A recent judgment of the Tax Court, now on appeal to the Supreme Court of Appeal (Commissioner for the South African Revenue Service v Oakleaf Investments Holdings 79 (Pty) Ltd t/a Lesedi Power Company), raises an important procedural question in South African tax litigation: to what extent may SARS reformulate its case during the appeal process without issuing a revised assessment?

Although the underlying dispute concerns the deductibility of pre-trade expenditure, the significance of the matter lies elsewhere. The appeal turns on the proper interpretation and application of Rule 31 of the Tax Court Rules, and on the balance it seeks to strike between SARS’ powers in litigation and the taxpayer’s entitlement to procedural certainty.

The outcome of the appeal may have implications beyond the facts of the particular case.

The statutory framework: assessments, objections and Rule 31

The Tax Administration Act establishes a structured framework for the resolution of tax disputes. Once an assessment has been issued, a taxpayer may object to it and, if dissatisfied with the outcome, may appeal to the Tax Court.

Rule 31 regulates the stage at which SARS delivers its statement of grounds of assessment and opposing appeal. The purpose of the rule is to crystallise the issues that fall to be determined by the Tax Court. Rule 31(3) permits SARS to include a new ground of assessment, unless that ground:

• constitutes a novation of the whole of the factual or legal basis of the disputed assessment; or
• requires the issue of a revised assessment.

The rule therefore allows a degree of flexibility, while at the same time imposing limits designed to ensure procedural fairness and certainty.

The dispute in Oakleaf (Lesedi)

The taxpayer, an independent power producer, incurred substantial expenditure prior to the commencement of trade in developing a solar photovoltaic facility. In its 2014 year of assessment, it claimed deductions for this expenditure, described as “development fees”, in terms of section 11A read with section 24J of the Income Tax Act.

In its finalisation of audit letter and the additional assessment that followed, SARS disallowed the deduction on the basis that:

• the expenditure was capital in nature;
• the authorities relied upon by the taxpayer, including CSARS v South African Custodial Services (Pty) Ltd and ITC 1870, only applied to the now defunct section 11(bA) of the Income Tax Act, which were applicable to preproduction interest and related finance charges, but were not applicable to section 24J; and
• the expenditure did not arise “in terms of” the relevant financial arrangements, notwithstanding any close connection to the raising of finance.

When SARS later delivered its Rule 31 statement, it maintained its opposition to the deduction but advanced a different basis for doing so. SARS accepted that “related finance charges” under section 24J may have a wide ambit and that costs not directly incorporated into loan agreements could, in principle, qualify. The focus of its opposition shifted instead to an alleged lack of factual particularity, contending that the taxpayer had not adequately demonstrated the necessary nexus between the expenditure and the relevant financial arrangements.

The Tax Court’s decision

The Tax Court held that SARS’ Rule 31 statement did not comply with Rule 31(3). In the Court’s view, SARS had not merely elaborated on the grounds set out in the assessment, but had abandoned the legal foundation of that assessment and replaced it with a materially different factual case.

The Court emphasised that the comparison required by Rule 31(3) is between the Rule 31 statement and the assessment itself, rather than the objection decision. It further held that permitting SARS to introduce a fundamentally different factual and legal basis at the Rule 31 stage would be prejudicial to the taxpayer and inconsistent with the structure of the objection and appeal process.

On that basis, the Court concluded that the new grounds advanced by SARS required the issue of a revised assessment and granted relief in favour of the taxpayer.

The appeal and the issues before the Supreme Court of Appeal

SARS has appealed the judgment to the Supreme Court of Appeal. The appeal raises, in broad terms, two related questions:

1. whether SARS’ Rule 31 statement constituted a novation of the factual or legal basis of the assessment, or whether it amounted to a permissible elaboration of the existing grounds of disallowance; and
2. what the appropriate consequence is if a contravention of Rule 31(3) is established.

The appeal is therefore not concerned with the substantive deductibility of the expenditure, but with the procedural limits applicable to SARS once an assessment has been issued.

Why the case matters

The appeal highlights an issue that arises with some frequency in practice. Whilst SARS is entitled to defend an assessment and to require a taxpayer to discharge the burden of proof, taxpayers are entitled to know the case they are required to meet and to object meaningfully to the grounds upon which an assessment is based.

