A taxpayer’s right to manage its exposure
06 February 2013
Posted by: Erich Bell
When dealing with exposure to taxation, there is little doubt that it is preferable to be proactive about managing your potential liability, rather than to try to fix a tax-related problem once it has surfaced.
The tax implications of transactions or events often play a significant role in business decisions and taxpayers are required to assume a stance or view on an issue, despite the risk that the tax authorities may disagree with those views. Significant uncertainties, such as the potential penalties that could stem from such a view or position taken, may however restrict business activities unnecessarily if this risk cannot be managed.
Tax risk management is about a considered approach to your tax risks – it is not about trying to reduce them to zero. A company’s policy on tax risk management will determine
1. The value that can be achieved by taking risks.
2. The costs that can be saved by reducing risks.
3. The resources needed to manage both the upside-opportunities and downside-risks.
This article considers the impact of the introduction of the understatement penalty regime in the Tax Administration Act (TAA) on a taxpayer’s ability to manage its exposure to understatement penalties.
Additional tax: limited rights to taxpayers
Prior to the enactment of the TAA, relevant sections of the Income Tax Act imposed additional tax when, among others, a taxpayer made an incorrect statement/entry in any tax return which resulted or would have resulted in the taxpayer paying less tax than he should have. An incorrect statement included any entry that SARS deemed did not reflect the correct interpretation and application of the provisions of the Income Tax Act.
A similar additional tax liability was triggered when anything which should have been included in a tax return, was not included. In terms of the Income Tax Act this included any unallowable deduction, set-off, disregarding or any exclusion of an amount in determining a taxpayer’s taxable income.
This additional tax was calculated by determining the difference between the tax actually paid, and the tax that should have been paid if there was no negligence or intentional oversight of certain amounts, multiplied by two. A taxpayer who adopted a tax position that SARS did not agree with could therefore have been exposed to a potential 200% penalty in addition to its tax liability.
Unless the omission or incorrect statement/entry stemmed from an intention to evade tax, the Commissioner had the discretion to impose the additional tax or part thereof as he deemed fit. In practice, the Commissioner’s discretion was based on the recommendations of a penalty committee. In the event of the Commissioner not imposing the whole additional tax charge, his decision was subject to objection and appeal, in which case the Tax Court had the power to reduce, confirm or increase the amount of the additional tax imposed by the Commissioner.
It is submitted that under the additional tax regime, a taxpayer had a right to question the additional tax imposed, but had very little legal backing when it came to determining the exact extent of its exposure to additional tax. As a result of certain tax positions taken, managing the risk of additional tax became very challenging.
The rights of taxpayers under the new regime
From 1 October 2012, the relevant sections of the Income Tax Act have been abolished and understatement penalties in respect of any taxes covered by the TAA are now imposed in terms of Chapter 16 of the TAA. Similarly to the Income Tax Act, these penalties are imposed when the fiscus (treasury) is biased due to the failure to render a tax return, an omission from a tax return or an incorrect entry in a tax return.
Such an understatement penalty is calculated as the shortfall, which refers to the shortfall in tax paid as a result of the action that harmed SARS, multiplied by the highest applicable penalty rate from the table provided in the TAA. The table in the TAA provides different rates for the understatement penalty, depending on the behaviour of the taxpayer and the circumstances under which the behaviour occurred. The use of this table provides the taxpayer with a much clearer picture of what to expect when it comes to exposure to penalties resulting from different behaviours.
The relevant behaviours listed in the TAA, in order of increasing severity as far as the penalty rate is concerned, are:
(i) substantial understatement;
(ii) reasonable care not taken in completing a return;
(iii) no reasonable grounds for the tax position taken;
(iv) gross negligence; and lastly
(v) intentional tax evasion.
It is important to note that a section of the TAA places the burden of proof on SARS. This means that SARS will have to prove the facts that lead to them to issuing an understatement penalty. This section should therefore provide a taxpayer a foot to stand on when managing his risk exposure. This can be achieved by implementing certain processes and actions, which could make it extremely difficult for SARS to dismiss the burden of proof imposed by the relevant section.
Unfortunately, it may be a matter for the courts to consider whether SARS has successfully dismissed its obligation before the penalty is dismissed. It would nevertheless be in a taxpayer’s best interest to implement such measures to manage this risk exposure and attempt to make it unattainable for SARS to discharge this obligation. The position of the taxpayer in the case of each of the behaviours is briefly considered next.
Intentional tax evasion
Intentional tax evasion will exist if a taxpayer knowingly fails to comply with the requirements of a tax law in order not to pay the tax that they are legally obliged to pay. There is no apparent process or action that can, or for that matter should, provide relief from penalties for intentional tax evaders.
Intentional tax evasion can be distinguished from wrongfully applying complex legislation or intentionally doing tax planning to avoid tax in a manner which does not comply with the requirements of the relevant legislation. It is submitted that taxpayers can protect themselves from being classified into this category of behaviour. This can be achieved by providing arguments and documenting proof of the fact that the taxpayer followed the requirements of the relevant tax legislation when he/she was busy tax planning, and that the planning was done within the confines of the law.
In the Short Guide to the TAA published by SARS, gross negligence is described as doing (or not doing) something in a way that suggests complete or high level disregard for the consequences. Although the term ‘gross negligence’ is not capable of precise definition, cases arising from areas of law other than taxation provide some guidance on its meaning.
