Constitutional Court has its say on understatement penalties
Constitutional Court has its say on understatement penalties
By Esther van Schalkwyk, Associate Director
SARS has traditionally taken a narrow approach in interpreting the term bona fide inadvertent error, the existence of which allows taxpayers to escape understatement penalties ranging between 10% and 200% of the understatement of tax. This took a turn in 2022 when SARS reportedly conceded before the Supreme Court of Appeal (SCA) in CSARS v The Thistle Trust 2023 (2) SA 120 (SCA) 85 SATC 347 that the Trust’s reliance on a tax opinion gave rise to a bona fide inadvertent error. The Constitutional Court (CC) has now also had its say on understatement penalties and although coming from a different angle, the pronouncements were, once again, taxpayer-friendly.
It is questionable whether the judgment in the Thistle case handed down by the SCA in 2022 created legally binding precedent on the meaning of the term bona fide inadvertent error, since SARS’ reported concession meant that the matter was not argued before the court. Nevertheless, the SCA gave its stamp of approval to SARS’ concession by stating that it was “correctly” made. Whether legally binding or not, this casts serious doubt on the correctness of SARS’ prior stance in its Guide to Understatement Penalties (issue 2 dated 18 April 2018), that bona fide inadvertent errors are limited to certain typographical errors and can never arise where a taxpayer acts deliberately in adopting a certain position.
The penalty debate progressed in 2023 when the SCA in CSARS v Coronation Investment Management SA (Pty) Ltd 2023 (2) All SA 44 (SCA) 85 SATC 413 excused Coronation from all penalties on the basis that its reliance on expert advice gave rise to a bona fide inadvertent error, even though Coronation did not disclose the content of the advice to SARS or the court.
The SCA judgments in both Thistle and Coronation were on appeal to the CC, and the judgments of the CC in both appeals have now also been delivered.
In a judgment handed down on 21 June 2024, the CC in Coronation Investment Management SA (Pty) Ltd v CSARS [2024] ZACC 11 (CC) found in Coronation’s favour on the merits and SARS’ cross-appeal in respect of understatement penalties therefore did not come up for consideration. Given that the understatement and underestimation penalties which SARS sought to impose on Coronation would have been substantial, it is worth considering the history of the litigation between the parties:
Since the CC judgment in Coronation did not take the penalty debate any further, all eyes were on the CC’s judgment in The Thistle Trust v CSARS [2024] ZACC 19, which was finally handed down on 2 October 2024.
Although the Tax Court had found in the Thistle Trust’s favour on the merits (the matter concerned the application of the ‘conduit pipe’ principle to the taxation of capital gains distributed to beneficiaries through multiple trusts in a tiered trust structure) - this was overturned by the SCA, where the Trust lost on the merits. In the CC, the majority agreed with the SCA by holding in SARS’ favour that the conduit pipe principle did not apply, with two out of eight judges dissenting.
SARS had applied for leave to cross-appeal the penalty issue to the CC if the Trust lost on the merits. In a surprising turn of events, SARS denied ever having made the concession before the SCA that the Trust’s reliance on expert advice was a bona fide inadvertent error, although SARS accepted that its counsel did not argue the point before the SCA.
Despite the interpretation of the penalty provisions being a matter of great public importance, the CC dismissed SARS’ application for leave to cross-appeal as not being in the interests of justice. This was because the CC would have been sitting as the court of first and last instance in interpreting the term bona fide inadvertent error (since the Tax Court did not reach the penalty issue and the point had not been argued before the SCA) and SARS had no sustainable case for imposing the penalties (therefore the cross-appeal would ultimately fail).
However, the CC made instructive remarks regarding the two blameworthy behaviour categories, at least one of which SARS argued should apply, in holding that SARS had no reasonable prospects of discharging the onus of proving the facts that would bring the Thistle Trust’s conduct within either of these categories:
The dissenting judges in Thistle agreed with the majority’s reasoning on the penalty issue, therefore these remarks were effectively unanimous by no less than eight judges of the CC. It was clearly the view of the bench in Thistle that a taxpayer who adopts a position contrary to SARS’ position is not automatically liable for understatement penalties – rather, to discharge the onus resting on it, SARS must prove the facts which bring the taxpayer’s conduct within the chosen behaviour category, amongst other things.
