1 December 2022 by Tax & Exchange Control Alert

Understatement penalties and bona fide inadvertent errors

As taxpayers may be aware, should they cause or make an “understatement”, they may be liable to the South African Revenue Service (SARS) for an understatement penalty in terms of section 222 of the Tax Administration Act 28 of 2011 (TAA). This penalty could range from between 10% and 200% of the amount of the shortfall in tax.

An understatement is defined in section 221 of the TAA as any prejudice to SARS that results from, inter alia, failure to submit a return, an omission from a return, an incorrect statement in a return, or simply failing to pay tax if no return is required.

The applicable percentage is determined with reference to a table in section 223, setting out certain categories against which the taxpayer’s relevant behaviour or the amount involved must be judged.

It should be appreciated that, once it is established that there was indeed an understatement, the imposition of an understatement penalty by SARS is not a matter for discretion but is in fact mandated by law.

There are only a few circumstances in which a taxpayer may be excused. These are if (i) the understatement results from a bona fide inadvertent error; (ii) the taxpayer qualified for relief under the voluntary disclosure programme; or (iii) the taxpayer was in possession of a qualifying tax opinion as contemplated in section 223(3) of the TAA.

What constitutes a bona fide inadvertent error?

Our focus in this article is the concept of a bona fide inadvertent error.

In SARS’ formal Guide to Understatement Penalties (Issue 2), SARS essentially takes the following position.

In the first instance there must have been an error, essentially being a mistake or misconception of some sort. However, it is qualified by two factors, being that the error must be bona fide, and inadvertent. 

On the meaning of an “inadvertent” error, SARS concludes that “the understatement must result from an unintentional default, an accidental omission, an unplanned statement, an involuntary failure to pay the correct tax”.

On the meaning of “bona fide”, SARS appears to interpret it as meaning “genuine” or “real” and is somewhat reluctant to accept the meaning “good faith”.

In general, SARS is at pains to point out that it is the “trigger” that must be bona fide inadvertent, and not the person who made the error – divorcing it from the conduct of the taxpayer.

Specifically, “an inadvertent error is one that does not result from deliberate planning, and a bona fide inadvertent error is one that genuinely does not result from deliberate planning”.

SARS also points out that an error resulting from an opinion that was intentionally sought can never be a bona fide inadvertent error.

SARS essentially then concludes that “it seems likely that the only errors that may fall within the bona fide inadvertent class are typographical mistakes – but only properly involuntary ones”.

The Thistle Trust case

We reported on the case of Commissioner, SARS v Thistle Trust (516/2021) [2022] ZASCA 153 in our Tax Alert on 24 November 2022. That alert dealt with the substantive tax issues that were in dispute, but for the purposes of this article, we will only look at the imposition of the understatement penalty that was in dispute in that case.

In the Thistle Trust case, the taxpayer had obtained a tax opinion on the specific tax treatment of consecutive or back-to-back distributions by trusts. The taxpayer accepted the position taken in the opinion, and completed and submitted its tax returns on that basis.

SARS disagreed with the position taken by the taxpayer, assessed the taxpayer accordingly, and imposed an understatement penalty.

The Supreme Court of Appeal (SCA) ultimately held that SARS was correct in its assessment to tax, but during the course of the proceedings, it appears that a concession was made by SARS on the issue of the understatement penalty.

The SCA specifically records that:

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 section 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.”

The SCA’s interpretation of the exemption for bona fide inadvertent errors from understatement penalties (agreeing with the concession made by SARS) seems to differ from SARS’ interpretation as formulated in its guide.

The SCA appears to suggest that a taxpayer may “consciously and deliberately” adopt an incorrect position taken in an opinion, and complete its returns accordingly, and at the same time be regarded as having acted in good faith and unintentionally – qualifying  for exemption from understatement penalties.

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