It has become general practice for SARS to issue a letter of demand requesting a reasonable explanation as to why a person or third party should not be held personally responsible for the debt owing to SARS by a corporate entity. SARS goes further by stating that if the requested explanation does not reach their offices within 21 business days, the Receiver will have no alternative but to come to the conclusion that such a person is personally liable for the outstanding debt to them – and that all legal remedies will be exhausted to recover the said debt.
The separate legal personality that a company or close corporate possess is enshrined in section 19(1) of the Companies Act, which states that from the date of incorporation of the company, the company shall have all the legal powers and capacity of an individual, except when the company’s memorandum of incorporation prohibits it. According to the cases of Salomon v Salomon & Co Ltd 1897 AC 22 (HL); Ochberg v Commissioner for Inland Revenue 1931 AD 215 and Hughes v Ridley 2010 (1) SA 381 KZP, the profits and losses and assets and liabilities belong to the company. Therefore, a juristic person’s separate legal personality needs to be acknowledged by SARS. In the Ochberg- case the court said that:
“…as long as the law allows it, the court has to recognise the position. But then too the person himself must abide by that. A company being a juristic person, remains a juristic person separate and distinct from the person who may own all the shares, and must not be confused with the latter.”
However, section 163(4) of the Companies Act states that “whenever a court, on application by an interested person, or in any proceedings in which a company is involved, finds that the incorporation of, or any act by or on behalf of, or any use of, that company constitutes an unconscionable abuse of the juristic personality of the company as a separate entity, the court may declare that the company is to be deemed not to be a juristic person in respect of such rights, obligations or liabilities of the company, or of such member or shareholder thereof, or of such other person as specified in the declaration, and the court may give such further order or orders as it may deem fit in order to give effect to such declaration…”
For the first time in South African company law, the doctrine of piercing of the corporate veil is enacted in the Companies Act, a mechanism that can be utilised very effectively by SARS. Luckily this doctrine also has its limitations. In the matter of ITC 1611 59 SATC 126, Wunsch J held that a court can lift the veil only if that is legitimate by application of established doctrines, such as the plus valet rule or the fraus legis rule (or in other cases of fraud or dishonesty) or, possibly, the actio pauliana, that is if the requirements for such application are present, or a finding of a true relationship of principal and agent. There is, we consider, no self-standing doctrine of piercing the veil.
That being said, according to section 22(1) of the Companies Act, if a company carries on its business recklessly or with gross negligence, with the intent to defraud any person or for any fraudulent purpose, the directors and prescribed officers can be held personally liable. Therefore a director is liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the director having been a party to an act or omission by the company despite knowing that it was being conducted in a reckless, gross negligent manner and with the intention to defraud any person or trade under insolvent circumstances. It will be a rocky road for SARS if they vest personal liability for the company’s tax debt with directors.
The legislator, however, paved the way even further for SARS to target directors as far as it pertains to personal liability. Section 48(9) of the Value Added Tax Act states that “where a vendor is a company, every member, shareholder or director who controls or is regularly involved in the management of the company’s overall financial affairs shall be personally liable for the tax, additional tax, penalty or interest for which the company is liable.” When exactly a person will be regarded as in control of or be regularly involved in the management of the overall financial affairs of the company or of any entity, will be a question of fact.
Control or regularly involved is not defined by the VAT Act, but control is defined in the International Financial Reporting Standards (IFRS). These standards describe the term as “having the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities”. Control is presumed when the parent company acquires more than half of the voting rights of a enterprise. Therefore a holding company that is the controlling shareholder may be held liable for outstanding tax to SARS.
This section has draconian implications providing SARS with an opportunity to hold any director, member or shareholder personally liable for any VAT, additional tax, penalty or interest under the VAT Act. Section 48(9) must, however, not be understood so as to implicate all directors, members or shareholders. Section 48(9) will only find application where the director, member or shareholder controls or is regularly involved in the management of the company’s overall financial affairs. SARS will have to consider the facts of the case to establish the extent of the application of section 48(9). This section is also very burdensome, because it forces personal liability on shareholders and directors for what is in reality, a liability of the company.
However, section 48(9) of the VAT Act must be read in conjunction with sections 19(1), (2); 22(1) and 77(9) of the Companies Act. Section 19(1) enshrines the separate legal personality of a company while section 19(2) states that a person is not, solely by reason of being an incorporator, shareholder or director of a company, liable for any liabilities or obligations of the company, except to the extent that this Act or the company’s Memorandum of Incorporation provides otherwise. Section 48(9) of the VAT Act may very well be inconsistent with the wording of section 19(2) and 22(1) of the Companies Act by imposing personal liability on shareholders and directors for debt incurred by the company without the directors and shareholders acting in a fraudulent or grossly negligent manner.
Section 5(4)(i) of the Companies Act also states that if there is any inconsistency between the Companies Act and the Auditing Professions Act, 26 of 2005; the Labour Relations Act, 66 of 1995; the Promotion of Access to information Act 2 of 2000; the Promotion of Administrative Justice Act 3 of 2000; the Public Finance Management Act 1 of 1999; the Security Services Act 36 of 2004 and the Banks Act 124 of 1993, the last mentioned Act will apply . Neither the VAT Act nor the Income Tax Act is listed, which means that in all other instances the Companies Act will be applicable.
Lastly, section 77(9) of the Companies Act states that a court may relieve the director from liability on any terms the court considers just if it appears that (a) the director acted honestly and reasonably; or (b) regarding the circumstances, it would be fair to excuse the director which is a remedy that a vendor or director upon whom personal liability is being imposed by SARS may revert to.
If you do receive a SARS letter imposing personal liability upon you as director or shareholder for a company’s debts owed to SARS, be extremely cautious when replying to SARS, even though it might seem upon interpretation of the law that SARS’ power to impose personal liability on a person is limited. It’s worth noting that section 48(9) of the VAT Act has not been challenged in our courts thus far and until it is, it may remain a purely academic debate.