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The importance of financial statements for tax purposes · Tax Break: South African tax for professionals

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Welcome and thank you for joining me for Tax break.
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This is a podcast about South African tax for South African
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tax professionals and practitioners.
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My name is Peter. Finish 1 And in each episode,
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Ashley my thoughts with you on a topic Gora recent development in
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South African tax and I try to keep the episode short enough
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that you can listen to them whenever you've got a few
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minutes to spare Today. I'm talking about a recent tax
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code case. So as you would probably know in
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the tax code judgments, the tax payer is, is the taxpayer's
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identity is not revealed so that taxpayers just referred to as
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tax payer did. And if we look at the the the
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facts of the case and the judgment, I don't think there's
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anything new that creates new president or that that changes
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the way that we would look at things.
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But I do think that there are quite a few useful reminders in
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this case for us as taxpayers or tax practitioners.
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You might also feel that if you listen to what are the, the
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taxpayers set up worked, there are one or two elements that
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that might feel very normal or something that you come across
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quite often in in this right. So, if we look at the facts
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first, the tax payer is an individual and the shareholder
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of and the director of about 20 companies.
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Now the court described these companies as property companies.
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So the company earned rental income declared dividends and
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the judgment states that these dividends stain remained
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outstanding on loan account. And the dispute related to one
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of these loan accounts alone owing by a company that was just
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called Company A to the tax payer of about 42,000,000 Rand
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plus the interest accrued on it. So Zach's position was that the
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credit loan and the interest on it represented undeclared
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income. So the tax payer had and there
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was an asset for the tax payer and the tax payer did indicate
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that this inflow in his financial in, in his tax
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returns. Now, if you go back to the
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origin of the dispute, as far as we can see it from the judgment,
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the tax payer submitted unaudited financial statements
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to Sash. And it's unclear whether these
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were submitted as part of the the, the submission of the
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return or in a, in a, in a verification later on.
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But I do think there's an important point perhaps to
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already mention here, although it's not stated explicitly in
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the case when you're dealing with an individual and financial
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statements prepared for individuals, it's very likely
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that those financial statements, they wouldn't be the same degree
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of financial system or controls as you may find for legal
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entities. And so, so that could affect
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the, the way in which these financial statements are
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prepaid, right. So initially in the dispute, the
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tax payer tried to and his advisors tried to explain the
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loan account, explain the origins of the loan account.
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But then somewhere during the course of the dispute, they
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changed direction and provided reconstructed financial
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statements to SASH. And in these reconstructed
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financial statements, the loan account balance was
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significantly reduced. It went from 42,000,000 to about
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3 million Rand. And the tax payer also changed
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accountants or advisers midway through the dispute.
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So Sasha identified various inconsistencies in the
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taxpayer's explanation of the loan accounts and on the basis
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that the tax payer did not discharge the burden of proof in
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Section 102 of the Tax Administration Act, Sash then
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assessed the tax payer on the on the amounts of these loan
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accounts, right. If we then if if you read
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through the judgment, you'll see that the, the taxpayers, new
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accountants or the, the persons who prepared the financial
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statements, the, the, the new audited financial statements,
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there was the that accountant testified.
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Sash also called on an expert witness to testify from from
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from their perspective, right. So if we look at the at what the
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court held firstly that this was a factual dispute about about
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the source of the loan account and therefore the burden of of
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proof was on the tax payer. And the court then found that
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the tax payer failed to discharge this burden of proof
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for a number of reasons. Firstly, the version changed or
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the explanation of the loan account changed as well as the
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amount of the loan account. Secondly, the court noted that
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the tax payer was unable to provide any evidence why the
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original financial statements were incorrect.
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So there was number documentation.
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The previous auditors or their accountants were not called to
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taste Tiffy. So the tax payer actually didn't
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provide any evidence as to what the what on what basis these
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other financials were incorrect. The third basis was that the the
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the new financial statements, although they were called for
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audited financial statements were actually unaudited and such
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raised serious, serious concerns that were then confirmed for for
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for the at least the supported as far as the court was
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concerned by the expert witness. That's Ashgold.
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And the last thing is that the tax payer himself did not
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testify. So the judge was very careful to
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point out that a court would not necessarily draw an adverse
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inference from the absence of a tax payer.
