South Africa: Punitive Costs Award Against Revenue

It is not easy to obtain an order for costs in the tax court, still less to get a punitive one against the South African Revenue Service (SARS). The Income Tax Act provides five grounds on which costs may be awarded against either taxpayer or SARS, and it was in terms of subsection (a), "the claim of the Commissioner is held to be unreasonable", that the Gauteng tax court recently awarded, not merely costs, but costs on the attorney and client scale against SARS in ITC 1816 69 SATC 62. This is the most punitive scale of fees that a court can impose and is used only when the court wishes to express its extreme displeasure with a litigant.

The facts were that the taxpayer, a Chartered Accountant (SA), was employed as a structured finance specialist and head of the business and market development division of a company in the banking sector from November 1995. In 1999 she and her employer commenced discussions, initiated by the employer, to enter into a restraint of trade agreement, which culminated in the signing of such an agreement on 29 October 1999. On 27 October the taxpayer had signed a letter acknowledging the contents of the agreement and agreeing to be bound by its contents. The terms of the agreement were that, in return for payment of R1.1 million in two tranches of R440 000 on 25 October 1999 and R660 000 on 30 September 2001, the taxpayer agreed to a restraint of one year after she left the employment of the bank. The record does not make this clear, but perhaps the reason for the letter of 27 October was to protect the employer, having paid out the first tranche, while the agreement was being hammered into its final shape. The first payment was duly made on the agreed date and, by agreement, used partly to settle her loan of R360 000 with the employer, which she had obtained to acquire shares in the employer in terms of an employee share scheme, while the remaining R80 000 was paid into her bank account. This was the payment that attracted the attention of SARS and led ultimately to the case.

As it happened, the taxpayer was retrenched at the end of August 2001, one of the conditions of which was that she would receive the second tranche on due date.

In her 2002 tax return the taxpayer disclosed the accrual of the restraint of trade of R1.1 million and receipt of the first tranche. SARS contended that the amount had accrued in respect of services rendered or to be rendered and as such fell to be included in her gross income. SARS gave two reasons for its contention: the fact that the first tranche had been paid before the agreement had been signed, and that the nature of the agreement was to remunerate the taxpayer for services rendered. In effect, SARS was claiming that the agreement was a sham and a disguise for compensating the taxpayer for services rendered.

Later, at the hearing, SARS sought to introduce an alternative argument, namely that the payment had the dual purpose of enabling her to pay the interest on her loan and to restrain her for one year. SARS added a further alternative, the reason for which flew in the face of the well established principles of accrual; namely that the second tranche had accrued, not on 29 October 1999, but on 30 September 2001, by which time the Act had been amended to include restraint payments in gross income. This contention seems to have received no attention from the court, and counsel for SARS conceded that it was not properly before the court, but in any event it was without merit and another example of the persecutory approach for which SARS was ultimately punished.

The court heard the evidence of the taxpayer to the effect that the restraint was genuine, and after September 2001 she had in fact honoured it. She was aware that the employer had enforced similar restraints against other former employees and never had she considered that the restraint was anything other than seriously intended. She had never been a director or a member of the management committee of the bank and was therefore unaware of certain discussions that had taken place at that level, where the management had noted that the employee share scheme was not achieving its objective and should be replaced by restraint agreements with key employees. She was, however, in possession of knowledge that was sensitive to the bank and would be of value to competitors. As for the payment on 25 October and signature of the letter on 27 October 1999, before the agreement had been signed, she indicated that the negotiations had been continuing for some time and she had verbally agreed to their terms by 25 October.

The taxpayer called another former employee, J, as a witness. Originally there had been an identical case against him, but SARS had conceded his appeal on the day of the hearing. Despite this, and to the further displeasure of the court, SARS had proceeded against the taxpayer. J’s evidence was in all respects similar to that of the taxpayer, and he was even more emphatic than the taxpayer that by 25 October 1999 binding oral agreements were in place.

SARS then called A, the CEO of the bank, as a witness. A testified as to the reason for the decision to enter into restraints with key employees and stated that the only reason had been to apply genuine restraints to these employees. Whereas in 1995 it had been easy to attract staff, this was longer the case in 1999. Under cross-examination he stated that the Board of the bank would never have drafted and entered into agreements which did not accurately reflect their true intentions. He found offensive SARS’ accusations that the agreements were shams. He also confirmed that it was the policy of the bank "to enthusiastically enforce" restraint agreements.

The court found that the agreement was genuine and an example of a common feature of commercial life and companies sought to apply "golden handcuffs" to key employees.

The court then turned to the application for costs against SARS. It described the late introduction of the alternative argument on apportionment as "yet another unjust and unreasonable action on the part of the respondent, bordering on harassment of the taxpayer". It then set out what it called SARS’ "whimsical conduct" in relation to the grounds of assessment. SARS had been consistently obstructive in carrying out its duty, under both the Income Tax Act and the Promotion of Administrative Justice Act, to furnish the taxpayer with adequate reasons for its assessments. SARS had conceded the appeal of J but not that of the taxpayer, even though the two matters were essentially identical. SARS had accused both the taxpayer and J of impropriety and put them both to the considerable expense of preparations for and, in the case of the taxpayer, participation in the hearing; and yet SARS had produced "not a shred of evidence of impropriety". Despite having consulted with A days before the hearing, and therefore knowing that his evidence would be adverse to its case, SARS persisted in putting the taxpayer to the expense of an appeal with a predictable outcome. After stating that: "Such conduct in our view constitutes the harassment of a taxpayer and does not behove the respondent", the court punished the "arrogant disregard for the rights of the appellant to administrative action that is reasonable and procedurally fair" by awarding costs to the taxpayer on the attorney and client basis.

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