If based on a ‘substantial understatement’, SARS must remit the understatement penalty if the taxpayer made full disclosure of the arrangement to SARS and was, by the time the relevant return was due, in possession of an opinion by an independent registered tax practitioner that satisfied the requirements of section 223(3) of the TAA. One of these requirements is that the opinion must be based on a full disclosure of the facts and circumstances of the arrangement that gave rise to the prejudice to SARS or the fiscus and another is that the opinion must confirm that the taxpayer’s position is more likely than not to be upheld if the matter proceeds to court. Although ‘substantial understatement’ is only one of the available categories, where a taxpayer was in possession of such an opinion which considered the available SARS guidance on an issue and submitted its tax returns based on the advice contained in the opinion, the taxpayer’s behaviour could hardly constitute reasonable care not taken in completing return, no reasonable grounds for ‘tax position’ taken or gross negligence (this view would seem to be supported by the CC’s remarks in Thistle). It would also seem that the behaviour of the taxpayer would not fall into the ‘intentional tax evasion’ category, unless there was some sort of collusion between the taxpayer and the tax practitioner who issued the opinion. In these circumstances, SARS would only be able to levy an understatement penalty if it was able to show that the ‘arrangement’ in question constituted an ‘impermissible avoidance arrangement’ (an arrangement to which the general anti-avoidance provisions applied).
Especially since the CC in Thistle declined to comment on the meaning of a bona fide inadvertent error, the SCA’s pronouncements on the meaning of this term remain instructive. In view of these pronouncements of the SCA, SARS’ prior narrow view of the term bona fide inadvertent error seems to require an update. Moreover, in the case of taxpayers acting on reasoned expert advice and given the CC’s remarks in Thistle, SARS will not easily discharge the onus of proving the facts which bring the taxpayer’s behaviour into one of the categories required to successfully impose understatement penalties. The value of tax opinions that comply with the requirements of section 223 should thus not be underestimated.
SARS has traditionally taken a narrow approach in interpreting the term bona fide inadvertent error, the existence of which allows taxpayers to escape understatement penalties ranging between 10% and 200% of the understatement of tax. This took a turn in 2022 when SARS reportedly conceded before the Supreme Court of Appeal (SCA) in CSARS v The Thistle Trust 2023 (2) SA 120 (SCA) 85 SATC 347 that the Trust’s reliance on a tax opinion gave rise to a bona fide inadvertent error. The Constitutional Court (CC) has now also had its say on understatement penalties and although coming from a different angle, the pronouncements were, once again, taxpayer-friendly.
It is questionable whether the judgment in the Thistle case handed down by the SCA in 2022 created legally binding precedent on the meaning of the term bona fide inadvertent error, since SARS’ reported concession meant that the matter was not argued before the court. Nevertheless, the SCA gave its stamp of approval to SARS’ concession by stating that it was “correctly” made. Whether legally binding or not, this casts serious doubt on the correctness of SARS’ prior stance in its Guide to Understatement Penalties (issue 2 dated 18 April 2018), that bona fide inadvertent errors are limited to certain typographical errors and can never arise where a taxpayer acts deliberately in adopting a certain position.
The penalty debate progressed in 2023 when the SCA in CSARS v Coronation Investment Management SA (Pty) Ltd 2023 (2) All SA 44 (SCA) 85 SATC 413 excused Coronation from all penalties on the basis that its reliance on expert advice gave rise to a bona fide inadvertent error, even though Coronation did not disclose the content of the advice to SARS or the court.
The SCA judgments in both Thistle and Coronation were on appeal to the CC, and the judgments of the CC in both appeals have now also been delivered.
In a judgment handed down on 21 June 2024, the CC in Coronation Investment Management SA (Pty) Ltd v CSARS [2024] ZACC 11 (CC) found in Coronation’s favour on the merits and SARS’ cross-appeal in respect of understatement penalties therefore did not come up for consideration. Given that the understatement and underestimation penalties which SARS sought to impose on Coronation would have been substantial, it is worth considering the history of the litigation between the parties:
- The Tax Court found in Coronation’s favour on the merits (in short, that the foreign business establishment (FBE) exemption applied to a controlled foreign company (CFC) of Coronation);
- The SCA found the opposite (in short, that the FBE exemption could not apply as the CFC sought to outsource what the SCA interpreted as the CFC’s primary business); and finally
- The CC turned the matter back around by finding in Coronation’s favour (in short, that the FBE exemption indeed applied based on the CC’s interpretation of the nature of the CFC’s business).
