A recent Tax Court judgment[1] has provided useful guidance on the procedural principles applicable to applications to strike out allegations contained in pleadings in tax litigation. This case highlights the importance of relevance in determining whether impugned statements should remain part of the record and underscores the strategic role of pleadings in disputes involving transfer pricing and time-bar defences.

Although interlocutory in nature, the judgment is noteworthy because it illustrates the high threshold that must be met before courts will interfere with pleadings in tax disputes.

Background to the dispute

The case arose from additional income tax assessments issued by SARS following a transfer pricing audit of the taxpayer’s affairs for the 2011–2013 years of assessment. The audit concerned transactions between the taxpayer and several related non-resident entities which, according to SARS, did not reflect arm’s-length returns as contemplated in section 31 of the Income Tax Act[2].

Following the issuance of additional assessments, the taxpayer pursued an appeal before the Tax Court. As part of its challenge, the taxpayer raised a point in limine based on Article 9(3) of the Double Taxation Agreement between South Africa and Switzerland. In essence, the taxpayer argued that SARS was barred from adjusting the relevant profits because the applicable five-year limitation period had expired.

During the course of the litigation, SARS delivered its Rule 31 statement[3] setting out the factual and legal grounds for the additional assessments. The taxpayer subsequently brought an interlocutory application seeking to strike out certain passages from the statement.

The application to strike out

The taxpayer applied to strike out particular paragraphs in the Rule 31 statement which alleged that the taxpayer’s failure to account for notional arm’s-length income constituted ‘wilful default’. The taxpayer contended that this allegation introduced a new basis for the assessment and should therefore be regarded as scandalous, vexatious, or irrelevant within the meaning of Uniform Rule 23(2)[4].

In addition, the taxpayer sought the removal of the words ‘managed or’ in a paragraph dealing with the relationship between the taxpayer and related entities. According to the taxpayer, this wording impermissibly expanded the factual basis of SARS’ case and therefore ought to be struck out.

Legal principles considered by the court

The court reiterated the well-established test applicable to applications to strike out allegations in pleadings. Under Uniform Rule 23(2) a matter may only be struck out if it is scandalous, vexatious or irrelevant, and if the applicant would suffer prejudice should the allegations remain in the record.

Drawing on Constitutional Court[5] authority, the court noted that:

• Scandalous allegations are those that are abusive or defamatory;
• Vexatious allegations are those intended to harass or annoy; and
• Irrelevant allegations are those that do not contribute to determining the issues before the court.

The decisive enquiry is therefore whether the impugned allegations are capable of contributing to the determination of the issues before the court.

Court’s reasoning

The court rejected the taxpayer’s contention that the allegation of wilful default was irrelevant. The taxpayer had relied on Article 9(3) of the Double Taxation Agreement, which limits the ability of a contracting state to adjust profits after a specified period. However, the same provision expressly provides that the time limitation does not apply in cases involving fraud or wilful default.

The court held that SARS’ allegation of wilful default was therefore directly relevant to the taxpayer’s time-bar defence. If the allegation were ultimately proven, the limitation period relied upon by the taxpayer would not apply. As a result, the allegation clearly contributed to determining the issues before the court and could not be regarded as irrelevant.

The court reached a similar conclusion in relation to the wording ‘managed or’ controlled. The existence of a connected-person relationship between the taxpayer and the foreign entities formed part of the factual basis of SARS’ transfer pricing case. The language used in the pleading reflected statutory terminology contained in the definition of ‘connected person’, and therefore could not be considered improper or irrelevant.

Outcome and implications

The Tax Court dismissed the taxpayer’s application to strike out the relevant passages and ordered the taxpayer to pay the costs of the application, including the costs of two counsel.

The decision confirms that courts will generally be reluctant to excise allegations from pleadings where those allegations bear directly on an issue raised by the opposing party. In tax litigation in particular, allegations relating to fraud or wilful default may assume procedural significance where taxpayers rely on statutory or treaty-based limitation periods.

For taxpayers and advisors, the case also illustrates the potential importance of allegations concerning wilful default in transfer pricing disputes, especially where taxpayers rely on treaty-based or statutory time limitations to challenge additional assessments.

As SARS continues to scrutinise cross-border transactions and transfer pricing arrangements, this decision serves as a reminder that procedural disputes regarding pleadings can play a meaningful role in shaping the course of tax litigation.