessary to determine the additional tax, penalty or interest had been completed before the commencement date of this Act (i.e. before 1 October 2012). Substantial understatement relief The first issue raised was that a penalty for a substantial understatement may be remitted in full if, prior to the date for filing of a return, the taxpayer was in possession of an opinion of a registered tax practitioner that stated that it was more likely than not that the filing position adopted by the taxpayer would be 24

25 upheld if the issue were to proceed to court on appeal. Taxpayers argued that they would have availed themselves of that facility had they been aware of it at the time they filed their return. The amendment, found in section 270(6B), provides that the requirement that an opinion was obtained timeously is regarded as having been met. The Explanatory Memorandum to the Tax Administration Laws Amendment Bill, 2013 (the TALAB), explains the position in the following terms: One of the requirements for remittance is that the taxpayer must be in possession of an opinion by a registered tax practitioner, regarding the arrangement in issue that was issued by no later than the date that the relevant return was due. As a taxpayer submitting a return before commencement of the Act was not aware of this requirement at that time, this amendment will enable taxpayers seeking remittance of a substantial understatement penalty in respect of an understatement made before the commencement date of the Act, to use an opinion obtained after the relevant return was submitted. Taxpayers objecting to penalties imposed in respect of a substantial understatement may therefore retroactively avail of this concession by obtaining an opinion from a registered tax practitioner if the circumstances are appropriate. Extenuating circumstances Under the Act, prior to 1 October 2012, the penalty that could be imposed for understatement was, in the discretion of the Commissioner, an amount equal to twice the tax payable. In addition, the additional tax charge could be remitted by the Commissioner in whole or in part if the Commissioner was satisfied that 25

26 there were extenuating circumstances, and provided that there was no intention to evade tax. The amendment to the Tax Administration Act (the TAA), contained in section 270(6D), provides relief in respect of an understatement penalty that has been imposed on a return filed before 1 October A taxpayer may object to the penalty (whether or not objection has been made against the assessment in question). If the return was required under the Act, a senior SARS official, if satisfied that there are extenuating circumstances, must, in considering the objection, remit the penalty in whole or in part. Practically, where an objection against the assessment has already been filed and a taxpayer wishes to object to the penalty by raising extenuating circumstances, the secondary objection must be filed manually with SARS, as the e-filing system is not configured to handle the additional or secondary objection to the assessment. Welcome relief The amendments to section 270 of the TAA are most welcome and bring a touch of sanity and realism to the resolution of inequities that would otherwise have arisen. Cliffe Dekker Hofmeyr TAA: Sections 222, 270 Explanatory Memorandum to the TALAB, Preservation orders A Cape Town based businessman has been the subject of investigation by SARS into alleged VAT fraud, and has been issued with an assessment for R291 million. 26

27 An unexplained gift to the daughter of the tax debtor When his daughter, a swimwear model, received out of the blue and without explanation an eye-wateringly large gift of $15.3 million (equivalent to some R143 million) from an unnamed Arab admirer plus two luxury cars worth R2.75 million, SARS suspected that this money and these assets were intended for her father and had been ostensibly channelled to her so as to avoid their being seized by SARS to fund the payment of her father s tax debt. Predictably, she asserted that these funds and those assets belonged to her and not to her father and that SARS had no claim on those assets because she had no outstanding tax debts. These events were the background to the decision of the Cape High Court in CSARS v C-J Van Der Merwe [2014] 76 SATC 138 in respect of the return day of a provisional preservation order that had been granted ex parte by Rogers J in August 2013 in terms of section 163 of the Tax Administration Act No. 28 of 2011 (the TAA) in which the businessman was the first respondent and his daughter the second respondent. In terms of that provisional order, the daughter was interdicted from dealing with, encumbering or disposing a list of assets, including the aforementioned two luxury cars and the residue of the gift of $15.3 million that she had received in May 2013, and any assets she had acquired with that gift. The requirements for granting of a preservation order The interest of the court s ruling, in which it confirmed the provisional preservation order, lies in its analysis of section 163 of the TAA which reads as follows (1) A senior SARS official may, in order to prevent any realisable assets from being disposed of or removed which may frustrate the collection of the full 27

28 amount of tax that is due or payable or the official on reasonable grounds is satisfied may be due or payable, authorise an ex parte application to the High Court for an order for the preservation of any assets of a taxpayer or other person prohibiting any person, subject to the conditions and exceptions as may be specified in the preservation order, from dealing in any manner with the assets to which the order relates. (3) A preservation order may be made if required to secure the collection of the tax referred to in subsection (1) and in respect of (a) Realisable assets seized by SARS under subsection (2); (b) The realisable assets as may be specified in the order and which are held by the person against whom the preservation order is being made; (c) All realisable assets held by the person, whether it is specified in the order or not; or (d) All assets which, if transferred to the person after the making of the preservation order, would be realisable assets. No necessity to prove that the assets would otherwise be dissipated or diminished In his judgment, Savage AJ noted that, at common law, a preservation interdict required that the applicant prove that the assets sought to be preserved would otherwise be diminished with the specific objective of frustrating his claim. By contrast, he said, the purpose of a preservation order in terms of section 163(3) of the TAA is to prevent any realisable assets from being disposed of or removed which may frustrate the collection of the full amount of tax that is due or payable or the official on reasonable grounds is satisfied may be due or payable. In terms of the Act, it is not necessary for the applicant to prove that the assets in question would be dissipated or diminished if the preservation 28

