In a recent judgment handed down by the Johannesburg tax court in Taxpayer Arrow v CSARS (IT45776), the court had to determine, amongst various other things, (a) whether SARS could lift the veil of prescription and (b) whether SARS’ was correct in imposing understatement penalties under the circumstances.
Briefly, the background to the case was that the taxpayer, a natural person, was entitled to substantial amounts from a trust, which was directly linked to his employment at a company/companies. The taxpayer declared the amounts as exempt dividend income on the back of advice received to the effect that the amounts are paid to the trust as dividends in respect of shares and on-distributed to taxpayer Arrow. SARS disagreed and taxed the amounts as normal gross income based many alternative grounds for assessment, including GAAR and substance over form. SARS also imposed understatement penalties. The additional assessment was made some 8 years after the original assessment in which SARS assessed the amounts as exempt dividend income.
Prescription
One of the taxpayer’s defences was that prescription prevented SARS from raising the additional assessment. Indeed, it was common cause that the original assessment was older than three years. SARS however, purports to have acted on the basis that the taxpayer, during the course of audits, was provided ample opportunity to explain to SARS that the “exempt dividends” in fact relate to employment. And so, the argument goes, the taxpayer did not disclose a material fact to SARS or misrepresented during the course of the audit/(s) and therefore SARS can lift the veil of prescription.
The judgment on prescription and understatement penalties
The court approaches the issue of prescription by first asking– what must be established and by whom? In seeking answers to these questions, the court refers to:
- the 2019 High Court judgment in Wingate Pearse;[1]
- the 2021 Supreme Court of Appeal judgment in Spur[2]; and
- a tax court judgment in ITC 1929.[3]
The court’s reasoning appears to be as follows:
- that which must be established is SARS’ subjective satisfaction of material non-disclosure or misrepresentation (citing Wingate Pearse as authority);
- SARS carries the burden of proof (citing Spur as authority); and
- SARS must prove their subjective satisfaction that there was non-disclosure or mispresenting either in the return or in the three-year period thereafter (citing ITC 1929 as authority but also seemingly inferring the ITC 1929 judgment was approved by the SCA in the 2021 Spur case).
The court ultimately concludes by agreeing with SARS that the taxpayer’s failure to disclose the fact that the dividend was received by virtue of his employment amounted to material non-disclosure as envisaged by section 99(2), which warranted the lifting of the veil of prescription. Interestingly, the court does not conclude that the taxpayer misrepresented anything even though that was raised by SARS. The reason for this, from my reading of the judgment, is that the taxpayer, according to the court’s judgment on the issue of understatement penalties, bona fide believed that the amounts were exempt dividend income and therefore did not intend to deceive. That being exactly the basis on which the court dismisses SARS case for understatement penalties.
Criticism
With respect, I do not agree with the court’s conclusion on prescription for the following reasons:
- I am in respectful disagreement with the judgment in the 2019 Wingate Pearse case for reasons detailed in my Book titled Practical Guide To Handling Tax Disputes, and in an article here, insofar as that judgment suggests SARS’ subjective satisfaction is what is required to lift the veil of prescription. In short, my reasoning is that SARS must objectively establish and indeed prove the existence of the non-disclosure or misrepresentation (see, for example, my article about a judgment from the Western Cape Tax Court in December 2024 here confirming exactly this point). SARS’ subjective satisfaction is not relevant to the issue of prescription. The question is quite simply: does the misrepresentation or non-disclosure exist objectively and, if so, did it cause SARS not to assess the taxpayer correctly in the original assessment because of that non-disclosure or misrepresentation?
- The judgment in ITC 1929 is also a judgment I am in respectful disagreement with. The judgment suggests that taxpayers can cure misconduct (such as fraud, misrepresentation or non-disclosure of material fact) after the return has been filed. The reason for that conclusion by the court is because of the following approach adopted by the court in ITC 1929 to the interpretation of section 99(2):
‘what caused Sars [sic] in its original assessment and during the period of three years thereafter not to assess the full amount of tax chargeable?’[4] (emphasis added).
I have said the following about this approach by the court in ITC 1929:
“The basis for the addition of the words ‘and during the period of three years thereafter’ in the question above is debatable. Section 99(2) clearly provides exceptions to the prescription rules in section 99(1). Section 99(1)(a) provides that an original assessment by SARS prescribes within three years from the date of issue. Section 99(2)(a) must therefore be interpreted with reference to the original assessment. It could therefore be argued that the question should rather be phrased thus: what caused SARS not to assess the taxpayer correctly in the original assessment? If this is the correct question, the argument that a taxpayer can cure any misconduct falls away.”[5]
Indeed, I maintain, the question ought to be whether the taxpayer misrepresented something in the tax return or failed to disclose something in the tax return. In the Arrow case, the taxpayer clearly did not mispresent – having relied on advice in filing the return, he bona fide believed the dividends are exempt and disclosed it as such.
But what then ought the taxpayer to have disclosed about the fact that the dividend relates to employment. Where on an income tax return is a taxpayer called upon to disclose that exempt dividend income relates to employment income? The question cannot be whether the taxpayer did not disclose something during the course of the audit after the assessment has been raised. If so, then taxpayers can cure their misconduct and the judgment in ITC 1929 is correct. But you cannot have it both ways.
- The court’s reliance on the Spur case is in my view, with respect, misplaced insofar as the court seems to suggest the SCA judgment confirms the principle in the ITC 1929 judgment that one must look at the taxpayer’s conduct in the three-year period after the original assessment. In 2021 Spur case, SARS led evidence showing that it was the manner in which the taxpayer completed the return that caused SARS not to assess the taxpayer correctly the first time. Not the taxpayer’s behaviour and submissions after the return was filed and the original assessment issued. SARS was able to prove that had the taxpayer filed the return correctly, SARS would have identified the risk and investigated it before the assessments prescribe but because the taxpayer “lied” in the return the court held they could lift the veil of prescription.
Conclusion
On the above basis and, assuming there is no place on a tax return where a taxpayer is required to disclose that exempt dividend income relates to employment income, it seems to me SARS ought not to have passed the prescription hurdle. This conclusion also seems justified on the basis of the SCA’s judgment in Brummeria[6] that the prescription rule is there to achieve finality
“… and it would be unfair to an honest taxpayer if the Commissioner were to be allowed to continue to change the basis upon which the taxpayer were assessed until the Commissioner got it right…”
Indeed, honest taxpayers ought to be protected by the principles of prescription. And, in taxpayer Arrow’s case, the court found him to have acted innocently, in good faith and without intention to deceive yet rules the taxpayer should not be afforded the protection of prescription…
[1] Wingate Pearse v CSARS 2019 (6) SA 196 (GJ).
[2] CSARS v Spur Group [2021] ZASCA 145.
[3] 82 SATC 264.
[4] ITC 1929.
[5] Theron, N. & Louw C. 2024. Practical Guide To Handling Tax Disputes, Lexis Nexis.
[6] Commissioner for the South African Revenue Service v Brummeria Renaissance (Pty) Ltd and Others[2007] ZASCA 99, [2007] SCA 99 (RSA), [2007] 4 All SA 1338 (SCA), 2007 (6) SA 601 (SCA).
