Tax law is often difficult to interpret and frequently the South African Revenue Service ("SARS") and the Courts hold a different view to that of a taxpayer and its advisers. A consequence for taxpayers in South Africa is the understatement penalty ("USP"), which may be imposed by SARS based on certain criteria set out in the Tax Administration Act,2011 (the "TAA"). USPs are based on a matrix of possible taxpayer behaviours. However, prior to enquiring into the matrix, there are two preliminary possibilities of relief.
The first is that in respect of a USP levied for a "substantial understatement", the USP must be remitted where, at the relevant time, the taxpayer had an opinion by an independent registered tax practitioner which confirmed the correctness of that taxpayer's tax treatment of the tax position (albeit later proven wrong), in compliance with the requirements of section 223 of the TAA.
The second is where the understatement results from a "bona fide inadvertent error", in which case a USP cannot be imposed. So far, in practice, this has been interpreted extremely narrowly, for example, to instances of computation error and an escape from understatement penalties based on the "bona fide inadvertent error" defence appears to only be accepted by SARS in very limited circumstances. We have previously written about bona fide inadvertent errors before.
The Thistle Trust Case
In the recent case of CSARS v The Thistle Trust (the "Thistle Trust Case") which dealt with the tax treatment of amounts distributed by a trust (the "Taxpayer") to its beneficiaries, there were two pertinent questions before the Supreme Court of Appeal ("SCA"), one of which is relevant to USPs.
The first question was whether the capital gains which arose as a result of disposals by various South African trusts were taxable in the hands of the Taxpayer being a trust itself (by virtue of the fact that such amounts were distributed by those Trusts to the Taxpayer), or taxable in the hands of the Taxpayer's beneficiaries (by virtue of the fact that those amounts received by the Taxpayer were distributed thereafter by the Taxpayer to its own beneficiaries). In this regard, the SCA held in favour of SARS, namely that the amounts were taxable in the hands of the Taxpayer and not in the hands of its beneficiaries.
The second question, the Taxpayer having lost on the merits, dealt with the USPs. In this regard, SARS had imposed a 50% USP on the Taxpayer for understating its taxable capital gains in light of the Taxpayer's treatment of the amounts it received. The USP was imposed on the basis that, in terms of section 223 of the TAA, the Taxpayer had "no reasonable grounds for the tax position taken".
We note that it was common cause that the Taxpayer had obtained a legal opinion which had been sought by another entity within the group of entities in which the Taxpayer found itself.
In respect of the USP, SARS initially adopted the position that, in the light of the legal opinion, it should be concluded that the Taxpayer had consciously and deliberately adopted the position it took when it elected to distribute the amounts of the capital gains as it did. SARS was accordingly of the view that the Taxpayer's actions (and the understatement) were not as a result of a bona fide inadvertent error. (It is unclear from the judgement whether the legal opinion which the Taxpayer had access to was an opinion in terms of section 223 of the TAA.)
Although SARS adopted the initial view that the Taxpayer's actions were deliberate, and imposed the USP on the basis of this view, during argument SARS conceded that the understatement by the Taxpayer resulted from a bona fide inadvertent error and that the Taxpayer's actions in understating its taxable capital gains were unintentional. In this regard, the SCA, in expressly commenting that the SARS concession was indeed correct, stated as follows:
". 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 s 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."
Thus, although the court found that SARS correctly raised the additional assessments and the relevant amounts were taxable in the Taxpayer's hands, the court held that SARS was not entitled to levy a USP because the Taxpayer's understatement arose as a result of a bona fide inadvertent error.
This judgement constitutes a significant confirmation by the SCA that reliance on legal advice (even if proven incorrect) can justify the finding of a bona fide inadvertent error. Within the USP regime, this is a first line of defence to a taxpayer, prior to any analysis of whether the behaviour of that taxpayer falls into one or the other of the penalty categories in section 223 of the TAA, and regardless of whether the opinion it obtained complied with section 223 of the TAA.
The finding significantly widens the ambit of the defence of bona fide inadvertent error and may serve as support for future taxpayer arguments against the levying of USPs in appropriate circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.