2013 Edition: Updated Annually

2013 EDITION: UPDATED ANNUALLY

THE TAX ADMINISTRATION ACT 28 OF 2011 AND SARS AUDITS SUCCESSFULLY, IN LIGHT OF THE CONSTITUTION OF THE REPUBLIC OF SOUTH AFRICA 108 OF 1996 AND OTHER SUPPORTING LEGISLATION

DANIEL NICOLAAS ERASMUS [email protected]

1 PREFACE TO THE FIRST EDITION ______

This book deals with the relevant law up to 30 April 2013, and will be updated annually.

This book analyses the inter-relationship in particular between ss 1(c), 33, 41(1), 195(1) and 237 of the Constitution 108 of 1996 (‘the Constitution’) (collectively referred to as ‘constitutional obligations’); s 4(2) of the South African Revenue Service Act 34 of 1997 (‘SARS Act’); the Promotion of Administrative Justice Act 3 of 2000 (‘PAJA’); and a decision by the Commissioner for the South African Revenue Service (‘the Commissioner’ or ‘SARS’, as the case may be) to exercise his powers to audit in terms of ss 40 to 49 of the Tax Administration Act 28 of 2011 (the TAA), read with ss 1 (definition of ‘relevant information’) and 3(2) (definition of ‘for the purposes of the administration of a tax Act’) of the TAA, by requiring taxpayers to produce or provide information, documents and things at the commencement of an inquiry or audit of taxpayers, and concludes that such a decision constitutes ‘administrative action’ as defined in s 1 of PAJA, or, alternatively is subject to the constitutional principle of legality. This conclusion is reached on the basis that such a decision, of an administration nature made, or leading to a further decision proposed to be made, or required to be made, to issue revised assessments will:

 have been taken by an organ of State exercising a public power or performing a public function in terms of legislation;

 involve the exercise of a discretionary power, in that it is for SARS to determine whether and in what circumstances it will require any particular taxpayer to provide information, documents and things;

 adversely affect taxpayers’ rights, and has a direct, external legal effect. The fact that the power in question is preliminary and investigative, and that its exercise does not in itself determine whether any tax, penalties

2 and interest is payable, does not detract from the impending conclusion usually made by the same SARS officials requesting the information, documents or things, that tax, penalties and interest will most likely become payable as a direct result of the preliminary investigation. The decision imposes on taxpayers an obligation to do something (to produce or provide information, documents and things) which, but for the exercise of that power, taxpayers would not in law be obliged to do, due to taxpayers’ privacy rights in terms of s 14 of the Constitution, and entitling them to expect SARS to abide by its constitutional obligations. Normally taxpayers would have a right to keep private and confidential information, documents and things that must now be produced or provided to a SARS official. A failure by taxpayers to comply exposes them to criminal prosecution under s 234 of the TAA. Furthermore, the power exercised by SARS is not subject to the normal objection and appeal processes in the Income Tax Act, limiting the opportunity for taxpayers to challenge such a decision in terms of the Income Tax Act.

Lastly, there is no relevant exclusion in the definition of ‘administrative action’ that removes this type of decision from that definition in PAJA.

In exercising this power, despite the decision not being subject to objection and appeal, SARS is obliged to act in a lawful, reasonable, procedurally fair manner, with adequate reasons, adhering to the provisions of PAJA, the principle of legality, and its constitutional obligations. A failure to do so would render its decision to invoke its powers under these sections liable to be set aside on review on any applicable codified review grounds stated in s 6(2) of PAJA, or in terms of the constitutional principle of legality.

Consequently, in order for taxpayers to satisfy themselves that their constitutional rights to lawful, reasonable, and procedurally fair conduct from SARS have not been violated, they are entitled in terms of s 3(1) and (2) of PAJA to adequate notice and to adequate reasons in terms of s 5(1) and (2) of PAJA for SARS’ decision made in terms of ss 40 to 49 of the TAA, on the basis that such a decision to investigate what ultimately may include a determination of culpability

3 that could adversely affect the rights of the taxpayer, in a manner that has an impending direct, external legal effect, in that revised assessments can ensue. This determination cannot be made in the abstract, and depends upon the facts and circumstances of each case. The recent Constitutional Court case of Viking Pony Africa Pumps (Pty) Ltd t/a Tricom Africa v Hidro-Tech Systems (Pty) Ltd & Another 2011 (1) SA 327 (CC) at paragraphs [37] and [38] supports this conclusion.