If SARS were permitted to substitute the basis of an assessment during litigation, the objection process would be undermined and Rule 31 would lose much of its intended effect. Conversely, an unduly restrictive approach could impede SARS from properly articulating its case where an assessment has been imperfectly expressed.

The Supreme Court of Appeal’s decision may therefore provide important guidance on the balance to be struck between these competing considerations.

Conclusion

The Oakleaf (Lesedi) appeal affords the Supreme Court of Appeal an opportunity to clarify the scope and purpose of Rule 31(3), and to reaffirm the role of procedural certainty and fairness in the resolution of tax disputes.

Whatever the outcome, the judgment is likely to be of interest to taxpayers, practitioners and SARS alike, and may influence the conduct of tax litigation going forward. 

A Procedural Question at the Heart of Tax Litigation

A conversation with Johan Kotze, Tax Executive – Tax Dispute Resolution, Shepstone & Wylie:

Q: Johan, you’ve recently written about a Tax Court judgment that is now on appeal to the Supreme Court of Appeal. In simple terms, what is the case about?

At a high level, the case is not really about tax incentives or the deductibility of particular expenses. It raises a procedural question: to what extent may SARS change or reformulate its case during the appeal process, without issuing a revised assessment.

The Tax Court was asked to consider whether SARS’ statement of grounds of assessment under Rule 31 was consistent with the basis on which the assessment had originally been raised.

Q: Why is that an important question?

Because tax litigation is structured. An assessment is issued, a taxpayer objects to it, and the dispute then proceeds on defined grounds. Rule 31 plays an important role in that process by crystallising the issues that the Tax Court is asked to decide.

If the basis of an assessment can shift materially during litigation, it becomes difficult for taxpayers to know what case they are required to meet, and the objection process risks losing much of its practical significance.

Q: Is this a technical issue that only affects tax specialists?

Not really. While Rule 31 is specific to tax litigation, the underlying concern is procedural fairness and certainty. Those are principles that run through administrative law more generally.

From that perspective, the case is of interest beyond tax practitioners. It touches on how decision-makers are expected to conduct litigation once a decision has been taken and challenged.

Q: What did the Tax Court decide in this matter?

The Tax Court held that SARS’ Rule 31 statement did not comply with Rule 31(3) because it amounted to a departure from the factual and legal basis of the original assessment. In the Court’s view, the grounds advanced at the Rule 31 stage required the issue of a revised assessment.

Importantly, the Court’s reasoning focused on procedure rather than on the substantive tax position.

Q: SARS has appealed that decision. What will the Supreme Court of Appeal be asked to consider?

In broad terms, the Supreme Court of Appeal will be asked to determine whether the Rule 31 statement amounted to an impermissible novation of the assessment, or whether it was simply a permissible elaboration of the existing grounds.

A related question is what the appropriate consequence should be if a breach of Rule 31(3) is established. Those are procedural questions, rather than questions about the underlying tax treatment.

Q: Does the appeal require the Supreme Court of Appeal to decide the tax merits of the dispute?

No. The appeal does not turn on whether the expenditure in question is deductible. It turns on how far SARS may go, procedurally, in defending an assessment once it has been issued and objected to.

That distinction is important, because it frames the case as one about process rather than outcome.

Q: What should taxpayers and practitioners take away from this case at this stage?

The main takeaway is the importance of process. Assessments, objections and appeals are not informal steps; they serve specific functions. How a case is framed at the assessment stage can matter later.

The appeal may provide useful guidance on the role of Rule 31 and the extent to which procedural certainty is protected in tax litigation.

Q: What happens next?

The appeal will be heard by the Supreme Court of Appeal in due course. It would not be appropriate to speculate on the outcome, but the judgment should bring clarity to an area that has practical significance for both taxpayers and SARS.

Q: Once the Supreme Court of Appeal has given its judgment, do you expect to reflect on the outcome?

Yes, once the appeal has been decided it may be useful to reflect on the judgment, particularly if it provides clarity on the operation of Rule 31 and the procedural framework governing tax appeals.

For now, however, it is appropriate to allow the appeal process to run its course.