The onus of proof rule for the imposition of understatement penalties

As a basic principle, under s102(1) of the Tax Administration Act, No 28 of 2011 (TAA), the onus of proof that an amount is not taxable or that an amount is deductible, rests on the taxpayer, whereas under s102(2) of the TAA, the onus of proof pertaining to the facts upon which an understatement penalty is imposed, is upon the South African Revenue Service (SARS).

Too often, upon the conclusion of investigations or reviews, SARS threatens exorbitant understatement penalties for seemingly innocuous and easily resolvable queries. A good example is the classic turnover/expenditure reconciliation process which could produce, in certain instances, horrendous results for a taxpayer where the calculations are devoid of commercial logic. By its very nature, a turnover/expenditure reconciliation is a first-level enquiry and only serves the purpose of testing reasonability between amounts declared by a taxpayer in its VAT201 returns and the amounts reflected in that same taxpayer’s annual financial statements. Unreconciled differences are often taken as gospel, resulting in either income tax or Value-Added Tax (VAT) assessments, coupled with the imposition of understatement penalties (in some cases, as far as accusing a taxpayer of intentional tax evasion).

In examining the onus of proof requirement, s102(1) of the TAA has the effect of placing the onus to deal with and explain the unreconciled differences upon the taxpayer, no matter how ridiculous the result of the first-level enquiry from SARS’ side might be. Explaining the unreconciled differences would generally not be of concern, as SARS may not have taken account of various factors, such as overlapping tax periods or the adoption of certain accounting policies for recognising revenue and expenditure. To the extent that unreconciled differences do, however, remain in SARS’ favour, the issue of severe understatement penalties still remains. But should understatement penalties even feature in a scenario such as this?

A not too uncommon scenario arises in SARS’ findings letters, to the effect that unreconciled differences are regarded as intentional tax evasion, which brings with it potential understatement penalties of 150% for a ‘standard case’, under s223 of the TAA. Taxpayers are then essentially forced to provide reasons to SARS so as to avoid the imposition of the 150% understatement penalty, without SARS having first provided any shred of evidence that intentional tax evasion actually exists. This results in a serious misapplication of the TAA and a reversal of the onus from SARS back to the taxpayer.

Proving ‘intentional tax evasion’ in a simple turnover/expenditure reconciliation context would be extremely difficult for SARS, to say the least. As stated above, a turnover/expenditure reconciliation exercise is a first level enquiry, without having regard to any actual source documentation (such as tax invoices) making up the various transactions of a taxpayer.

A first level enquiry, forming the basis of a findings letter (for example), should provide the taxpayer an opportunity to review the stated findings and provide evidence to SARS to the extent that an error has been made in the calculations. A first level enquiry cannot constitute a basis for accusing a taxpayer of ‘intentional tax evasion’ where SARS has failed to discharge its onus of proof under s102(2) of the TAA.

In understanding the behaviour of ‘intentional tax evasion’ as contemplated in s223 of the TAA regard must be had to SARS’ Short Guide to the Tax Administration Act (Guide), which clearly states, at page 81, “to evade tax includes actions that are intended to reduce or extinguish the amount that should be paid, or which inflate the amount of a refund that is correctly refundable to the taxpayer” and goes on further to state that the “most important factor is that the taxpayer must have acted with intent to evade tax. Intention is a wilful act, that exists when a person’s conduct is meant to disobey or wholly disregard a known legal obligation, and knowledge of illegality is crucial”.

A first level turnover/expenditure reconciliation enquiry by SARS can never, in our view, establish any intent to evade tax as it is merely a test of reasonability. Once the test of reasonability is complete, it is only actual source documentation, coupled with a host of other factors that could remotely bring into play ‘intentional tax evasion’. Taxpayers should not merely provide reasons to defend an ‘intentional tax evasion’ allegation where no credible evidence has been put forward by SARS to discharge its (frankly difficult) onus pertaining to the imposition of understatement penalties under s102(2) of the TAA.