SYNOPSIS. May In this issue. Regional offices. Disputes between SARS and taxpayers - new procedures.. 2

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1 SYNOPSIS In this issue Disputes between SARS and taxpayers - new procedures.. 2 Financial managers liable for employees tax and VAT. 5 Does interest accrue if it can be set aside on insolvency?.. 6 Tax consequences of insolvency Interpretation Note Zero-rating of exports documentary proof Regional offices Bloemfontein (051) Cape Town (021) Durban (031) East London (043) Johannesburg (011) Port Elizabeth (041) Pretoria (012)

2 Disputes between SARS and taxpayers - new procedures Some cause for unease Although SARS has always had the power to settle disputes with taxpayers, (see City of Cape Town v Claremont Union College 1934 AD 414 at 452; Namex (Edms) Bpk v KBI (1994) 56 SATC 91 (A) at 109) it is safe to say that, since the enactment of Part IIIA of the Income Tax Act in 2003, which deals specifically with the settlement of disputes, SARS is unlikely to conclude any settlement with a taxpayer, except in accordance with those statutory provisions. The definition of dispute and settle For the Commissioner to have the power to enter into a settlement in terms of Part IIIA, the matter must involve a dispute, as defined in section 88A(1). A dispute is defined as a disagreement on the interpretation of either the relevant facts or the applicable law, or both. Oddly, the definition does not say that the dispute must concern a contested assessment, but this is probably implicit since section 88H refers to a settlement between the Commissioner and the person aggrieved by an assessment. Part IIIA of the Income Tax Act deals specifically with the settlement of disputes From this, it follows that, where the only issue is the taxpayer s ability to pay the assessed tax, this is not a dispute which the Commissioner is empowered to settle in terms of Part IIIA. In practice, therefore, it seems that only a dispute which is the subject of an objection, which has not been withdrawn or resolved, falls within the scope of Part IIIA of the Act. Settle is defined in section 88A(1) as meaning to resolve a dispute by compromising any disputed liability, other than by the Commissioner or the taxpayer accepting the other s interpretation of the facts or the law, or both. This is rather odd. Surely it cannot mean that, if the Commissioner accepts the taxpayer s version of the facts and the taxpayer accepts the Commissioner s interpretation of the law (or vice-versa), there can be no settlement in terms of Part IIIA? Section 88D defines the circumstances in which it will be appropriate, or inappropriate, for SARS to settle a dispute in terms of Part IIIA. Circumstances under which to settle a dispute Section 88C states that it would be inappropriate and not to the best advantage of the state to settle a dispute where, in the opinion of the Commissioner (a) there was intentional tax evasion or fraud, and the considerations listed in section 88D do not apply; 2

3 (b) the settlement would be contrary to law or a clearly established practice of the Commissioner and no exceptional circumstances justify a departure from such law or practice; (c) it is in the public interest to have judicial clarification of the issue (i.e. it is in the public interest for the dispute to be determined by the courts); (d) the pursuit of the matter through the courts will significantly promote compliance with the tax laws; (e) the person concerned has not complied with the Act, and such non-compliance is serious. Section 88D states that the Commissioner may, where it would be to the best advantage of the state to do so, settle a dispute having regard to (a) whether the settlement would be in the interests of good management of the tax system, overall fairness, and the best use of the Commissioner s resources; (b) the cost of litigation as against the possible benefits with reference to prospects of success in a court, the prospects of collecting the amounts due, and the costs associated with collection; (c) any complex factual or quantum issues or evidentiary difficulties; (d) a situation where a participant or a group of participants in a tax avoidance scheme have accepted the Commissioner s position in the dispute, in which the settlement may be negotiated in an appropriate manner to unwind existing structures and arrangements; (e) whether the settlement of the dispute will promote compliance with the tax laws in a cost-effective way. There must be full disclosure by the person concerned, and any settlement is conditional on such full disclosure. Procedure for settlement and alteration of the assessment In terms of section 88E, a dispute may be settled by the Commissioner personally or by an official delegated by the Commissioner for that purpose, but that person must not have any personal, business or financial relationship with the person concerned. The procedure for settlement is set out in section 88F(1) (5). In terms of these provisions, there must be full disclosure by the person concerned, and any settlement is conditional on such full disclosure. All disputes settled in whole or in part must be evidenced by a written agreement between the parties, and this agreement will be a full and final settlement of all the specified aspects of the dispute. The Commissioner and his officials must adhere to the secrecy provisions of the Act. Section 88H provides that where a dispute has been settled, the Commissioner can alter the assessment in order to give effect to the settlement; any such altered assessment is not subject to objection and appeal. 3

