South African taxpayers could face more SARS penalties

The National Treasury and SARS have proposed amendments that would make it more difficult for taxpayers to rely on the “bona fide inadvertent error” defence to escape penalties for mistakes on their tax returns.

The annual draft tax Bills by the National Treasury and the South African Revenue Service (SARS) have recently been circulated for comment.

Webber Wentzel partner Joon Chong explained that these Bills contain contentious proposed amendments to the understatement penalty (USP) regime.

The effect will allow the “bona fide inadvertent error” defence to avoid any USP only where the prejudice results in a “substantial understatement”. This is an objective test based on the calculated tax shortfall to SARS.

The gateway to the USP regime is the existence of an “understatement”, a broadly defined term in section 221 of the Tax Administration Act (TAA).

The broad definition means that almost any error on a tax return, regardless of its magnitude or the taxpayer’s intent, can technically be an understatement and result in a USP.

The current wording of section 222(1) of the TAA provides that a bona fide inadvertent error is a complete defence against the imposition of any USP. However, the term “bona fide inadvertent error” is not defined anywhere in the TAA.

In its Guide to Understatement Penalties (Issue 2), SARS expresses a narrow view. “It seems likely that the only errors that may fall within the bona fide inadvertent class are typographical mistakes – but only properly involuntary ones,” SARS said.

Chong explained that taxpayers have argued for a broader interpretation encompassing honest mistakes of law made in good faith.

This has given rise to important judgments by the Constitutional Court and the Supreme Court of Appeal, which challenged SARS’ narrow interpretation of the meaning of “bona fide inadvertent error”.

These cases have not always resulted in a win for the taxpayer on the tax positions taken. However, they established a judicial trend towards protecting taxpayers who act in good faith and rely on professional advice.

“These cases form the critical backdrop to understanding the proposed amendments in the draft TALAB,” Chong explained.

SARS v Coronation

In the 2023 case of CSARS v Coronation Investment Management SA, the taxpayer won on the merits of the case at the Constitutional Court.

However, Chong explained that the Supreme Court’s reasoning on USP and the meaning of bona fide inadvertent error remains good law.

Despite finding against Coronation on the technical tax issue, the SCA set aside the 10% “substantial understatement” USP that SARS had imposed.

Coronation argued that it relied on an opinion from a leading tax expert, but it did not disclose the opinion’s contents to SARS, as the opinion was protected under legal privilege.

The Supreme Court confirmed that a taxpayer can consciously and deliberately adopt a specific tax position based on professional advice, be proven wrong on the law, and still not be liable for USP because their actions were not taken in bad faith.

The court concluded that Coronation submitted its tax returns with the genuine bona fide belief that its interpretation of the foreign business establishment exemption was correct.

Its reasoning directly contradicted SARS’ narrow view that a deliberate (i.e. non-accidental) choice of tax position can never be an “inadvertent” error.

The Supreme Court also rejected SARS’s attempt to draw a negative inference from Coronation’s refusal to disclose its legal opinion.

It held that it was not incumbent on the taxpayer to waive its legal privilege. “To conclude that the opinion was unfavourable was ‘simply speculative’ and insufficient to attribute bad faith by the taxpayer,” Chong said.

Thistle Trust v SARS

Chong explained that in the 2024 Thistle Trust v CSARS case, the Constitutional Court found against the taxpayer on the tax issue but rejected the 50% USP imposed by SARS.

The court established the principle that relying on a reasoned opinion from senior counsel, as the taxpayer did, provides “reasonable grounds” for a tax position, even if the advice is ultimately held to be incorrect in court.

SARS argued that if the taxpayer had taken reasonable care in completing its returns, it would have ignored the legal advice received from senior counsel and instead adopted the SARS interpretation.

The Constitutional Court held that the SARS argument is based on the proposition that no taxpayer can act reasonably on advice that differs from SARS’ statements of its interpretation of tax legislation.

“The argument would elevate SARS to the status of an authority that can decree the only reasonable interpretations of tax legislation. It is an untenable argument,” the court held.

The Constitutional Court further confirmed that SARS bears the burden of proving the facts that justify the imposition of a USP.

“SARS cannot simply assert that a taxpayer lacked reasonable grounds – it must present evidence to prove it,” Chong explained. The court acknowledged the public importance of defining the meaning of a bona fide inadvertent error.

However, it declined to set guidelines because the preceding courts had not reasoned their judgments on the issue, and SARS had no sustainable case for imposing the 50% USP.

“This judicial restraint left the legislative ambiguity of the meaning of bona fide inadvertent error unresolved. The proposed amendments in the draft TALAB now seek to resolve that ambiguity,” she said.

Proposed amendments in draft TALAB

Chong said that, currently, the bona fide inadvertent error defence is a general exclusion which applies to any understatement.

The proposed amendments intend for the defence to be de-linked from taxpayer behaviour and available when the taxpayer’s conduct results in a “substantial understatement”, an objective calculation.

This would nullify the core USP-related principles drawn from the Coronation and Thistle Trust judgments.

A “substantial understatement” is defined as one where the resulting prejudice to SARS or the fiscus exceeds the greater of

• 5% of the amount of tax properly chargeable or refundable under the relevant tax statute for the relevant period, or
• R1 million.

“The issues in dispute when challenging any USP in additional assessments will shift from arguing about the nature of the error, inadvertent or deliberate, to proving the quality of the taxpayer’s conduct, reasonable or unreasonable,” Chong said.

She added that SARS bears the burden of proving the behaviours relied on for the USP.

“The tax opinion will become a critical piece of evidence as it would be relied on to prove that even if the tax position adopted was wrong, it was arrived at through a diligent and reasonable process that justifies reducing the USP,” she said.