Tax Penalty Shake-Up: What it means for taxpayers

Notably, revenue collection efforts are set to be strengthened through the application of understatement penalties in instances where bona fide inadvertent errors result in a tax shortfall for any given assessment year. It is essential to understand that once an understatement is identified, SARS is legally obligated to impose an understatement penalty unless the shortfall is due to a bona fide inadvertent error. In all other scenarios, SARS retains discretion only in determining the behaviour category to apply when levying the penalty. 

Currently, bona fide inadvertent errors are exempt from understatement penalty provisions. However, the proposed changes would eliminate this immunity, subjecting such errors to a "substantial understatement" penalty moving forward. 

Under the existing framework, understatement penalties are determined based on a table that categorizes various taxpayer behaviours, with penalties escalating in severity according to the degree of culpability. These penalties include: 

A 10% penalty for "substantial understatements," applicable when the prejudice to SARS or the fiscus exceeds the greater of 5% of the tax properly chargeable or refundable for the relevant period, or R1,000,000. This definition requires amendment, as it currently applies only where there is an actual tax debt of R1,000,000 or more, rendering the 5% reference redundant. 

A 25% penalty for failing to take reasonable care in completing the return. 

A 50% penalty for lacking reasonable grounds in completing the return. 

A 75-150% penalty for impermissible avoidance arrangements, international tax evasion, and gross negligence. 

When an understatement arises from a bona fide inadvertent error, no penalty or behaviour category is applied to the tax shortfall. This recognizes that taxpayers may occasionally make genuine, unintentional errors that are not intended to avoid or evade tax, even if the amount is substantial. Case law has established that such errors refer to unintentional defaults or accidental mistakes that do not result from deliberate planning and are involuntary in nature. Examples include typographical mistakes. 

The Minister's proposal to associate bona fide errors with substantial understatement behaviour is particularly stringent, as it leaves no room for errors. It assumes that all taxpayers, even those making genuine mistakes, will be subject to an understatement penalty to align with "similar penalty frameworks." 

We hope the Minister will also reconsider the definition of substantial understatement, as the current definition presupposes that every shortfall exceeds R1 million, even if it is more than 5% of the total taxable income. This interpretation by the Revenue Service would disadvantage smaller taxpayers and those in an assessed loss position, even if the default arose from a genuine, non-deliberate error. 

If the amendment is enacted, taxpayers unable to fall within the "substantial understatement" category will automatically default to the "no reasonable care taken in completing the return" or "no reasonable grounds for tax position taken" categories, subject to penalties of 25% or 50%. This provision would undoubtedly prejudice taxpayers who make smaller genuine errors where the tax in question is not at least R1 million. 

This proposed change has raised concerns among taxpayers and tax professionals alike, as it could create a more punitive tax environment. Smaller taxpayers and those who make genuine unintentional mistakes could be disproportionately affected, especially if the definition of substantial understatement remains unchanged. Corporates, regardless of size, would need to ensure that the information contained in their tax returns is 100% accurate before submission, as there will be no room for error if this amendment is implemented. 

With this proposed change, it would be interesting to see how much revenue SARS has calculated that they will collect in order to meet the revenue targets set by the Minister. 

Authors:

Althea Soobyah,Partner: Head of Tax & Nicole Erlank, Manager