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What taxpayers should know about South Africa’s litigation strategy

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South Africa’s tax regime is undergoing significant reform. International Tax Review speaks with two of the country’s leading tax advisers to discover how taxpayers can avoid disputes and what strategy the South African Revenue Service (SARS) is likely to pursue in the near future.

International Tax Review (ITR): What can South African taxpayers do to minimise the risk of tax disputes arising with SARS?

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Le Roux Roelofse, Deloitte (LR) (left): A company should have a clearly defined tax risk management policy under which it clearly understands its tax function, ensures it is properly resourced and is clear on its approach to taking aggressive or conservative tax filing positions.

That will help prepare it for queries by SARS and will reduce the risk of tax queries becoming tax disputes.

Two other critical elements are: to leave a proper audit trail so there is documentary evidence backing up tax disclosures made; and to communicate frequently and openly with SARS to establish the company's credentials as a responsible taxpayer.

Nina Keyser, Webber Wentzel (NK): If there is any doubt about the application of the Income Tax Act or Value Added Tax Act, taxpayers can ask for a formal binding ruling in respect to any specific transaction. This will reduce the risk of any future assessments because SARS is bound by its rulings.

Taxpayers are not bound by SARS's rulings, but if the taxpayer chooses to treat a transaction contrary to the ruling, the likelihood of an assessment, and therefore a dispute, increases.

Under the new Tax Administration Act SARS can elect taxpayers for investigation or audit on the basis of a risk assessment or any random basis. Therefore a taxpayer can be selected for audit on the basis, for example, of a refund claim, but it can also be one of the taxpayers randomly selected for audit. There is very little a taxpayer can do to avoid a random audit.

Further, under the new Tax Administration Act, SARS is obliged to issue a letter of findings to taxpayers after an audit has been completed, setting out the grounds for any material adjustments to be made as a result of the audit.

Taxpayers then have 21 days to respond. This is the first opportunity to address SARS, and if used appropriately, the parties can reach agreement before the assessment is even raised.

ITR: If a company is challenged by SARS over tax, how should it develop its dispute strategy?

NK: We generally recommend that taxpayers elect to use the formal alternative dispute resolution procedure, which becomes available after an objection has been disallowed and the taxpayer elects to appeal.

The procedure is one of mediation rather than arbitration and the parties are not bound by the outcome unless they opt to enter into a settlement agreement.

It is worthwhile to try and avoid costly litigation. The procedure is without prejudice and if the parties fail to reach a settlement, the matter proceeds to court.

The only annoying aspect of the alternative dispute resolution procedure is that the officials at the mediation may agree to a settlement proposal, but it has to be referred to an appeal committee and the committee can override the decision of the officials at the mediation.

LR: Under challenge, the company should assess the merits of its case and, if appropriate, seek external expert advice on the prospect of success should it end up in court.

If the company thinks it has a strong case on the merits, it should not be afraid to position itself to litigate and from its initial interactions with SARS it should clearly establish the grounds of its case and assert its rights.

If the amount in dispute is not material or if the company concludes it does not have a particularly strong case, it may want to pursue alternative dispute resolution as a cheaper and shorter process.

However, if this route is pursued, the taxpayer will have to compromise and some tax will become payable. The right strategy from there is to be co-operative with SARS, but to firmly assert one’s rights and not be afraid to rely on constitutional protections.

ITR: What is the most effective way for a company to organise its dispute teams when involved in a tax dispute with SARS?

LR: Taxpayers should engage their external tax advisers to assist with an initial evaluation and brief appropriate experienced counsel to appear in court.

It is important the advisers who gave initial advice on the subject matter of the dispute be involved in the litigation process as they often have the background knowledge necessary to successfully litigate the dispute.

They also need to work with counsel to ensure the company is properly prepared to address SARS’s assertions. The closer the matter gets to court, the more important it is that the company and its advisers have dedicated teams set up to prepare for and run the litigation.

ITR: Are you seeing any trends in the types of tax cases SARS is taking up and those in which it is being successful in the courts?

LR: Although South Africa has a general anti-avoidance tax rule, we have not seen much evidence of this rule being successfully applied, although the South African substance over form doctrine does seem to have been developed by our courts beyond its traditional narrow range to frustrate some blatant tax avoidance schemes.

SARS will continue to challenge sophisticated finance and tax anti-avoidance structures where there is significant risk of an erosion of the South African tax base.

SARS is also heavily focusing on high net worth individuals and has been publicly involved in litigating one such prominent individual, Dave King. We can expect more such prominent public disputes and litigation.

ITR: What will be SARS’s main areas of focus in tax audits and what will its tax litigation strategy be in the next one or two years?

LR: We have not really seen any court cases on transfer pricing in South Africa.

SARS has substantially beefed up its transfer pricing capacity recently and we are seeing more frequent tax audits in this area.

Given the prevalence of multinationals investing into South Africa, we expect SARS to really focus on transfer pricing and be prepared to litigate appropriate cases.

Its strategy is likely to be to focus on a big case where it is fairly certain of being successful.

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SARS will ensure it is well prepared and may also engage appropriate international tax experts. Any such case will not only be about the immediate issue in dispute but about the message it sends to the taxpayer community about SARS’s willingness and capacity to litigate in transfer pricing.

NK (pictured right): SARS is focusing on transfer pricing and share incentive schemes.

SARS has also designed a new type of return which requires the taxpayer to reconcile between the various taxes. Taxpayers must, for example, reconcile turnover declared for VAT purposes to the gross income declared for income tax purposes; or the salaries and wages claimed as a deduction for income tax purposes to the remuneration declared for employees' tax purposes.

SARS is also comparing imports declared for customs duty purposes to VAT.

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