2 September 2011

Estimated assessments and the extrapolation of financial information

An interesting case recently came before the United Kingdom's Upper Tribunal (Tax and Chancery Chamber) in the matter of Queenspice Ltd v Commissioners for Her Majesty's Revenue and Customs [2011] STC 1457.

The taxpayer conducted business as a restaurant and, for purposes of its output VAT liability, had stated its turnover for the relevant period to be £164 045, or £4 206 per week on average.

However, the revenue authority, on two occasions, had sent officers to the business premises of the taxpayer where they conducted "cash ups" and noted the turnover for the day. This was done on Friday 19 October 2007 and Saturday 30 August 2008.

Based on the information retrieved, being the daily turnover for the said two days, the revenue authority calculated the average weekly turnover of the taxpayer for the relevant period to be £6 972. This was done on the assumption that half the weekly turnover of a restaurant such as the taxpayer is usually generated on a Friday and a Saturday.

The revenue authority thus concluded that there had been a 65% under-declaration of turnover by the taxpayer and, accordingly, it issued estimated assessments to the taxpayer reflecting a higher output VAT liability, going back six years.

In the First-Tier Tribunal, the taxpayer led evidence by an expert statistician who testified that using information relating to only two days could not be used as a sound basis for extrapolating the turnover over a period of six years. The taxpayer was unsuccessful and appealed to the Upper Tribunal on the basis that, inter alia, the First-Tier Tribunal had ignored the evidence of the expert statistician.

In respect of the applicable legal principles, the Upper Tribunal stated the following:

  • The primary obligation is on the taxpayer to make an accurate return.
  • Where this is not done, the revenue authority must make an assessment, to the best of its judgment, on the information available.
  • The judgment must be exercised honestly and in good faith and the information available must be considered fairly.
  • The conclusion must be reasonable and not arbitrary.

It continued by arguing that, because the primary obligation is on the taxpayer to make an accurate return, the revenue authority does not have to carry out exhaustive investigations - it does not have to do the taxpayer's work for it. In making an estimated assessment there is necessarily an element of guess work involved. The revenue authority may take an educated guess, and is even allowed a substantial margin for error, as long as the principles of honesty, good faith, fairness and reasonableness are complied with.

In respect of the evidence led, it was noted that the expert statistician's evidence was purely theoretical - he did not inspect the books of the business nor did he have any experience in the restaurant industry. The revenue official who made the estimates, on the other hand, had extensive experience in customs, excise and VAT evasion, including evasion in the restaurant industry. No evidence was led from the management or staff of the restaurant.

The First-Tier Tribunal had to decide between the purely theoretical contention of the expert statistician and the practical approach of the revenue official. It decided that it preferred the revenue official's approach and that his approach complied with the legal principles outlined above. The Upper Tribunal agreed and the appeal was dismissed.

Of course, the judgment leaves one somewhat astonished, and unnerved, as logically and statistically it is a simple truth that an extrapolation from a sample of two days over a period of six years is bound to result in gross inaccuracies. The margin for error granted to the tax authority could lead to inequitable results.

However, it can be inferred from the judgment that the taxpayer should perhaps not have limited its case to theoretical statistical evidence and should have led evidence from its management, staff and other sources in order to prove its turnover.

In the South African context, the Value-Added Tax Act No 89 of 1991 does not explicitly make provision for an estimated assessment to be issued, but it does make provision for an assessment to be issued in the case where, inter alia, a vendor defaults on rendering a return. Presumably, where insufficient information is available to determine the true tax liability, an amount may be estimated.

However, in respect of income tax, section 78 of the Income Tax Act 58 of 1962 specifically provides that "the Commissioner may estimate either in whole or in part" the taxable income of a taxpayer who defaults in furnishing a return. Unfortunately the section does not provide any guidance as to what the estimate may be based on or how the Commissioner may go about making such assessment.

Paragraph 95 of the draft Tax Administration Bill, 2010, provides as follows:

  1. SARS may make an original, additional, reduced or jeopardy assessment based in whole or in part on an estimate if the taxpayer-

(a) fails to submit a return as required; or

(b) submits an inadequate or incorrect return or information.

  1. SARS must make the estimate based on information readily available to it.

The Tax Administration Bill therefore goes somewhat further in providing that such an assessment may be based on information readily available but, like the Income Tax Act, does not provide any principled guidance either.

Heinrich Louw

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