What is meant by “a part or amount of a disputed assessment not objected to” in Rule 32(3) of the Tax Court Rules?

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What is meant by “a part or amount of a disputed assessment not objected to” in Rule 32(3) of the Tax Court Rules?

• 01 March 2023
• Tax Administration
• Kyle Mandy and Jadyne Devnarain

The rules prescribed for the resolution of disputes and the conduct of appeals under section 103 of the Tax Administration Act were repealed and replaced in 2014. Under Rule 32, a taxpayer may not include in the statement of grounds of appeal “a new ground of objection against a part or amount of a disputed assessment not objected to [in the notice of objection] under Rule 7.”

In Tax Court Case IT 45710, the Tax Court in the Western Cape was faced with interpreting and applying this aspect of Rule 32(3).

Facts

In the 2018 year of assessment, the taxpayer reflected an amount in its annual financial statements as an expense. The amount in question was the share of profit to which a partner in a partnership venture with the taxpayer (a connected person in relation to the taxpayer) was entitled. It is evident, though not expressly recorded in the judgment, that the income and expenditure of the partnership had been reported in the income statement as part of the operating net income and that the share of the partner had been accounted for by reducing the net income. In this way the net income of the taxpayer reflected only its stand-alone income and its share of the partnership profit.

When the taxpayer submitted its return of income for the year of assessment, it made no adjustment to the income disclosed in the income statement in respect of the share of the partnership net income to which the other partner was entitled. The South African Revenue Service (“SARS”), following an audit, included in taxable income the amount of partnership profit that was attributable to the partner and certain other amounts.

The taxpayer filed an objection against the inclusion of the amount in taxable income. The judgment records at paragraph [18]:

“The objection was to the effect that the Commissioner had erred in adding back the disputed amount, because such disputed amount met the requirements of the General Deduction Formula (i.e., section 11(a) read with section 23(g) of the ITA) and therefore qualified as a valid deduction from the applicant's taxable income (‘the deduction ground’).”

SARS allowed the objection in respect of the other amounts assessed to normal tax but disallowed the objection in respect of the partnership profit amount. The taxpayer then proceeded on appeal to the Tax Court.

In the statement of grounds of objection in terms of Rule 32, the taxpayer added a further ground of objection, namely that the amount that had been included in gross income was not its gross income (because it was neither a receipt by nor an accrual to the taxpayer on its own behalf or for its own benefit); rather, in simple terms, it belonged to the partner.

SARS challenged the new ground on the basis that it constituted a new ground of objection against a part or amount of a disputed assessment not objected to under Rule 7. As such, SARS asserted that the new ground was prohibited in terms of Rule 32(3).

Submissions made by the taxpayer

The taxpayer submitted that Rule 32(3) permitted a new ground of objection in this instance. It contended that the objection was to the inclusion in taxable income of an amount of R11 million and that it was irrelevant whether the basis for the objection was that an amount should have been allowed as a deduction or that the amount was not part of the gross income of the taxpayer. Put differently, the taxpayer asserted that the premise of both the new ground (relating to the receipt/accrual) and the old ground (relating to the deduction) is that the disputed amount should not have been included in the applicant's taxable income.

Further, the taxpayer contended that Rule 33(2) caters for the Commissioner to set out a clear and concise reply to any new grounds, material facts or applicable law in the Rule 32(3) statement filed by the taxpayer. Thus Rule 33(2) clearly countenances “new grounds” being included in a rule 32 statement.

Submissions made by SARS

SARS raised three issues:

1. The taxpayer initially challenged the disallowance of a deduction from its income in its Rule 7 grounds of objection and was now challenging the amount of the gross income assessed. The fundamental criteria/tests for purposes of these arguments are two distinct processes. A determination of whether an amount constitutes a valid deduction under sections 11(a) and 23(g) of the Income Tax Act, No. 58 of 1962 (‘Income Tax Act”) is founded on establishing whether the amount was expended in the production of income for the purposes of trade. A determination of a taxpayer’s gross income is founded on establishing the amounts in cash or otherwise that had been received by or had accrued to such taxpayer for the benefit of that taxpayer in the relevant tax period, excluding amounts that were capital in nature.
2. The taxpayer objected to a globular amount and not to the amount of gross income included in the assessment in its Rule 7 grounds of objection.
3. Despite the fact that the quantum involved in both grounds was the same, it did not follow that the new ground reflected an amount or part of the disputed assessment.

