A Taxpayer’s Right to Manage its Exposure
31 January 2013
Posted by: Author: Peter van der Zwan
A Taxpayer’s Right to Manage its Exposure
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 a 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. 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, section 76 of the Income Tax Act 1 imposed additional tax when, among others, a taxpayer made an incorrect statement in any return which resulted or would, if accepted, have resulted in the assessment of normal tax at an amount which is less than the tax properly chargeable. An incorrect statement included any statement 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 by any omission of something that ought to have been included in a tax return, which in terms of section 76(5) included the impermissible deduction, set off, disregarding or exclusion of an amount in determining a taxpayer’s taxable income.
This additional tax was determined as an amount equal to twice the difference between the tax that should have been payable had it not been for the incorrect statement or omission and the tax actually paid. 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 stemmed from an intention to evade tax, the Commissioner had the discretion to remit the additional tax or part thereof as he thought fit. In practice, the Commissioner’s discretion was based on the recommendations of a penalty committee. In the event of the Commissioner not remitting 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 query the additional tax imposed, but had very little legal backing when it came to determining the exact extent of its exposure to additional tax. This made managing the risk of additional tax resulting from tax positions taken challenging to say the least.
The rights of taxpayers under the new regime From 1 October 2012, section 76 of the Income Tax Act has been repealed 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 section 76 of the Income Tax Act, these penalties are imposed when the fiscus is prejudiced due to default in rendering a return, an omission from a return or an incorrect statement in a 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 prejudiced SARS, multiplied by the highest applicable penalty rate from the table in section 223 of the TAA.
The table in section 223 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.
"There is no apparent process or action that can, or for that matter should, provide respite from penalties for intentional tax evaders.” The relevant behaviours listed in section 223, in order of increasing severity as far as the penalty rate is concerned, are: (i) substantial understatement; (ii) reasonable care not taken in completing return; (iii) no reasonable grounds for tax position taken; (iv) gross negligence and lastly (v) intentional tax evasion. It is important to note that section 102(2) of the TAA places the burden of proving the facts on which SARS based the imposition on an understatement penalty upon SARS.
It is therefore suggested that the penalty rate table in section 223 should enable a taxpayer to be in a position to manage its exposure to the risk of penalties to a large extent by implementing certain processes and actions, which could make it extremely difficult for SARS to discharge the burden of proof imposed by section 102(2).
Unfortunately, it may be a matter for the courts to consider whether SARS has successfully discharged its onus before the penalty is waived. It would nevertheless be in a taxpayer’s best interest to implement measures to manage this exposure and attempt to make it unattainable for SARS to discharge this onus.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 willfully 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 respite from penalties for intentional tax evaders.
Intentional tax evasion can be distinguished from a misapplication of complex legislation or tax planning by the willful intention to evade tax in a manner that does not stroke with the requirements of the relevant legislation. It is submitted that a taxpayer can protect themselves from being classified into this category of behaviour by documenting reasons or arguments for taking a specific tax position or undertaking an action with reference to the requirements of the relevant legislation as evidence of tax planning within the boundaries of the law as opposed to tax evasion.
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 2, cases arising from areas of law other than taxation provide some guidance on its meaning. In the case of S v Van Zyl 3 it was held that it is non-consciousness 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 depart so radically from the standard of the reasonable person that it can amount to gross negligence 4.
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 Transnet Limited v The owners of the MV Stella Tingasand the MV Atlantica that where considering gross negligence in relation to a person consciously taking a risk, the conduct in question must involve a departure from the standard of the reasonable person to such an extent that it may be categorised as extreme; complete obtuseness of mind must be demonstrated.
A person merely failing to take care that people usually undertake in similar circumstances, 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 can be said to be grossly negligent, if it implements processes with built-in controls that take into account the tax consequences to deal with transactions or events.
This may be particularly relevant in the case of regular day-to-day activities; for example, a process checking that invoices captured comply 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 as to 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 obtuseness of mind in relation to the tax implications of the event).
No reasonable grounds for tax position taken
A tax position is defined in section 221 of the TAA as an assumption underlying whether an item or amount is taxable, deductible, should be taxed at a reduced rate or qualifies as a reduction from tax payable.
A taxpayer will be in a position where it has no reasonable grounds for a tax position taken, if they are not able to reasonably argue the assumption(s) made or views taken in respect of any aspect of the mentioned aspects affecting its tax obligation. 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 guide to the TAA indicates that SARS interprets this phrase to mean that a taxpayer is required to take the degree of care that a reasonable, ordinary person in the circumstances of the taxpayer would take to fulfill their tax obligations.”
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 to mean that a taxpayer is required to take the degree of care that a reasonable, ordinary person in the circumstances of the taxpayer would take to fulfill their tax obligations. SARS acknowledges that reasonable care does not necessarily mean perfection.
The united Kingdom imposes a penalty for careless inaccuracies in a return. The relevant tax law defines careless as a failure to take reasonable care. As the wording and context is similar to that in the TAA, views on that provision may be helpful in interpreting the meaning of ‘reasonable care’ in section 223 of the TAA.
Some of the examples of failures to take reasonable care provided by HMRC in the CH81145 guide suggest 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 the risk of a penalty resulting from not taking reasonable care in completing a return to a large extent by implementing, and being able to demonstrate that certain controls over the processes that generate the information used in the return and to complete the tax return.
Substantial understatement 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 prejudice to the fiscus exceeds the greater of 5% of the tax properly chargeable for the relevant period or R1 million. As this behaviour is based on the quantity of the understatement, as opposed to an actual behaviour, there would have been very little a taxpayer could do to manage this risk if it was not for section 223(3) of the TAA.
Section 223(3), however, states that the Commissioner must remit an understatement penalty for substantial understatement if he is satisfied that the taxpayer made full disclosure of the arrangement that prejudiced the fiscus when the return was due.
Section 223(3) 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, that took full account of the specific facts and circumstances (including all the steps in a transaction where the general anti-avoidance rules or substance over form doctrine is involved) and that confirms that the taxpayer’s position is more likely than not to be upheld if the matter were to proceed to court. This provision clearly provides taxpayers with a procedural mechanism that it can implement to ensure that it is not exposed to a penalty associated with substantial 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. It is further submitted 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 procedural mechanism for remittance of substantial understatement penalties in section 223(3) of the TAA, a taxpayer should theoretically be able to manage its exposure to understatement penalties to such an extent that it may no longer be exposed to these penalties. It is of critical importance that taxpayers, especially larger corporate taxpayers, take time to consider their strategy and implement a policy to manage their exposure to understatement penalties.
Source: By Pieter van der Zwan Associate Professor North-West University (TaxTalk)