South Africa: What Constitutes A "bona Fide Inadvertent Error" For Purposes Of Understatement Penalties?

Section 222(1) of the Tax Administration Act, 2011 ("TAA") provides that, in 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, as determined under section 222(2), unless the 'understatement' results from a "bona fide inadvertent error".

In terms of section 222(2), an understatement penalty is determined with reference to the table contained in section 223, which takes into account among other things the "behaviour" of the taxpayer. The first listed "behaviour", item (i), which attracts the lowest penalty percentage, is "substantial understatement" which is defined as "a case where the prejudice to SARS or the fiscus exceeds the greater of five per cent of the amount of 'tax' properly chargeable or refundable under a tax Act for the relevant tax period, or ZAR1 000 000". Thereafter, a further five behaviours are listed, ranging from (ii) "reasonable care not taken in completing return" to (v) "intentional tax evasion" (which attracts the highest penalty percentage). The South African Revenue Service ("SARS'") Guide to Understatement Penalties ("SARS Guide") indicates that:

"If the act or omission of the taxpayer is not encapsulated in any of the listed behaviours, there is no basis for the determination of a penalty and consequently there can be no penalty."

On the basis that categories (ii) to (v) seem to require a level of blameworthiness, it seems that the "bona fide inadvertent error" exclusion would be most (if not only) relevant in relation to a "substantial understatement". It is noted that SARS seems to answer the question of whether a "bona fide inadvertent error" has been made by asking whether reasonable care had been taken in completing return. The distinction between these phrases is important in the context of a prospective voluntary disclosure programme ("VDP") application since it is one of the requirements that the disclosure must "involve a behaviour referred to in column 2 of the understatement penalty percentage table in section 223".

In ABC Holdings (Pty) Ltd v The Commissioner for the South African Revenue Service, the tax court held that "... the bona fide inadvertent error has to be an innocent misstatement by a taxpayer on his or her return, resulting in an understatement, while acting in good faith and without the intention to deceive."

The SARS Guide prefers a very narrow interpretation and states as follows:

"An inadvertent error is one that does not result from deliberate planning, and a bona fide inadvertent error is one that genuinely does not result from deliberate planning. Importantly, the lack of deliberate planning must relate to the error, that is, the default, omission, incorrect statement, failure to pay the correct tax, or impermissible avoidance arrangement must be genuinely involuntary.

In a similar vein, for example, the payment of an amount of tax when a return is not required, or deductions of capital expenses in returns, presupposes the application of forethought. Even when this forethought is based on bona fide incorrect reasoning, or an opinion incorrectly interpreted without the intention to deceive, the payment, non-payment, or incorrect statement itself cannot be said to be validly unmeant. Only if the amount captured or its location on the return does not coincide with the actual intent of the taxpayer, could such an error possibly be regarded as an authentically unthinking mistake.

From the foregoing, it seems likely that the only errors that may fall within the bona fide inadvertent class are typographical mistakes – but only properly involuntary ones. This does not mean that a lack of reasonable care will be excused. An error cannot be said to be legitimately unplanned when for instance, a clerk makes a capturing error that results in an understatement, and as it should be, the return is reviewed by their supervising public officer or tax practitioner, and this person, misses the error because they are anxious to attend the golf day organised by a supplier. In such an instance, the choice not to take the reasonable care appropriate to their station cannot be said to be truly unpremeditated.

SARS gives an example of a taxpayer who filed a tax return that included a deduction in respect of a donation of ZAR2 500 to a charity. It then turns out the charity's system issued an erroneous certificate and that the donation was only ZAR1 000. SARS however is of the view that the omission does not constitute a "bona fide inadvertent error" as "the amount was deliberately captured in the return" but that since none of the behaviours per the table are applicable, no penalty can be imposed. How would one make sense of this if there was a "substantial understatement", eg, the donation was ZAR2.5-million and not ZAR2 500?

