1

SYNOPSISMay 2006

Regional officesBloemfontein (051) 503-4100

Cape Town (021) 529-2000

Durban (031) 250-3700

East London (043) 726-9380

Johannesburg (011) 797-4000

Port Elizabeth (041) 391-4400

Pretoria (012) 429-0000

In this issue

Disputes between SARS and

taxpayers - new procedures . . 2

Financial managers liable

for employees’ tax and VAT . 5

Does interest “accrue” if it can

be set aside on insolvency? . . 6

Tax consequences of insolvency -

Interpretation Note 8 . . . . . 8

Zero-rating of exports -

documentary proof . . . . . 12

2 May 2006

Although SARS has always had the power to settle disputes with taxpayers,

(see City of Cape Town v Claremont Union College 1934 AD 414 at 452;

Namex (Edms) Bpk v KBI (1994) 56 SATC 91 (A) at 109) it is safe to say that, since

the enactment of Part IIIA of the Income Tax Act in 2003, which deals specifically

with the settlement of disputes, SARS is unlikely to conclude any settlement with

a taxpayer, except in accordance with those statutory provisions.

The definition of “dispute” and “settle”

For the Commissioner to have the power to enter into a settlement in terms of Part

IIIA, the matter must involve a “dispute”, as defined in section 88A(1).

A “dispute” is defined as a disagreement on the interpretation of either the

relevant facts or the applicable law, or both. Oddly, the definition does not say

that the dispute must concern a contested assessment, but this is probably

implicit since section 88H refers to a settlement “between the Commissioner and

the person aggrieved by an assessment”.

From this, it follows that, where the only issue is the taxpayer’s ability to pay the

assessed tax, this is not a “dispute” which the Commissioner is empowered to

settle in terms of Part IIIA. In practice, therefore, it seems that only a dispute

which is the subject of an objection, which has not been withdrawn or resolved,

falls within the scope of Part IIIA of the Act.

“Settle” is defined in section 88A(1) as meaning to resolve a dispute by

compromising any disputed liability, other than by the Commissioner or the

taxpayer accepting the other’s interpretation of the facts or the law, or both. This

is rather odd. Surely it cannot mean that, if the Commissioner accepts the

taxpayer’s version of the facts and the taxpayer accepts the Commissioner’s

interpretation of the law (or vice-versa), there can be no settlement in terms of

Part IIIA?

Section 88D defines the circumstances in which it will be appropriate, or

inappropriate, for SARS to settle a dispute in terms of Part IIIA.

Circumstances under which to settle a dispute

Section 88C states that it would be inappropriate and not to the best advantage

of the state to settle a dispute where, in the opinion of the Commissioner –

(a) there was intentional tax evasion or fraud, and the considerations listed in

section 88D do not apply;

Some cause for unease

Part IIIA ofthe Income

Tax Actdeals

specifically with the

settlementof disputes

Disputes between SARS and taxpayers - new procedures

3May 2006

(b) the settlement would be contrary to law or a clearly established practice of the

Commissioner and no exceptional circumstances justify a departure from such

law or practice;

(c) it is in the public interest to have judicial clarification of the issue (i.e. it is in the

public interest for the dispute to be determined by the courts);

(d) the pursuit of the matter through the courts will significantly promote

compliance with the tax laws;

(e) the person concerned has not complied with the Act, and such

non-compliance is serious.

Section 88D states that the Commissioner may, where it would be to the best

advantage of the state to do so, settle a dispute having regard to –

(a) whether the settlement would be in the interests of good management of the

tax system, overall fairness, and the best use of the Commissioner’s resources;

(b) the cost of litigation as against the possible benefits with reference to

prospects of success in a court, the prospects of collecting the amounts due,

and the costs associated with collection;

(c) any complex factual or quantum issues or evidentiary difficulties;

(d) a situation where a participant or a group of participants in a tax avoidance

scheme have accepted the Commissioner’s position in the dispute, in which the

settlement may be negotiated in an appropriate manner to unwind existing

structures and arrangements;

(e) whether the settlement of the dispute will promote compliance with the tax

laws in a cost-effective way.

