A section 80J case on paper. A warning about letters of audit findings in practice.
At first glance, Erasmus looks like one of those judgments many practitioners will politely read, nod at and then move on from. After all, it is a section 80J case. Section 80J notices are rare. Most taxpayers will never see one. Many tax practitioners will see very few of them. That is precisely why it would be a mistake to treat Erasmus as some niche GAAR curiosity with little practical relevance.
The real value of Erasmus is not that it says something interesting about section 80J notices. It is that it implies something important about a much more familiar document: the section 42(2)(b) notice, better known in practice as the letter of audit findings.
Put bluntly, the lesson is this: SARS cannot tell a taxpayer one story before the assessment, issue the assessment on that story, and then in its rule 31 statement insist that the real story was materially different all along.
The issue in Erasmus, very briefly
The issue before the SCA was simple enough. SARS issued a section 80J notice and then a GAAR assessment on one factual basis. In broad terms, the original case was that the dividends in question were funded by the Newshelf repurchase and that the STC credits were used to shield the resulting dividends tax. Later, in its rule 31 statement, SARS changed course. It accepted that the dividends were in fact funded by the Trust’s subscription for new shares in Treemo, coupled with the call option arrangement and the circular movement of funds.
The amount of tax sought did not materially change. But the factual engine of the case did. So did the remedy SARS wanted to apply under GAAR.
The SCA held that this was not permissible. The court said the case was, at its heart, one of powers rather than procedure. Section 80J(4), properly interpreted, did not allow SARS to revise or modify its reasons for invoking GAAR after the GAAR assessment had already been issued. The court further held that rule 31 could not operate as an independent source of power to save what SARS had done. Why? Because the changes in the rule 31 statement went to the core of the GAAR determination. In substance, SARS had attempted a new exercise of power after the assessment had already been issued.
That was the decision. But it should not be the punchline.
Why ordinary audit cases should care
The reason ordinary audit cases should care is that section 80J notices and section 42(2)(b) notices are functionally very similar. Each tells the taxpayer what SARS’ provisional case is before assessment. Each invites the taxpayer to respond to that case. Each exists so that SARS can hear the taxpayer out before it crystallises its view into an assessment.
That similarity is not some invention by the author. In Trustees of the CC Share Trust and Others v CSARS, SARS itself argued that, save for the different time periods, a section 80J notice and a section 42(2)(b) notice are sufficiently similar to be combined in a single notice. The High Court recorded that argument. The same judgment also observed that both provisions create an iterative process: SARS gives its initial view, the taxpayer responds, further information may be sought, and only then is a final view adopted.
That matters. It matters because the taxpayer’s right under section 42(3) is to respond to the facts and conclusions set out in the section 42(2)(b) document. In other words, the letter of audit findings is not supposed to be decorative. It is not there so that SARS can merely go through the motions before doing whatever it planned to do anyway. It is there so that the taxpayer can know the case he or she must meet before the assessment is raised.
Rule 31 and the prohibition on novation
Now enter rule 31.
Rule 31 allows SARS to include a new ground of assessment in its statement of grounds of opposing appeal, but not if that new ground constitutes a novation of the whole of the factual or legal basis of the disputed assessment, or if it requires the issue of a revised assessment.
That wording is important. It recognises that there is a difference between elaborating a case and replacing it. SARS is entitled to explain its case better. It is not entitled to swap the case out for another one.
This is exactly where Erasmus becomes useful well beyond GAAR. Even if one puts section 80J to one side entirely, the judgment arguably supports a very simple proposition: rule 31 is not a laundry service for a bad assessment. It is not a device through which SARS may wash an assessment clean of its original defects by pleading a different factual foundation later.
One must therefore ask a very practical question in every tax appeal: when one compares the rule 31 statement to the earlier section 42(2)(b) document, is SARS still defending the same assessment case, or has SARS novated the factual or legal basis for that assessment?
If the latter is true, the difficulty for SARS is not merely cosmetic. It is fundamental. What is then being defended in rule 31 is no longer the disputed assessment. It is a different assessment case.
Two practical examples
Take understatement penalties. Assume SARS issues a letter of audit findings saying that a taxpayer omitted taxable income from an undeclared bank account and that, because the taxpayer omitted the amount from gross income, the taxpayer is grossly negligent. The assessment then follows on that footing. Later, in rule 31, SARS says the real problem was that taxpayer was aware of the income in the bank account, was told by his accountant that it is probably taxable, that the taxpayer himself is a business man of 20 years’ experience and has a law degree, therefore, the taxpayer was grossly negligent in failing to declare the income in question.
That is not refinement. That is substitution.[1] The taxpayer was invited to answer one penalty case and is later confronted with another. That is exactly the type of creep rule 31 is supposed to prevent.
Consider next the all-too-familiar situation where SARS seeks to lift the veil of prescription. In the letter of audit findings, SARS says prescription does not protect the taxpayer because the taxpayer claimed an expense for income tax purposes that is not deductible. The taxpayer responds to that allegation. Then, in rule 31, SARS says the real reason for lifting the veil of prescription is that the taxpayer purposefully disclosed the expense on the “other” section of the tax return so as to attempt to hide it because the taxpayer new the expense was not deductible and that amounts to misrepresentation.
Again, that is not a better articulation of the same case. It is a different key being used to unlock prescription. If SARS wants to rely on a different key, it must say so in the proper place and at the proper time. Rule 31 is not the proper place. And after the assessment, it is no longer the proper time.
If SARS wants to novate, it must start again
This is where sections 42, 92 and 96 of the TAA should come back into focus.
Section 42(2)(b) requires SARS, after an audit that identifies potential adjustments of a material nature, to provide the taxpayer with a document containing the outcome of the audit, including the grounds for the proposed assessment or decision. Section 42(3) then gives the taxpayer the right to respond to the facts and conclusions set out in that document.
Section 92, in turn, allows SARS to issue an additional assessment if SARS is satisfied that an assessment does not reflect the correct application of a tax Act to the prejudice of SARS or the fiscus, subject of course to the limitation rules in sections 99 and 100.
And section 96 matters perhaps even more than it usually gets credit for. In the case of an assessment not fully based on the taxpayer’s return (which is the case in almost all additional assessments), SARS must provide a statement of the grounds for the assessment. That is not an empty formality. It is part of the statutory architecture of assessment itself.
Once that is appreciated, the answer becomes fairly obvious. If SARS truly wishes to change the factual or legal basis of an assessment, then SARS should do so through the machinery the TAA actually provides. Before assessment, that means proper compliance with section 42. After assessment, that means using section 92 where its requirements are met and where section 99 permits it. What SARS should not be allowed to do is use rule 31 to circumvent sections 42, 92 and especially section 96.
Stated differently, rule 31 is there to defend the disputed assessment. It is not there to manufacture a better one after the fact.
Conclusion
Erasmus may wear GAAR clothing, but its practical warning is much broader.
When reading a rule 31 statement, practitioners should stop asking only whether SARS has added some new detail. The better question is whether SARS is still defending the same factual and legal basis that was put to the taxpayer in the letter of audit findings. If not, one may well be dealing with a novation prohibited by rule 31.
And if SARS wants to novate, the answer is not to become creative in pleadings. The answer is to start again and use the powers the statute actually gives it, in the manner the statute requires. That might include issuing a new letter of audit findings and allowing the taxpayer to respond again.
[1] If you are struggling to see that distinction, consider perhaps a career at a revenue authority.
