Canada: Understatement Penalties: The Price Of Not Obtaining A Tax Opinion

The Tax Administration Act 28 of 2011 ("TAA"), which came into operation on 1 October 2012, levies penalties on taxpayers who understate the amount of tax which they owe to the fiscus. These penalties are known as "understatement penalties" and will be imposed on taxpayers when the fiscus is prejudiced by the taxpayers conduct in reporting its taxable income. Such prejudice arises to the fiscus when there is a difference between the amount of tax that should have been reported by the taxpayer and the actual amount reported by the taxpayer. However these understatement penalties may be reduced in certain circumstances by obtaining a tax opinion from a registered tax practitioner or by making a voluntary disclosure of the understatement.

The rate at which the understatement penalty is imposed depends on the behaviour of the taxpayer and the circumstances in which the taxpayer reported the understatement. The maximum penalty percentage that can be charged is 200%. The South African Revenue Services ("SARS") has no discretion when levying an understatement penalty and is obliged under the TAA to levy the penalty.

As mentioned above, there are certain instances where a taxpayer can have the SARS remit an understatement penalty or have the rate of penalty reduced.

The first instance applies where there is a "substantial understatement". A "substantial understatement" is where the prejudice to the SARS or the fiscus exceeds the greater of 5 per cent of the amount of tax properly chargeable or refundable under the relevant tax period, or R1 million. A penalty for "substantial understatement" is imposed at 25 per cent in a standard case or 50 per cent in a repeat case.

Section 223(3) of the TAA provides that the SARS must remit the understatement penalty if it is satisfied that (1) the taxpayer has made full disclosure of the arrangement giving rise to the prejudice by no later than the date the relevant return was due and (2) the taxpayer was in possession of an opinion prepared by a registered tax practitioner. The opinion of the tax practitioner must be issued no later than the relevant return date, take into account the specific facts and circumstances of the arrangement, and confirm that the taxpayer's position is more likely than not to be upheld if the matter proceeds to Court.

Second a tax opinion may go a long way in assisting a taxpayer in avoiding understatement penalties when a penalty is imposed in circumstances where the SARS alleges that there are "no reasonable grounds" for the tax position taken by the taxpayer. According to the SARS Short Guide to the TAA a taxpayer may have reasonable grounds for a tax position which the taxpayer has adopted, after having given regard to relevant authorities such as income tax law, a Court decision or a general ruling. By obtaining a tax opinion from a registered tax practitioner the taxpayer would then be in a position to argue that it did in fact have reasonable grounds for adopting its tax position and the SARS would then bear the onus of proving the contrary.

Lastly, where the taxpayer makes voluntary disclosure of the understatement in its tax liability then the rate of the penalty will be reduced. The amount of the reduction depends upon the time at which the taxpayer makes the disclosure to the SARS, either before or after notification of an audit.

As such, under the TAA obtaining independent tax advice from a registered tax practitioner in respect of one's tax affairs can assist a taxpayer in reducing or eliminating any understatement penalties that the SARS may levy.

Understatement penalty percentage table as set out in section 223(1) of the TAA:

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