Posted in sections, this is my Doctoral Thesis on taxpayers rights when audited by the tax authorities in South Africa – equally applicable to many English-based law systems in Africa and abroad (eg. India). This will be of particular use to any tax practitioners doing work in Africa and in other English-based legal systems around the world.

Analysis Of Challenging The Commissioner’s Discretionary Powers In Auditing Taxpayers under The Constitution Of The Republic of South Africa

CHAPTER 3 – LIMITATIONS TO INVOKING SECTIONS 74A AND 74B OF THE INCOME TAX ACT

3.3 LAWFULNESS

Lawfulness is the first part of just administrative action contemplated in s 33(1) of the Constitution, and in PAJA, and the first principle of legality. Lawfulness, embraces authority, jurisdictional facts, and abuse of discretion, including improper or ulterior purposes or motives, mala fides or bad faith, the failure to apply mind, or failure take into account relevant, and taking into account irrelevant considerations, unlawful fettering of a discretion, and arbitrary and capricious decision-making by SARS, and in the context of this thesis, in exercising its powers under ss 74A and 74B.

In Industrial Equity Ltd v Deputy Commissioner of Taxation and Others13 the Australian High Court held that the powers of access and inquisition must be exercised for the purpose of the taxing act, and that question is to be considered in the context of the provisions levying income tax.

American jurisprudence has also developed significantly in this area.14 A summary of American jurisprudence, analogous to the principles analysed in this thesis, includes: in making inquiries and obtaining information from taxpayers, the investigation must have a legitimate purpose; the information must not already be in the State’s possession; all procedural steps must have been followed; the demands must not be overbroad; taxpayers do not have to manufacture documents not in their possession; and must relate to persons and information that will have a bearing on the tax being investigated in respect of the taxpayer under investigation.

A lawful decision of SARS must comply with the constitutional obligations of: impartially, fairness, equitable and unbiased conduct, in an accountable and transparent fashion with timely, accessible and accurate information in respect of s 195(1) as analysed in Chapter 4 infra.

To ensure the lawfulness of an inquiry and audit, consideration must also be given to any legitimate expectation created by SARS in its Code of Conduct, with its internal guidelines in the SARS Internal Audit Manual,15 which in the case of exercising a discretion in terms of ss 74A and 74B includes:

(a) ‘insight into…the business process of the taxpayer…’;16

(b) ‘(after) screening the tax returns…(the taxpayer)…warrant(s) an audit…’;17

(c) it has identified ‘which elements of the tax return(s) need to be audited…’;18 and

(d) obtaining ‘information from other sources…(on)…the potential issues of the relevant case…’.19

The inquiry and audit should be based on specific facts as effectively called for in the definition of ‘for the purposes of the administration of this Act’ in s 74 of the Income Tax Act:

(a) there must be an amount received by accrued to any person that must be in question;20

(b) there must be a property disposed of under a donation;21

(c) there must be a dividend declared22 under investigation;

(d) the investigation must be in relation to an inquiry in a return, financial statement, document, declaration of facts or valuation, and the originating document must also exist to enable the further inquiry;23

(e) the investigation must relate to the determination of the liability for any tax, interest or penalty; here the existence of general evidence to suggest that the person is a taxpayer should at least exist;24

(f) the investigation must relate to collecting a liability, and the liability must exist;25

(g) ascertaining whether or not an offence has been committed by the taxpayer, whilst conducting the inquiry and audit. This is a very controversial issue as civil investigation provisions are being used to investigate criminal conduct by the taxpayer, where the taxpayer is being compelled26 to give incriminating evidence, in contravention of the provisions of s 35(3) of the Bill of Rights. This is prima facie unconstitutional;27

(h) ascertaining general compliance, which is vague28 and very general; this should also be prefaced by evidence that the person under investigation is the subject of an inquiry and audit owing to the existence of some evidence that warrants the exercise of the power to ensure that the decision of SARS is not arbitrary, capricious or has an ulterior or improper purpose. The random selection29 of a taxpayer, without any form of preparatory justification by SARS for the inquiry and audit, may fall foul of the impartiality30 provision in s 195(1) of the Constitution. It should also be clear that the audit or investigation is in respect of a named person who is or should be a ‘taxpayer’31 as defined in the Income Tax Act;

(i) the enforcement and performance of administrative function provisions, which again is a very vague and general provision, requiring some justification32 from SARS that the inquiry and audit is necessary and within the scope and purport of its powers, as qualified by the requirement of effectiveness and efficiency set out in s 4(2) of the SARS Act.

All of these facts will have a source, giving rise to the initial information upon which SARS relies to enable it to commence the inquiry and audit in the first place. At this point it becomes important for SARS to follow its own internal guidelines, and to provide the necessary justification to proceed with the inquiry and audit, otherwise the conduct of SARS will prima facie be unlawful. Furthermore, taxpayers can also expect that in carrying out its audit and inquiry functions, SARS will not act in a vexatious or oppressive manner towards those taxpayers.33

Next:  3.3.1 Authority

In accordance with Circular 230 Disclosure

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Footnotes

13 (1990) 170 CLR 649 at 659; See also FH Faulding & Co Ltd , The Commissioner of Taxation for the Commonwealth of Australia 94 ATC 4867 where the tax authority was held to have exceeded its information gathering powers in making a request for information in circumstances involving offshore information where the section did not entitle them to do so.