Through the analysis of the inter-relationship between ss 1 (definition of ‘relevant information’), 3(2) (definition of ‘for the purposes of the administration of a tax Act’), and 40 to 49 of the TAA, the Constitution, the SARS Act and PAJA, the book goes further to conclude that even if PAJA were not applicable (primarily because the ‘administrative action’ definition in PAJA may be too restrictive to include a decision in terms of ss 40 to 49 of the TAA), SARS would still be bound by its constitutional obligations to comply with the constitutional principle of legality as stated by the Constitutional Court in various cases, including Fedsure Life Assurance Limited v Greater Johannesburg Transitional Metropolitan Council 1999 (1) SA 374 (CC), Pharmaceutical Manufacturers Association of SA and another In re: the ex parte application of the President of the Republic of South Africa and others 2000 (2) SA 674 (CC), President of the Republic of South Africa and another v South African Rugby Football Union and others 2000 (1) SA 1 (CC) and Minister of Health v New Clicks South Africa (Pty) Ltd 2006 (2) SA 311 (CC). The principle of legality entails, inter alia, lawfulness, a basic level of rationality in decision-making, that an administrator should apply its mind properly in deciding whether and in what manner to exercise its powers, and that the administrator should exercise such powers only for the purposes they were conferred, and not in an arbitrary or irrational manner. In more recent judgments, procedural fairness in certain instances is also required, and so are reasons for a decision. The developing constitutional principle of legality ensures that SARS must satisfy the jurisdictional facts of the empowering provisions of ss 1 (definition of ‘relevant information’), 3(2), and 40 to 49 of the TAA, act lawfully, be reasonable, procedurally fair and give reasons – all connected to SARS’ constitutional obligations to be, inter alia, accountable, reasonableness, give reasons and be transparent when SARS carries out its duties.

4 Often it is not evident to taxpayers from SARS’ wide-ranging demands that the information, documents and things have been requested for purposes lawfully mandated by tax legislation, read with these constitutional obligations; or that SARS has properly applied its mind to the purposes in deciding to target a particular taxpayer for inquiry and audit; or that in formulating its demands it has adhered to the SARS Service Charter and the SARS Internal Audit Manual, and any legitimate expectations created by these guidelines.

SARS is to ensure its conduct is not inconsistent with the Constitution as envisaged in s 2, and in doing so, must adhere to the norms, spirit and purpose of the Constitution, by fulfilling its constitutional obligations in terms of ss 1(c), 33, 41(1), 195(1) and 237 of the Constitution where: the rule of law is supreme, only power conferred by the Constitution should be assumed; and public administration must be governed by the democratic values and principles enshrined in the Constitution, including a high standard of professional ethics; impartial, fair and unbiased conduct; efficient, economic and effective use of resources; public administration that must be accountable; and transparent, providing the public with timely, accessible and accurate information. In terms of s 4(2) of the SARS Act, SARS is specifically enjoined to perform its functions in the most cost-efficient and effective manner and in accordance with the values and principles in s 195(1) of the Constitution. Failure by SARS to adhere to these constitutional obligations will entitle taxpayers to approach the courts in terms of ss 2 and 172(1) of the Constitution to declare the conduct of SARS invalid. Taxpayers will then be entitled approach the High Court to review such invalid conduct in terms of a Rule 53(1) application, made under s 43(2)(a) of the Supreme Court Act 59 of 1959, citing one of the codified grounds of review in s 6(2) of PAJA, or the principle of legality, in support of such an application for review.

The ultimate conclusion to the book is that where SARS’ conduct is unlawful, unreasonable or procedurally unfair (or ‘invalid’ conduct in terms of s 2 of the Constitution) in exercising its powers in making a decision to audit, or is not supported by adequate reasons, taxpayers should first and foremost attempt to bring a review application in terms of s 6, 7 and 8 of PAJA to the High Court on

5 the basis that the decision is ‘administrative action’ as defined in PAJA; and, in the alternative, that SARS has transgressed the principle of legality. Taxpayers, under these facts and circumstances, would also be entitled to raise the defence of ‘just cause’ (read with ss 49, 127 and 234 of the TAA) for refusing to produce or provide the relevant information to SARS, escaping criminal prosecution under s 234 of the TAA.

A fundamental problem in this book is whether or not a SARS’ decision in terms of ss 40 to 49 of the TAA is ‘administrative action’ as defined in PAJA. The SARS unofficial viewpoint appears to be that on a challenge by a taxpayer to a SARS decision in terms of ss 40 to 49 of the TAA, one of the arguments is that a decision to audit does not fall within the definition of ‘administrative action’. However, SARS is aware that the principle of legality would be an alternate basis for challenging SARS’ powers and decisions to audit in terms of ss 1 (definition of ‘relevant information’), 3(2) (definition of ‘for te purposes of the administration of a tax Act), and 40 to 49 of the TAA, if the taxpayer were unsuccessful in having such a decision determined as ‘administrative action’. The book also analyses this problem and concludes that a decision to audit by SARS is ‘administrative action’ as defined in PAJA, but with the alternative submission that if it is not, the constitutional principle of legality will apply.

