When a genuine mistake can rule out a penalty

The Tax Administration

Act’s (No 28 of 2011) understatement penalty regime imposes penalties on taxpayers whose tax positions have resulted in prejudice to the South African Revenue Service (Sars) or the fiscus.

The legislation does not provide Sars with a discretion on imposing understatement penalties in the case of prejudice. Instead, the act is instructive that an understatement penalty must be imposed.

The penalty s quantum depends on a specified list of behaviours by taxpayers that Sars deems to have been present in the circumstances. Each understatement in a tax period is investigated to determine which, if any, of the listed behaviours applies. These behaviours range from reasonable care not taken in completing a tax return , for which a minimum penalty of 25% is imposed, to the harshest penalties imposed for intentional tax evasion , being up to 200% the higher the degree of culpability, the more severe the penalty. Identifying the appropriate behaviour for imposing a penalty in each case is one of the few instances where the burden of proof is on Sars and not the taxpayer.

The only departure from the Tax Administration Act s instruction to impose a penalty is where the prejudice to Sars or the fiscus resulted from a bona fide inadvertent error on the part of a taxpayer.

In recent years, many cases that have proceeded to the tax and other superior courts have dealt with understatement penalties and substantial tax matters. In many cases, the imposed penalties have been upheld.

Shift In Approach

We have, however, recently seen a shift in our courts approach to the interpretation of the legislation dealing with understatement penalties, particularly on two grounds:

Sars’s identification of the relevant behaviour which has resulted in the prejudice and what constitutes a bona fide inadvertent error to escape penalties in its entirety.

Regarding the first matter, there appears to have been a practice that Sars, rather than identifying the appropriate behaviour and then applying the penalty percentage that corresponds with that behaviour, simply chooses a percentage penalty that it feels should apply in the circumstances with no regard to the appropriate behaviour.

In Lance Dickson

Construction CC v Commissioner for the South African Revenue Service delivered out of the Western Cape High Court on January 31 2023, the court called foul on such an approach by the commissioner and confirmed that the prejudice did not entitle Sars to then impose any penalty it considered applicable . The court went on: It follows that if, for example, Sars finds that there has been an understatement based on the taxpayer s failure to take reasonable care in completing its return, it must impose the 25% penalty: it does not have any discretion to lower the percentage. Similarly, if the behaviour category relied on by Sars is the absence of reasonable grounds for the tax position taken, it must impose a 50% penalty. There is thus no statutory basis to impose a 25% penalty in respect of behaviour falling within the ambit of item (iii).

Although a high court decision only, it is optimistic that the judiciary has called out Sars in their imposition of understatements, based on percentages only, without regard to the legislated list of behaviours which should determine the amount.

More encouraging is that we now have two Supreme Court of Appeal cases that have dealt with bona fide inadvertent errors, which should preclude any understatement penalties from being imposed. In practice, Sars has taken an extremely strict (and possibly incorrect) interpretation of what constitutes a bona fide inadvertent error. In CSARS v The Thistle Trust delivered on November 7 2022, the SCA dealt with the understatement penalty swiftly and noted “Sars initially adopted position that, in the light of the legal opinion, it should be concluded that the Thistle Trust had consciously and deliberately adopted the position it took when it elected to distribute the amounts of the capital gains as it did. However, during the argument before us, counsel for Sars conceded, correctly, that the understatement by the Thistle Trust was a bona fide and inadvertent error as it had believed that s 25B was applicable to its case. Though the Thistle Trust erred, it did so in good faith and acted unintentionally.

In the Coronation matter delivered on February 7 2023 (which refers to Thistle Trust), a similar position was taken: Nor is there anything to suggest that CIMSA s tax

WE NOW HAVE TWO SUPREME COURT OF APPEAL CASES THAT HAVE DEALT WITH BONA

FIDE INADVERTENT

ERRORS returns were not submitted in the bona fide belief that CGFM may be eligible for a s 9D exemption. The fact that this court has now found that this course is not open to it, does not in any manner reflect on the bona fides of CIMSA, any more than it reflects on the bona fides of any losing party in litigation.

The SCA now accepts that a party, in the mistaken belief that their position is accurate can still rely on the exclusion from the imposition of penalties where their bona fides can be demonstrated.

In these cases, the High Court judges and the SCA justices are applauded for bringing some sense of sanity to a penalty regime that has become almost a standalone area of litigation. Practitioners hope these judgments will either have Sars relook at their application of the legislation or, better yet, a change in legislation altogether by parliament.

● Pieter Janse van Rensburg is a director at AJM Tax. He also serves as a nonexecutive director on the board of the South African Institute of Taxation