4 Impact on concluded settlement where taxpayer failed to make full disclosure In terms of section 88F(7), the Commissioner must adhere to the terms of the [settlement] agreement unless it emerges that material facts were not disclosed to it or there was fraud or misrepresentation of the facts. Moreover, in terms of section 88F(8) the Commissioner has the right to recover any outstanding amounts involved in the settlement in full where the person concerned fails to adhere to any agreed payment arrangement. Interestingly, the Act does not say that the Commissioner can cancel the settlement on these grounds. There is cause for unease in these provisions. Assume that a settlement is entered into between SARS and the taxpayer and that a new assessment is issued reflecting the settlement. Assume that SARS thereafter comes to the view that the taxpayer did not (as required by section 88F(1)) make disclosure of all relevant facts during the discussions that preceded the settlement. Assume, further, that the taxpayer disputes the Commissioner s view that there was non-disclosure, and asserts that he or she did indeed make full disclosure, or that the facts not disclosed were not material facts. Can SARS unilaterally decide that there was non-disclosure of relevant material facts and set aside the settlement agreement? Section 88F(7) says that SARS must adhere to the terms of the agreement unless it emerges that material facts were not disclosed to it, or there was fraud or misrepresentation of the facts. And section 88F(2) says that the settlement agreement is conditional upon full disclosure of material facts known to the person concerned at the time of the settlement. What happens now? Can SARS unilaterally decide that there was, indeed, non-disclosure of relevant material facts and set aside both the settlement agreement and the altered assessment? If so, what procedure must SARS follow in taking this drastic step, and what right, if any, does the taxpayer have to contest it? Within what time must SARS take such action before the right to set aside the agreement prescribes? Part III is silent on these questions. If SARS is of the view that the settlement agreement is nullified (by the alleged non-disclosure), can SARS alter the assessment back to what it was before, or does the original assessment automatically revive, with the result that SARS can now take a statutory judgment against the taxpayer in terms of section 91(1)(b) and enforce this by execution proceedings? Is the taxpayer limited to objecting to that reinstated assessment, or can the taxpayer also dispute, by way of ordinary civil proceedings, SARS s entitlement to set aside the settlement? Can the taxpayer, for example, obtain an interdict to prevent SARS from setting aside the settlement agreement? Is the dispute as to whether full disclosure was made by the taxpayer in the lead-up to the conclusion of the settlement now to be heard in the civil courts? If so, it may necessitate a complex and lengthy trial involving disputed factual issues regarding what disclosure was and was not made, plus the legal question of whether any proven non-disclosures were material. 4

5 Financial managers can be personally liable for employees tax and VAT In terms of paragraph 11(2C) of the Fourth Schedule to the Income Tax Act 58 of 1962 (which was added to the Act with effect from 1 March 2004) where an employer is a company, every shareholder and director who controls or is regularly involved in the management of the company s overall financial affairs shall be personally liable for the employees tax, additional tax, penalty or interest for which the company is liable. A similar amendment was made to the Value-Added Tax Act 48 of 1991, section 48(9) of which now reads (9) Where a vendor is a company, every shareholder and director who controls or is directly involved in the management of the company s overall financial affairs shall be personally liable for the tax, additional tax, penalty or interest for which the company is liable. It is significant that this liability is not expressed to be dependent on negligence or any other kind of fault or dereliction of duty by the financial manager. Nor is liability excluded where the financial manager had delegated responsibility to attend to the company s payment of employees tax to another person. This is a statutory liability that attaches to a person purely by reason of the fact that he controls or is regularly involved in the management of the company s overall financial affairs. Of course, while the company remains able to pay the employees tax and VAT due by it, these provisions are academic. But if a company were to go insolvent, SARS would be entitled, in terms of these provisions, to recover the unpaid tax from those persons whose duties bring them within the ambit of this statutory liability.... liability is not excluded where the financial manager had delegated responsibility to attend to the company s payment of employees tax to another person. 5

