An edited version of a longer article I wrote earlier.
CAN SARS SIMPLY THROW ‘SUBSTANCE OVER FORM’ OUT THERE?
1. It often happens that SARS simply advances the threat of substance over form when attempting to attack a transaction entered into by a taxpayer. Other times, the doctrine is relied upon as an alternative reason for issuing a revised assessment, where SARS’ other substantive reasons are weak.
2. This approach by SARS should be challenged on the following basis:
3. The SARS Internal Audit Manual describes the norm practiced by SARS in the implementation of audits and enquiries. The observance of these practices creates a self-imposed limitation which SARS should not deviate from, save in exceptional circumstances and with sufficient reason. If SARS applies these administrative norms regularly in the exercise of its duties, then SARS violates the principles of impartiality, equality, fairness and accountability if it fails to apply these norms to all taxpayers undergoing audits or enquiries.
4. To ensure that SARS complies with its duties comprehensively recorded in the SARS Internal Audit Manual, and in compliance with its duties in terms of section 4(2) of the SARS Act and section 195 of the Constitution (both sections require SARS to act with a high standard of professional ethics, impartially, fairly, without any bias, and in an accountable and transparent manner), SARS must summarise the ‘findings of the audit’ and set out the ‘conclusion based on these findings’. If it appears that the taxpayer’s returns are substantially correct, the audit should be terminated. If the taxpayer’s returns appear not to be substantially correct, then these findings must be made available in SARS’ letter of findings, with the conclusions.
5. What is the nature of the findings that are referred to? Findings based on physical evidence, in the form of information, documents or things extraneous to the tax returns. This would include the actual agreements signed by the parties.
6. But the enquiry does not end there. If SARS avers that the agreements are a ‘fraud’, then they must provide evidence other than from the agreements themselves (on an armchair analysis basis) that the agreements are a fraud. For instance, evidence of another agreement superseding the one presented to SARS, or testimony of an individual stating that the agreements are a fraud.
7. SARS’ approach to the findings must adhere to their Practice Manual which states that SARS must produce ‘concrete evidence’. This entails solid, undisputed evidence as opposed to mere conjecture where accusations that are unsubstantiated by proof are made.
8. During the initial investigative stages, SARS have two ways forward:
a. SARS must conduct further investigation to substantiate their initial suspicions that the agreements are a ‘fraud’ and find the ‘concrete evidence’ that their suspicions are founded; or
b. SARS must cease the audit.
9. In attempting to apply the substance over form doctrine to a variety of transactions, SARS’ reasoning and conclusions must be considered in light of the recent unreported judgment NWK Limited v CSARS on substance over form.
10. If SARS contends that the transaction under investigation is a simulated one then, in terms of the judgment, SARS cannot at the same time have been satisfied that such transaction had a tax avoidance effect. To have been so satisfied presupposes the validity of the transaction. In such circumstances the court has held that the Commissioner may not invoke section 103 (the previous section before section 80A was introduced) of the Income Tax Act, 58 of 1962 in the alternative. SARS must be requested to make up their minds and decide whether the transaction is a simulated one, or one that falls foul of the old section 103 provisions. Here SARS must exercise a choice. If they are to proceed on the basis of section 103, then they must abandon the substance over form attack.
11. To rebut a substance over form allegation, the taxpayer need only prove that the parties actually intended that each agreement would inter partes have the effect according to the tenor of the agreements. This usually appears off the face of the documents by the parties that signed the agreements. Written confirmation of this fact should be submitted to SARS at the time they make the finding, before the revised assessments are reached, to confirm that the agreements are what the parties intended them to be. That disposes of the lose allegation by SARS that the agreements are a sham.
12. A sham will be established if it can be shown that the parties do not intend to be bound by all the terms of their contract. This is difficult for SARS to prove. Usually, no concrete evidence supporting such a finding will be put forward by SARS.
13. In addition to the difficulty of discharging the onus of proof to enable SARS to raise a lawful revised assessment, in terms of the SARS Practice Manual, before any estimates are made, SARS are duty bound to provide concrete evidence.
14. The onus rests on SARS to prove that the agreements are not what they purport to be and that the parties attempted to conceal the true nature of a transaction by giving it a form different to what they really intended. This is effectively alleging fraudulent activity and SARS must have concrete facts and evidence on which such a conclusion is based. It will not suffice to simply draw inferences through expert witnesses, or inferences derived from conjecture or from other inferences. Oftentimes, SARS simply follows their historical discourse by using adjectives rather than concrete evidence in an attempt to justify their findings. This approach of SARS in arriving at its conclusions is clearly flawed in logic.
15. The concepts of ‘syllogism’, ‘didactive reasoning’ and ‘cause and effect’ are the tools used for a proper analysis. A syllogism is a statement of logical relationship. The typical syllogism has three parts:
a. The major premise, a statement of broad applicability;
b. The minor premise, a narrower statement of particular applicability that is related sufficiently to the major premise, so as to arrive at the third part, the conclusion;
c. The conclusion which follows logically from the major and the minor premises.
16. SARS will attempt to state that the major premise is that simulated transactions can be ignored, and their true nature must be given effect to in determining the tax consequences.
17. In both theories, the minor premise rests on ignoring the rights and obligations that flow from each of the agreements between different contracting parties. There is no premise for ignoring the agreements, other than SARS’ allegation. It is only by following SARS’ contention (with no concrete evidence of a fraud being present) that one can reconstruct all the transactions to reflect something other than what they purport to be.
18. The minor premise to uphold the major premise and to arrive at the logical conclusion requires that the identity and existence of the different contracting parties is completely ignored. The assumption is made that each party, and the representatives of those parties together with their professional advisors, knowingly committed the fraud – without SARS providing a shred of evidence that any one party did so.
19. This line of reasoning will show that any findings and conclusions by SARS are driven by an ulterior motive – to collect more tax, rather than to establish the true nature of the transaction.
20. Taxpayers must ensure that SARS adheres to the principles explained above.