In terms of section 222(1) of the South African Tax Administration Act, 2011 (the “TAA”), “[i]n the event of an ‘understatement’ by a taxpayer, the taxpayer must pay, in addition to the ‘tax’ payable for the relevant tax period, the understatement penalty determined under subsection (2) unless the ‘understatement’ results from a bona fide inadvertent error” (our emphasis).
It is thus clear that where the South African Revenue Service (“SARS”) raises an additional assessment imposing an additional amount of tax payable by the relevant taxpayer, SARS may also impose an understatement penalty, provided that the relevant requirements are met.
Section 222(2) of the TAA then provides that this “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” (our emphasis).
“Shortfall” is defined in section 222(3) and includes, inter alia, the difference between the amount of an assessed loss or any other benefit to the taxpayer properly carried forward from the tax period to a succeeding tax period and the amount that would have been carried forward if the “understatement” were accepted, multiplied by the tax rate determined under subsection (5).
It seems that where a capital loss claimed by a taxpayer is disallowed by SARS, and no capital gain was set off against such loss in the specific year of assessment during which the capital loss arose, according to SARS, this should meet the requirements of a “shortfall”, meaning that an understatement penalty may still be imposed, provided that there is an “understatement”.
In terms of section 221 of the TAA, an “understatement” means: “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’
- an ‘impermissible avoidance arrangement’.”
“Prejudice” is not defined in the TAA or Income Tax Act, 1962 and, therefore, the ordinary meaning of the word applies. The word prejudice used in the context (of law) means to “cause harm to (a state of affairs)…”
Therefore, in order for there to be prejudice to SARS or the fiscus, SARS or the fiscus must suffer some damage or be adversely affected as a result of any of the events listed in paragraphs (a) to (e) above.
It is clear that harm would be caused to SARS if a taxpayer realised a capital loss and that capital loss is set off against a capital gain in such year of assessment. SARS, however, levies understatement penalties despite such a loss not being set off against any capital gain. Put differently, if SARS disallows a capital loss claimed by a taxpayer in a year of assessment, understatement penalties are imposed in that year of assessment, even if the capital loss was not utilised in that year of assessment (and may never be utilised). It is not clear on what basis the Commissioner, in these circumstances, alleges that there is a prejudice. It is understood that this is on the basis that capital gains may potentially be set off against such a capital loss in future.
However, in this regard, it is relevant to note that in terms of section 129(3) of the TAA, in an appeal against an understatement penalty imposed by SARS, SARS carries the burden of proof.
The onus is therefore on SARS to prove that there has been a prejudice to SARS or the fiscus and how the relevant provisions find application where no “harm to [the] state of affairs” of SARS or the fiscus has arisen. In particular, it is possible that such harm may never arise, for example, if the relevant taxpayer is liquidated shortly after the realisation of the capital loss, or the taxpayer never realises any capital gains which may be set off against such capital loss.