Procedure for settlement and alteration of the assessment

In terms of section 88E, a dispute may be settled by the Commissioner personally

or by an official delegated by the Commissioner for that purpose, but that person

must not have any personal, business or financial relationship with the person

concerned.

The procedure for settlement is set out in section 88F(1) – (5). In terms of these

provisions, there must be full disclosure by the person concerned, and any

settlement is conditional on such full disclosure. All disputes settled in whole or in

part must be evidenced by a written agreement between the parties, and this

agreement will be a full and final settlement of all the specified aspects of the

dispute. The Commissioner and his officials must adhere to the secrecy

provisions of the Act.

Section 88H provides that where a dispute has been settled, the Commissioner

can alter the assessment in order to give effect to the settlement; any such

altered assessment is not subject to objection and appeal.

There mustbe fulldisclosure by the personconcerned,and anysettlement isconditionalon such fulldisclosure.

4 May 2006

Impact on concluded settlement where taxpayer failed to make fulldisclosure

In terms of section 88F(7), the Commissioner “must adhere to the terms of the

[settlement] agreement unless it emerges that material facts were not disclosed to it

or there was fraud or misrepresentation of the facts”.

Moreover, in terms of section 88F(8) the Commissioner has the right to recover any

outstanding amounts involved in the settlement in full where the person concerned

fails to adhere to any agreed payment arrangement. Interestingly, the Act does not

say that the Commissioner can cancel the settlement on these grounds.

There is cause for unease in these provisions. Assume that a settlement is

entered into between SARS and the taxpayer and that a new assessment is issued

reflecting the settlement. Assume that SARS thereafter comes to the view that the

taxpayer did not (as required by section 88F(1)) make disclosure of “all relevant

facts” during the discussions that preceded the settlement. Assume, further, that

the taxpayer disputes the Commissioner’s view that there was non-disclosure, and

asserts that he or she did indeed make full disclosure, or that the facts not

disclosed were not “material facts”.

Section 88F(7) says that SARS “must adhere to the terms of the agreement unless it

emerges that material facts were not disclosed to it, or there was fraud or

misrepresentation of the facts. And section 88F(2) says that the settlement

agreement is “conditional upon full disclosure of material facts known to the person

concerned at the time of the settlement”.

What happens now? Can SARS unilaterally decide that there was, indeed,

non-disclosure of relevant material facts and set aside both the settlement agreement

and the altered assessment? If so, what procedure must SARS follow in taking this

drastic step, and what right, if any, does the taxpayer have to contest it? Within what time

must SARS take such action before the right to set aside the agreement prescribes?

Part III is silent on these questions. If SARS is of the view that the settlement

agreement is nullified (by the alleged non-disclosure), can SARS alter the

assessment back to what it was before, or does the original assessment

automatically revive, with the result that SARS can now take a statutory judgment

against the taxpayer in terms of section 91(1)(b) and enforce this by execution

proceedings?

Is the taxpayer limited to objecting to that reinstated assessment, or can the

taxpayer also dispute, by way of ordinary civil proceedings, SARS’s entitlement to

set aside the settlement? Can the taxpayer, for example, obtain an interdict to

prevent SARS from setting aside the settlement agreement? Is the dispute as to

whether full disclosure was made by the taxpayer in the lead-up to the conclusion

of the settlement now to be heard in the civil courts? If so, it may necessitate a

complex and lengthy trial involving disputed factual issues regarding what

disclosure was and was not made, plus the legal question of whether any proven

non-disclosures were “material”.

Can SARS

unilaterally decide

that there was

non-disclosure of

relevant material

facts and set aside

the settlement

agreement?

5May 2006

In terms of paragraph 11(2C) of the Fourth Schedule to theIncome Tax Act 58 of 1962 (which was added to the Act with

effect from 1 March 2004) –

“where an employer is a company, every shareholder and director

who controls or is regularly involved in the management of the

company’s overall financial affairs shall be personally liable for the

employees’ tax, additional tax, penalty or interest for which the

company is liable”.

