This judgement sends a broader warning to taxpayers that SARS has far-reaching powers to tax undisclosed foreign income and even impose severe penalties where consistent, credible explanations cannot be presented to substantiate such receipts. The SCA decision in Lutzkie is not simply a case about a taxpayer who changed his version of events. It is a case about how core tax principles, the correct disclosure of taxable receipts to the Tax Authority, and the imposition of penalties, are applied by SARS when a taxpayer fails to substantiate their position with reliable evidence.
The taxpayer’s fatal error was not merely inconsistency, but further the failure to appreciate that South African tax law places the full onus on the taxpayer to prove that income is not taxable, as required under section 102(1) of the Tax Administration Act, No. 28 of 2011 (“TAA”).
Background
In this case, SARS conducted a lifestyle audit and identified the foreign deposit into the taxpayer’s account from an entity in the British Virgin Islands. The taxpayer’s initial explanation was uncomplicated, stating that the receipt was a loan to fund legal fees. Despite providing an acknowledgement of debt, the taxpayer’s averment was rejected by SARS.
However, by the time the matter reached the Tax Court, the taxpayer’s explanation had changed completely. The foreign deposit was no longer categorised as a loan, with the previously submitted acknowledgement of debt now being said to be something that “did not happen”. The taxpayer’s foreign payment was now claimed to be the repayment of a shareholder loan from a dissolved foreign company, of which the taxpayer was the beneficial owner.
The taxpayer’s inability to maintain a consistent narrative adversely affected credibility, directly affecting the application of the Income Tax Act, No. 58 of 1962. Notwithstanding the fact that the disputed foreign income had been received by the taxpayer in 2006, SARS still exercised its legislative powers to audit the taxpayer and query the inbound payment. This serves as a stark warning that even the effluxion of time offers little protection to taxpayers in cases of non-compliance.
The Onus of Proof is Decisive
The SCA crucially reaffirmed that the burden of proving that income and receipts are not taxable firmly rests with taxpayers. Where a taxpayer avers that an amount received is a loan, or that the invested capital is being repaid – this must be proved by the taxpayer. Not through assumptions or reconstruction years after the fact, but through reliable and credible documentary evidence.
The categorising and correct declaration of funds received by taxpayers will determine the tax treatment thereof, and when a taxpayer’s explanation is dubious and unsubstantiated, the taxpayer will fail to discharge the onus of proof imposed by section 102(1) of the TAA.
Why the Taxpayer’s Evidence Failed
In Lutzkie, the taxpayer did not testify to explain the transaction himself, instead his auditor attempted to reconstruct a believable version from historic emails and information gathered long after the transaction occurred in 2006.
The Court described this as an attempt to “construct a version out of nothing” and referred to the taxpayer and his auditor’s explanation as “contrivance and intentional obfuscation”.
This was not criticism of poor record keeping, but rather a finding that the taxpayer’s evidence was so unreliable that it could not possibly discharge the taxpayer’s burden of proof. Credibility, in this case, determined whether the evidence presented could possibly operate in the taxpayer’s favour, which was not the case.
The Penalty: Punitive or Permissive?
The taxpayer argued that the 90 percent penalty raised by SARS was excessively punitive in nature, because the taxpayer had not intended to evade tax. The SCA firmly rejected this argument, as it ruled that the taxpayer’s shifting explanations and the reliance on documents that were later disavowed, justified SARS’ view of the seriousness of the conduct.
In a notable remark, the Court expressed that SARS could have imposed a 200 percent penalty and that 90 percent was lenient. Courts are assessing not only the underlying transaction, but also how taxpayers and their advisors conduct themselves during audit and dispute resolution processes. An ever-evolving explanation becomes a noteworthy aggravating factor.
Where the Voluntary Disclosure Programme Becomes Critical
The set of facts seen in Lutzkie are precisely those that should trigger consideration of a Voluntary Disclosure Programme (“VDP”) application, before SARS starts asking questions.
Where undisclosed income has accrued to, or been received by taxpayers, the VDP process may be their saving grace. However, the timing of a VDP application is crucial, as once SARS initiates a lifestyle audit or starts asking questions about suspect deposits, the VDP door is effectively closed. At that point, taxpayers are no longer able to utilise a voluntary disclosure process to regularise their tax defaults. By coming clean timeously, taxpayers can lawfully avoid criminal prosecution and even avoid the imposition of penalties by SARS.
The VDP process exists precisely to deal with situations where there is a tax default, the transaction history is complex, and the tax treatment may not have been correctly declared to SARS. It allows taxpayers to regularise their affairs before credibility becomes an issue in litigation.
A Clear Warning
Where taxpayers suspect that their complex international financial affairs have not been fully and correctly declared to SARS, this judgment should serve as a stark warning.
By pro-actively enlisting the assistance of specialist tax attorneys to review their tax affairs, taxpayers may keep SARS audits and queries at bay. As Lutzkie demonstrates, adopting a head-in-the-sand approach and waiting for SARS to kick-off a lifestyle audit before starting to assemble a paper trail is high-risk and costly.
These are precisely the circumstances where professional advice should be sought early, with a VDP application being considered before SARS comes knocking.