The courts held that it is not being conscious of risk-taking that distinguishes gross negligence from ordinary negligence. A person’s conduct in relation to a risk that a person is conscious of could however be so completely different from the standard of a reasonable person that it can amount to gross negligence. In the case of taxation, a taxpayer is likely to be aware of the risk of not complying with the requirements of the relevant tax legislation.
It was suggested in another court case that where gross negligence is considered in relation to a person consciously taking a risk, the conduct in question must involve a departure from the standard of a reasonable person to such an extent that it may be categorised as extreme; a complete lack of intellect must therefore be demonstrated.
A person merely failing to take care when others in similar circumstances do may be negligent, but not grossly negligent. Based on this brief discussion of the meaning of gross negligence, it is submitted that it would be unlikely that a taxpayer would be regarded as being grossly negligent, when he/she implements processes with built-in controls that take into account the tax consequences of certain transactions or events.
This may be particularly relevant in the case of regular day-to-day activities. An example would include a process checking that captured invoices complies with the requirements of the VAT Act to deduct input tax. For less frequent or once-off events, such as structuring of deals or transactions, the risk of being grossly negligent towards the tax consequences should to a large extent be manageable by documenting reasons or arguments for taking positions and showing that those tax consequences have been considered (i.e. not complete lack of intellect in relation to the tax implications of the event).
No reasonable grounds for tax position taken
A tax position is defined in the TAA as an assumption being made whether an item or amount is taxable, deductible, should be taxed at a reduced rate or qualifies as a reduction from tax payable. If a taxpayer is unable to reasonably argue the assumptions made or views taken in respect of any aspect affecting its tax obligation, it will find itself in a position where there is no reasonable grounds for the tax position it has taken.
In this regard, written views, including tax opinions, as to how an assumption or view was arrived at should go a long way in ensuring that the taxpayer can provide grounds for a tax position taken. The involvement of a tax specialist may enhance the position of the taxpayer as to the reasonability of these grounds, especially where the views or assumption deals with a more complex matter.
Reasonable care not taken in completing return
The TAA does not define what is meant by the phrase ‘reasonable care’. The guide to the TAA indicates that SARS interprets this phrase as follows: that a taxpayer is required to take the degree of care that a reasonable, ordinary person in similar circumstances to that of the taxpayer would have taken to fulfil his/her tax obligations.
SARS acknowledges that reasonable care does not necessarily mean perfection.The United Kingdom imposes a penalty for being carelessly inaccurate in a return. The relevant tax law defines careless as a failure to take reasonable care. Because the wording and context is similar to that in the TAA, views on that provision may be helpful towards interpreting the meaning of ‘reasonable care’ in the TAA.
Some examples of failures to take reasonable care are provided by Her Majesty’s Revenue and Customs (HMRC) in the CH81145 guide. The guide suggests that a failure to implement adequate and appropriate processes, controls and procedures to ensure that tax returns are completed accurately may constitute a failure to take reasonable care.
It is therefore submitted that it should be possible to mitigate (reduce to an acceptable level) the risk of a penalty resulting from not taking reasonable care when completing a return. This can be achieved to a large extent by implementing, and being able to demonstrate the effectiveness of certain controls over the processes that generate the information used in the return, and how the controls help to complete a tax return.
Based on the discussion of these four behaviours, it appears as if it should be possible for a taxpayer to manage and substantially reduce its exposure to penalties resulting from these behaviours.
The last behaviour, a substantial understatement, is defined as a case where the obligation to the fiscus exceeds the greater of 5% of the tax properly chargeable for the relevant period or R1 million. Because this behaviour is based on the quantity of the understatement, as opposed to a taxpayer’s actual behaviour, there would have been very little a taxpayer could do to manage this risk if it was not for the section of the TAA previously mentioned.
The section however, states that the Commissioner must remit / cancel an understatement penalty for substantial understatement if he is satisfied that the taxpayer made full disclosure of the arrangement that disadvantaged the fiscus when the return was due.
The section further requires that the taxpayer must be in possession of a tax opinion written by a registered tax practitioner that was issued by no later than the date on which the return was due. The opinion must have fully explained the specific facts and circumstances taken into account (including all the steps in a transaction where the general anti-avoidance rules or substance over form doctrine was involved). This only means that each case must be decided on its own facts and according to its own set of circumstances and not by issuing a ruling because a precedent was created in a similar case previously.
This section clearly provides taxpayers with a set of procedures that it can implement to ensure that it is not exposed to a penalty associated with a large understatement. This discussion suggests that the understatement penalty system in Chapter 16 of the TAA offers taxpayers the opportunity to manage their exposure to understatement penalties.
The discussion further lays claim to the fact that it should be possible to implement measures to address the first four behaviours that can result in understatement penalties. If these measures are implemented in combination with the set of procedures for remittance (cancellation) of substantial understatement penalties in the previously mentioned section of the TAA, a taxpayer should theoretically be able to minimize or eradicate its exposure to understatement penalties.
It is of critical importance that taxpayers, especially larger corporate taxpayers, take time to consider their strategy and implement a policy that manages their exposure to understatement penalties.
Source: Pieter van der Zwan