A similar amendment was made to the Value-Added Tax Act 48 of

1991, section 48(9) of which now reads –

“(9) Where a vendor is a company, every shareholder and director who

controls or is directly involved in the management of the company’s

overall financial affairs shall be personally liable for the tax, additional

tax, penalty or interest for which the company is liable”.

It is significant that this liability is not expressed to be dependent on

negligence or any other kind of fault or dereliction of duty by the

financial manager. Nor is liability excluded where the financial

manager had delegated responsibility to attend to the company’s

payment of employees’ tax to another person. This is a statutory

liability that attaches to a person purely by reason of the fact that he

“controls or is regularly involved in the management of the company’s

overall financial affairs”.

Of course, while the company remains able to pay the employees’ tax

and VAT due by it, these provisions are academic. But if a company

were to go insolvent, SARS would be entitled, in terms of these

provisions, to recover the unpaid tax from those persons whose duties

bring them within the ambit of this statutory liability.

... liability is notexcluded where

the financialmanager had

delegatedresponsibility to

attend to thecompany’spayment of

employees’ tax to another person.

Financial managers can be personally liable foremployees’ tax and VAT

6 May 2006

In case number 11483 (not yet reported), the Port Elizabeth Tax Court was confronted with the following scenario.

Between November 1999 and August 2000, the taxpayer had

invested a total of R865 963 in an illegal pyramid scheme conducted

by one A. The investments took the form of a loan and the

acknowledgement of debt stated that interest was payable. In fact,

no interest was paid by A to the taxpayer, and A’s estate was

sequestrated in November 2000. The taxpayer submitted a claim

against the insolvent estate for R1 166 000, which included

R449 036 in respect of interest.

The only issue before the Tax Court was whether interest had

accrued to the taxpayer in terms of the definition of “gross income”

in section 1 of the Income Tax Act 58 of 1962 in respect of the loan to A.

SARS did not dispute that the venture in which the taxpayer had invested his

money was an illegal pyramid scheme, but argued that the Income Tax Act does

not distinguish between income from legal activities and from illegal activities.

The court accepted this argument, but said that “the root of the matter” was

whether the interest in question had “accrued” to the taxpayer. The court held that

the answer was in the negative, on the grounds that the taxpayer “never had an

unconditional right to claim interest from A.”

The court said that “A’s pyramid scheme was, from its inception, insolvent” and

hence that any disposition without value made within two years of sequestration

was liable to be set aside. The court went on to say that –

“Had any interest been paid by A to the appellant, those payments of interest would

have been dispositions without value. Such dispositions may be set aside by a court on

application…. Thus, in my view, the appellant never had an unconditional right to claim

interest from A”.

Dubious conclusion

With respect, this conclusion is dubious. It is certainly true that where a taxpayer’s

entitlement to an amount is subject to a suspensive condition, there is no accrual

unless and until that condition is fulfilled. The situation at hand, however, involved

not a suspensive condition, but a resolutive condition. The difference (as explained

by Christie, The Law of Contract, 4th edition, p 159) is that –

Does interest “accrue” if it can be set aside on insolvency?

7May 2006

“A condition precedent suspends the operation of all or some of the obligations flowing

from the contract until the occurrence of a future uncertain event, whereas a resolutive

condition terminates all or some of the obligations flowing from the contract upon

occurrence of a future uncertain event.”

In other words, the contract which the taxpayer entered into with A, and the accrual of

interest provided for in that contract, was effective unless and until the disposition of

interest by A, arising out of that contract in terms of the Insolvency Act, was set aside in

terms of the Insolvency Act.

It is not clear whether that disposition of interest had been set aside by the time (some six

years later) the matter came before the Tax Court, but presumably it had been. Whether

this occurred in the same tax year as the loans were given is uncertain.

The Tax Court had no power to set aside a voidable disposition. If the disposition had

been set aside in the same tax year as the loans, the Tax Court ought, in its judgment, to

have declared that the interest had indeed accrued to the taxpayer, but that the fulfilment

of the resolutive condition had vitiated that accrual. If the setting aside of the interest as a

voidable disposition had occurred in a tax year subsequent to the loans, then the Tax

Court ought to have ordered that the fulfilment of the resolutive condition had vitiated the

earlier accrual of the interest with retrospective effect, and should have remitted the

assessment back to the Commissioner with the instruction that it be amended to exclude

that accrual.