This preface would not be complete without writing something about the attitude of SARS to the TAA, in so far as it may affect audits. Firstly, in drafting a handbook for public consumption on the TAA SARS states:

What does the Tax Administration Act seek to do?

Balance between powers and rights sought in the Tax Administration Act

The TAA seeks to promote a better balance between the powers and duties of SARS and the rights and obligations taxpayers and to make this relationship more transparent. This balance will greatly contribute to the equity and fairness of tax administration. International experience has amply demonstrated that if taxpayers

6 perceive and experience the tax system as fair and equitable, they will be more inclined to fully and voluntarily comply with it.

For example, to ensure consistent treatment of taxpayers in comparable circumstances, and consequently greater equity and fairness in tax administration, certain discretionary powers of SARS are now linked to objective criteria. Open-ended discretions on important matters have been fettered.

It is important to note that TAA does not seek to re-codify basic rights of taxpayers as they apply in any event, for example the right to administrative justice under the Constitution §33.

Then in a response document prepared by SARS to the Parliamentary Standing Committee on Finance during 2011, addressing various criticisms:

Extract from SCOF to Parliament in 2011

Reasonable conduct by SARS and “anti-abuse” provisions

Comment

Various comments were made that specific clauses should contain provisions that require SARS’s officials to act reasonably or otherwise protect a taxpayer from the abuse of power.

Response

It is suggested that these comments are generally misconceived.

The obligation to act reasonably

The concerns that SARS officials will act unreasonably, unless the Bill requires them to act reasonably, are misconceived. Once the Bill is read together with the Promotion of Administrative Justice Act, 2000 (“PAJA”) most, if not all, of the issues raised will fall away.

All administrators (including SARS) must comply with PAJA, unless the statutes

7 which govern them are inconsistent with PAJA. The Constitutional Court, in this regard, has held that all statutes that authorise administrative action must now be read together with PAJA unless, upon a proper construction, the provisions of the statutes in question are inconsistent with PAJA (Zondi v MEC for Traditional & Local Govt Affairs 2005 (3) SA 589 (CC) at par 101).

The obligation on SARS and its officials to act reasonably is also implicit in the duty under section 7 of the Constitution to give effect to the right to administrative fairness, which inter alia mandates that the administrative conduct be reasonable.

Accordingly, it is then not necessary for the Bill itself to spell out all the relevant aspects of administrative justice, for example that conduct by SARS officials in the determination of appropriate time periods for compliance with information requests, should be reasonable.

‘Anti-abuse’ provisions

The mere fact that administrative provisions are capable of being abused and infringing taxpayer rights does not render such provisions unconstitutional.

All powers are capable of being abused, but if this happens, the Courts have the power and duty to review and set aside the conduct of the officials concerned. This has been made clear by the Constitutional Court.

“Any power vested in a functionary by the law (or indeed by the Constitution itself) is capable of being abused. That possibility has no bearing on the constitutionality of the law concerned. The exercise of the power is subject to constitutional control and should the power be abused the remedy lies there and not in invalidating the empowering statute.”

(Van Rooyen and Others v The State and Others (General Council of the Bar of South Africa Intervening) 2002 (5) SA 246 (CC) at par 37).

Prof Daniel N. Erasmus [email protected]

8 TABLE OF CONTENTS ______

CHAPTER 1 (available on line at www.ErasmusOnTax.com and www.IITF.net ) 11 INTRODUCTION TO THE CONSTITUTION IN THE CONTEXT OF AUDITS 1.1 ADVENT OF THE CONSTITUTION 12 1.2 THE RELEVANT CONSTITUTIONAL PROVISIONS 20 1.3 A CONSTITUTIONAL BALANCE OF SARS’ POWERS AND THE ‘ADMINISTRATIVE ACTION’ DEBATE 34 1.3.1 Introduction 34 1.3.2 Administrative action 35 1.3.3 Conclusion 46 1.4 THE RELEVANCE OF PAJA AND THE PRINCIPLE OF LEGALITY 46 1.4.1 Introduction 46 1.4.2 The principle of legality 50 1.4.3 Recent developments in the principle of legality 56 1.5 ADEQUATE REASONS 57 1.5.1 Introduction 57 1.5.2 The relevance of s 3(2) of the TAA 57 1.5.3 The meaning of ‘adequate reasons’ 62 1.5.4 Conclusion 65 1.6 JUDICIAL REVIEW 66 1.7 CONCLUSION TO THE BOOK 73

