A case we’ve all had to deal with – please use this as a cautionary tale. SARS essentially has argued that a shareholder loan represents undeclared income to the shareholder.

Key facts:

• Taxpayer has 19 or 20 companies, in which he is the sole shareholder and director, representing a mix of trading and property companies. The property companies are the crux of this case.
• The property companies earn rental income, which is then declared as a dividend to the shareholder. It is however never paid out, resulting in large credit balances owing to the taxpayer.
• The taxpayer would then use these credit loans to fund operations in other companies. This was either directly company to company or via his personal balance sheet. He would charge interest on monies lent to other companies and pay interest on monies borrowed. The lending rate always exceeded the borrowing rate.
• The key entity in question, Company A, also took ownership of his private home. The taxpayer also made various payments from Company A, including certain charitable donations. In addition Company A renovated the private home, with the split between private and business expenditure being unclear.

SARS argued that the taxpayer had failed to declare interest on this loan account as well as failed to declare portions of the capital as income, where appropriate.

The taxpayer fired their accountants and appointed new ones to resolve the tax issues. After the ADR was concluded, the new accountants decided that the AFS were incorrect and wanted to draft new accounts. During the entire objection and ADR process, the taxpayer and the new accountants had maintained that the loan account was simply a movement in cash with no income.

After the ADR, the accountants restated the accounts with a significantly reduced loan account. In the appeals process, the new accountants attempted to explain and reconcile the differences, stating that the main reason for the changes were an incorrect allocation between private and business expenses.

SARS did not accept the revised accounts. Nor did they come up with their own number. Instead, SARS relied on s 102, stating that it is the taxpayer’s responsibility to prove the number. SARS just needs to make up it’s mind whether it finds the evidence sufficient. The taxpayer did not agree with this statement. The core of the dispute is summarised as follows:

“During the 2014 year of assessment, the Taxpayer advanced funds amounting to R30 179 163 to Company A. The balance on this loan was R42 816 245 at the end of the 2015 year of assessment, resulting to an increase of R12 637 082. The Taxpayer has not provided any proof to confirm the source of these funds. The income declared by the Taxpayer on his returns for the said year is low and the inference is drawn that the Taxpayer received additional income in order to advance funds to Company A and has omitted the said income from his tax returns. Even though the Taxpayer borrowed funds from the Taxpayer D Group during the same period the funds were advanced to Company A, there is no evidence to suggest any link between the borrowings from the Taxpayer D Group and advances made to Company A.”

SARS also made the argument that, by this stage, it had been presented with 4 different versions of the loan accounts. Legally, this should give rise to a negative inference – in other words, if I’m telling a story that keeps changing, then it can be fairly inferred by an outside observer that my statements are less than honest, even though the law presumes honesty.

The only witness called by the taxpayer was the partner of the accounting firm. She confirmed that she had reconstructed the accounts using the bank statements.

Company A’ s financial statements were re-drawn. What was crucial for present purposes was the way in which the loan account was accounted for. That required her to make certain assumptions about the nature of the entry. She went through a laborious exercise of debiting and crediting the loan account depending on how it was classified in the bank statements. But bank statements are not always exact renditions of a transaction, something she readily accepted. But she stated that where there was not sufficient evidence about a transaction, they (she or her staff involved) allocated it to the taxpayer’s loan account. She repeated several times that this was a conservative approach. Explaining what this meant she said it meant it was to the benefit of SARS. But under cross examination she was unable to explain why it was to the benefit of SARS given that it did not change her version that these figures did not represent undeclared income.

There are a number of issues with this approach:

• As the partner was not there for the transactions, she is unable to provide true evidence of their nature, as that would require someone who was present at the time of transaction and with direct knowledge of the transaction.
• The partner had to make a number of assumptions about the nature of transactions as the taxpayer was not forthcoming. Amongst this was that there were payments made into Company A that related to a government contract issued to another company entirely. It was never explained why that payment was made into Company A books.
• For the improvement of the home the taxpayer lived in, owned by Company A, there was no direct evidence linking expenses to the improvements made. Instead, the partner had to rely on a quantity surveyors report.
• Under cross examination, she conceded that she had merely acted as compiler, she could give no assurance on the accuracy of the work done.

SARS appointed an expert witness who essentially refuted most of the partners claims. A key point – the partner had made it clear that she was appearing not as an expert witness, but a factual one. As such, she could only provide evidence on what she herself had done or seen. An expert witness on the other hand, is allowed to provide an opinion or judgement based on the facts presented to them.

[77] That is correct. SARS correctly argues that on this aspect Ms P’s testimony is that of an expert. But she did not testify as an expert so her testimony on these facts cannot be admissible. She was on her own admission a compiler of financial information not an expert in a position to express an opinion. Since her evidence was crucial to the issue of whether the loan account was derived from undeclared income, her opinion on this issue does not take the taxpayer further in his burden in respect of the onus.

As such, the expert witness can make express an opinion on the accounts presented to them. Ms P could not – and she admitted as much. However, as the Court held:

[93] Ms P cannot be faulted for the diligence of her efforts. But she was given a poisoned chalice. She had to account for funds without access to the FGB records and it would seem, for they were never discovered, the taxpayer’s private accounts. Not having had the benefit of his testifying she had to rely on evidence that was hearsay. Nor was she qualified as an expert so she could not venture opinion evidence either. 

So where did this case end up? With the taxpayer being held liable for income on the capital and undeclared interest.