The root of the matter was whether interest had “accrued” to the taxpayer

... the contract

which the

taxpayer entered

into with A, and

the accrual of

interest provided

for in that

contract, was

effective unless

and until the

disposition of

interest by A was

set aside ...

8 May 2006

Tax consequences of insolvency

Interpretation Note brings

Interpretation Note no 8 (issue 2) issued on22 March 2006 and the follow-up “Briefing

note: update of Interpretation Note 8”summarise SARS’s interpretation of the law inrelation to the tax consequences of insolvency, and provide a useful guide to SARS’s practices in this regard.

Insolvent taxpayers: pre-1997

Until the Income Tax Act was amended in 1997

to make an insolvent estate a “person” for tax

purposes, the income of an insolvent estate was not subject to income tax. This

anomalous situation was the effect of the decision in Thorne and Molenaar NNO v

Receiver of Revenue, Cape Town (1976 (2) SA 50 (C), 38 SATC 1) which held that, if

the trustee of an insolvent estate were to be subject to tax, it could only be as a

“representative taxpayer” and not in his personal capacity. The court held that,

although the trustee of an insolvent estate fell within the statutory definition of

“trustee”, he did not fall within the definition of “representative taxpayer”.

As a result, prior to the 1997 amendments, where a person’s estate was voluntarily

or compulsorily sequestrated, the Commissioner’s practice – the Act being silent on

the matter – was to raise two assessments during that year. In the first assessment

the taxpayer was assessed on all income received by or accruing to him from the

beginning of the year to the date of his insolvency. This was a debt due by the

estate, which the trustee was obliged to admit and accord its statutory preference

under the Insolvency Act, 1936. If the insolvent was a partner, the Commissioner

also had a preferential claim against the insolvent partnership for that part of the tax

due by the insolvent which was referable to his income from the partnership; (see

sections 101(b) and 49(2) of the Insolvency Act). The Commissioner also had a

preferential claim against the insolvent estates of certain persons in terms of

section 99 of the Insolvency Act.

In the second assessment, the insolvent was treated as a new taxpayer from the

date of his insolvency and was liable, as such, for tax in his own right.

Irrespective of whether the sequestration was voluntary or compulsory, the

insolvent was not entitled to carry forward any assessed loss incurred prior to the

date of sequestration unless the sequestration order was later set aside; see

section 20(1)(a)(i). Rehabilitation was not sufficient in this regard.

greater clarity

Theinsolventwas not

entitled tocarry

forward any assessed

lossincurred ...

9May 2006

Insolvent estates: post-1997

The Income Tax Act 1997 introduced the following changes in regard to the

taxation of insolvent persons and insolvent estates:

The definition of “person” was extended to include an insolvent estate, and an

“insolvent estate” meant an insolvent estate as defined in section 2 of the

Insolvency Act.

The definition of “representative taxpayer” was extended to include the trustee or

administrator of an insolvent estate in respect of the income received by or accrued

to the insolvent estate. However, where income accrues to the insolvent estate

during the course of winding-up, the trustee is not a representative taxpayer in

respect of such income, and no liability for income tax falls on him, nor does he

have any obligation to render a return of such income. Such income is simply dealt

with in the same way as other assets in the insolvent estate which vest in the

trustee in terms of the Insolvency Act, and in respect of which he performs a

statutory duty of realisation and distribution to creditors.

As a representative taxpayer, the trustee is, with regards to the income received by

or accrued to the insolvent person prior to the date of the sequestration of his

estate, subject in all respects to the same duties, responsibilities and liabilities as if

the income were received by or accrued to him beneficially and he is liable to

assessment in his own name in respect of that income, but only in his

representative capacity; see section 95(1)bis.