The judgment

The judgment reviewed the history of the relevant rule from its earliest iteration in the Income Tax Act up until the promulgation of the current rules in 2014. In this review it was apparent that the courts considered that, in applying rules prohibiting the introduction of new grounds of appeal, the Appellate Division (as it then was) had suggested, as early as 1987, in relation to the relevant provisions then in the Income Tax Act that:

“It is naturally important that the provisions of s 83(7)(b) be adhered to, for otherwise the Commissioner may be prejudiced by an appellant shifting the grounds of his objection to the assessment in issue. At the same time, I do not think that in interpreting and applying s 83(7)(b) the court should be unduly technical or rigid in its approach. It should look at the substance of the objection and the issue as to whether it covers the point which the appellant wishes to advance on appeal must be adjudged on the particular facts of the case."

Subsequently, the review records that the Tax Court in a matter heard in 2010 had considered that the introduction of new grounds of assessment by the Commissioner did not unduly burden the taxpayer and stated that both the taxpayer and the Commissioner will be entitled to add additional grounds and additional defences in their statements that they would be required to file under the rules as then promulgated. The Court in that matter went as far as to indicate that “it cuts both ways”, suggesting that what was permissible for the Commissioner should also be permissible for the taxpayer.

The case of HR Computek (Pty) Ltd v CSARS was also cited. Here the taxpayer had objected against the imposition of a penalty and interest in respect of an amount of additional tax assessed. On appeal, the taxpayer sought to add a new ground of appeal challenging the amount of the additional tax assessed by SARS. This was rightly rejected by the SCA. The taxpayer had not objected to the amount of additional tax in its original grounds of objection and was precluded at the appeal stage from bringing a new ground that related to the additional tax assessed. Without doubt, the additional tax was an amount or part of the disputed assessment not objected to.

The kernel of the issue, in casu, was whether the new ground related to “a part or amount of the disputed assessment not objected to under rule 7”. Van Zyl AJ discussed at length ITC 1912 , which held that the introduction of a new ground of appeal was not outlawed in Rule 32(3). The Court, in that matter, had concluded that:

“The fact that the taxpayer had adopted a different approach to the same issue would not place the Commissioner at an unfair disadvantage. It would have all the tools at its disposal to ensure that the issues were fully ventilated at the appeal hearing. The Commissioner conceded at the hearing that if the application were not successful, there would be no prejudice to it in the appeal.”

Although agreeing with the decision in ITC 1912, Van Zyl AJ considered that he doubted whether it supported the taxpayer’s contentions “given the particular nature of the new ground in the present case” (at paragraph [61]).

The essence of Van Zyl AJ’s reasoning is disclosed in paragraph [77]:

“In the present matter the new ground essentially relates to a different amount (the gross income amount) of the assessment as compared to that of the objection. The new ground seeks alteration on appeal of that different amount of the assessment, even though it uses the disputed amount of R11 million as the tool to achieve such alteration. Having regard for the substance of the applicant’s objection and the facts of the case, it cannot be correct that an objection to the disallowance of an expense amount for failing to meet the requirements of sections 11(a) and 23(g) of the ITA is equivalent to an objection against the gross income amount of the assessment on the basis that this amount is to be reduced because a portion thereof actually accrued to a non-taxpayer third party.”

In regard to SARS’ second issue, Van Zyl AJ, at paragraph [78], reproduced the statement of amounts objected to in the Rule 7 grounds of objection:

Then, at paragraph [79], the judgment continues:

“The applicant only objected to these adjustments, which formed part of the disputed assessment. Its gross income amount was not adjusted in any assessment issued to the applicant. It therefore did not object to the gross income amount.”

