The audit process – recent case law and the taxpayer's perspective

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The audit process – recent case law and the taxpayer's perspective

• 11 November 2020
• Individuals Tax
• PWC

The recent case of Carte Blanche Marketing CC and Others v Commissioner for the South African Revenue Service (26244/2015) [2020] ZAGPJHC 202 (31 August 2020) provided clarity on, inter alia, when a decision taken by the South African Revenue Service (‘SARS’) is ripe for review in the High Court in the context of the information gathering provisions of the Tax Administration Act No. 28 of 2011 (‘TAA’). Selected aspects of the Carte Blanche case are discussed herein.

The applicants (‘the Taxpayers’) were selected for an audit in terms of section 40 of the TAA by SARS to allegedly verify their compliance with the tax acts. The Taxpayers sought the review and setting aside of this decision.

A brief background to the matter is as follows. On 4 August 2014 the Taxpayers were formally notified that they had been selected for an audit in terms of section 40 of the TAA. In terms of these letters the Taxpayers were called upon to make available certain records in order to enable the audit team at SARS to conduct an audit. The three notices stated that the decision to conduct the audit was based on a risk assessment. The Taxpayers did not provide the Commissioner with any documentation to prove their compliance, thus the audits progressed, and consideration was given to the documentation in the Commissioner’s possession only. In the letters dated 18 February 2015, the Commissioner informed the Taxpayers of the findings in respect of the first and second applicants, the basis thereof and that the Commissioner intended to issue additional assessments for alleged underpayment of the income tax. Pursuant to those letters the present application was instituted on 14 April 2015.

Notable aspects of the Taxpayers’ case are as follows:

• The Taxpayers maintained that their tax affairs had always been in order. In support thereof they relied on the fact that they had never been subjected to any audit and that tax clearance certificates had in the past been issued to them by SARS.
• They contended from the outset that SARS committed itself to a ‘risk assessment basis’, being the relevant consideration upon which it decided to subject the Taxpayers to an audit. The lawfulness of the decision therefore depends, inter alia, on SARS having in fact established the existence of an income tax risk pertaining to the Taxpayers.
• The Taxpayers sought the review and setting aside of SARS’s decision to select the Taxpayers for an audit in terms of section 40 of the TAA on the basis that it was unlawful a) as it was taken for an ulterior purpose, b) it was taken for a reason not authorised by the empowering legislation (i.e. the TAA), c) it was irrational and d) it was taken in bad faith.

Notable aspects of SARS’s case are as follows:

• According to SARS, the risk identified stemmed from a Customs investigation into the Taxpayers’ activities and the litigation in that regard over a period of just less than ten years. SARS also expanded its audit to the alleged discrepancy in turnover between the (first and second) Taxpayers’ VAT returns when compared to their income tax returns.
• SARS opposed the application on the basis that a) a decision in terms of section 40 of the TAA did not constitute reviewable administrative action, b) even if it was, the decision in issue was lawful and should not be set aside.

The review proceedings proceeded on the basis that it was brought as a legality review. In other words, the court considered whether the decision was reviewable under the principle of legality.

As a starting point, the court had to consider what powers the empowering provision (i.e. section 40) gives the Commissioner. The purpose of the TAA is ‘to ensure the effective and efficient collection of tax’ as contemplated in section 2 of the TAA. The TAA is to be read against the background of the South African Revenue Service Act, No. 34 of 1997 (‘SARS Act’), in particular sections 3 and 4 thereof. Section 3 states that SARS's objectives are the efficient and effective collection of revenue as well as control over the import, export, manufacture, movement, storage or use of certain goods. Section 4 of the SARS Act prescribes that in order to meet its objective of efficient and effective tax collection the Commissioner ‘must … secure the efficient and effective, and widest possible, enforcement’ of, among other things, the Income Tax Act, No. 58 of 1962 (‘Income Tax Act’). The Commissioner is therefore not only empowered to use the available mechanisms to collect all taxes payable to the fiscus, it is legally enjoined to do so.

All the tax acts function by means of self-assessment systems which cause the Commissioner not to be in possession of the information and documentation that would prove or disprove compliance with the said Acts. In order to enable the Commissioner to verify compliance it is therefore essential that:

• the taxpayer be statutorily obliged to keep the records that would prove its compliance with the relevant Act and to make them available when called upon to do so; and
• the Commissioner be provided with extensive powers to obtain the evidence that would enable him to properly administer and enforce the relevant legislation.

These duties and powers are currently regulated by the TAA. In particular, section 40 of the TAA provides for the selection for inspection, verification or audit and states that SARS may select a person for inspection, verification or audit on the basis of any consideration relevant for the proper administration of a tax act, including on a random or a risk assessment basis. The wording, context and purpose of section 40 suggests that provided that the intended audit is to be undertaken for the proper administration of a tax act, there is no limitation to the considerations on which a decision to select a taxpayer is to be founded.

The court then had to consider what was sought and for what purpose.

All three applicants received notifications from SARS dated 4 August 2014 (‘audit notifications’). The documents requested by SARS are normally the kind that would prove the correctness of the VAT and income tax returns filed by a taxpayer and are those that a compliant taxpayer should have in its possession. On the face of it, the court commented that it seemed like every enquiry directed was relevant for the administration of a tax act i.e. the Income Tax Act. Objectively adjudged, it seems that no value could be served and no purpose (to SARS) could be achieved, save to prove or disprove the correctness of the taxpayers’ VAT and income tax returns.