A trustee who, as a representative taxpayer, pays any tax in respect of the insolvent

person prior to the date of sequestration of his estate is entitled to recover the

amount so paid from the estate of the insolvent person or to retain out of any

moneys of such estate that may be in his possession or that may come to him as

trustee an amount equal to the amount so paid.

These amendments came into force on 4 July 1997 and apply to any estate

voluntarily or compulsorily sequestrated on or after that date. The effect of the

amendments is to make an insolvent estate a taxpayer in its own right. The trustee,

as representative taxpayer of the insolvent estate, is entitled to claim any

deductions for which the estate qualifies, as a person and a taxpayer in its own

right. Thus, the estate is entitled to deductions in terms of section 11(a) for the

trustee’s remuneration and for the premium on a fidelity bond.

These amendments do not abolish the principle that an insolvent who, with the

consent of the trustee, enters into employment or carries on a trade, derives the

resultant income adversely to the trustee and he, not the trustee, is liable to tax on

such income.

From a tax point of view, therefore, the effect of insolvency is to terminate the tax

status of the taxpayer and to substitute in his or her place a new entity, namely the

insolvent estate. This new entity comes into existence on the date when the

insolvent surrendered his or her estate or, in the case of compulsory sequestration,

the date of the provisional order if that order is later made final.

The effect of insolvency

is that three separate

taxpayers may be liable

for tax: the insolvent

individual for the period

prior to insolvency, the

insolvent estate

(a new entity for tax

purposes), the

insolvent person for the

period post-insolvency.

10 May 2006

The effect of insolvency is thus that three separate taxpayers may be liable for tax,

namely –

· the insolvent individual for the period prior to insolvency;

· the insolvent estate (a new entity for tax purposes);

· the insolvent person for the period post-insolvency.

Separate returns for the periods before and after sequestration

Where the estate of a person is sequestrated, section 66(13(b) requires separate

returns to be made for the periods –

· commencing on the first day of the tax year and ending on the date preceding

the date of sequestration; and

· commencing on the date of sequestration and ending on the last day of that tax

year.

The interpretation and effect of section 25C

The extension of the definition of “person” to include an insolvent estate must be

read together with the simultaneous enactment of section 25C.

Section 25C was amended in 2001 to expand its scope by providing for capital

gains and losses as determined in terms of the Eighth Schedule.

In its present format, section 25C states that, for the purposes of the Income Tax

Act –

“the estate of a person prior to sequestration and that person’s insolvent estate

shall be deemed to be one and the same for the purpose of determining –

(a) the amount of any allowance, deduction or set-off to which that insolvent

estate may be entitled;

(b) any amount which is recovered or recouped by or otherwise required to be

included in the income of that insolvent estate;

(c) any taxable capital gain or assessed capital loss of that insolvent estate.”

The Interpretation Note comments that this provision has the effect, inter alia, of

crystallising all capital gains and capital losses in the insolvent estate, and it also

has the effect of permitting an assessed loss or assessed capital loss, as

contemplated in section 20(2) and an assessed loss as contemplated in the Eighth

Schedule, to be carried forward from the insolvent person prior to sequestration

into his or her insolvent estate.

The Interpretation Note states that section 25C has the consequence that –

· an assessed loss, incurred by the insolvent person, can be set off against the

income of the insolvent estate, and the provisions of section 20(1)(a)(i) are

therefore not applicable in respect of the estate;

11May 2006

· expenditure and losses claimed by the insolvent person prior to the date of

insolvency can be recouped in the insolvent estate, for example, a depreciation

allowance, a doubtful debts allowance, a hire purchase allowance, etc;

· debts included in the income of the insolvent person prior to the date of

insolvency can be claimed as bad debts by the insolvent estate;

· the write-off of assets or allowances can continue to be deducted in the insolvent

estate;

· there can be included in the income of the insolvent estate any amounts

recovered during the winding-up period in respect of debts written off as bad

prior to sequestration;

· there may be included in the income of the insolvent estate any amount that is

required to be included in the income of the insolvent person, for example, the

amount granted as an allowance in respect of doubtful debts in the previous year

of assessment, the value of closing stock, etc;

· there is no disposal of the person’s assets at the date of sequestration and

capital gains and capital losses are therefore determined in the hands of the

insolvent estate when the assets are disposed of to third parties.

