The case involved a SARS Income Tax and VAT audit of Pretoria East Motors (Pty) Ltd (“Pretoria East”), an authorised dealer on behalf of Toyota South Africa (Toyota SA). Pretoria East conducted business as a car dealership in Pretoria, selling new and used vehicles. During 2003 SARS officials conducted a detailed audit of the taxpayer’s tax affairs for the 2000 – 2004 years of assessment. Upon conclusion, additional Income Tax and VAT assessments were raised, including penalties at the maximum rate of 200 per cent.
The taxpayer’s accounting system was a customised system, installed not by the taxpayer but by Toyota SA. It not only reflected the taxpayer’s financial position, but also provided statistical information to Toyota SA to manage the complexities inherent in the taxpayer financing its operations under a floor plan agreement with Toyota Financial Services (Pty) Ltd. One of the system’s peculiarities was that some purely internal transactions were reflected as “sales” on the system. The accounting system could therefore be misleading, if not properly understood. (Evidence was that: “It is a very complicated system that Toyota South Africa has got which requires substantially more information that you would normally have in an accounting system.”)
The SCA Judge Ponnan first dealt with the onus under sec 82 of the Income Tax Act. The onus was on Pretoria East to show on a preponderance of probability that the decisions of SARS against which it appealed were wrong (CIR v SA Mutual Unit Trust Management Co Ltd 1990 (4) SA 529 (A) at 538D).
SARS raised additional assessments on the basis of information in the taxpayer’s own records. Basically, the SARS auditor examined the Pretoria East accounts and, where she found a discrepancy that she did not understand and for which, in her view, no adequate explanation was furnished, she simply raised an assessment to additional tax - either Income Tax or VAT or, in some instances, both.
- Firstly (par ): “It does not appear that Ms Victor sought to familiarise herself with the workings of the accounting system utilised by the taxpayer, even though the information available to her … was that it was a customised system…”;
- Secondly (par ): “As best as can be discerned, Ms Victor’s approach was that if she did not understand something she was free to raise an additional assessment and leave it to the taxpayer to prove in due course at the hearing before the Tax Court that she was wrong. Her approach was fallacious”;
- Thirdly, the SCA then proceeded to make the following observations regarding the manner in which SARS should conduct itself when undertaking a tax audit:
- “The raising of an additional assessment must be based on proper grounds for believing that, in the case of VAT, there has been an under declaration of supplies and hence of output tax, or an unjustified deduction of input tax. In the case of income tax it must be based on proper grounds for believing that there is undeclared income or a claim for a deduction or allowance that is unjustified. It is only in this way that SARS can engage the taxpayer in an administratively fair manner, as it is obliged to do. It is also the only basis upon which it can, as it must, provide grounds for raising the assessment to which the taxpayer must then respond by demonstrating that the assessment is wrong. This erroneous approach led to an inability on Ms Victor’s part to explain the basis for some of the additional assessments and an inability in some instances to produce the source of some of the figures she had used in making the assessments.” (emphasis added) (par )
- In response to the SARS suggestion that “…insufficient proof had been proffered by the taxpayer”, all the ledger accounts were put in a van and taken to the SARS office where Ms Victor was invited to take whatever she needed. She declined. The SCA stated that the SARS auditors had been given access to all documentation foundational to the Pretoria East accounts but chose not to examine any thereof. The SCA found that “this disturbing approach persisted in the Tax Court”. (par )
- The SCA also indicated (par ) that the SARS approach in this matter “… was untenable, for, it left the taxpayer none the wiser as to what was truly in issue and what needed to be produced in order for it to discharge the burden of proof that rested upon it.”
- According to the SCA (par ): “It must be stressed that SARS is under an obligation throughout the assessment process leading up to the appeal and the appeal itself to indicate clearly what matters and which documents are in dispute so that the taxpayer knows what is needed to present its case.” (emphasis added)
The upshot was that the SCA ordered SARS to pay the taxpayer’s costs (two counsel) in the SCA.