6 Does interest accrue if it can be set aside on insolvency? In case number (not yet reported), the Port Elizabeth Tax Court was confronted with the following scenario. Between November 1999 and August 2000, the taxpayer had invested a total of R in an illegal pyramid scheme conducted by one A. The investments took the form of a loan and the acknowledgement of debt stated that interest was payable. In fact, no interest was paid by A to the taxpayer, and A s estate was sequestrated in November The taxpayer submitted a claim against the insolvent estate for R , which included R in respect of interest. The only issue before the Tax Court was whether interest had accrued to the taxpayer in terms of the definition of gross income in section 1 of the Income Tax Act 58 of 1962 in respect of the loan to A. SARS did not dispute that the venture in which the taxpayer had invested his money was an illegal pyramid scheme, but argued that the Income Tax Act does not distinguish between income from legal activities and from illegal activities. The court accepted this argument, but said that the root of the matter was whether the interest in question had accrued to the taxpayer. The court held that the answer was in the negative, on the grounds that the taxpayer never had an unconditional right to claim interest from A. The court said that A s pyramid scheme was, from its inception, insolvent and hence that any disposition without value made within two years of sequestration was liable to be set aside. The court went on to say that Had any interest been paid by A to the appellant, those payments of interest would have been dispositions without value. Such dispositions may be set aside by a court on application. Thus, in my view, the appellant never had an unconditional right to claim interest from A. Dubious conclusion With respect, this conclusion is dubious. It is certainly true that where a taxpayer s entitlement to an amount is subject to a suspensive condition, there is no accrual unless and until that condition is fulfilled. The situation at hand, however, involved not a suspensive condition, but a resolutive condition. The difference (as explained by Christie, The Law of Contract, 4th edition, p 159) is that 6

7 The root of the matter was whether interest had accrued to the taxpayer A condition precedent suspends the operation of all or some of the obligations flowing from the contract until the occurrence of a future uncertain event, whereas a resolutive condition terminates all or some of the obligations flowing from the contract upon occurrence of a future uncertain event. In other words, the contract which the taxpayer entered into with A, and the accrual of interest provided for in that contract, was effective unless and until the disposition of interest by A, arising out of that contract in terms of the Insolvency Act, was set aside in terms of the Insolvency Act. It is not clear whether that disposition of interest had been set aside by the time (some six years later) the matter came before the Tax Court, but presumably it had been. Whether this occurred in the same tax year as the loans were given is uncertain.... the contract which the taxpayer entered into with A, and the accrual of interest provided for in that contract, was effective unless and until the disposition of interest by A was set aside... The Tax Court had no power to set aside a voidable disposition. If the disposition had been set aside in the same tax year as the loans, the Tax Court ought, in its judgment, to have declared that the interest had indeed accrued to the taxpayer, but that the fulfilment of the resolutive condition had vitiated that accrual. If the setting aside of the interest as a voidable disposition had occurred in a tax year subsequent to the loans, then the Tax Court ought to have ordered that the fulfilment of the resolutive condition had vitiated the earlier accrual of the interest with retrospective effect, and should have remitted the assessment back to the Commissioner with the instruction that it be amended to exclude that accrual. 7

8 Tax consequences of insolvency Interpretation Note brings greater clarity Interpretation Note no 8 (issue 2) issued on 22 March 2006 and the follow-up Briefing note: update of Interpretation Note 8 summarise SARS s interpretation of the law in relation to the tax consequences of insolvency, and provide a useful guide to SARS s practices in this regard. Insolvent taxpayers: pre-1997 The insolvent was not entitled to carry forward any assessed loss incurred... Until the Income Tax Act was amended in 1997 to make an insolvent estate a person for tax purposes, the income of an insolvent estate was not subject to income tax. This anomalous situation was the effect of the decision in Thorne and Molenaar NNO v Receiver of Revenue, Cape Town (1976 (2) SA 50 (C), 38 SATC 1) which held that, if the trustee of an insolvent estate were to be subject to tax, it could only be as a representative taxpayer and not in his personal capacity. The court held that, although the trustee of an insolvent estate fell within the statutory definition of trustee, he did not fall within the definition of representative taxpayer. As a result, prior to the 1997 amendments, where a person s estate was voluntarily or compulsorily sequestrated, the Commissioner s practice the Act being silent on the matter was to raise two assessments during that year. In the first assessment the taxpayer was assessed on all income received by or accruing to him from the beginning of the year to the date of his insolvency. This was a debt due by the estate, which the trustee was obliged to admit and accord its statutory preference under the Insolvency Act, If the insolvent was a partner, the Commissioner also had a preferential claim against the insolvent partnership for that part of the tax due by the insolvent which was referable to his income from the partnership; (see sections 101(b) and 49(2) of the Insolvency Act). The Commissioner also had a preferential claim against the insolvent estates of certain persons in terms of section 99 of the Insolvency Act. In the second assessment, the insolvent was treated as a new taxpayer from the date of his insolvency and was liable, as such, for tax in his own right. Irrespective of whether the sequestration was voluntary or compulsory, the insolvent was not entitled to carry forward any assessed loss incurred prior to the date of sequestration unless the sequestration order was later set aside; see section 20(1)(a)(i). Rehabilitation was not sufficient in this regard. 8