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But in this case, the tax payer had key information that only he
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could provide. For example, why did he sign off
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on financial statements that were wrong?
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Why did he sign off on financial statements with a loan account
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that was so significantly incorrect?
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And perhaps most importantly, what were the actual underlying
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transactions? What happened in these companies
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that should have been reflected in the financial statements?
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So in this case, the, the court did draw an adverse inference
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from the fact that the tax payer himself did not testify, right.
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So that then takes us to the question, what can we possibly
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take from this case? So I'm going to highlight three
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things that in my mind comes to comes out from this case that
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other taxpayers and tax practitioners should be aware of
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or at least reminded of. I'm sure if you dig deeper into
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the case, there would be a lot more.
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The first principle is something that I'm sure most of you came
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across in your studies. And that's, I think the, the,
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the case that I remember from, from my studies was a sub Nigel
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case to say that the courts are not concerned with deductions
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that may be considered proper from an accountant's interview
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or from a prudent businessman. The court is concerned with what
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can be deducted in terms of the language of the law.
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In a lighter case, about 25 years later in the Eaton All
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case, the court again said that the court was concerned about
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the correct interpretation of the statutory provisions.
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So in other words, how do you apply the provisions and the
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language used to the set of facts that you've got?
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The Code is not concerned about accountancy or commercial
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practice. So in other words, the tax
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consequences of a transaction would come from the transaction
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itself. So what is the underlying
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transaction? What was it the the terms of
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that transaction, those kind of things and then how the law
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applies to that and that you would typically probably get
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from agreements or contracts or then in this case, as the judge
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said, from the person who executed those, those
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transactions himself, the tax payer.
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That said, I think financial statements are a key source of
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information at Sasha's disposal. And you would, I would say, go
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as far as expect any proper Revenue Service to examine them
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properly and compare the financial statements to what is
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in the tax return. And from a recent instruction
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that I've been working on, we have assisted the company to
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respond to queries raised in an audit.
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I can tell you that that's exactly what Sarah does.
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They raised a number of valid good questions about what was
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it, the accounting treatment, what is the tax treatment, and
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what's the underlying set of facts?
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And if there are different, why are they different?
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So I think the first point to take home is that it's
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absolutely key to ensure that there is consistency in
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information between your tax return and your financial
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statements, not to say that these things must look exactly
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the same because you could have treatments that differ.
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So if we go back to where the example of dividends provided in
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earlier in the case, dividends are income for for for
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accounting purposes, but they are exempt income from from a
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tax perspective. But factually, the information
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that the financial statements would give you is to say that
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the loan accounts arise from dividends or not.
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The second thing I would like to mention, and I guess there's an,
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there's an element of, of personal experience and
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preference in here is that I think 1 can quite safely say
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that loan accounts can be dangerous things.
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So you need to not to say that you can't use them or you
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shouldn't have them. But what is important is that
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you need to understand the origin of the learner account
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very well and what goes into the loan account or out of the loan
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account. So I can tell you from
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experience that when dealing with queries or disputes, they
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often arrive involve loan accounts.
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So I guess from the introduction of the introductory few
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paragraphs to the judgment, it seemed to most obvious to me
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that what the what the loan account arose from was probably
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dividends that were declared so exempt income for some reason
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that was not considered by the court or not advanced by the
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taxpayers. So it might be that in this case
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that's not what these amounts were.
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But the point remains that dividends or loan accounts are
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something that you need to be very careful with and you need
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to understand very well what goes in into them.
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Lastly, and the last point I would like to make is that I
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think ultimately it's important for taxpayers to realise that
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they are themselves responsible for information presented to
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such information in their returns to make sure that they
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understand what's there and it's correct.
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So the case is a good illustration that reliance on
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advisers can only take you that far.
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Ultimately it comes down to what are the transactions that you've
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done and what is factually the correct information.
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And that is something that would the taxpayers themselves would
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would in most cases have. So as I said, I'm sure there's a
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lot of other things we can one and pick out of this case, but
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these are my top three take home points.
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At least that's it for today's episode.
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If you've got any questions, comments, ideas for future
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episodes, please send me an e-mail.
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My e-mail address is in the show notes.
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If you like the podcast, please go and subscribe on your
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friends and colleagues about it. Just remind us always nothing in
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this podcast is intended to be tax advice or a replacement for
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tax advice. Until next time, goodbye.