It appears that the listing of the amounts objected to was to enable the Court to reject the taxpayer’s statement that it had objected to the full amount of the disputed assessment, because the additional assessment had also included adjustments to which the taxpayer did not object.

The judgment concludes on the second issue raised by SARS at paragraph [83]:

“Even if the applicant had for the sake of the argument objected to the whole of the disputed assessment, this would not suffice to prove that it had objected to the gross income amount specifically, which was not adjusted in the assessment and which would require specific identification in the objection to satisfy the requirements of rule 7.”

This conclusion was purportedly justified by reference to the HR Computek case, where Van Zyl AJ noted, at paragraph [89]:

“The Court in HR Computek confirmed that a globular objection to a full assessment amount does not by implication constitute an objection to every amount of the assessment. Thus, even if the applicant had objected to the whole of the disputed assessment, its failure to specify the objection to the gross income amount in detail in the letter of objection means that it is precluded at this stage from raising the new ground challenging this amount in the rule 32 statement.”

On SARS’ third issue, the judgment makes mention of the unreported Tax Case ITC 13796 (at paragraph [98]) where the Tax Court had prohibited a taxpayer from raising a new ground disputing an amount as gross income. Originally the taxpayer had asserted that the amount was a loan and in the new ground asserted that it had accrued when he was insolvent and did not accrue to him but to his trustee in insolvency. The Court in that case had found that the new ground did not address an amount or part of the assessment objected to under rule 7.

In deciding on the third issue, the Court’s reasoning is reflected in paragraphs [91] to [93]:

“[91] As set out above, the original ground seeks as its outcome the allowance of a deduction amount of R11 072 237.00 paid as a profit distribution to the BECP. This outcome would be achieved by an upward alteration of the total deductions allowed in respect of the disputed assessment, on the basis that the Commissioner erred in the disallowance of the expense.

[92] The new ground, on the other hand, seeks an alteration of the gross income amount of the disputed assessment downward so as to reduce the applicant's income tax liability. The new ground would achieve this by shifting a portion of the applicant's declared gross income to a third party.”

By extension of the argument, the learned acting judges stated at paragraph [93]:

“The outcomes sought, properly considered, are thus not similar. That the final desired result, being the reduction of the applicant’s income tax liability, is similar is unsurprising but also immaterial, as this is a tax appeal where the applicant is disputing its income tax liability as assessed.”

In conclusion, Van Zyl AJ stated at paragraph [103]:

“In all of these circumstances, I find that the new ground does not fall within the ambit allowed by rule 32(3) for introduction at this stage. This is because, for the reasons set out above in the course of the discussion of the Commissioner’s case, the new ground, properly considered, constitutes an entirely new case on appeal, aimed at the reduction of an amount to previously objected against, namely the applicant’s gross income. The new ground is not merely a ‘re-packaging’ of the legal basis upon which the applicant wishes to have the disputed amount disregarded for the purposes of the determination of its income tax liability.”

Commentary

This judgment cannot stand without a challenge. It is premised on an erroneous statement in paragraph [13]:

“The applicant listed an amount of gross income of R320 846 361.00 for the 2018 tax year in its tax return for that period, thereby declaring that this amount of gross income had been received by or had accrued to it for the 2018 tax year. Its Annual Financial Statements (‘AFS’) for the 2018 year disclose gross income in the amount of R320 846 361.00. The applicant’s income tax assessments for the 2018 tax year reflect a gross income in the same amount.” (Emphasis added)

This is compounded in paragraph [14]:

“The applicant claimed an amount of R73 215 161.00 in expense deductions for the 2018 tax year as per this ITR14 return. The deduction amount of R73 215 161.00 claimed includes an amount of R11 072 237.00 (‘the disputed amount’) that relates to the distribution of profits paid to a related party referred to in the AFS as the Taxpayer B Partnership (‘the BECP’).” (Emphasis added)

