TAX COURT CONFIRMS AUDITOR’S ADVICE IS NOT “GET-OUT-OF-JAIL-FREE” CARD
The Tax Court has again confirmed that there is no safety for taxpayers in relying on their auditor’s views to justify a tax position adopted.
To the contrary, where a taxpayer infers that their tax position is justified “because my auditor said so”, it can actually result in a larger tax penalty. Last month, the Tax Court has again sent a clear message on the misconception that taxpayers may delegate their tax obligations to their auditors or may rely on their auditor’s advice blindly.
In the recent case of LDC Taxpayer v Commissioner for the South African Revenue Service (IT 24888) [2021] ZATC 6 (18 June 2021) (“the LDC case”) the Tax Court was again forced to deal with this matter. The Tax Court remarked that the taxpayer’s “failure to disclose the capital gain was the result of a tax position adopted on advice of its auditors”. This was found to provide no defense and, had SARS not made a ‘mistake’ in raising the penalty, the Tax Court was of the view that a higher penalty could have been raised.
The matter of professional negligence of auditors is also highlighted by the LDC case. It will be interesting to see what action the Independent Regulatory Body of Auditors will take to protect the reputation of their profession and whether the taxpayer will seek damages from the auditor concerned.
Tax Court ordered taxpayer to pay understatement penalty despite relying on auditor’s advice
In the LDC case, the taxpayer sold and transferred ownership of an immovable property during the 2017 year of assessment. Attached to the property was development rights to subdivide it into 72 erven. The purchase price of R25,200,000 was payable in tranches of R350,000 as and when the purchaser transferred each erf to a further third-party end-user.
The taxpayer adopted the tax position that the sale proceeds did not accrue to it during the 2017 year of assessment. Rather, the taxpayer argued, the capital gain only accrued to it on the transfer of each individual erf from the purchaser to the respective third-party end-users. The taxpayer thus did not declare this capital gain in its 2017 income tax return.
SARS disagreed, maintaining that the taxpayer should have declared the capital gain. As there was no suspensive condition in the sale agreement, SARS insisted that the capital gain accrued to the taxpayer on the date of disposal, being the date of conclusion of the agreement. SARS classified the taxpayer’s behaviour as “reasonable care not taken in completing a return”, raised an additional assessment, and imposed a 25% understatement penalty.
The taxpayer appealed to the Tax Court, continuing with its argument that the capital gain only accrued to it at a later stage. The taxpayer further argued that even if the capital gain accrued to it, SARS did not suffer any prejudice as the same tax amount would ultimately have been paid to it. SARS was victorious and the taxpayer was ordered to pay the 25% understatement penalty of R798,372. In handing down its judgment, the Tax Court referred to the following two well-known Supreme Court of Appeal cases:
- In CIR v People’s Store (Pty) Ltd 1990 (2) SA 353 it was confirmed that “income” need not be an actual amount of money but includes every form of property earned by a taxpayer, including any debt or right to which a money value can be attached. The capital gain thus accrued to the taxpayer during the 2017 year of assessment and had to be declared in its income tax return.
- The taxpayer itself relied on the prominent case of Purlish Holdings v CSARS (76/18) [2019] ZASCA 04 (“Purlish”) contending that “prejudice” must amount to more than mere financial loss to the fiscus. The Tax Court correctly disagreed with the taxpayer’s line of argument and interpretation of Purlish. The Tax Court held that not only was there financial prejudice to SARS, but the audit entailed a resource allocation in the form of additional time and human capital.
The taxpayer’s case was, respectfully, born dead
Considering the well-known cases referred to by the Tax Court, the taxpayer’s tax position taken was patently unreasonable and had very little chances of success. Although SARS categorized the taxpayer’s behaviour as “reasonable care not taken in completing a return”, SARS conceded to the Tax Court that “this was, in hindsight, incorrect and that the penalty should rather have been based on ‘no reasonable grounds ‘for tax position’ taken’”. The latter attracts an understatement penalty of 50% and SARS admitted that it “lost an opportunity in using that 50%”. Since SARS did not raise this as an item for adjudication, and fortunately for the taxpayer, the Tax Court did not have the discretion to increase the penalty.
Was the taxpayer in possession of a compliant section 223(3) opinion?
SARS must remit an understatement penalty if a taxpayer complies with section 223(3) of the Tax Administration Act, 2011 (“the Act”). This section requires that full disclosure is made to SARS of the arrangement that gave rise to the prejudice to SARS by no later than the date that the relevant return was due. The taxpayer must also be in possession of an opinion by an independent registered tax practitioner that:
- Was issued by no later than the date that the relevant return was due;
- Was based upon full disclosure of the specific facts and circumstances of the arrangement; and
- Confirmed that the taxpayer’s position is more likely than not to be upheld if the matter proceeds to court.
We doubt that the taxpayer was in possession of a section 223(3) opinion, as the facts would not support the legal issuance thereof. It is important to note for taxpayers that their only legal refuge, when acting on their auditor’s advice, is to obtain such a section 223(3) opinion.
What does this mean for taxpayers?
To date, auditors have been very successful in claiming that they are not liable for mistakes in financial statements. However, such a privilege of non-liability would not apply to a tax case. If the taxpayer in the LDC case decides to pursue a claim for professional negligence, the auditor may have its work cut out for it.
SARS may also look at the LDC case and realise that they are not fully utilising the understatement penalty provisions available to them in the Act.