14 But an analysis thereof is beyond the scope of this thesis; For American comparative law that may influence court decisions in South Africa in terms of s 39(1)(c) of the Constitution (quoted from the headnotes): US v McCarthy 514 F 2d 368: ‘…(1) that the investigation has a legitimate purpose and that the inquiry may be relevant to that purpose, (2) that the information sought is not already within the Government’s possession, and (3) that the Government has followed the procedural steps required by the Internal Revenue Code’; Martin v Chandis 128 F.2d 731: where the Ninth Circuit held: ‘(t)he rights of an internal revenue agent to require production of papers and records for examination are statutory, and in order to obtain the relief granted by statute, he must bring himself within the terms thereof’; In US v Williams 337 F Supp 1114: ‘…message slips held by taxpayer’s telephone answering service … to check his returns … subpoena was overbroad and out of proportion to ends sought, and as such not entitled to enforcement’; First National Bank of Mobile v US 160 F.2d 532: where ‘(a) third party should not be called upon to produce records and give evidence … unless such records and evidence are relevant to or bear upon the matter being investigated’; US v Coopers and Lybrand 413 F Supp 942: where ‘Internal Revenue Service summons requesting records, papers, and other data of a taxpayer will be enforced only if the information sought is not already in the possession of the IRS is designed to protect taxpayers and third parties from the abuse of summons power’; Hubner v Tucker 245 F.2d 35: where a ‘(s)pecial agent, internal revenue service, who sought to enforce subpoena against third person to compel production of records in investigation of others’ tax liability, had no right to examine any paper unless it was proved to have therein entry relating to tax liability of persons under investigation, under statute relating to examination of books and witnesses’; US v Brown 536 F.2d 117: where the cout held ‘“Books, papers, records, or other data” to be produced under … the Internal Revenue Code relating to examination of books and witnesses … did not … authorize the IRS to require the manufacture of documents or other data for examination’; Local 174 International Brotherhood of Teamsters v US 240 F.2d 387: where ‘(i)n proceeding by revenue agents to compel union’s production of records relating to transactions with taxpayer-president, agents had burden to show that demand was reasonable under all circumstances and to prove that books and records were relevant or material to tax liability of taxpayer and that union possessed books or records containing items relating to taxpayer’s business’. (Emphasis supplied); See also US v Newman 441 F.2d 170.

15 The SARS Internal Audit Manual, see 3.2 supra.

16 Ibid. at page2.

17 Ibid. at page 4.

18 Ibid. at page 5.

19 Ibid. at page 6.

20 Section 74(1)(a)(i) of the Income Tax Act.

21 Ibid. s 74(1)(a)(ii).

22 Ibid. s 74(1)(a)(iii).

23 Ibid. s 74(1)(b).

24 Ibid. s 74(1)(c).

25 Ibid. s 74(1)(d).

26 Constitution ss 35(3)(h)-(j). See also ITC 1818 69 SATC 98 and Seapoint Computer Bureau (Pty) Ltd v McLoughlin and de Wet NNO 1997 (2) SA 636 (W).

27 This analysis based on the Canadian Supreme Court case of R v Jarvis 2002 (3) SCR 757 discussed later in this thesis at page 88.

28 See Local 174 International Brotherhood of Teamsters v US, 240 F.2d 387 for comparative American jurisprudence where the court held (quoted from the headnote): ‘agents had [a] burden to show that [the] demand was reasonable under all circumstances and to prove that books and records were relevant or material to tax liability of taxpayer …and the taxpayer… possessed books or records containing items relating to taxpayer’s business.’ (Emphasis supplied)

29 In US v Third Northwestern National Bank 102 F Supp 879 the court held (quoted from the headnote): ‘A ‘fishing expedition’ under statute permitting Internal Revenue agent to examine records bearing upon matters to be included in income tax return cannot amount to an inquisition or arbitrary inquiry on the part of an Internal Revenue agent, and determination as to whether inquiry is reasonable, and therefore justifiable ‘fishing’, must be determined from all the facts in each case, including the end for which the information is sought, and proof and prevention of tax frauds is not the only factor to be considered’ (Emphasis supplied). This basic requirement limits a simple random taxpayer selection without SARS performing some preparatory work.

30 In Reckitt and Coleman (NZ) Ltd v The Taxation Board of Review and The Commissioner of Inland Revenue Turner J stated: ‘It is of the highest public importance that in the administration of [tax] statues every taxpayer shall be treated exactly alike, no concession being made to one to which another is not equally entitled…Where there is no express provision for discretion, however, and none can be properly implied from the tenor of the statute, the Commissioner can have none; he must with Olympian impartiality hold the scales between the taxpayer and the crown giving to no one any latitude not given to others.’ (Emphasis supplied)

31 Section 74(1)(f) of the Income Tax Act.

32 For the requirements of lawful justification, see Premier of Mpumalanga and Another v Executive Committee of the Association of Governing Bodies of State-Aided Schools: Eastern Transvaal 1999 (2) BCLR151 (CC) at para [42]: ‘…no question of justification …can arise as the decision taken…did not constitute ‘a law of general application’ as required by that provision…’; cf.Registrar of Pension Funds and another v Angus NO and others [2007] 2 All SA 608 (SCA) where the court held ‘in terms of law [of general application]’ would enable a decision. SARS decisions are enabled ‘in terms of law [of general application]’.

33Chairman of the Board on Tariffs and Trade and Others vs Brenko Inc and Others 64 SATC 130 at para’s [29] and [30], where it was held by the Supreme Court of Appeal that ‘…investigatory proceedings, which have been recognised to be absolutely essential to achieve important policy objectives, are nevertheless subject to the constraint that the powers of investigation are not exercised in a vexatious, oppressive or unfair manner (cf. Bernstein and Others v Bester and Others NNO 1996(2) SA 751 (CC) at 584F-I)…’; See also Gardener v East London Transitional Local Council and Others 1996(3) SA 99 (E) at para’s 116E-G.