29 order were not granted, nor can such a requirement be regarded as implicit in the Act. Savage AJ said in this regard that Whilst the grant of a preservation order may be considered harsh, there are compelling reasons within the context of our constitutional democracy why steps which assist the fiscus securing the collection of tax are required, which include court orders to preserve assets so as to secure the collection of tax. Had it been intended by the legislature that the court infuse the requirement of necessity to prevent dissipation into a determination as to whether a preservation order should be granted in terms of s163(3), as such would have been apparent from the statute. Savage AJ said (at para [43]) that, in terms of the TAA, a court was merely required To arrive at a conclusion, reasonably formed on the material before it, as to whether a preservation order is required or not to secure the collection of tax. Did the evidence establish that a preservation order was required to secure the collection of tax? Savage AJ held (at para [65]) that, on the evidence, the version put forward by the second respondent, namely, the extraordinary and unexplained generosity of a donor was palpably implausible and so far-fetched and untenable that the court was justified in rejecting it. That version of events, said the court, had to be weighed against the facts laid before the court by SARS, including her father s tax debts. Savage AJ said (at para [72] that The sudden wealth acquired by the second respondent lies squarely within her knowledge and she was obliged in such circumstances to 29

30 provide the answer necessary to substantiate her opposition to a final order being granted. The case put up by her in answer to that of the applicant [SARS] is so highly improbable in human experience that it cannot be accepted In the result, Savage AJ confirmed the earlier provisional preservation order. ENSafrica TAA Section SARS s power to recover tax The Tax Administration Act No. 28 of 2011 (TAA) came into effect on 1 October 2012 (save for certain provisions that are still to come into force). This important piece of legislation seeks to incorporate into one Act all those administrative provisions (except for customs and excise) that are generic to all tax Acts and that were previously duplicated across all the different tax Acts. Significantly, the TAA provides the South African Revenue Service (SARS) with substantial powers in relation to important administrative aspects of tax, such as the collection of information and the imposition and recovery of tax. However, due to the relatively recent enactment of the TAA, there is not a vast amount of case law providing guidance as to the manner in which many of the provisions should be interpreted, and thus the exact scope of SARS powers under the TAA. In the recent case of Commissioner for the South African Revenue Services v Miles Plant Hire (Pty) Ltd [2014] 76 SATC 1 ( Miles Plant Hire ), the North Gauteng Division of the High Court was required to decide on a question of law concerning the interpretation of section 177(3) of the TAA. 30

31 Section 177 of the TAA Section 177 of the TAA grants SARS the power to institute sequestration, liquidation or winding-up proceedings in order to recover a tax debt. Specifically, section 177 states the following: (1) SARS may institute proceedings for the sequestration, liquidation or winding-up of a person for an outstanding tax debt. (2) SARS may institute the proceedings whether or not the person - (a) is present in the Republic; or (b) has assets in the Republic. (3) If the tax debt is subject to an objection or appeal under Chapter 9 or a further appeal against a decision by the tax court under section 129, the proceedings may only be instituted with leave of the court before which the proceedings are brought. In Miles Plant Hire, it was undisputed that section 177(3) of the TAA confers a discretion on the court, where there is a pending tax dispute, to permit a tax debt due to be recovered in sequestration, liquidation or winding-up proceedings. What was in issue, and what the court was required to decide, was when such discretion must be exercised. The taxpayer argued that section 177(3) involved a two-step process i.e.: SARS first has to apply to the court to obtain permission to institute sequestration, liquidation and winding-up proceedings. If leave to institute the proceedings requested is granted, SARS is thereafter required to prepare a further application to actually institute sequestration, liquidation and winding-up proceedings and bring the application before a different judge. Principles of interpretation to be applied The court began by setting out the principles of interpretation to be applied, which it stated were recently affirmed by the Supreme Court of Appeal in Natal Joint Municipal Pension Fund v Endumeni Municipality [2012] (4) SA 593 (SCA), where Wallis J held the following: 31

32 [18] The present state of the law can be expressed as follows. Interpretation is the process of attributing meaning to the words used in a document, be it legislation, some other statutory instrument, or contract, having regard to the context provided by reading the particular provision or provisions in the light of the document as a whole and the circumstances attendant upon its coming into existence. Whatever the nature of the document, consideration must be given to the language used in the light of the ordinary rules of grammar and syntax; the context in which the provision appears; the apparent purpose to which it is directed and the material known to those responsible for its production. Where more than one meaning is possible each possibility must be weighed in the light of all these factors. The process is objective not subjective. A sensible meaning is to be preferred to one that leads to insensible or unbusinesslike results or undermines the apparent purpose of the document The inevitable point of departure is the language of the provision itself, read in context and having regard to the purpose of the provision and the background to the preparation and production of the document [25] Which of the interpretational factors I have mentioned will predominate in any given situation varies. Sometimes the language of the provision, when read in its particular context, seems clear and admits of little if any ambiguity. Courts say in such cases that they adhere to the ordinary grammatical meaning of the words used. However that too is a misnomer. It is a product of a time when language was viewed differently and regarded as likely to have a fixed and definite meaning, a view that the experience of lawyers down the years, as well as the study of linguistics, has shown to be mistaken. Most words can bear several different meanings or shades of meaning and to try to ascertain their meaning in the abstract, divorced from the broad context of their use, is an unhelpful exercise. The expression can 32