The imposition of understatement penalties in terms of Chapter 16 of the Tax Administration Act 28/2011, and the factors to consider when imposing such a penalty, is an issue unresolved by the courts. However, the Tax Court's judgment in XYZ CC v The Commissioner for the South African Revenue Service (Case 14055) (as yet unreported), November 20 2017, sets out some helpful principles in this regard.


The taxpayer, XYZ CC, which supplies agricultural inputs (eg, lime and gypsum) to farmers, disputed being taxed on an additional R2 million by the South African Revenue Service (SARS) for the 2013 tax year.

The taxpayer initially claimed that the R2 million constituted social development expenditure incurred in respect of Entity E, an entity which also operates in the agricultural sector, and therefore was a permissible deduction under Section 11(a) of the Income Tax Act (58/1962). SARS disallowed the deduction and imposed a 100% understatement penalty. The taxpayer's objection to the penalty was disallowed and it subsequently appealed.

However, while giving evidence before the Tax Court, the taxpayer's accountant testified that the R2 million was not part of the taxpayer's gross income, based on a credit note that the taxpayer had issued to Entity E which allegedly reflected an agreed price reduction. Therefore, it was unnecessary to prove that the requirements of Section 11(a) of the Income Tax Act had been met.

Mr B, the sole member of the taxpayer, gave evidence that he had wanted to make a donation to the V Trust. The V Trust served a community in Kwazulu-Natal of which Mr A, who worked for Entity E, was the leader.

When Mr B discovered that he could not make a deductible donation to the V Trust under Section 18A of the Income Tax Act, he suggested the alternative arrangement that the taxpayer would credit Entity E's account with R2 million. Entity E would pass this gift to the community, which would then be told by the V Trust that the taxpayer had made the donation.

Mr B indicated that he wanted to gain "some BEE points" for 2013 from this arrangement. In order to prove that the money was donated to the community, Mr A's accountant wrote a letter addressed to the taxpayer in which the V Trust thanked it for the donation.


Deduction The Tax Court held that, although social development expenditure may be claimed as a deduction, the taxpayer could not prove that the R2 million was deductible in terms of Section 11(a). It also held that the taxpayer could not prove that the R2 million was not part of its gross income, as suggested by its accountant.

Understatement penalties After finding that the amount of R2 million formed part of the taxpayer's taxable income for 2013, the Tax Court considered whether SARS had correctly imposed the 100% understatement penalty. According to the understatement penalty percentage table under Section 223(1) of the Income Tax Act, in a 'standard case' a 100% understatement penalty will be imposed where the taxpayer's conduct allegedly constitutes gross negligence.

The Tax Court referred to the fact that, in terms of the table in Section 223(1), a 50% understatement penalty applies when there are "reasonable grounds for the 'tax position' taken" and that a 25% understatement penalty applies when reasonable care is not taken in completing the return. The Tax Court held that, in terms of Section 223(1), the circumstances in which the 25% and 100% penalties will be applied are therefore defined in terms of fault. However, the circumstances which result in a 50% penalty are instead defined by the absence of reasonable grounds for the tax position taken by the taxpayer.

Under Section 129(3) of the Income Tax Act, where an appeal is brought against an understatement penalty, the "tax court must decide the matter on the basis that the burden of proof is upon SARS and may reduce, confirm or increase the understatement penalty". With reference to case law on this issue, the Tax Court found that in cases involving the exercise of a discretion by SARS, a tax court must exercise its own discretion. Thus, the Tax Court had to consider whether the present case involved gross negligence on the part of the taxpayer.

The Tax Court referred to Transnet Limited t/a Portnet v Owners of the MV Stella Tingas (2003 (2) SA 473 (SCA)) in which it was held that, in order for there to be gross negligence, there must be an extreme departure from the standard of the reasonable person. It also referred to Lewis Group v Woollam (2017 (2) SA 547 (WCC)) in which it was held that neither poor business decision making nor a company director's misguided reliance on incorrect professional advice constitute gross negligence.

Based on the contradictory evidence given by Mr B and the taxpayer's accountant, the Tax Court held that both the objection and the appeal procedures were followed on advice given by the taxpayer's accountant, which Mr B had not fully understood. Where there were contradictions between the parties' evidence, Mr B's evidence was preferable. SARS attempted to argue that the taxpayer could not claim that it was the victim of poor advice from its accountants. However, the Tax Court found that the evidence showed that the tax position adopted by the taxpayer was the result of advice given by its accountant. In other words, this constituted misguided reliance by a member of a close corporation on incorrect professional advice, which does not constitute gross negligence. As such, the Tax Court held that the understatement penalty must be reduced to 50% in the absence of reasonable grounds for the taxpayer's tax position.


The judgment is helpful as it explains how to interpret the types of conduct under Section 223(1) of the Income Tax Act. Most importantly, it demonstrates that SARS will be entitled to impose a 100% understatement penalty for gross negligence only where it is clear that a taxpayer's conduct was either considered extreme or constituted more than misguided reliance on incorrect tax advice. If this cannot be proven, a lower penalty must be imposed (to be determined on a case-by-case basis).

Taxpayers should also take note that SARS has recently released a Draft Guide to Understatement Penalties, which could provide an indication as to SARS's interpretation of the understatement penalty provisions.

For further information on this topic please contact Louis Botha at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email ( The Cliffe Dekker Hofmeyr website can be accessed at

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