The understatement penalty (“USP”) regime introduced by the South African Revenue Service (“SARS”) in terms of the Tax Administration Act, No 28 of 2011 (the “TAA”), which is still in its infancy stages, has led to some uncertainty as to when an USP should, veritably, be levied by SARS. An “understatement” is defined in section 221 of the TAA to mean “any prejudice to SARS or the fiscus as a result of –
- a default in rendering a return;
- an omission from a return;
- an incorrect statement in a return; or
- if no return is required, the failure to pay the correct amount of ‘tax’.”
With the enactment of the TAA, it was envisaged by SARS that the USP regime would be a prime means of safeguarding itself with an arsenal of extensive financial sanctions in a bid to punish errant taxpayers whose actions result in any of the four aforementioned misdemeanours. The levying of an USP, which is predicated on the taxpayer’s behaviour, ranges from a mere ten percent to an astronomical two hundred percent, particularly in instances of repeated intentional tax evasion.
The crucial issue is whether the taxpayer’s behaviour resulted in a prejudice to SARS or the fiscus. The term “prejudice” which is the fulcrum of the definition of an understatement has not been defined in the Act. It follows that the ordinary dictionary meaning must be espoused in this instance; this in itself creates the uncertainty as to whether the levying of the USP by SARS is warranted. This is best illustrated by way of example. A taxpayer submits a Value-Added Tax (“VAT”) return for a refund of R10m on 1 September 2014 and the taxpayer later notifies SARS, on 2 September 2014, that the refund was erroneously inflated (i.e. the refund was actually R8m). The crisp issues at hand are as follows:
- whether or not SARS is justified in levying an USP on the R2m, if SARS assessed the return on 4 September 2014, and paid out the reduced refund on 6 September 2014?
- whether or not SARS has been prejudiced in this instance?
- whether or not an administrative action by SARS (i.e. SARS raising an assessment to correct the refund amount) falls into the ambit of “prejudice”?
To shed light on the above, one needs to first understand the interplay between sections 221, 222(1), 222(2), and 222(3) of the TAA. More specifically, in the event of an understatement by the taxpayer, the taxpayer must pay, in addition to the tax payable for the relevant tax period, the USP determined in terms of section 222(1), unless the understatement results from a bona fide inadvertent error (for the purposes of the example, assume that there was no bona fide inadvertent error prevalent). Section 222(2) states that the understatement penalty is the amount resulting from applying the highest applicable understatement penalty percentage in accordance with the table in section 223 to each shortfall determined under subsections (3) and (4) in relation to each understatement in a return. In the present case the shortfall is the sum of –
- the difference between the amount properly refundable for the tax period and the amount that would have been refundable if the understatement were accepted (emphasis added).
The ordinary dictionary meaning of “accepted” is: (verb).”to agree or consent to; accede to…”. Surely, what is envisaged by “accepted” and “prejudice” is the notion that SARS has accepted the erroneous claim submitted by the taxpayer when SARS processes the VAT return and pays the refund to the taxpayer. Stated differently, the word prejudice used in the context (of law) means to “cause harm to (a state of affairs)…”. It follows that harm would be caused to SARS if SARS consented to the erroneous refund and subsequently made payment of that refund to the taxpayer (SARS would have been out of pocket to the quantum of the incorrect amount i.e. the difference between the amount properly refundable and the amount that was refunded).
In the context of the above, it is prudent to say that no prejudice to SARS or the fiscus is evident or prevalent as the erroneous refund (i.e. the R10m) was not paid out to the taxpayer. Furthermore, by notifying SARS of the error, this could be deemed as being synonymous with a voluntary disclosure before notification of audit/investigation as per section 223(1) of the USP percentage table in the TAA. It follows from this that it cannot be deemed acceptable for an administrative action to warrant classification as “prejudice” to SARS.
On the other hand, if the taxpayer had not notified SARS that the refund was erroneously inflated, yet SARS carried out the same steps outlined above (that culminated in SARS raising an assessment to correctly reflect the amount properly refundable), would this justify the levying of an USP under these circumstances? On one hand, the USP would not be justifiable for the very same reasons stated in the above example; i.e. the incorrect refund was not paid out and therefore no actual monetary prejudice came into existence. In contrast to this, it could also be argued that SARS could proceed from the point of view that the lack of disclosure was intentional and that the assessment resulted in a thwarting of the taxpayer’s attempt to understate its tax liabilities. In turn, the attempt to understate would be punishable in the same manner as the successful execution thereof. Therefore, a taxpayer who unknowingly declared an incorrect refund – and thus preventing it from notifying SARS timeously – would only be left with the exceptional argument of a bona fide inadvertent error as a remedy, from the levying of an USP. However, the shortcoming of this argument would be that it would require the definition of an understatement to be read as “any prejudice, or the threat thereof, to SARS or the fiscus”. Such an interpretation would thus need to either be confirmed by the legislature or by SARS through a published Interpretation Note.
In light of the above, it follows that in the absence of an express definition of the word “prejudice” it is debatable as to whether or not an USP should be levied by SARS in respect of issues where there is clearly no monetary prejudice to SARS; this opens the door to legal wrangles as to the intention of the legislature. Hopefully, SARS will assist in clarifying the issue in the not too distant future by way of an Interpretation Note or legislative changes.
In conclusion, the USP regime, in our view, was designed to protect SARS and/or the fiscus against any prejudice, emanating from any of the four actions underpinning an “understatement” that results in an actual monetary prejudice and not an administrative prejudice.