Good news for South African taxpayers

SARS has traditionally taken a strict view of what constitutes a “bona fide inadvertent error” that allows taxpayers to avoid understatement penalties ranging from 10% to 200% of the tax shortfall. 

However, the revenue service must update this view as the Supreme Court of Appeal (SCA) and the Constitutional Court have clarified what constitutes such an error. 

The clarification from the courts also showed how important it is for taxpayers to receive professional tax advice. 

BDO South Africa Associate Director Esther van Schalkwyk explained that the courts’ view on this matter is largely favourable to taxpayers. 

For years, SARS has taken a strict view of what constitutes a “bona fide inadvertent error” – a golden ticket that allows taxpayers to avoid understatement penalties ranging from 10% to 200% of the tax shortfall.  

However, in 2022, this stance shifted when SARS, before the SCA in CSARS vs The Thistle Trust, conceded that the Trust’s reliance on a tax opinion was such an error.

There’s some uncertainty about whether the SCA’s ruling in the Thistle case established a binding precedent on interpreting “bona fide inadvertent error.” 

Since SARS conceded the point, the matter was not argued before the court. Nonetheless, the SCA affirmed SARS’ concession, adding weight to the idea that relying on a professional tax opinion may qualify as such an error. 

This challenges SARS’ earlier stance, which limited errors to typographical mistakes, asserting that such errors could never arise when adopting a deliberate tax position. 

The Constitutional Court has now also had its say on understatement penalties and has taken a view largely favourable to taxpayers.

The debate progressed in 2023 when the SCA ruled in the CSARS vs Coronation case, again excusing the taxpayer from penalties despite Coronation not disclosing the advice it relied on. 

Both cases, Thistle and Coronation, were appealed to the Constitutional Court, and these judgments have now been delivered. 

In the Coronation case, the Constitutional Court found in the company’s favour on the merits, ruling that the foreign business establishment (FBE) exemption applied to its controlled foreign company (CFC). 

Consequently, SARS’ appeal regarding understatement penalties was not considered. This was a significant victory for Coronation, also given that the penalties SARS sought would have been substantial.

The majority of the Constitutional Court in The Thistle Trust v CSARS handed down on 2 October 2024, upheld the SCA’s decision, therefore ruling in SARS’ favour on the merits. 

Interestingly, SARS attempted to backtrack on its earlier concession regarding understatement penalties, claiming it never conceded that the Trust’s reliance on expert advice amounted to an error. 

However, the Constitutional Court dismissed SARS’ application for a cross-appeal, deeming it not to be in the interests of justice to hear the cross-appeal.

Importantly, the court made significant remarks about two key penalty behaviour categories, at least one of which SARS argued should apply. 

The court found there were indeed reasonable grounds for the tax position adopted by The Thistle Trust, and the Trust had taken reasonable care in completing its return, especially considering it relied on professional legal advice. 

These comments, supported by eight judges, suggest that simply adopting a position contrary to SARS should not automatically lead to penalties.

For SARS to successfully impose penalties, it must demonstrate that the taxpayer’s actions fall within one of the behaviour categories outlined in section 223 of the Tax Administration Act. 

These range from “substantial understatement” to “intentional tax evasion.” If a taxpayer fully discloses an arrangement to SARS and relies on a professional opinion that meets specific requirements, SARS is unlikely to prove the presence of any of the behaviour categories. 

Only in cases involving impermissible avoidance arrangements might SARS succeed in imposing penalties.

While the Constitutional Court did not define what constitutes a bona fide inadvertent error, the SCA’s rulings provide valuable guidance.  

SARS’ previous narrow interpretation requires an update, especially when taxpayers act on professional advice. 

This emphasises the importance of obtaining tax opinions that meet the requirements of section 223 – a safeguard that taxpayers should not overlook, warned Van Schalkwyk.