South Africa: Another Reminder That SARS Bears The Onus Of Proving Understatement Penalties

In the matter of Lance Dickson Construction CC v Commissioner for the South African Revenue Service, the High Court set aside the order of the Tax Court in favour of the South African Revenue Service ("SARS") and upheld an appeal by Lance Dickson Construction CC ("Taxpayer") with costs.

The Taxpayer, in its tax return for the 2017 year of assessment, did not declare any proceeds from the disposal of certain property to a related entity, Kwali Mark Construction CC ("KMC"), as it believed and as stated in the agreement of sale between the Taxpayer and KMC, that capital gains tax ("CGT") would be paid by the Taxpayer when the property was on-sold by KMC to an unrelated third-party and the relevant proceeds were received by the Taxpayer. Because these conditions were not fulfilled in the 2017 year of assessment, the Taxpayer did not declare proceeds on the disposal of the property in its tax return.

SARS disagreed with the Taxpayer and submitted that CGT should have been paid when the Taxpayer disposed of the property to KMC, a view that the Tax Court agreed with. SARS also imposed an understatement penalty, in terms of section 222 of the Tax Administration Act, 2011 ("TAA") in the event of an "understatement". If there is an "understatement", SARS must then consider whether the understatement results from a "bona fide inadvertent error". If this is established, that is the end of the inquiry, and no understatement penalty may be levied. However, where there is no such error, SARS is required to identify the appropriate behavioural category under which a taxpayer's conduct allegedly resorts in terms of the table set out in section 223 of the TAA before it can impose an understatement penalty.

The purpose of the understatement penalty regime under the TAA is to encourage voluntary compliance and deter non-compliance and tax evasion. Thus, the purpose of the understatement penalty regime is not to raise money for the fiscus, but to ensure taxpayer compliance.

In this case, SARS established that there was an "understatement" and because the understatement did not result from a "bona fide inadvertent error", SARS levied a penalty of 25% on the Taxpayer for "reasonable care not taken in completing return" in terms of the understatement penalty percentage table in section 223 of the TAA.

In the Tax Court proceedings, SARS' factual witness conceded that SARS had mistakenly relied on behaviour (ii) "reasonable care not taken in completing return" instead of "no reasonable ground for 'tax position' taken", a behaviour that imposes an understatement penalty of 50%.

Notwithstanding this concession by SARS, the Tax Court claimed that although it was precluded from increasing the penalty from 25% for behaviour (ii) to 50%, for behaviour (iii), the Taxpayer cannot escape liability for the understatement penalty. The Tax Court concluded that Taxpayer was liable to pay the 25% understatement penalty.

The High Court was tasked with determining whether the conclusion arrived at by the Tax Court was correct.

The High Court found that the Tax Court had erred in confirming the understatement penalty of 25% because SARS had failed to prove the factual basis for the imposition of this penalty when its determination was challenged by the Taxpayer in the Tax Court. The High Court found that SARS could not prove behaviour (ii) and that the court could not make a determination on behaviour (iii) because this behaviour was not alleged by SARS.

The High Court directed SARS to alter the 2017 additional assessment issued to the Taxpayer to exclude the understatement penalty imposed. In addition, the High Court held that the approach adopted by SARS in assessing the understatement penalty was unreasonable in the circumstances and therefore it would be just and equitable to order SARS to pay the taxpayer's costs in the Tax Court.

It is notable that in an earlier Supreme Court of Appeal ("SCA") judgment in Commissioner for the South African Revenue Service v Thistle Trust SARS conceded during its arguments that the understatement by the Thistle Trust resulted from a "bona fide inadvertent error" as the Thistle Trust had believed it was correct in its view and in support of its view placed reliance on an independent legal opinion. Based on this concession, the Thistle Trust was relieved from paying the understatement penalty. The SCA held that this point was correctly conceded by SARS that the understatement was a bona fide error and that SARS was not entitled to impose the understatement penalty.

In the most recent SCA judgment of Commissioner for the South African Revenue Service v Coronation Investment Management SA (Pty) Ltd, the taxpayer relied on an independent legal opinion but because it did not disclose the opinion or make the opinion available to SARS, SARS drew the inference that the tax opinion did not support the taxpayer's position and contended that this was not a bona fide inadvertent error. The court held that for SARS to speculate that a tax opinion must have gone against the taxpayer simply because it was not disclosed to SARS, is not sufficient to attribute male fides on the part of the taxpayer and therefore SARS' claim for understatement penalties must fail.

The abovementioned cases serve as a reminder that the onus of proving understatement penalties rests on SARS. Taxpayer's should note that SARS is required to prove the factual basis for the determination of understatement penalties and if SARS fails to do so, there will be no basis, either in fact or law, for it to recover understatement penalties from taxpayers.

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