Power of the Court in tax disputes
A recent Supreme Court of Appeal case highlighted that understatement penalties not only place significant pressure on a taxpayer’s financial resources, but could also be indicative of a lack of commitment to proper corporate tax compliance and risk management. Where a taxpayer disagrees with the understatement penalty imposed, the onus is on the taxpayer to submit proof of why the relevant understatement penalty or the penalty percentage is inappropriate in the circumstances.
In Purlish Holdings v The Commissioner for the South African Revenue Service (76/18)  ZASCA 04 (26 February 2019), the Supreme Court of Appeal had to decide on whether or not the imposition of understatement penalties by SARS was justified, and if the Tax Court was competent to increase the understatement penalties so imposed.
The taxpayer, Purlish Holdings (Pty) Ltd, submitted nil income tax returns for the 2011 – 2014 years of assessment. According to the returns submitted, the taxpayer had not received any income nor did it incur any expenditure during the relevant years of assessment, being a dormant company. At the time of submission, the taxpayer had already made substantial provisional tax payments. This would result in a refund being due to the taxpayer, upon assessment by SARS.
As a result of the substantial refund, SARS conducted corporate income tax and value-added tax audits for the relevant years of assessment. These audits revealed that the taxpayer was party to consultancy agreements from which it derived substantial amounts of income during the relevant years of assessment. Despite the aforementioned, the taxpayer submitted nil income tax returns and also failed to register for and submit value-added tax returns.
Following these audits, SARS then imposed understatement penalties at 100% in terms of section 223 of the Tax Administration Act (2011), being of the opinion that the taxpayer acted grossly negligent. Pursuant to an objection lodged by the taxpayer, SARS reduced the income tax penalties from 100% to 25%, and the value-added tax penalties from 100% to 50%.
The taxpayer then approached the Tax Court. The grounds of appeal only required the Tax Court to consider if SARS was justified in levying understatement penalties. The taxpayer was of the opinion that, because substantial amounts of provisional tax payments had been made, there was no prejudice to SARS or the fiscus, as any overpayment credit could be utilised to extinguish any outstanding tax debt. The Tax Court not only found that SARS was justified in levying these understatement penalties, but also held that the taxpayer was grossly negligent and that these penalties should be increased to 100%.
The taxpayer then appealed to the Supreme Court of Appeal.
The outcome of the Supreme Court of Appeal case
Section 102(2) of the Tax Administration Act (2011) imposes the burden of proving the facts, on which the imposition of an understatement penalty is based, on SARS. Therefore, SARS must prove that the taxpayer displayed one of the behaviours listed in the understatement penalty table in section 221 of the Tax Administration Act (2011), and that there was a prejudice to SARS or the fiscus.
The Supreme Court of Appeal held that such prejudice should not only be determined in financial terms. Regard must also be had to the additional SARS resources that were required to conduct the relevant audits. Such requirement also amounted to a prejudice, as SARS could have utilised these resources for other purposes (i.e. it was an opportunity cost).
The Supreme Court of Appeal further held that the Tax Court was not competent to adjudicate on the increase of the understatement penalties, as this issue was not raised in the statement of the grounds of appeal. The statement merely sought justification for the penalties imposed. Accordingly, this is the only matter which the Tax Court was competent to adjudicate.
The lessons learnt
Lesson 1: When evaluating whether or not an understatement resulted in any prejudice to SARS or the fiscus, the evaluation should not only be based on financial terms, but also consider any other opportunity costs, such as a depletion in SARS resources (e.g. time).
Lesson 2: When entering into tax dispute resolution, the proper formulation of the statement of grounds of objection or appeal is imperative to the outcome of the tax dispute. A court is only competent to consider those issues that were raised in the statement of the grounds of objection or appeal. It is important to get it right from inception, as the statement cannot be amended post submission.
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