9 Insolvent estates: post-1997 The Income Tax Act 1997 introduced the following changes in regard to the taxation of insolvent persons and insolvent estates: The definition of person was extended to include an insolvent estate, and an insolvent estate meant an insolvent estate as defined in section 2 of the Insolvency Act. The definition of representative taxpayer was extended to include the trustee or administrator of an insolvent estate in respect of the income received by or accrued to the insolvent estate. However, where income accrues to the insolvent estate during the course of winding-up, the trustee is not a representative taxpayer in respect of such income, and no liability for income tax falls on him, nor does he have any obligation to render a return of such income. Such income is simply dealt with in the same way as other assets in the insolvent estate which vest in the trustee in terms of the Insolvency Act, and in respect of which he performs a statutory duty of realisation and distribution to creditors. As a representative taxpayer, the trustee is, with regards to the income received by or accrued to the insolvent person prior to the date of the sequestration of his estate, subject in all respects to the same duties, responsibilities and liabilities as if the income were received by or accrued to him beneficially and he is liable to assessment in his own name in respect of that income, but only in his representative capacity; see section 95(1)bis. The effect of insolvency is that three separate taxpayers may be liable for tax: the insolvent individual for the period prior to insolvency, the insolvent estate (a new entity for tax purposes), the insolvent person for the period post-insolvency. A trustee who, as a representative taxpayer, pays any tax in respect of the insolvent person prior to the date of sequestration of his estate is entitled to recover the amount so paid from the estate of the insolvent person or to retain out of any moneys of such estate that may be in his possession or that may come to him as trustee an amount equal to the amount so paid. These amendments came into force on 4 July 1997 and apply to any estate voluntarily or compulsorily sequestrated on or after that date. The effect of the amendments is to make an insolvent estate a taxpayer in its own right. The trustee, as representative taxpayer of the insolvent estate, is entitled to claim any deductions for which the estate qualifies, as a person and a taxpayer in its own right. Thus, the estate is entitled to deductions in terms of section 11(a) for the trustee s remuneration and for the premium on a fidelity bond. These amendments do not abolish the principle that an insolvent who, with the consent of the trustee, enters into employment or carries on a trade, derives the resultant income adversely to the trustee and he, not the trustee, is liable to tax on such income. From a tax point of view, therefore, the effect of insolvency is to terminate the tax status of the taxpayer and to substitute in his or her place a new entity, namely the insolvent estate. This new entity comes into existence on the date when the insolvent surrendered his or her estate or, in the case of compulsory sequestration, the date of the provisional order if that order is later made final. 9

10 The effect of insolvency is thus that three separate taxpayers may be liable for tax, namely the insolvent individual for the period prior to insolvency; the insolvent estate (a new entity for tax purposes); the insolvent person for the period post-insolvency. Separate returns for the periods before and after sequestration Where the estate of a person is sequestrated, section 66(13(b) requires separate returns to be made for the periods commencing on the first day of the tax year and ending on the date preceding the date of sequestration; and commencing on the date of sequestration and ending on the last day of that tax year. The interpretation and effect of section 25C The extension of the definition of person to include an insolvent estate must be read together with the simultaneous enactment of section 25C. Section 25C was amended in 2001 to expand its scope by providing for capital gains and losses as determined in terms of the Eighth Schedule. In its present format, section 25C states that, for the purposes of the Income Tax Act the estate of a person prior to sequestration and that person s insolvent estate shall be deemed to be one and the same for the purpose of determining (a) (b) (c) the amount of any allowance, deduction or set-off to which that insolvent estate may be entitled; any amount which is recovered or recouped by or otherwise required to be included in the income of that insolvent estate; any taxable capital gain or assessed capital loss of that insolvent estate. The Interpretation Note comments that this provision has the effect, inter alia, of crystallising all capital gains and capital losses in the insolvent estate, and it also has the effect of permitting an assessed loss or assessed capital loss, as contemplated in section 20(2) and an assessed loss as contemplated in the Eighth Schedule, to be carried forward from the insolvent person prior to sequestration into his or her insolvent estate. The Interpretation Note states that section 25C has the consequence that an assessed loss, incurred by the insolvent person, can be set off against the income of the insolvent estate, and the provisions of section 20(1)(a)(i) are therefore not applicable in respect of the estate; 10

