Understatement penalties and bona fide errors
In terms of section 222 of the Tax Administration Act No. 28 of 2011, a penalty (known as an understatement penalty) must be levied in the event of an “understatement ” unless that understatement results from a “bona fide inadvertent error”.
The penalty amount is calculated by applying a certain percentage (determined by a relevant behaviour in the understatement penalty percentage table in section 223 of the Tax Administration Act) to the “shortfall ”.
Most of us are familiar with the fundamental requirement for the imposition of an understatement penalty, namely that an understatement penalty will be levied when underdeclaring taxable income or overstating an assessed loss. In other words, there must be an understatement to begin with.
As was illustrated in several recent court judgments discussed in this article, there are two more requirements that must be adhered to before an understatement penalty must (or can) be imposed.
First, no understatement penalty may be imposed if the understatement results from a bona fide inadvertent error (the burden of proof in this regard rests on the taxpayer). Second, for an understatement to exist, The SA Revenue Service (Sars) must prove that it results in prejudice to Sars or the fiscus.
The judgments discussed below clearly illustrate the importance of (i) not simply accepting penalties imposed by Sars and (ii) obtaining tax advice when faced with significant transactions.
CSARS v The Thistle Trust (November 7 2022)
The Supreme Court of Appeal considered the meaning of a “bona fide inadvertent error”, with its finding being aptly summarised in paragraph 29 of the case as follows:
“Sars initially adopted the 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 circumstances, it was conceded that Sars was not entitled to levy the understatement penalty.”
In other words, an incorrect tax position consciously and deliberately adopted by a taxpayer based on expert advice can be considered a bona fide inadvertent error. Much has been written about this judgment, but it is important to understand the taxpayer must demonstrate its bona fides in adopting a certain tax position that it (in good faith) believed to be true.
Although the above argument was made for the remittance of an understatement penalty imposed under Chapter 16 of the Tax Administration Act, said argument and consideration of the remittance was extended to apply to “Administrative Non-Compliance Penalties” imposed under Chapter 15 of the act by the appeal court in CSARS v Coronation Investment Management SA (Pty) Ltd (February 7 2023), where reference was made to Thistle.
Enviroserv Waste Management (Pty) Ltd v CSARS (December 18 2023)
The appeal court adjudicated a dispute relating to the so-called accelerated manufacturing allowance the taxpayer claimed regarding its waste management process. Of relevance here is that Sars imposed a 25% understatement penalty. The taxpayer appealed to the merits of the case and the imposition of the understatement penalty because (in its view) it resulted from a bona fide inadvertent error.
The court, however, took a different approach and considered first whether there was an
“understatement ” at all, which would only be the case if there was prejudice to Sars or the fiscus.
Regarding its judgment in Purlish Holdings (Pty) Ltd v CSARS, the appeal court confirmed that it is insufficient for Sars to merely show that its conduct falls within sections 221 and 223 of the Tax Administration Act. It must also show prejudice to Sars or the fiscus.
Although prejudice is not limited to financial prejudice and includes the risk that the misstatement will hamper
Sars ’ s ability to effectively administer tax legislation, a mere risk is insufficient. The appeal court concluded that Sars made no effort to prove the risk, and no understatement penalty could be levied.
Unitrans Holdings v CSARS (January 9 2024)
The high court in Gauteng found that the taxpayer in question incurred impermissible expenditure. On this basis, Sars imposed an understatement penalty due to a substantial underdeclaration of taxable income. The taxpayer argued that there was no understatement as the claim for deductions resulted from a bona fide inadvertent error.
The taxpayer further argued that Sars had to satisfy itself that there was no such an error. As the argument goes, the taxpayer contended that Sars did not even plead that the understatement was due to an inadvertent bona fide error. The court disagreed and found that the taxpayer did not demonstrate a basis to justify the court’s interference with the tax court’s decision to uphold the penalty.
In this case, the taxpayer did not commit a mistake in claiming the deductions. Instead, it maintained its tax position that it is entitled to the deduction. This case should be distinguished from the Thistle Trust case discussed above, in which the taxpayer relied on a tax opinion.
It is clear that taxpayers who have been subject to an understatement penalty should seek professional advice from a suitably qualified tax adviser to identify any potential remedies available that may result in the remittance of these penalties.
There is more to arguing against an understatement penalty than merely stating that it resulted from a bona fide inadvertent error.
TAXPAYERS WHO HAVE BEEN SUBJECT TO AN UNDERSTATEMENT PENALTY SHOULD SEEK PROFESSIONAL ADVICE