Penalties Given Hinge On Taxpayer’s Conduct

THE Tax Administration Act, No 28 of 2011, took effect from October 2012 and, as a result, the new rules governing the imposition of the understatement penalty also took effect.

Previously, the Commissioner: South African Revenue Service (SARS) could levy additional tax of up to twice the tax which otherwise would have been payable in accordance with section 76 of the Income Tax Act, No 58 of 1962.

Typically, a taxpayer subjected to an audit would be invited by SARS to advance reasons why additional tax should not be imposed in the particular case prior to the issue of an additional assessment. The manner in which section 76 was drafted meant that SARS was entitled to levy up to 200% additional tax where the taxpayer made a default in rendering a return in respect of any year of assessment, or omitted from his return any amount which ought to have been included therein.

The Commissioner was conferred a discretion to remit the additional tax where he was of the opinion that there were extenuating circumstances, but was unable to remit the tax where he was satisfied that any act or omission on the part of the taxpayer was done with the intent to evade tax.

The enactment of the Tax Administration Act has changed the old approach in that the Tax Administration Act itself prescribes the quantum of the understatement penalty to be imposed, which depends on the taxpayer’s conduct.

Item	Behaviour	Standard Case	If obstructive, or if it is a ‘repeat case’	Voluntary disclosure after notification of audit	Voluntary disclosure before notification of audit
(i)	“Substantial understatement’	25%	50%	5%	0%
(ii)	Reasonable care not taken in completing return	50%	75%	25%	0%
(iii)	No reasonable grounds for ‘tax position’ taken	75%	100%	35%	0%
(iv)	Gross negligence	100%	125%	50%	5%
(v)	Intentional tax evasion	150%	200%	75%	10%

 Section 223 of the Tax Administration Act sets out a table (see above) which prescribes the quantum of understatement penalties to be imposed depending on the taxpayer’s conduct.

It is important to note the definitions contained in section 221, which apply directly to the imposition of the understatement penalty. The Tax Administration Act defines a “repeat case” as a second or further case of any of the behaviours listed in the table which prescribes the understatement penalty percentage to be imposed, within five years of the previous case.

A “substantial understatement” means a case where the prejudice to SARS exceeds the greater of 5% of the amount of tax properly chargeable or refundable under a tax act for the relevant period, or R1m. A “tax position” means an assumption underlying one or more aspects of a tax return, specifically whether or not an amount, transaction, event or item, is taxable or is deductible, or may be set off.

Where a taxpayer chooses to make a voluntary disclosure before notification of an audit, the understatement penalty is reduced to zero, in all cases except when the taxpayer was grossly negligent or intentionally evaded tax.

In those cases, where a taxpayer chooses to make a voluntary disclosure after SARS has commenced an audit, the understatement penalty may range from 5% to 75%, depending on the taxpayer’s specific behaviour.

Where SARS takes the view that the taxpayer has been obstructive, or has previously been subjected to the understatement penalty, the understatement penalty will range from 50% to 200%, depending on the taxpayer’s behaviour.

In what is referred to as a “standard case” in the table, the understatement penalty will range from 25% to 150%, depending on the taxpayer’s specific conduct.

When determining the amount of the understatement penalty to be levied, the Commissioner is required to reach a conclusion as to the taxpayer’s behaviour and, at the same time, to determine whether the taxpayer should be treated as a standard case, or whether the taxpayer is a repeat offender — which would give rise to a higher level of understatement penalty.

As a result of the enactment of the table to be used by SARS in determining the understatement penalty to be levied, the only occasion on which no understatement penalty may be levied is where the taxpayer goes forward to SARS prior to the notification of an audit. In all other cases, the taxpayer will face an understatement penalty, which is more onerous than what was the case under section 76 of the Income Tax Act.

If SARS conducts an audit on a taxpayer’s affairs, and decides that certain deductions claimed do not qualify as such under the provisions of the Income Tax Act, and the adjustment is regarded a substantial understatement, the penalty could amount to 25% or 50%, depending on the taxpayer’s specific behaviour.

In levying the understatement penalty as a result of a substantial understatement, it is not necessary that SARS takes account of the taxpayer’s intention which gave rise to that adjustment. The only occasion on which the Commissioner must remit a penalty imposed for a substantial understatement is if SARS is satisfied that the taxpayer made full disclosure of the reportable arrangement which gave rise to the prejudice to SARS as defined in section 34 of the Tax Administration Act no later than the date that the relevant return was due, and was in possession of an opinion issued by a registered tax practitioner as defined in section 239 of the Tax Administration Act  The obligation to disclose under section 34 of the Tax Administration Act relates only to those arrangements regarded as reportable arrangements as defined in the act.

Section 223(3) of the Tax Administration Act requires that the opinion was issued by no later than the date on which the relevant return was due to the Commissioner, took account of the specific facts and circumstances of the arrangement, and confirmed that the taxpayer’s position is more likely than not to be upheld if the matter proceeds to court.

It is critical that, in future, taxpayers exercise reasonable care in completing their returns, failing which the understatement penalty prescribed in the table will be levied.

Where SARS reaches the conclusion, based on the facts of the taxpayer’s case, that reasonable care was not taken in completing their tax return, the understatement penalty will be levied at the level of 50% or 75%, depending on whether it is a standard or a repeat case. Clearly, where the taxpayer goes forward under the voluntary disclosure programme, the understatement penalty will be reduced.

"It has become almost impossible for taxpayers to satisfy the Commissioner that no understatement penalty should be levied."

"When determining the amount of understatement penalty to be levied, the Commissioner is required to reach a conclusion as to the taxpayer's behaviour."

Where SARS takes the view that the taxpayer had no reasonable grounds for the tax position taken, the understatement penalty is increased. Where, for example, a taxpayer has sought an opinion on a particular aspect prior to the finalisation of their tax return, it would be difficult for SARS to levy the understatement penalty on the basis that the taxpayer had no reasonable grounds for the tax position taken by the taxpayer.

Where the Commissioner is satisfied that the taxpayer was grossly negligent, the understatement penalty will be increased. Where a taxpayer, for example, fails to make full and proper disclosure in their tax return, they would, in all likelihood, be regarded as having been negligent, and thereby face a greater understatement penalty.

The highest level of understatement penalty is applicable in those cases where a taxpayer has it intentionally evaded tax, and this would comprise those cases where a taxpayer has deliberately understated income, falsified invoices to claim deductions, etc. Besides facing the risk of enhanced understatement penalties, taxpayers in such cases would face the risk of criminal prosecution as well.

The rules regulating the levy of the understatement penalty should ensure greater consistency in the manner in which penalties are levied on taxpayers. The difficulty which the Commissioner faces will be to ascertain the taxpayer’s behaviour in a particular case, and thereby ensure that the taxpayer is subjected to the correct level of understatement penalty.

Previously, under section 76, taxpayers were able to satisfy the Commissioner that additional tax should not be levied because of the particular circumstances of the case.

As a result of the introduction of the penalty table set out in this article, it has become almost impossible for taxpayers to satisfy the Commissioner that no understatement penalty should be levied.

Based on the transitional rules in the Tax Administration Act, it is questionable whether SARS may levy the understatement penalty by using the penalty table on tax returns submitted before 1 October 2012 instead of the old additional tax rules.

Where a taxpayer is subjected to an audit by SARS, and is subjected to the understatement penalty, they are entitled to ask the Commissioner for reasons why the particular amount of penalty was levied.

■ Dr Beric Croome is a tax executive at ENS. This article first appeared in Business Day :Business Law & Tax Review (February 2013) Free Image via ClipArt.