A Cautionary Tale for SARS: Novation, Rule 31, and the Perils of Shifting Grounds

A Cautionary Tale for SARS: Novation, Rule 31, and the Perils of Shifting Grounds

• 22 May 2025
• Individuals Tax
• Jana de Clerk and Hopolang Mollo

The recent judgment in IT 25209 delivered by the Johannesburg Tax Court provides important clarity on the procedural and substantive boundaries of Rule 31 under section 103 of the Tax Administration Act 28 of 2011 (“the Tax Court Rules”).

At issue was whether the taxpayer was entitled to a default judgment under Rule 56(1) due to SARS’ purported novation in its Rule 31 statement. This article examines the facts, analyses the court’s reasoning, and considers broader implications for taxpayers and practitioners navigating procedural rules alongside substantive tax law.

Background

The taxpayer, an independent power producer, earned income from selling electricity generated by a solar photovoltaic facility to Eskom. In its 2014 tax return, the taxpayer deducted costs related to raising capital—termed “development fees”—arguing these qualified as “related finance charges” under the definition of “interest,” thus deductible under section 24J of the Income Tax Act 56 of 1962 (“ITA”).

Initially, SARS allowed this deduction but later disallowed it following an audit. In its finalisation letter, SARS denied that the development fees met the “related finance charges” definition and rejected the taxpayer’s reliance on precedent cases such as C:SARS v South African Custodial Services (Louis Trichardt) (Pty) Ltd (“SACS”) and ITC 1870. Notably, SARS accepted, at that stage, the factual connection between the expenses and the taxpayer’s financing efforts, without dispute.

SARS’ Rule 31 Statement

In contrast, SARS’ Rule 31 statement conceded the applicability of SACS and ITC 1870, affirming that the development fees qualified as deductible interest under section 24J. However, SARS then contended the taxpayer failed to prove the necessary close connection between the development fees and the solar project.

The Court’s Judgment

The court emphasized that to assess whether a new ground raised in a Rule 31 statement contravenes Rule 31(3), the statement must be compared to the original assessment. Rule 31(3) allows SARS to raise new grounds so long as they do not amount to a novation—that is, a complete replacement of the factual or legal basis of the disputed assessment—or require a revised assessment.

Here, the court found SARS had materially changed its position—a volte-face. Whereas SARS originally argued the closeness of the expenditure was insufficient, it never disputed the existence of such closeness. In the Rule 31 statement, SARS shifted the burden onto the taxpayer to prove the connection, effectively creating a new legal and factual basis for disallowance.

The court held this amounted to a novation, which would prejudice the taxpayer by forcing a wide-ranging factual enquiry into pre-2014 expenditures. Consequently, SARS’ Rule 31 statement was held non-compliant with Rule 31(3), as it effectively required a revised assessment.

Because SARS abandoned its original legal foundation, the appeal was rendered untenable. The court ruled in favor of the taxpayer, ordering the disallowance of development fees to be reversed and the deduction allowed under section 24J.

Key Takeaways

• SARS must rely on grounds stated in the additional assessment or finalisation letter throughout litigation. Grounds introduced later by SARS’ legal team, unsupported by the initial assessment grounds, are impermissible.
• The judgment underscores a critical “burden” on SARS auditors to ensure all relied-upon grounds are detailed upfront.
• While Rule 31(3) allows raising new grounds, these must not amount to a novation of the entire factual or legal basis or necessitate a revised assessment.
• New grounds that clarify or support original assessment bases are acceptable; completely new legal or factual arguments that alter the foundation are not.
• Expert knowledge of tax law and SARS’ procedural framework is crucial for taxpayers and practitioners to detect and challenge improper novations and procedural irregularities.

This judgment serves as a vital reminder that SARS must maintain procedural integrity and that taxpayers should vigilantly monitor any “change of horses mid-race” to protect their rights.

Learn more about this ruling, which highlights the critical importance of procedural fairness and thoroughness in SARS’ assessments. Gain valuable insights and practical guidance for taxpayers and practitioners navigating tax disputes. Register now for our upcoming webinar to secure your spot.

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