Monday 12 August 2013

Amendment takes Human Error into Account

In the National Budget, presented on 27 February 2013, the Minister of Finance indicated that the rules regulating the imposition of the understatement penalty in terms of the Tax Administration Act, No 28 of 2011, would be amended to deal with those case where a taxpayer made an inadvertent error in filing a tax return with the South African Revenue Service.  

This was on the basis that, without the amendment, a taxpayer could have faced a penalty of 25% or 50%, even though the taxpayer had made a genuine mistake such as a transposition error in filing their return.

Previously, under section 76 of the Income Tax Act, No 58 of 1962, as amended (‘the Act’), the Commissioner was empowered to levy additional tax of 200% of the tax which should have been paid by a taxpayer.  

The Commissioner was then conferred a discretion to reduce the additional tax where there were extenuating circumstances, and, furthermore, it was required that the taxpayer had the intent to evade taxation for the additional tax to be imposed.  

Thus, the provisions contained in section 76 of the Act were subject to the exercise of a discretion by the Commissioner, and determined by taking account of subjective criteria.

With the introduction of the Tax Administration Act, the penalty regime was revised to introduce objective criteria such that the amount of penalty would be determined by the taxpayer’s behaviour.

Currently, the understatement penalties which may be levied by SARS under the Tax Administration Act are as follows:

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 221 defines a “substantial understatement” as a case where the prejudice to SARS exceeds a rate of 5% of  the tax  properly chargeable or refundable under a tax act for the relevant tax period or the amount of R1 million.  

Thus, where a taxpayer submits a tax return which is subsequently audited by SARS and an adjustment is made thereto such that the tax payable is increased by R1 million or 5% of the amount of tax properly chargeable under a tax act, the penalty which may be levied may amount to 25% for the first occasion of such an event or 50% where the taxpayer has previously been subjected to an understatement penalty within the last five years.

Thus, the quantum of the understatement penalty which may be levied on a taxpayer will be determined by the taxpayer’s behaviour and the level of penalty will increase depending on the nature of the behaviour of the taxpayer.

On 4 July 2013, the National Treasury released the draft Tax Administration Laws Amendment Bill 2013 for comment.  That Bill proposes various changes to the imposition of the understatement penalty such that the level of penalties is reduced in various cases.  

Accordingly, the revised table will take effect on that date that the Bill is promulgated. 
The Bill therefore proposes that the understatement penalty table be amended along the following lines:

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’
10%
20%
5%
0%
(ii)
Reasonable care not taken in completing return
25%
50%
15%
0%
(iii)
No reasonable grounds for ‘tax position’ taken
50%
75%
25%
0%
(iv)
Gross negligence
100%
125%
50%
5%
(v)
Intentional tax evasion
150%
200%
75%
10%

The draft memorandum on the objects of the Tax Administration Laws Amendment Bill 2013 indicates that the rationale for amending section 223 is to align the percentage of the penalty with comparative tax jurisdictions where largely similar penalty regimes apply. 

The Bill reduces the level of understatement penalty in respect of substantial understatement, reasonable care not taken in completing a return and no reasonable grounds for tax position taken by the taxpayer.

The version of the draft Bill released on 4 July 2013 indicated that the reduction in the level of understatement penalty would take effect from 1 October 2012.  

However, on 5 July 2013, the SARS website indicated that the draft Tax Administration Laws Amendment Bill 2013 and its memorandum of objects had been replaced with new versions.  

From a review of the versions released on 5 July 2013, it is apparent that it is now proposed that the effect date of the changes in the level on understatement penalty will be the date on which the Tax Administration Laws Amendment Bill 2013 is enacted.  

Those taxpayers who have received assessments from SARS and have been subjected to the understatement penalty will feel aggrieved in that the level of understatement penalty imposed on them is greater than what will be applied to taxpayers in future years, even though SARS admits that the sanctions originally contained in section 223 of the Tax Administration Bill were out of line with comparative tax jurisdictions where similar penalty regimes are applied.

It must be remembered that SARS is compelled to remit a penalty imposed for a substantial understatement in terms of section 223(3) of the Tax Administration Act where the taxpayer made full disclosure of the arrangement as defined in section 34 of the Tax Administration Act that gave rise to the prejudice to SARS by no later than the date that the relevant return was due to SARS and was in possession of an opinion by a registered tax practitioner in the prescribed form.  

The draft Tax Administration Laws Amendment Bill 2013 proposes an amendment to section 223(3)(b) that the opinion must be issued by an independent tax practitioner.  The draft memorandum on the Tax Administration Laws Amendment Bill 2013 indicates that the amendment requires that the opinion relied on by the taxpayer must be given by a tax practitioner that is independent from the taxpayer.  

The commentary on the draft Bill indicates that opinions prepared by in-house tax practitioners, in, for example, a large corporate group, will not qualify as a result of their potential vested interests relating to such matters.

The Bill also proposes an amendment to section 224 of the Tax Administration Act, stating unequivocally that a taxpayer has the right to object and appeal against an understatement penalty.  It is questionable whether this amendment is necessary in light of the provisions contained in section 104 of the Tax Administration Act, which confers the right to object against assessments issued to taxpayers.

