The hidden danger of disputing understatement penalties

By Doria Cucciolillo, Tax Consultant, BDO SA

In ITC 14247 the Gauteng Division of the Tax Court, recently considered the imposition of understatement penalties (section 222(1) of the Tax Administration, 2011 (the TAA) in respect of a taxpayer that made provisional tax payments against the tax amount owing.

Although the taxpayer actively traded during the 2011 to 2014 years of assessment, it submitted nil income tax returns and failed to register as a VAT vendor or to submit VAT returns. However, the taxpayer made provisional tax payments of nearly R14 million for the 2011 to 2013 years of assessment, which it then later tried to claim back as a refund. This raised suspicion at SARS and resulted in VAT and income tax assessments being raised. SARS also levied understatement penalties at 100% on the income tax and VAT understatements, but following an objection by the taxpayer, these penalties were reduced to 25% and 50%. The taxpayer appealed to the Tax Court to set the understatement penalties aside. It argued that SARS was not entitled to levy an understatement penalty as there was no “understatement” as required in section 221 of the TAA. Although the taxpayer conceded the existence of “an omission” or “incorrect statement” in respect of income tax or a “default in rendering a return” for purposes of VAT, it maintained that due to SARS having received provisional tax payments there was no “prejudice to SARS or the fiscus”.

The court found against the taxpayer on the basis that SARS indeed suffered prejudice in the form of opportunity cost caused by the delayed recovery of income tax and VAT. Although SARS received the provisional tax payments, it was not entitled to use the funds as they reflected as a refund due to the taxpayer. The court confirmed that SARS could levy an understatement penalty on the shortfall between the tax properly chargeable and the tax that would have been chargeable if the understatement had been accepted (i.e. the full amount of the assessed tax).

SARS must impose an understatement penalty (section 222 of the TAA) at the highest applicable rate prescribed by the understatement penalty table (section 223). SARS contended that the reduced penalties were extremely lenient and requested the court to increase the understatement penalties. SARS relied on section 129(3) of the TAA which authorises the Tax Court to reduce, confirm or increase an understatement penalty when a taxpayer appeals against the imposition of such a penalty, provided that SARS successfully discharges the burden of proof. The court concluded that the taxpayer acted with “gross negligence” by submitting nil income tax returns and by not submitting VAT returns. Consequently, the taxpayer ended up facing higher understatement penalties.

This case illustrates that taxpayers should be mindful when appealing against understatement penalties as they might end up in a worse position should the court exercise its discretion to increase an understatement penalty. This case also demonstrates that provisional tax payments may not always absolve a taxpayer from understatement penalties.

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