At the end of 2019, the distinction between a "bona fide inadvertent error" and "reasonable care not taken in completing return" was considered by the Tax Court in Port Elizabeth in Income Tax . The taxpayer (Appellant), a close corporation, appointed professional accountants to prepare and complete its 2016 income tax return.

Based on input from the accountant, the Appellant changed certain accounting depreciation policies to bring it in line with the wear-and-tear rates of SARS. The accountants prepared a tax computation in preparation of the Appellant's income tax return, but forgot to add back the adjustment in respect of the change in accounting policy. The same omission was made in the tax return completed by the accountant and submitted to SARS, which resulted in an overstatement of the Appellant's assessed loss.

When SARS conducted an audit, the discrepancy was identified. A revised assessment was issued and an understatement penalty was imposed on the basis that the taxpayer had not taken reasonable care in completing the return. The Appellant objected to the imposition of the penalty, inter alia, on the basis that the omission constituted a bona fide inadvertent error. The objection was disallowed and the Appellant then lodged an appeal.

The court had to consider, among other things, whether the Appellant should be excused from paying the penalty on the basis that the understatement was as a result of the bona fide inadvertent error. In dismissing the appeal, court held as follows:

• The dictionary meaning of the word 'inadvertent' was linguistically not that straightforward;
• the context of what will constitute an honest mistake must be provided by the provisions which follow section 222(1). An "inadvertent" error cannot include any error that is the result of neglect as it would be inconsistent with the nature of the wrongdoing for which the taxpayer is responsible in terms of the Table. The determination of what an inadvertent error is, must therefore be done with reference to what it was not, i.e., an error is not inadvertent, and therefore inexcusable, where the taxpayer's action or omission can be classified as a failure to take reasonable care in the completion of his or her tax return, or as being intentional or grossly negligent.
• Taking reasonable care in the context of submitting a tax return requires giving "appropriately serious attention to complying with the obligations imposed under the tax legislation". While it could be accepted that the incorrect statement in the return was an honest mistake, it also had to be an inadvertent mistake.
• "Reasonable care requires the taxpayer to take the degree of care that would be expected of a reasonable and prudent taxpayer in the position of the taxpayer concerned to fulfil his or her tax obligations... The question was whether on an objective analysis there had been a failure by the taxpayer to take reasonable care and it was a factual question that must be decided on the facts of each case."
• The accountant had failed to act with the expected diligence when he advised the Appellant to effect a change to its accounting policy but then failed to ensure that the change was reflected in the tax computation and in the tax return. The mistake was then carried over into the tax return which indicates that the return was prepared without being checked to the financial statements. Such "failures speak of an absence of reasonable measures and/or the implementation of measures to avoid the obvious mistake in question".
• The question was therefore not whether the accountant's conduct should be imputed to the Appellant, but rather whether the Appellant had exercised the standard of care and diligence expected of a reasonable taxpayer in respect of the completion and submission of its tax return.

The court held that a reasonable taxpayer would at a minimum have taken steps to satisfy itself that the accountant did not make an obvious error in preparing the return. In the previous tax year, the Appellant had made a profit and in the 2016 tax year it suffered a loss of more than ZAR37-million per its tax return. A diligent taxpayer would have picked this up, and this indicates, in the absence of any evidence to the contrary by the Appellant, that the Appellant had not carefully reviewed the tax return before submission. Accordingly, the incorrect statement did not constitute a bona fide inadvertent error; instead, the Appellant had failed to take reasonable care in completing its tax return.

It seems from the above that an escape from understatement penalties based on the "bona fide inadvertent error" defence will only be accepted by SARS in very limited circumstances, and in particular, will not be accepted in respect of an error where it can be said that the taxpayer did not take reasonable care in completing the relevant tax return. This should also be taken into account when considering a prospective VDP application. While the imposition of an understatement penalty under section 222 or a decision by SARS not to remit an understatement penalty is subject to objection and appeal, unless a VDP disclosure is in respect of "gross negligence" or "intentional tax evasion", a successful VDP application before notification of an audit offers certainty that no understatement penalties will be payable.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.