It is clear that the reduced level in the quantum of the understatement penalties proposed in the draft Bill are not as onerous as the level of penalties currently contained in the Tax Administration Act.  It is unfortunate that the amendments will not benefit those taxpayers who have been subjected to understatement penalties since 1 October 2012.

In practice, it would appear that SARS takes the view that the understatement penalty should apply to all adjustments made to tax returns submitted by taxpayers, even where those tax returns were submitted prior to 1 October 2012, that is, the date on which the Tax Administration Act took effect.  

Based on the rule of law and the principles relating to the interpretation of statutes, it would appear that the provisions of section 270(6) of the Tax Administration Act should require SARS to consider imposing additional tax, in the case of income tax, under section 76 of the Act, or other equivalent provisions in other tax acts, in respect of events which took place prior to 1 October 2012 and not to levy the prescriptive understatement penalty contained in section 223 of the Tax Administration Act.  

No doubt the interpretation of the application of the understatement penalty to adjustments made after 1 October 2012 to tax assessments relating to years of assessment prior to 1 October 2012 will, ultimately, be determined by the courts.

  Dr Beric Croome is a tax executive at ENS. This article first appeared in Business Day, Business Law and Tax Review, Aug 2013. 

Monday 5 August 2013

The Future Taxation of Trusts

In the National Budget, tabled in Parliament on February 27, the Minister of Finance indi­cated that government was proposing several legislative measures during 2013/14 to curtail perceived tax avoidance associated with trusts. The Treasury also indicated its concern regarding the use of trusts to avoid estate duty, which it intended to review.

It was pointed out that the proposals in the budget would not apply to those trusts established to cater for the needs of minor children and people with disabilities,that is, so called special trusts.

Originally,   Treasury   indicated that discretionary trusts should no longer act as flow-through vehicles, with the result that a trust should be taxed as a separate and distinct entity. It was expected that legislation would be introduced whereby trusts would be liable to pay tax in their own right, without the possibility of passing income and capital gains through to beneficiaries.

However, the budget documentation was somewhat unclear in that it indicated that, to the extent that a trust derives taxable income and distributes that to a beneficiary, such amount would be deductible for the trust, and the beneficiary would then be taxed thereon as having received ordinary revenue.

The Minister of Finance indicated that trading trusts would similarly be taxable at the entity level, with distributions being treated as deductible payments to the extent of the trust's taxable income. It was pointed out that trusts would be regarded as trading trusts where they either conducted a trade or where the beneficial ownership interests in the trust were freely transferrable.

National Treasury is concerned 
that trusts are being used for tax avoidance  purposes
Some years ago, government attempted to define trading trusts in order to regulate the manner in which such trusts should be taxed, but eventually abandoned the idea, because it was unable to comprehensively define what should constitute a trading trust.

Finally, the budget indicated that distributions received from offshore foundations will always be treated as ordinary revenue in the future.

To  date, no draft legislation has been released setting out the manner in which government intends to deal with the taxation of trusts in the future.

On June 14, a meeting was held by representatives of the National Trea­sury and the Commissioner: South African Revenue Service with representatives of the Fiduciary Institute of Southern Africa, Financial Planning Institute, Law Society of South Africa, South African Institute of Chartered Accountants, South African Institute of Tax Practitioners and the Society of Trust and Estate Practitioners, to discuss the taxation of trusts in the future.

It would appear that National Treasury is concerned that trusts are being used for tax avoidance purposes, and wishes to understand the position better.

The delegates to the meeting were also asked how frequently founda­tions are used and the reasons there­ fore. It was indicated that founda­tions are not widely used, and this aspect will probably be investigated further.

In addition, the meeting discussed interaction between the Master's Of­fice and the Commissioner: SARS. It is more than likely that the tax returns submitted by trusts will be­ come more onerous, so that greater disclosure regarding the activities conducted by trusts will be made to SARS.

The National Budget estimated that estate duty would contribute some R900 million in the 2013/14 fiscal year, which represents a small part of budgeted state revenue. It remains unclear why estate duty continues to exist. Ideally, the taxation of trusts, capital gains tax and estate duty should be reviewed holistically to formulate a sound fiscal policy.

The Minister of Finance announced on February 27 that Judge D Davis of the High Court would chair a commission of enquiry into the tax structure of South Africa. It is hoped that that commission will review the taxation of trusts in South Africa, taking account of the capital gains tax and estate duty implications relating thereto.

National Treasury indicated in the meeting held on June 14 that no tax changes regarding trusts have been finalised, and that any amendments proposed to the taxation of trusts will be discussed in depth, and a discussion paper released for comment, but this is not likely to happen in the short term.

The 2013 Taxation Laws Amendment Bill has been released, which contains most of the amendments required to give effect to the tax policy decisions contained in the 2013 budget.

Taking account of the meeting held on June 14, no amendments to the taxation of trusts are contained in the 2013 Taxation Laws Amendment Bill, but the matter will be properly reviewed and considered before amendments are made. This move should be supported, as it is far better that the taxation of trusts is reviewed holistically than introducing ad-hoc amendments to address perceived tax avoidance.

Dr Beric Croome is an executive in the Tax department at Edward Nathan  Sonnenbergs. This article first appeared in tax ENSight, June 2013 and in The Times newspaper, Legal Times supplement on 2 August 2013.