22 July 2011

The "understatement penalty" - towards a more nuanced approach?

The South African Revenue Service (SARS) current Strategic Plan 2010/11 - 2012/13 indicates that, amongst others:

  • The core and unwavering strategic intent of any revenue administration is driving compliance.
  • Revenue targets are set to grow by 9.7%, 11.4% and 13.4 % over the period 2009/10 - 2012/13 respectively.
  • In line with global best practice, SARS intends differentiating its service offerings based on the needs and behaviours of different taxpayer groupings to enhance its efficiency and effectiveness in revenue collection and to improve compliance.

Taxpayers and advisers should therefore expect stringent compliance initiatives to underpin SARS's drive to achieve future revenue targets. Hence, expect any non-declaration, alternatively under-declaration of income, to attract strong attention.

On the other hand it appears that SARS's compliance efforts are to become more nuanced through differentiation. Certain aspects of the recent Tax Administration Bill (TAB), out for comment at the moment, seem to be a step in this direction.

The imposition of additional tax (generally referred to as "penalties") under s76 of the Income Tax Act is one area that generally lacks meaningful and objective differentiation. It's rather a case of one size fits all.

Many taxpayers and advisers can attest that the 200% penalty had, of late, become the new norm: s76 penalties are almost invariably imposed at the maximum level. In this regard, motivating extenuating circumstances to SARS gives new meaning to the saying about a camel passing through the eye of a needle.

The present wording of s76 is part of the problem. Section 76(2)(a) kicks off by giving the Commissioner carte blanche to remit the penalty imposed or any part thereof "... as he may think fit." However, the proviso that then follows indicates that, unless the Commissioner is of the opinion that there were extenuating circumstances, he shall not so remit if he is satisfied that any act or omission of the taxpayer was done with intent to evade taxation.

This construction has been interpreted as requiring SARS to commence its penalty imposition at the maximum 200% and where warranted, to work its way downwards. ITC 1295 42 SATC 19 held that the proviso in effect prohibited SARS from granting any remission where there had been evasion unless there were extenuating circumstances. In ITC 1331 43 SATC 76 it was held that the commencing point of consideration is the prescribed penalty and the issue thereafter is the extent by which it should be abated downwards, if at all, considering the circumstances of the particular case.

Authors on tax administration have pointed out that, in practice, the s76 penalty is pitched, almost by default, at 200%. The ball is then in the taxpayer's court to argue for remission. That process sometimes appears subjective and is highly unpredictable. Quite often the emphasis would be on the penal nature and deterrent effect of s76 rather than the prevailing extenuating circumstances. CSARS v NWK [2011] 2 All SA 347 (SCA) is a case in point. SARS persisted with the 200% penalty because it felt that there were no extenuating circumstances. On appeal the SCA reduced this to 100% indicating that 200% was "...severe and out of proportion to the wrong committed" by the taxpayer.

The imposition of s76 penalties and the subsequent remission thereof on the basis of extenuating circumstances have turned into somewhat of a lottery for taxpayers and advisers alike.

Chapter 16 (sections 221 - 224) of the TAB seeks to remedy the s76 short-comings through the introduction of an "understatement penalty".

In the Memorandum accompanying the TAB it is stated that "...the current open-ended discretion to impose an understatement penalty of up to 200% is now limited by a new structure whereby the percentage of the understatement penalty will be determined by the taxpayer's behaviour and objective criteria listed in the table. This is aimed at ensuring consistent treatment of taxpayers in comparable circumstances." It is also points out that the TAB's understatement penalty dispensation predominantly targets more serious non-compliance such as conduct that includes elements of tax evasion.

Section 222 first distinguishes between an "understatement" and a "substantial understatement" (both defined terms). This serves as a basis to quantify the "shortfall" due to the taxpayer's default. Once the "shortfall" has been determined, the s223 "understatement penalty percentage table" (the table) is used to calculate the "understatement penalty". In the event of any "understatement" by a taxpayer, the taxpayer must pay, in addition to the "tax" payable for the relevant tax period, the understatement penalty.

In deciding the applicable penalty percentage, two aspects play a role:

The taxpayer's behaviour at the time of the default (reasonable care / no reasonable grounds / gross negligence / intentional evasion).
The taxpayer's actions post detection by SARS (standard case / obstructive or repeat case / voluntary disclosure after audit notification / voluntary disclosure before audit notification).

The penalty matrix is as follows:

Item Behaviour Standard
case

 
If obstructive
or if it is a 'repeat case'
Voluntary
disclosure after
notification 
of audit
Voluntary
disclosure
before
notification
of audit
 (i) Substantial 'understatement'   25%  50%  5%  0%
 (ii) Reasonable care not taken in completing return  50  75%  25%  12%
 (iii) No reasonable grounds for 'tax position' taken  75%  100%  37%  18%
 (iv) Gross negligence  100%   125%  50%  25%
 (v) Intentional 'tax' evasion  150%  200%  75%  37%

In addition to this structured approach in respect of the understatement penalty, the TAB also introduces other significant changes:

  • Previously under s76 a taxpayer had to prove the existence of extenuating circumstances and motivate the downward remission from the 200% maximum.
  • In terms of the TAB's understatement penalty dispensation, the onus to prove the grounds for the imposition of an understatement penalty and the applicable percentage will now be on SARS. In terms of s224 SARS's imposition of an understatement penalty will be subject to the normal objection, appeal and dispute resolution procedures.
  • The understatement penalty dispensation will likewise apply to estimated and agreed assessments.

It is trusted that the TAB's understatement penalty dispensation will bring much-needed transparency, objectivity and predictability to SARS's imposition of penalties with regard to any alleged non-declaration or under-declaration of income - especially in light of the increased compliance actions envisaged by SARS in its Strategic Plan.

Johan van der Walt

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