SARS focuses on compliance

National Treasury released the Tax Administration Act, 2011 (TAAct) within a few weeks following the promulgation of the SARS strategic plan. The TAAct seeks to simplify the administrative provisions that are generic to all tax Acts and currently duplicated in the different tax Acts.

It appears that SARS will use the TAAct to drive the implementation of the objectives raised in the strategic plan.

SARS has stated that businesses are increasingly using sophisticated and complex financial schemes to evade tax obligations and minimise the effect of slow economic growth on profitability. Examples identified by SARS include the use of domestic loopholes to evade tax and take advantage of cross-border structuring and transfer pricing. SARS has also indicated that VAT processes will be under pressure as businesses deal with the slow economic growth. This is likely to lead to increased incidence of VAT fraud, including the over-claiming of input VAT and the non-accounting for output VAT.

The above matters have huge implications on how businesses, including short- term insurers conduct their VAT affairs. For example, any transfer pricing adjustments as a result of SARS attacking the transfer price charged between related entities could lead to adjustments to the VAT declarations. Such adjustments could result in interest and penalties being imposed.

As a measure to identify risks and enforce compliance, SARS recently introduced a Supplementary Declaration return (IT14SD). This return will require short-term insurers to be vigilant with respect to VAT accounting. The IT14SD is intended to reconcile financial information across PAYE, Income Tax, VAT and Customs tax types. The form requires the reconciliation to be accurate to within R100, and it has to be completed within 21 days.

For short- term insurers, completion of this return will be onerous because of reconciliation difficulties that arise as a result of the timing differences between VAT accounting (cash based) and financial accounting (accrual based). Furthermore, the VAT treatment of the different transactions undertaken by short-term insurers and the accounting systems used to effect these transactions add another dimension to the difficulties in reconciling financial information to the various taxes.

Currently, SARS is focusing on input tax apportionment in the financial services industry. In this regard, short term insurers should consider the effect of the investment income on input tax recovery. There is a misconception that because short-term insurers earn taxable premium income, there is no need to perform an apportionment calculation to determine input tax deductions as is the case with long-term insurers and other financial institutions. This view is incorrect. Because of the significant amount of exempt investment income earned by short-term insurers, it may be necessary to apportion input tax. For the purposes of determining apportionment requirements, investment income includes proceeds generated from the disposal of equity and debt securities, interest income and all other exempt and non-taxable income streams.

SARS has stated that all income which is accrued which is not taxable, such as dividend income should also be included in the apportionment ratio calculation. The question which arises in determining the apportionment ratio is what is the impact of reinsurance recoveries on the apportionment calculation? Reinsurance recovery income from foreign reinsurers is neither exempt nor taxable and, therefore, it needs to be determined whether this income should form part of the apportionment calculation.

To answer the above question, insurers should consider applying to SARS for approval of a suitable method of apportionment which provides a fair reflection of input tax incurred for the purposes of making taxable supplies. It is important to note that the TAAct requires that where a taxpayer applies for an alternative method of apportionment, the effective date of the new method cannot be earlier than the beginning of the current financial year in which the ruling application is submitted. The effective date of the TAAct is 1 October 2012. Therefore, taxpayers have a short window of opportunity to apply for a retrospective apportionment method for a period of five years, in terms of the current VAT legislation.

In light of the emphasis by SARS on tax compliance, short- term insurers cannot afford to be complacent. It appears that the promulgation of the TAAct will reward those taxpayers that voluntarily disclose tax liabilities and non- compliant tax payers will be punished. In this regard, the TAAct stipulates that a taxpayer will be required to pay, in addition to the tax payable, an understatement penalty which is calculated based on the behaviour of a taxpayer.

The behaviour of taxpayers is classified into five categories, namely: "substantial understatement‟, reasonable care not taken when completing a return, failure to provide reasonable grounds for a "tax position‟ adopted, gross negligence and intentional tax evasion. In this context, substantial understatement means liability of tax which exceeds the greater of five per cent of the tax payable/refundable or R1 million.

Where the understatement of tax is substantial, the taxpayer may be required to pay an understatement penalty of 25% of the understated tax. However, should the taxpayer voluntarily disclose the understatement of tax to SARS prior to notification of an audit, the authorities will waive the full amount of understatement penalty. The understatement penalty could increase to 150% of the tax due where there is gross negligence and up to 200% in the case of intentional tax evasion.

It appears that SARS is encouraging taxpayers to voluntarily disclose any tax liabilities. However, where SARS identifies the liability as a result of an audit, the taxpayer will pay a hefty price.

If short-term insurers are to avoid VAT costs as a result of promulgation of TAAct, compliance with the VAT Act cannot be ignored. The complexities of VAT accounting in the short-term insurance industry, the new requirement to reconcile all taxes and SARS‟ stated objective to increase tax compliance underscores the importance of reviewing and confirming the accuracy of VAT accounting in the short term insurance industry.

Article by Dorwin Nyaya of PwC. It first appeared in the SAIA Bulletin, September 2012.