The court stated that the decision taken in terms of section 40 of the TAA and the subsequent making of the assessments against the first two Taxpayers were separate decisions. Counsel for the Taxpayers accepted that the decision was not one which falls within the definition of administrative action as defined in the Promotion of Administrative Justice Act, No. 3 of 2000 (‘PAJA’), because the decision to select a taxpayer for an audit does not adversely affect the taxpayer’s rights and does not have a direct external legal effect – or certainly in this instance.

The initiation of an investigation does not constitute a decision which is capable of review. In this regard, the matter was not yet ripe for review as it was incomplete.The ripeness argument dovetails with the subsidiarity principle. The principle of subsidiarity requires that a party rely on the lower norm that regulates or should regulate the subject matter in issue. In Mazibuko v City of Johannesburg 2010 (4) SA 1 (CC) O’Regan J explained at paragraph 73 that:

‘where legislation has been enacted to give effect to a right, a litigant should rely on that legislation in order to give effect to the right or alternatively challenge the legislation as being inconsistent with the Constitution.’

In this application, the court stated that the lower norm is the section 42 procedure of the TAA or the sections 116 or 117 (establishment of the Tax Court and jurisdiction of the Tax Court) processes of the TAA. These sections of the TAA give effect to the constitutional rights the Taxpayers wish to protect with this application. The court found that the Taxpayers deliberately chose not to utilise ‘the lower norm’ and directly approached this court. In doing so they have breached the subsidiarity principle. Absent a challenge to the constitutional validity of the Chapter 9 appeal process on the basis that it ‘falls short of constitutional standards’ the court cannot entertain the application. To do so would impliedly impugn the validity of the Chapter 9 appeal process, without there having been a properly mounted constitutional attack.

The court concluded, inter alia, that:

• the timing of this application on the facts of this case was wrong; and
• it could not find on the evidence placed before this court that the decision taken by SARS was taken for a purpose other than for the administration of a tax act as contemplated in section 3(2) of the TAA.
• on the question of whether the decision was lawful, the decision was not capable of forming the subject of a legality review within the factual matrix of this case.

The application was therefore dismissed with costs, including the costs of two counsel.

This case is an important one as it, inter alia, provides clarity on when a decision is ripe for review in the High Court. It also brings a much-needed focus on the information-gathering provisions of the TAA, which are key provisions for taxpayers to be cognisant of once they have been selected for audit, inspection or verification.

This year PwC’s third annual Taxing Times 2020 Survey provided key insights in respect of taxpayers’ practical experiences, perceptions and needs with regard to five crucial areas that were tested, one of which was the audit process (including the debt management process).

Some positive developments as well as areas of improvement on the part of SARS in respect of the audit process were noted.

• On a positive note:

- 96% of the respondents stated that SARS allows an extension to submit a response to a section 46 request for relevant material.

- 52% of the respondents say that the section 46 requests from SARS for relevant material usually meet the criteria as set out in the TAA ‘most of the time’.

- 49% of the respondents state that it typically takes SARS one to three months to complete a verification audit (not an investigative audit).

• On a more concerning note:

- 48% of the respondents believe that SARS is likely to verify/audit their company post submission of CIT return on an annual basis.

- 20% of the respondents indicated that the turnaround time to finalise an investigative audit is longer than 18 months.

- 66% of the respondents reveal that SARS’s letter of assessment / audit findings is identical to SARS’s letter of audit findings.

- 58% of the respondents stated that SARS ‘sometimes’ complies with section 42 i.e. progress reports as part of the audit process, with 22% saying ‘never’.

- 51% of the respondents have called for SARS to improve facilities to communicate with SARS directly (excluding call centre and e-filing), while 55% call for SARS to improve the technical skills of staff.

The aforementioned results are important as they (much like the Carte Blanche case) ventilate taxpayers’ perceptions in respect of key aspects relating to the audit process and will be used to support constructive engagements with SARS about how it can improve public trust, efficiency, and confidence in the tax administration system as well as improve its stakeholder engagement. These are among SARS’s key strategic objectives and are important drivers not only to rebuild the organisation, but also to ensure the effective and efficient collection of taxes.

Key takeaways:

The decision taken in terms of section 40 of the TAA and the subsequent making of the assessments are separate decisions. The taking of the decision to select a taxpayer for audit does not necessarily lead to the making of an assessment. Similarly, the making of an assessment does not require the prior selection to subject the taxpayer to audit. The decision to select the taxpayer for audit is not one which falls within the definition of administrative action as defined in PAJA. This is so because the decision to select a taxpayer for an audit does not adversely affect the taxpayer’s rights and does not necessarily have a direct external legal effect.

Section 42 of the TAA performs the function of section 3(2) of PAJA – i.e. it affords a taxpayer in receipt of the audit notifications, reasonable opportunities to make representations, and once that procedure is exhausted, the decision would potentially have reached the required degree of ripeness capable of forming the subject of a review.

While the case is a win for SARS, it is clear that, in practice, SARS does have some work to do to restore taxpayers’ faith and confidence in the tax system. In the upcoming years, SARS will need to improve its technology / e-filing system, upskill staff and have due regard for taxpayers’ rights during the audit process.

On the other hand, taxpayers must be proactive, retain all the relevant documents in accordance with the recordkeeping provisions in the TAA and approach audits in the spirit of cooperation. This could be the difference between protracted expensive litigation and the resolution of an audit/dispute in an efficient, timely and costeffective manner.

This article first appeared on pwc.co.za.

Please click here to visit the author's website. The article can be found under Publications and Insights. 

Webinar Commentary

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Further webinar commentary on 2020 SARS Audit, verification and assessment is also available here.

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