The Tax Administration Act, No 28 of 2011 (“the TAA”) provides that SARS should, ten days prior to commencing a field audit, provide the taxpayer with notice of said audit. The notice “…must … indicate the initial basis and scope of the audit or investigation.” (sec 48(2)(b))
If one reads the above-mentioned section in conjunction with the Pretoria East case, the following conclusions could be drawn regarding the manner in which tax audits should be undertaken by SARS:
- The “initial basis and scope of the audit” should be communicated upfront by SARS to the taxpayer, i.e. the taxpayer should clearly understand what exactly the issues are that will come under audit scrutiny. That would enable the taxpayer to understand what the ambit of “relevant material” (TAA sec 1) in relation to the audit will be. It also makes clear what “reasonable assistance” the taxpayer might be required to provide with regard to the audit, insofar as the taxpayer is obliged to answer “questions relating to the audit” (TAA sec 49(b)) and “submitting relevant material as required” (TAA sec 49(c));
- The most important aspect of the Pretoria East case is that SARS should make a real effort to understand the intricacies of the taxpayer’s specific business. This entails the SARS auditor(s) beforehand gaining an insight into the commercial realities of the taxpayer’s particular business operation. This ensures that the audit does not happen in a vacuum where there is actually no (or a limited) understanding of the business environment, the tax consequences of which are being audited. The SCA was quite critical that this was lacking in the Pretoria East audit (especially in relation to the poor understanding of the taxpayer’s accounting system).
In overseas jurisdictions it is said that revenue authority auditors should have an understanding of “commerciality”. An example can be found in the Australian Tax Office (“ATO”) Guidelines on information-gathering. It states as follows under the heading “Understanding your circumstances”:
“Our information gathering helps us to understand your circumstances and activities. If you own a business, we seek to develop our understanding of it by obtaining information, including:
- your business operations
- the business structure used and its ownership
- the influences on your business
- the industry it operates in
- the tax aspects of the business.
And at the audit stage:
“When collecting information for an audit, we will generally have more contact with you and spend time at your premises to examine documents, record your processes and discuss issues with your key personnel. We need to gather sufficient information to either establish our view and support that position or determine that no further action is required.”
Had the SARS auditor as part of her Pretoria East audit approached the matter in line with the ATO guidance above, she might have been spared the SCA’s censure.
- The taxpayer should be placed in a position to understand exactly what type of information / documentation would be crucial for purposes of the audit. This is so that the taxpayer can do the necessary to provide the required proof, thereby discharging the onus. SARS should make clear what issues, information and / or documentation are in dispute so that the taxpayer can face the challenge head-on rather than to grope around trying to ascertain what “red flag” items are being interrogated by SARS;
- Where the SARS auditor does not understand the taxpayer’s business, alternatively disagrees with the accounting and / or tax treatment applied by the taxpayer, an assessment cannot simply be raised on the basis that the taxpayer will subsequently have an opportunity to contest and refute the additional assessment via the objection and appeal process. The ball is firmly in the SARS court to first provide proper grounds for the assessment since that is the only basis upon which SARS “…can engage the taxpayer in an administratively fair manner, as it is obliged to do.”
Read in conjunction with the TAA, the Pretoria East judgment is therefore helpful as it gives some indication regarding the obligations and responsibilities of SARS auditors when conducting tax audits.
Should a taxpayer facing a SARS audit feel that there might be misconceptions about its business operations, or that the auditors do not understand the business, they should invite the SARS auditors e.g. to physically inspect the operations and / or provide them with a “walk-through” of any relevant system, etc. Such invitation should be in writing and, should the taxpayer’s attempts to explain the “commerciality" of its business operations be rebuffed, its efforts should be formally recorded so that same can be available in subsequent proceedings.
In the Pretoria East case that stood the taxpayer in good stead (ten years later) in the hearing before the SCA.