11 expenditure and losses claimed by the insolvent person prior to the date of insolvency can be recouped in the insolvent estate, for example, a depreciation allowance, a doubtful debts allowance, a hire purchase allowance, etc; debts included in the income of the insolvent person prior to the date of insolvency can be claimed as bad debts by the insolvent estate; the write-off of assets or allowances can continue to be deducted in the insolvent estate; there can be included in the income of the insolvent estate any amounts recovered during the winding-up period in respect of debts written off as bad prior to sequestration; there may be included in the income of the insolvent estate any amount that is required to be included in the income of the insolvent person, for example, the amount granted as an allowance in respect of doubtful debts in the previous year of assessment, the value of closing stock, etc; there is no disposal of the person s assets at the date of sequestration and capital gains and capital losses are therefore determined in the hands of the insolvent estate when the assets are disposed of to third parties. None of the tax consequences of insolvency, discussed above, ensue where a person merely assigns his estate to a receiver or other person. His legal status does not thereby change, nor is there any alteration to his tax position. Any income derived from the assets of a business assigned to a receiver continues to be derived by the assignor and the latter remains liable for tax on such income. If, however, the assignor enters into a compromise with his creditors or receives a concession from them in terms of which his liabilities to them arising in the ordinary course of his trade are reduced or extinguished, the benefit so received (which is a deemed recoupment in terms of section 8(4)(m)) reduces the balance of any assessed loss vesting in him; see section 20(1)(a)(ii). None of the tax consequences of insolvency ensue where a person merely assigns his estate to a receiver or other person. His legal status does not thereby change, nor is there any alteration to his tax position. Rates of tax Up to the date of insolvency the insolvent person is taxed at the rates applicable to persons other than companies and trusts and, being a natural person, is entitled to the section 6 personal rebates, reduced pro rata where the insolvency occurred part-way through the year of assessment. This also applies to the period subsequent to insolvency, should any income accrue to him or her in a personal capacity. An insolvent estate, as a person and a taxpayer in its own right, is taxed at the rates applicable to persons other than companies and trusts but, not being a natural person, it is not entitled to the personal rebates. 11

12 Zero-rating of exports Having no documentary proof can cost you dearly The zero-rating of export sales add to the competitiveness of South African exporters in the international market. However, the actual exportation of goods does not, in itself, allow the zero-rating of the sale. If the required documentary proof cannot be furnished to a visiting SARS auditor, the export sale will be assessed at the rate of 14 per cent with penalty, interest and even additional tax being added. Exporters should note that Interpretation Note No 30 ( IN 30 ) (published on 31 March 2005) has been replaced by Issue 2 of IN 30, with effect from 1 April All rulings issued on the documentary proof requirements of the original IN 30 have been withdrawn by Issue 2, with effect from 1 April Vendors who have obtained rulings authorising the zero-rating of exports on the strength of alternative documentary proof of export must therefore obtain new rulings from SARS. However, any requirements of the original IN 30 that have been deleted in Issue 2 will not be enforced for the period 1 April 2005 to 31 March Issue 2 (which is less onerous that the original IN30) will therefore be applied retrospectively to 1 April The effect is that zero-rating of exports that did not meet these deleted requirements are accordingly no longer at risk of being assessed by SARS. Exporters should note that the requirements relating to EDI and export documentation have been relaxed: Electronic Data Interchange export or removal documentation no longer has to contain an original SARS Customs stamp; and The exporting vendor no longer has to retain a copy of the Customs import declaration of the country into which the goods have been imported. Because penalties that may be imposed for non-compliance with the documentary requirements are potentially high, vendors who have previously obtained rulings on exports should review these rulings and, where necessary, submit new applications. Editor: Ian Wilson Written by R C (Bob) Williams Sub-editor and lay out: Carol Penny Dis tri bu tion: Elizabeth Ndlangamandla Tel (011) Fax (011) This publication is provided by PricewaterhouseCoopers Inc. for information only, and does not constitute the provision of professional advice of any kind. The information provided herein should not be used as a substitute for consultation with professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all the pertinent facts relevant to your particular situation. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the author, copyright owner or publisher. 12 Copyright 2005 PricewaterhouseCoopers Inc. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers Inc (a South African incorporated entity) or, as the context requires, the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.