CHAPTER 2 (not available) 81 LIMITATIONS TO AUDITS 2.1 THE STATUTORY PROVISIONS 82 2.2 THE SARS INTERNAL AUDIT MANUAL 83

9 2.3 LAWFULNESS 90 2.3.1 Authority 95 2.3.2 Jurisdictional facts 96 2.3.3 Abuse of discretion 101 2.3.3.1 Improper or ulterior purpose or motive 104 2.3.3.2 Mala fides or bad faith 107 2.3.3.3 Failure to apply mind or relevant and irrelevant consideration 108 2.3.3.4 Unlawful fettering 110 2.3.3.5 Arbitrary and capricious decision-making 111 2.4 REASONABLENESS 112 2.4.1 Rationality 114 2.4.2 Proportionality 116 2.5 PROCEDURAL FAIRNESS 119 2.5.1 Bias 119 2.5.2 Audi alteram partem 121 2.6 LEGITIMATE EXPECTATIONS 125 2.6.1 The Legitimate Expectation Doctrine in the context of audits 2.6.2 Limitation to the Legitimate Expectation Doctrine 134 2.7 MULT-STAGED DECISION-MAKING 138 2.8 ‘JUST CAUSE’ DEFENCE 142

CHAPTER 3 (not available) 149 SECTION 195(1) OF THE CONSTITUTION, 1996, AND PUBLIC ADMINISTRATION DUTIES WITH REFERENCE TO AUDITS 3.1 INTRODUCTION TO SECTION 195(1), PAJA AND THE PRINCIPLE OF LEGALITY 150 3.2 THE DUTIES OF SARS EMANATING FROM SECTION 195(1) OF THE CONSTITUTION 152 3.2.1 Introduction 152

10 3.2.2 What are the democratic values referred to in s 195(1)? 155 3.2.3 High standard of professional ethics 159 3.2.4 Services must be provided impartially, fairly, equitably and without bias 169 3.2.5 Public administration must be accountable 171 3.2.6 Transparency must be fostered 175 3.2.7 Limitations to s 195(1) 178

CHAPTER 4 (not available) 181 JUDICAL REVIEW WITH REFERENCE TO AUDITS OF THE INCOME TAX ACT 4.1 INTRODUCTION 182 4.2 WHAT IS MEANT BY REVIEW 185 4.3 THE APPLICABILITY OF OBJECTION AND APPEAL 190 4.4 REVIEW APPLICATION DIRECTLY TO THE TAX COURT 191 4.5 REVIEWING UNCONSTITUTIONAL CONDUCT 196 4.5.1 Introduction 196 4.5.2 Sections 6, 7 and 8 of PAJA 197 4.5.3 Rule 53 of the Uniform Rules of Court 201 4.5.4 Save where any law otherwise provides 202 4.5.5 Show cause 203 4.5.6 The grounds of review 211 4.5.6.1 Introduction 211 4.5.6.2 Constitutionality of the inquiry and audit 214 4.5.6.3 Appropriate authority 216 4.5.6.4 Jurisdictional facts 217 4.5.6.5 Abuse of discretion 219 4.5.6.6 Reasonableness 220 4.5.6.7 Natural justice and Procedural fairness 221 4.5.6.8 Legitimate expectation 222 4.5.6.9 Constitutional obligations in terms of s 195(1) 224

11 4.6 SUPPORT FOR REVIEW OF AN DECISION TO AUDIT 225 4.7 PITFALLS IN BRINGING THE RULE 53 APPLICATION 228

CHAPTER 5 (not available) 237 THE TAX ADMINISTRATION ACT HISTOICAL CRITICISMS 5.1 INTRODUCTION 238 5.2 THE TAX ADMINISTRATION ACT 240 5.3 RELEVANT MATERIAL 244 5.4 REQUEST FOR RELEVANT MATERIAL, AUDIT SELECTION AND FIELD AUDIT 246 5.5 CONCLUSION 256

CHAPTER 6 (not available) 259 CONCLUSION 6.1 GENERAL CONSTITUTIONAL PROVISIONS 260 6.2 SECTION 33 OF THE CONSTITUTION AND PAJA 260 6.3 SECTION 195(1) OF THE CONSTITUTION 263 6.4 ADMINISTRATIVE ACTION, THE RULE OF LAW AND THE PRINCIPLE OF LEGALITY 264 6.5 REVIEW IN TERMS OF SS 6, 7 AND 8 OF PAJA OR THE PRINCIPLE OF LEGALITY 272 6.6 ‘GOOD CAUSE’ SHOWN DEFENCE 275 6.7 THE PROPOSED TAX ADMINISTRATION ACT 275

BIBLIOGRAPHY (not available) 279 APPENDIX A 280 BOOKS APPENDIX B 284 ARTICLES & MANUALS APPENDIX C 289 LOCAL CASE LAW

12 APPENDIX D 306 FOREIGN CASE LAW APPENDIX E 310 STATUTES

13 APPENDICES Audit letter 1 Audit letter 2 Audit letter 3