Author: Jana de Clerk (Tax Attorney | Tax Manager) and Hopolang Mollo (Tax Consultant)
The recent judgment in IT 25209 delivered by the Johannesburg Tax Court offers valuable insight into the procedural and substantive boundaries of Rule 31 of the rules promulgated under section 103 of the Tax Administration Act 28 of 2011 (“the Tax Court Rules”).
At the heart of the dispute was whether the taxpayer could succeed in obtaining a default judgment under Rule 56(1), as a result of potential novation in SARS’ Rule 31 statement. This article explores the facts of the case, unpacks the court’s legal reasoning, and considers the wider implications for both taxpayers and practitioners navigating the intersection of procedural rules and substantive tax law.
Background
- The taxpayer is an independent power producer, earning income from the sale of energy generated by it with the use of a solar photovoltaic electricity farm (“the solar facility”) to Eskom.
- In its 2014 tax return, the taxpayer deducted expenditure incurred in relation to raising funds and credit facilities required to provide capital to fund the establishment of the solar facility (“development fees”).
- The taxpayer argued that the expenditure fell within the meaning of “related finance charges” included in the definition of “interest” and as such is deducible under section 24J of the Income Tax Act 56 of 1962 (“ITA”).
- SARS initially allowed the deduction of the development fees, but subsequent to an audit of the taxpayer’s affairs, disallowed the deduction in the taxpayer’s 2014 year of assessment.
SARS’: Finalisation of audit letter (“finalisation letter”)
- In its finalisation letter SARS disallowed the deduction on the basis that the development fees did not constitute “related finance charges” and therefore did not meet the requirements of section 24J. SARS also maintained that the taxpayer’s reliance on C:SARS v South African Custodial Services (Louis Trichardt) (Pty) Ltd[1] (“SACS”) and ITC 1870 was misplaced.
- Significantly, SARS acknowledged that it had requested and received from the taxpayer a break-down of the pre-trade developmental expenses, which SARS had factually accepted as having a close connection to the procuring of loans and the raising of finance by the taxpayer for the furtherance of its solar farm project as a whole, none of which was factually challenged by SARS at that stage.
SARS’: Rule 31 statement
- However, in its Rule 31 statement SARS conceded that SACS and ITC 1870 were applicable and that the development fees constituted “interest” as defined and could be deducted under section 24J but claimed that the taxpayer failed to factually demonstrate the closeness of the connection between the development fees and its solar farm project as a whole.
The judgment
The court observed that, in determining whether a new ground raised by SARS in its Rule 31 statement contravened Rule 31(3) of the Tax Court Rules, it was necessary to compare the Rule 31 statement with the actual assessment. Rule 31(3) permits SARS to raise a new ground of assessment, provided that it does not amount to a novation of the whole of the factual or legal basis of the disputed assessment or require the issuance of a revised assessment.
In this case, the court found that SARS had fundamentally altered its position in the Rule 31 statement, effectively performing a volte-face. While SARS acknowledged that a close connection existed between the expenditure and the taxpayer’s financial arrangements, it contended (for the first time) that the taxpayer had failed to discharge its burden of proving that the pre-trade expenditure qualified for deduction.
Crucially, SARS had not previously disputed the closeness of the expenditure to the taxpayer’s financial agreements. Its original argument was that such closeness was insufficient, as the pre-trade expenditure had not arisen directly from the financial arrangements themselves. The court therefore concluded that SARS’ revised stance did not merely refine or elaborate on its earlier position but rather constituted a complete novation of the legal basis of the assessment.
This shift would cause significant prejudice to the taxpayer, as the new ground introduced by SARS would necessitate an extensive factual enquiry into expenditures incurred prior to the 2014 year of assessment. As such, it was held that the Rule 31 statement did not comply with Rule 31(3), as it not only introduced a wholly new factual and legal basis for the assessment but effectively required the issuance of a revised assessment.
The court further held that, by abandoning the original legal foundation of the assessment in its entirety, SARS had left nothing remaining of the appeal. Consequently, the court ruled in favour of the taxpayer and ordered the reversal of the disallowance of the development fees to be allowed as a deduction under section 24J.
What big eyes you have – key takeaways
- SARS must generally rely on the grounds provided in raising an additional assessment throughout the litigation process. In the event the additional assessment is consequent to an audit, as in the judgement, these would be the grounds as provided in the finalisation letter. Alternatively, for instance, if the additional assessment follows a verification, the grounds raised in the additional assessment.
- This judgement highlights a “burden” on SARS auditors to be thorough in their issuance of additional assessments, that is, all grounds SARS relies on in the issuance of the assessment should be sufficiently detailed in the additional assessment. Any reliance on SARS’ legal team to “build the case” at a later point, i.e. at litigation, is impermissible.
- Though, Rule 31(3) allows SARS to raise new grounds of assessment, these new grounds cannot amount to a novation of the whole factual or legal basis of the disputed assessment or require the issuance of a revised assessment. For example, if SARS clarifies its position or provides additional evidence that supports its original grounds, as submitted by the auditors, without fundamentally changing the basis of the assessment, this will not constitute a novation.
- If SARS introduces a completely new legal argument or factual basis that alters the original assessment’s foundation, that would be considered a novation.
The assistance of tax experts with extensive knowledge of the legislative are all the better to see SARS with. Absent the presence of keen big eyes of an expert, key administrative grounds which can render an entire assessment void are often neglected by taxpayers on the, often, unfortunately, misplaced, assumption that the authority acts within the confines of the law. Further still, seeing when SARS is trying to “change horses mid-race”
requires careful consideration of the case and expert knowledge of tax law, SARS’ systems and processes.
[1] 2012 (1) SA 552 (SCA).
