Prescription rules: When the clock stops ticking

capetownAuthor: Kyle Mandy (PwC).

In order to prevent the five year rule from being abused, there are certain exceptions.

Section 99 of the Tax Administration Act regulates the prescription of tax periods. The most important circumstances in which SARS is barred from raising further assessments in relation to a tax period are those relating to the passing of time.

As a general rule, SARS is time-barred from raising an assessment in relation to a tax period as follows:

  • three years after the date of assessment of an original assessment by SARS (e.g. for income tax);
  • five years after the date of assessment of an original assessment either by way of self-assessment or by way of a return (e.g. Value-Added Tax); and
  • five years from the date of payment of tax or the effective date (in the case of no payment being made) for a tax period where no return is required.

Taxpayers would therefore generally be able to assume that they would not be at risk of SARS raising additional assessments after the expiry of these time periods. This is of considerable assistance to both taxpayers and SARS as it is in the interests of both to bring finality to tax matters and this is the rationale which underlies prescription.

However, certain exceptions apply to this general rule. The most important of these exceptions is where there has been fraud, misrepresentation or non-disclosure of material facts which resulted in the proper amount of tax not being assessed. In such circumstances, the prescription periods would not apply to the extent that a causal connection exists between the behaviour in question and the non-assessment of the tax.

Section 99 also makes provision for SARS and the taxpayer to agree to extend prescription prior to the expiry of the prescription period. In practice, taxpayers often agree with SARS to extend prescription in order to promote a cooperative relationship with SARS, it also allows audits to be finalised after a full and comprehensive airing of all views and to avoid the premature issue of assessments to avoid prescription. However, not all taxpayers adopt this cooperative approach and this has led SARS to introduce some amendments to the prescriptions rules. These amendments are discussed below.

Two key amendments were made to section 99 by the Tax Administration Laws Amendment Act, 2015. Both of these amendments allow SARS to extend the period of prescription in certain circumstances.

The first amendment comes in the form of the introduction of a new section 99(3). This provision allows SARS to extend prescription by a period approximate to a delay arising from a taxpayer failing to timeously provide information requested by SARS or in resolving a dispute over SARS’ entitlement to information. In order to invoke this provision, SARS must give the taxpayer at least 30 days prior notice before the expiry of the prescription period.

In terms of section 46 of the Tax Administration Act (TAA), SARS is permitted to require a taxpayer to submit relevant material required by SARS within a reasonable period. Relevant material is defined in section 1 as “any information, document or thing that in the opinion of SARS is foreseeably relevant for the administration of a tax Act”. Not infrequently, disputes arise as to SARS’ entitlement to information. Such disputes usually take the form of a challenge to the relevance of the information to SARS administering the tax law or where the taxpayer contends that a document is protected by legal professional privilege.

The rationale for the introduction of this provision is concisely set out in the Memorandum on the Object of the Tax Administration Laws Amendment Bill, 2015 which states as follows:

“Too many of SARS’ resources are currently spent on information entitlement disputes, as opposed to conducting the audit within the period that additional assessments, if required, may be issued. This results in insufficient time to ensure SARS has all relevant information at its disposal to make correct assessments. In some cases, taxpayers, particularly large corporates, take more than six months to provide information required by SARS by simply failing to do so, disputing SARS’ right to obtain the information, attempting to impose conditions on access to the information and attempting to require specific mechanisms for accessing the information. Information entitlement disputes, particularly if pursued in the High Court, can take more than one year to resolve. These failures to provide information or information entitlement disputes are often tactical or even vexatious, given the fact that taxpayers are very much aware of the period within which SARS must finalise the audit and issue additional assessments, if required.”

The second amendment allows SARS to unilaterally extend prescription is incorporated in the new section 99(4). This provision lets SARS extend prescription by three years in the case of a SARS assessment or two years in the case of self-assessment in certain specified circumstances by giving a taxpayer prior notice of at least 60 days prior to prescription. The result is that prescription in these circumstances may be extended to six years for assessment by SARS and seven years for self-assessment. The purpose behind the provision is to allow SARS a longer period in order to finalise an audit or investigation relating to complex matters.

The difficulty that SARS faces is that some matters are so complex that it is strenuous for SARS to meet the prescription deadlines. It is for this reason that for certain complex audits and investigations SARS has introduced the power for it to extend prescription. South Africa is not unique in this regard and similar powers are to be found in many other countries, including Canada and Australia.

The circumstances in which SARS may extend prescription for complex matters as described above is where an audit or investigation relates to:

  • the doctrine of substance over form;
  • general anti-avoidance rules in any tax Act;
  • the taxation of hybrid entities or hybrid instruments; or
  • transfer pricing.

While the doctrine of substance over form (simulated or sham transactions), general anti-avoidance rules and transfer pricing are largely self-explanatory, hybrid entities and hybrid instruments does give rise to some uncertainty as to what is covered by these terms. As to what constitutes a “hybrid entity”, there is little to go on. What SARS is most likely referring to is a hybrid entity contemplated in the report Neutralising the Effects of Hybrid Mismatch Arrangements issued as part of the OECD/G20 Base Erosion and Profit Shifting Project (BEPS). However, clarity on this would be useful. Presumably, “hybrid instruments” refers to hybrid equity instruments and hybrid debt instruments contemplated in sections 8E and 8F of the Income Tax Act respectively, although this is not entirely clear. That term may also extend to the meaning attributed to it in the aforementioned BEPS report.

Taxpayers and tax practitioners would do well to acquaint themselves with the new prescription rules. The new rules will be able to be applied to all open tax periods from the date on which the Tax Administration Laws Amendment Act was promulgated and it is expected that SARS will make extensive use thereof going forward.

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This article first appeared on the March/April 2016 edition on Tax Talk.