None of the tax consequences of insolvency, discussed above, ensue where a

person merely assigns his estate to a receiver or other person. His legal status does

not thereby change, nor is there any alteration to his tax position. Any income

derived from the assets of a business assigned to a receiver continues to be

derived by the assignor and the latter remains liable for tax on such income. If,

however, the assignor enters into a compromise with his creditors or receives a

concession from them in terms of which his liabilities to them arising in the ordinary

course of his trade are reduced or extinguished, the benefit so received (which is a

deemed recoupment in terms of section 8(4)(m)) reduces the balance of any

assessed loss vesting in him; see section 20(1)(a)(ii).

Rates of tax

Up to the date of insolvency the insolvent person is taxed at the rates applicable to

persons other than companies and trusts and, being a natural person, is entitled to

the section 6 personal rebates, reduced pro rata where the insolvency occurred

part-way through the year of assessment. This also applies to the period

subsequent to insolvency, should any income accrue to him or her in a personal

capacity.

An insolvent estate, as a person and a taxpayer in its own right, is taxed at the rates

applicable to persons other than companies and trusts but, not being a natural

person, it is not entitled to the personal rebates.

None of the tax

consequences of

insolvency ensue

where a person

merely assigns his

estate to a receiver or

other person. His legal

status does not

thereby change, nor is

there any alteration to

his tax position.

12

• Editor: Ian Wilson • Written by R C (Bob) Williams • Sub-editor and lay out: Carol Penny

• Dis tri bu tion: Elizabeth Ndlangamandla •Tel (011) 797-5835 • Fax (011) 209-5835 • www.pwc.com/za

This publication is provided by PricewaterhouseCoopers Inc. for information only, and does not constitute the provision of professional advice of any kind. The information

provided herein should not be used as a substitute for consultation with professional advisers. Before making any decision or taking any action, you should consult a

professional adviser who has been provided with all the pertinent facts relevant to your particular situation. No responsibility for loss occasioned to any person acting or

refraining from action as a result of any material in this publication can be accepted by the author, copyright owner or publisher.

Copyright © 2005 PricewaterhouseCoopers Inc. All rights reserved. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers Inc (a South African incorporated entity)

or, as the context requires, the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.

Zero-rating of exports

The zero-rating of export sales add to the

competitiveness of South African

exporters in the international market.

However, the actual exportation of goods

does not, in itself, allow the zero-rating of

the sale. If the required documentary

proof cannot be furnished to a visiting

SARS auditor, the export sale will be

assessed at the rate of 14 per cent with

penalty, interest and even additional tax

being added.

Exporters should note that Interpretation Note

No 30 (‘IN 30’) (published on 31 March 2005)

has been replaced by Issue 2 of IN 30, with

effect from 1 April 2006.

All rulings issued on the documentary proof

requirements of the original IN 30 have been

withdrawn by Issue 2, with effect from 1 April

2006. Vendors who have obtained rulings

authorising the zero-rating of exports on the

strength of alternative documentary proof of

export must therefore obtain new rulings from

SARS.

However, any requirements of the original IN

30 that have been deleted in Issue 2 will not

be enforced for the period 1 April 2005 to

31 March 2006. Issue 2 (which is less onerous

that the original IN30) will therefore be applied

retrospectively to 1 April 2006. The effect is

that zero-rating of exports that did not meet

these deleted requirements are accordingly

no longer at risk of being assessed by SARS.

Exporters should note that the requirements

relating to EDI and export documentation

have been relaxed:

· Electronic Data Interchange export or

removal documentation no longer has to

contain an original SARS Customs stamp;

and

· The exporting vendor no longer has to

retain a copy of the Customs import

declaration of the country into which the

goods have been imported.

Having no documentary proof can cost you dearly

Because penalties that may be imposed for non-compliance with the documentaryrequirements are potentially high, vendors who have previously obtained rulings on exports

should review these rulings and, where necessary, submit new applications.