Tax advice – a thistle between the thorns

In order to prevent prejudice to the South African Revenue Service (SARS) or the fiscus, SARS introduced an understatement penalty to encourage compliance and prevent unwanted behaviour, such as non-compliance and tax evasion. 

What is an understatment penalty?

As stated in section 222(1) of the Tax Administration Act No 28 of 2011 (“TAA”), in the event of an ‘understatement’ by a taxpayer, the taxpayer must pay, in addition to the “tax” payable for the relent tax period, the understatement penalty (“USP”) determined under subsection (2) of section 222 of the TAA. The last-mentioned subsection refers to the USP percentage table contained in section 223 of the TAA. A USP will not be imposed where the ‘understatement’ results from a bona fide inadvertent error.

 What is an understatment?

An ‘understatement’ is defined in section 221 of the TAA as any prejudice to SARS or the fiscus as a result of:

• The failure to submit a return required under a tax Act or by the Commissioner;
• An omission from a return;
• An incorrect statement in a return;
• If no return is required, the failure to pay the correct amount of ‘tax’; or
• An ‘impermissible avoidance arrangement.”

These behaviours must, therefore, result in prejudice to SARS or the fiscus for a USP to arise.

 What is the reason for the understatement penalty?

 The USP regime is designed to focus on curbing certain taxpayer behaviours:

i. Substantial understatement;

ii. Reasonable care not taken in completing return;

iii. No reasonable grounds for “tax position” taken;

iv. Impermissible avoidance arrangement;

v. Gross negligence; and

vi. Intentional tax evasion.

Understanding taxpayer behaviour

SARS had indicated that the behaviours of a taxpayer will depend on the specific circumstances, and for a business i.e. the characteristics and complexity of its business activities (size, nature, taxable activities); the manner in which affairs are conducted (including the appropriateness of records, procedures, practices, and systems) and the diligence employed to guard against the errors occurring (including the effort to understand tax liabilities) will be taken into account. SARS will accordingly evaluate if reasonable care was taken in submitting a tax return.

 Determining the type of taxpayer behaviour often presents interpretative challenges in practice.

In the Thistle Trust v. Commissioner for the South African Revenue Service [2024] ZACC 19 case, following the conclusion of an audit, SARS argued that the liability to pay capital gains tax lies with the Thistle Trust and not its beneficiaries. On 21 September 2018, SARS issued additional assessments to the Thistle Trust for the undeclaration of capital gains received and imposed USPs. The Thistle Trust objected to the additional assessment claiming that the conduit principle should apply thereby passing the tax liability to the final beneficiaries.

In this case, the Thistle Trust contended that, even if the additional assessment was correct, its failure to account for these capital gains in its tax returns was a bona fide (good faith) inadvertent error within the meaning of section 222(1) of the TAA and, therefore, could not give rise to USPs.

SARS argued that the Thistle Trust’s understatement arose as a result of “no reasonable grounds for [a] tax position” taken, or alternatively, “reasonable care not taken in completing [a] return”.

It is important to note that SARS bears the onus of proving which behavioural category applies to the USP to be imposed.

The Thistle Trust, however, obtained tax advice with regards to the tax treatment of the transactions under consideration. SARS, however, argued that if the Thistle Trust had taken reasonable care in completing its return, it would have ignored the tax advice given to it and followed the stated SARS position, which such tax advice expressly considered and rejected. This argument is based on the proposition that no taxpayer can act reasonably on tax advice that differs from SARS’ interpretation of tax legislation. However, this argument would elevate SARS to the status of an authority that can decree the only reasonable interpretation of tax legislation. It is an untenable argument and was, therefore, dismissed by the court.

Therefore, the fact that tax advice was obtained could not be disregarded, although SARS did not agree with the tax position taken by the taxpayer. As a result, no USPs were imposed.

 The takeaway

Where tax advice was sought from a tax professional, it would be more challenging for SARS to prove that no reasonable grounds existed for a tax position taken or that reasonable care was not taken. To avoid tax disputes and the imposition of USPs, it would be prudent to consider obtaining tax advice before a tax position is taken.

Authors:

Elmien Theron, Associate Director

Priscilla Letsoalo, Assistant Manager