DENNIS DAVIS: Here be dragons: Sars win on underpriced clothing affirms the integrity of the tax system

A recent decision by the Supreme Court of Appeal (SCA) in the case of the commissioner of the SA Revenue Service (Sars) versus Dragon Freight holds great importance for the integrity of the tax system in general and the collection of customs in particular. 

It appears there have been numerous instances of clothing being imported into SA, in the main from China, in circumstances where the recipients of these imports have significantly underdeclared the transaction value of the consignment. This has enabled them to pay far less customs duty than they were lawfully required to do.     

Dragon Freight is a clearing agent. The other respondents in the litigation all imported goods from China. Nineteen containers of clothing and textile goods arrived in SA. The goods were detained by Sars because it was suspected that all of these respondents had underdeclared their value. 

The various respondents were requested to complete a standard trader questionnaire generated by Sars, in which they were asked, inter alia, to provide the following information: how the importer sourced this foreign supply and established a trading relationship; and details of travel abroad to negotiate trade, substantiated with copies of pages from the importer’s/buyer’s passport showing all trips overseas to meet the suppliers.  

The respondents did not answer these questions. They simply replied that the importer acquired supplies during trips abroad and each was unable to obtain a copy of passport evidence at the time. In response to the general inquiries generated by Sars, they contended they had obtained clothing at reduced prices from factories in China that were closing down and selling stock at lower prices.

From information generated by the General Administration of Customs of the People’s Republic of China (GACC), Sars obtained export declarations submitted to GACC in respect of eight of the containers. These revealed that the invoice prices furnished by the respondents to Sars were “ridiculously low”. The prices stated in export declarations were 1,000 times more than the prices declared to Sars.

Understandably, Sars believed that Dragon Freight and the importers were liable for underpaid customs duty and VAT. After this decision, Sars sought to seize the goods in terms of section 88(1)(c) of the Customs & Excise Act of 1964.

Astonishingly, given the facts of this case, the high court set aside Sars’ decision not to return the 19 containers and ordered the immediate release of the containers and goods. To add insult to injury, Sars was required to petition the SCA after the high court refused leave to appeal, presumably on the basis that there were no realistic prospects of success.   

That the judicial confidence in such an adverse decision against Sars was misplaced is evident from the following passage of the judgment of the SCA, finding that there was a significant basis for the decision made by Sars to seize the containers:

“There was no credible explanation for the unbelievably low prices charged by the suppliers of the goods. The initial explanation that an employee of the importers bought the goods at low prices at various markets in China is false. So too the importers’ assertions that the low prices were obtained because they were able to exploit the ‘trade war’ between the US and China; that the goods comprised old or ‘dead’ stock, or clothing not in demand in China; and that the goods could be purchased at ridiculously low prices on the Alibaba website.

“The evidence of the expert, Dr [Jaywant] Irkhede, and that of [the SA Apparel Association] and [Apparel & Textile Association of SA] makes it clear that the prices declared by the importers were unrealistic and unattainable.”

Had the high court decision been upheld, it would have presented devastating consequences for Sars in its attempt to enforce the customs regime and ensure clothing cannot simply be imported into SA at whatever arbitrary price the clearing agent or importer chooses. 

Though the judgment was based on the facts of the case and did not make new law, it remains of considerable significance. Consider the following scenario, which is part of a scheme perpetrated by under-declarers of clothing and textile goods from China: instead of a suit being imported at, say, R2,000 and then being sold for R4,000, triggering a gross profit of R2,000 (which after various legitimate deductions would have reduced the taxable income on which tax was to be paid), the suit was imported at a price of R100.

Assume the suit sold on the open market for R4,000. The customs savings would be lost by way of an increased income tax liability. Inevitably, therefore, a form of transfer pricing would have been invoked to increase the deductible expenses in respect of the transaction and radically reduce the income tax liability of the importer.  

It follows that this decision will greatly reduce the ability of the tax collector to impose lawful duty on imports and curb the possibility of a transfer pricing practice running rampant. It is disturbing that a case such as Dragon Freight was not only lost in the high court, but that a whole range of Stalingrad legal tactics were employed to subvert the clear purport of fiscal legislation.  

This raises profound questions about the ethical quality of tax advice being given in the circumstances. This should prompt an earnest conversation about the contours of legitimate tax avoidance as opposed to tax evasion. 

• Davis, a retired judge president of the Competition Appeal Court, is an adviser to the commissioner of the SA Revenue Service.