In its guide for the completion of the return of income for companies, SARS states at paragraph 13.2.30:

“The figures to be used are the figures reflected in the annual financial statement of the Company… When completing the Gross Profit/Loss part of the return, the normal accounting meaning attached to the terms reflected in the tax return must be followed.” (Emphasis added)

The statements in paragraphs [13] and [14] reveal that the Court had little appreciation of the manner in which a tax return is completed. It is abundantly clear that the tax return does not require the taxpayer to submit a return reflecting gross income, exempt amounts, deductions and prohibited deductions to arrive at taxable income. Rather, the return requires that the accounting income be disclosed and adjustments then be made to arrive at the taxable income as prescribed in the Income Tax Act.

It was the Court’s view, at paragraph [15], that:

“The applicant bore the burden in terms of section 102(1)(b) of the TAA of proving that the amount of R11 072 237.00 paid as a profit distribution to the BECP was an allowable deduction meeting the requirements of section 11(a), read with section 23(g), of the ITA.”

These statements underpin the Court’s reasoning. In short, the Court appears to assert that the taxpayer declared an amount as gross income in the return and another amount as a deduction in the return, but it only objected to the disallowance of a deduction.

The fact is that the taxpayer disclosed its accounting income and adjustments to that accounting income to arrive at the amount of taxable income. It is not evident from the judgment whether the profit distribution had simply been recorded as part of the financial information to reflect the profit before tax as reported in the annual financial statements (which is the most likely event) or whether an adjustment had been made in the tax computation part of the return to reflect the amount as a deduction that had not been reflected in the income statement. If no adjustment was made to the reported profit before tax, the taxpayer’s action cannot be interpreted as an admission that the gross income was the amount referred to in paragraph [13] and that the deductions allowable under the Income Tax Act included the amount referred to in paragraph [14].

Section 102(a) of the Tax Administration Act states that the taxpayer bears the burden of proving that an “amount, transaction, event or item is exempt or otherwise not taxable”. It would have been helpful if the Court had not limited its examination of burden of proof to the question whether a deduction had been properly claimed.

The purpose of the objection was to challenge the additional assessment to the extent that it included amounts listed in the Rule 7 grounds of objection and not to challenge the classification of amounts in the assessment as gross income or as deductible expenditure.

This is a prime case of SARS taking a position on appeal that leads to an unfair advantage. Rule 33 provides that SARS may respond to any new ground raised in the Rule 32 statement. SARS was therefore not ambushed or placed at a disadvantage at this early stage. The taxpayer’s assertion that the amount in question was a share of partnership profit due to a partner was common cause (paragraph [14]). On this basis, the amount of R11 million should not have been assessed as part of its taxable income. SARS had every tool at its disposal under the Rules to require the discovery of information that related to the partnership to enable it to put the taxpayer’s assertion to proof at trial.

It is submitted that, in this matter, the Court’s reliance on the HR Computek case is misplaced as the two matters are entirely distinguishable from each other. In the HR Computek case, the taxpayer sought to appeal an amount that had never been objected to. In this case, the taxpayer sought to introduce a new ground of appeal in relation to the same amount that had been objected to. All that the taxpayer did was to submit another basis on which the same amount should not be subject to tax. The purpose of the Rules is to provide a basis for a fair contest to establish the true tax liability. This judgment, regrettably, did not result in a fair basis for trying the merits. It is not known whether the taxpayer has noted an appeal against the decision.

The takeaway

Where a taxpayer is subjected to an assessment and wishes to object to the assessment, it is prudent to follow every avenue available to it in the Tax Court Rules. In other words, as a starting point, specific reasons should be requested from SARS, for the issuance of the assessment (to ultimately enable the taxpayer to formulate an objection in the prescribed form and manner). Thereafter, all possible reasons should be carefully canvassed and considered before filing the grounds of objection. This will leave limited wiggle room for SARS to take technical positions to contest the taxpayer’s grounds of appeal where its objection has been disallowed by SARS.

Source: PWC

 

 

 

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