Understatement penalty – the taxpayer’s right to reasons

Understatement penalty – the taxpayer’s right to reasons

• 31 January 2020
• Tax Administration
• Elle-Sarah Rossato

Important:

This article is based on tax law for the tax year ending 28 February 2020.

In Tax Case No. 24643 (judgment delivered 3 May 2019), the Gauteng Tax Court was asked to adjudicate the adequacy of the reasons for a penalty assessment levied by SARS following an audit which resulted in the issuing of an additional assessment.

In this instance the taxpayer had noted an appeal against the additional assessment including the penalty assessment. SARS asserted that the taxpayer had been grossly negligent in the preparation of his return of income and had imposed a penalty at a level consistent with such behaviour.

SARS delivered a notice of grounds of assessment and opposing the appeal, which it is required to deliver in terms of Rule 31 (‘the Rule 31 statement’). At paragraph 22, SARS stated:

‘22.1 The appellant neglected to provide complete and accurate information together with the submission of his annual income tax returns for the tax year in dispute;

22.2 The facts uncovered during the audit fell in the sole knowledge of the appellant, these facts the appellant failed to disclose to SARS;

22.3 It is SARS’ contention that there was no bona fide inadvertent error on the part of the appellant when he completed and submitted his tax returns;

22.4 SARS deems the conduct of the appellant as stipulated above to fall under the category of gross negligence in completing a return as listed in the understatement penalty percentage table of section 22(3)(1) of the Tax Administration Act.’

The taxpayer contested this statement, arguing that it did not disclose the reasons for the imposition of a penalty based on gross negligence.

In the case of a penalty assessment, the burden of proof rests on SARS, and it must establish, on a balance of probability, that the taxpayer’s actions were such as to justify the penalty assessed. Where an assessment of a penalty is contested on appeal, the Rule 31 statement must comply with the requirements of Rule 31(2), which states:

(2) The statement of the grounds of opposing the appeal must set out a clear and concise statement of—

(a) the consolidated grounds of the disputed assessment;

(b) which of the facts or the legal grounds in the notice of appeal under rule 10 are admitted and which of those facts or legal grounds are opposed; and

(c) the material facts and legal grounds upon which SARS relies in opposing the appeal.

The judgment Unterhalter J described the purpose of the Rule 31 statement and the responding statement that a taxpayer is required to submit thereafter at paragraphs [11] and [12]):

‘[11] The real question however that I must determine is whether the averments that are contained in paragraph 22 of the Rule 31 statement suffice for the purposes of Rule 31. It seems clear to me that the Rule 31 statement must set out a clear and concise statement of the material facts and legal grounds upon which SARS relies in opposing the appeal (see in particular Rule 31(2)(c)). That provision in the Rule is of course wholly consistent with the purpose of the Rule 31 statement and the Rule 32 statement because as Rule 34 explains, and as I have indicated these two statements set out the issues that go on appeal to the Tax Court.

[12] The Rule 32 statement has a similar requirement, which is that in the Rule 32(2) the statement must set out clearly and concisely, amongst other things, which of the facts or the legal grounds in the statement under Rule 31 are admitted and which of those facts and legal grounds are opposed. The very exercise that is therefore contemplated in the Rule 31 and Rule 32 statements is that there are facts and legal grounds that are sufficiently clearly and concisely specified so as to know what issues proceed to an appeal.’

The crisp issue was whether sufficient information had been provided concerning the behaviour of the taxpayer to justify the conclusion that he was grossly negligent. In this regard the following dicta from the judgment in Transnet Limited t/a Portnet v Owners of the N B Stella Tingas and Another 2003(2) SA 473 SCA at paragraph [7]:

‘It follows l think that to qualify as gross negligent the conduct in question, although falling short of dolus eventualis must involve a departure from the standard of the reasonable person to such an extent that it may properly be categorised as extreme. It must demonstrate where this is found to be conscious risk-taking, a complete obtuseness of mind or where there is no conscious risk taking a total failure to take care. If something less were required the distinction between ordinary and gross negligence would lose its validity.’

Noting that the extent of the penalty is set out in a table in section 223 of the Tax Administration Act, Unterhalter J explained the table at paragraph [15] and [16]:

‘[15] … Thus reading the table, the understatement penalty percentages differentiate substantial understatement from reasonable care not being taken in completing a return and gross negligence.

[16] The penalty percentages increase with the differentiation in the behaviour; and gross negligence in the standard case is visited with a penalty percentage of 100% and it is precisely that percentage that SARS alleges in the Rule 31 statement and that the taxpayer here has committed gross negligence.’

The issue was whether sufficient information was provided to the taxpayer to enable the taxpayer to prepare a case. SARS had argued that the facts would emerge from evidence in the trial and that all it needed to do was aver that there had been culpable behaviour. At paragraphs [23] and [24], Unterhalter J examined the necessity for disclosure:

‘[23] It is of the essence of the behaviour that is tabulated in section 223 that there are differentiated forms of culpability and in order to differentiate the behaviour it is necessary to understand by reference to some facts why the deviation that SARS has uncovered is so great from the standard of reasonable care that it amounts to gross negligence, rather than ordinary negligence or indeed simply a substantial understatement.

[24] That it seems to me is not purely a matter of evidence but is something where certain facts would have to be proved to show that gross negligence is present and that gross negligence must have something to do with what facts were not disclosed and why SARS believe that failure to disclose those facts is constitutive of gross negligence rather than mere negligence or indeed innocent understatement.’

Unterhalter J found that the averments in paragraph 22 of SARS’ Rule 31 statement did not disclose behaviour which would justify a finding of gross negligence, as opposed to ordinary negligence or substantial understatement. The exception taken by the taxpayer was upheld, at paragraphs [26] and [27]:

‘[26] Absent the essential facts that SARS relies upon as to why there is gross negligence, the pleadings will simply be a bare denial of gross negligence and that will not be helpful for the purposes of explaining the true dispute that must be resolved on appeal.

[27] I accordingly find that the exception is well taken and it is a true exception in the sense that the Rule 31 statement lacks averments necessary to sustain a finding of gross negligence and the imposition of an understatement penalty at the rate of 100%.’

SARS was ordered to remedy the defect in the Rule 31 statement within 15 days.

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This article first appeared on pwc.co.za

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