Since the CC judgment in Coronation did not take the penalty debate any further, all eyes were on the CC’s judgment in The Thistle Trust v CSARS [2024] ZACC 19, which was finally handed down on 2 October 2024.
Although the Tax Court had found in the Thistle Trust’s favour on the merits (the matter concerned the application of the ‘conduit pipe’ principle to the taxation of capital gains distributed to beneficiaries through multiple trusts in a tiered trust structure) - this was overturned by the SCA, where the Trust lost on the merits. In the CC, the majority agreed with the SCA by holding in SARS’ favour that the conduit pipe principle did not apply, with two out of eight judges dissenting.
SARS had applied for leave to cross-appeal the penalty issue to the CC if the Trust lost on the merits. In a surprising turn of events, SARS denied ever having made the concession before the SCA that the Trust’s reliance on expert advice was a bona fide inadvertent error, although SARS accepted that its counsel did not argue the point before the SCA.
Despite the interpretation of the penalty provisions being a matter of great public importance, the CC dismissed SARS’ application for leave to cross-appeal as not being in the interests of justice. This was because the CC would have been sitting as the court of first and last instance in interpreting the term bona fide inadvertent error (since the Tax Court did not reach the penalty issue and the point had not been argued before the SCA) and SARS had no sustainable case for imposing the penalties (therefore the cross-appeal would ultimately fail).
However, the CC made instructive remarks regarding the two blameworthy behaviour categories, at least one of which SARS argued should apply, in holding that SARS had no reasonable prospects of discharging the onus of proving the facts that would bring the Thistle Trust’s conduct within either of these categories:
- In relation to “[n]o reasonable grounds for ‘tax position’ taken”, the CC held that there were indeed reasonable grounds for the tax position taken by the Trust which was not only based on legal advice but upheld by the Tax Court in a reasoned judgment; and
- In relation to “[r]easonable care not taken in completing return”, the CC rejected SARS’ argument that the Trust failed to take reasonable care in completing its return by not following the stated SARS position (which was considered and rejected in the advice relied on by the Trust).
The dissenting judges in Thistle agreed with the majority’s reasoning on the penalty issue, therefore these remarks were effectively unanimous by no less than eight judges of the CC. It was clearly the view of the bench in Thistle that a taxpayer who adopts a position contrary to SARS’ position is not automatically liable for understatement penalties – rather, to discharge the onus resting on it, SARS must prove the facts which bring the taxpayer’s conduct within the chosen behaviour category, amongst other things.
If based on a ‘substantial understatement’, SARS must remit the understatement penalty if the taxpayer made full disclosure of the arrangement to SARS and was, by the time the relevant return was due, in possession of an opinion by an independent registered tax practitioner that satisfied the requirements of section 223(3) of the TAA. One of these requirements is that the opinion must be based on a full disclosure of the facts and circumstances of the arrangement that gave rise to the prejudice to SARS or the fiscus and another is that the opinion must confirm that the taxpayer’s position is more likely than not to be upheld if the matter proceeds to court. Although ‘substantial understatement’ is only one of the available categories, where a taxpayer was in possession of such an opinion which considered the available SARS guidance on an issue and submitted its tax returns based on the advice contained in the opinion, the taxpayer’s behaviour could hardly constitute reasonable care not taken in completing return, no reasonable grounds for ‘tax position’ taken or gross negligence (this view would seem to be supported by the CC’s remarks in Thistle). It would also seem that the behaviour of the taxpayer would not fall into the ‘intentional tax evasion’ category, unless there was some sort of collusion between the taxpayer and the tax practitioner who issued the opinion. In these circumstances, SARS would only be able to levy an understatement penalty if it was able to show that the ‘arrangement’ in question constituted an ‘impermissible avoidance arrangement’ (an arrangement to which the general anti-avoidance provisions applied).
Especially since the CC in Thistle declined to comment on the meaning of a bona fide inadvertent error, the SCA’s pronouncements on the meaning of this term remain instructive. In view of these pronouncements of the SCA, SARS’ prior narrow view of the term bona fide inadvertent error seems to require an update. Moreover, in the case of taxpayers acting on reasoned expert advice and given the CC’s remarks in Thistle, SARS will not easily discharge the onus of proving the facts which bring the taxpayer’s behaviour into one of the categories required to successfully impose understatement penalties. The value of tax opinions that comply with the requirements of section 223 should thus not be underestimated.
