By Joon Chong, a Partner & Arlia Abdul Ali, a Candidate Attorney at Webber Wentzel

In the case of Mr A and XYZ CC v The Commissioner of the South African Revenue Service the Tax Court had to determine whether the conduct of the taxpayers were properly classified by SARS as 'grossly negligent' for purposes of imposing understatement penalties.

Mr A failed to submit income tax returns for the 2007 to 2010 tax years and value-added tax (VAT) returns for the 4/2006 to period 2/2010 VAT periods. XYZ CC failed to submit income tax returns for the 2011 and 2012 tax years and VAT returns for the 9/2010 to 1/2013 VAT periods. These circumstances led to audits in the tax affairs of both taxpayers. The assessments which resulted from the audit included substantial penalties which were challenged in the appeal.

During the course of the appeal, the Commissioner abandoned the contention that the appeal concerned any “repeat cases”, and argued for penalties of 100% for gross negligence under the “standard case” column of the table in section 223 of the Tax Administration Act 28 of 2011 (TAA), which the court agreed to be the correct approach.

The court dealt with both taxpayers' arguments under four main headings.

Did the Commissioner prove that there was gross negligence?

The taxpayers argued that they were unable to submit their tax returns due to their administrative capacity not being up to standard, and that their conduct did not constitute 'gross negligence' but rather a failure to take reasonable care, which in terms of section 223 results in a penalty of 25%.

The court rejected this argument and held that no shortfall in administrative capacity caused or justified the failure to submit income tax or VAT returns. The court made reference to a previous application made by the first taxpayer for a tax amnesty in the 2006 year of assessment as proof that he undoubtedly knew what his obligations were with regard to the submission of VAT and income tax returns and therefore concluded that the failure to render their returns was properly classified as grossly negligent.

What does "a default in rendering a return" mean?

The term "understatement" is defined in section 221 as any prejudice to SARS or the fiscus as a result of, amongst others, a default in rendering a return. The taxpayers argued that the failure to render a return when it is required by law to be done is not “default in rendering a return” and that, accordingly, no understatement penalties could be charged.

The court saw no merit in this stating that if you omit something from the return, make a false statement in it, or fail to submit the return in its entirety - there is no doubt that you have made an “understatement” (assuming that the requirement of prejudice is satisfied). Section 95(1) of the TAA empowers SARS to make assessments based in whole or in part on an estimate, not only when a taxpayer has submitted a return or information that is incorrect or inadequate, but when the taxpayer “fails to submit a return as required”.

Is there a "shortfall" when a return is withheld?

The next argument raised by the appellants was that SARS never “accepts” a failure to submit a return, and for that reason there cannot be a shortfall as defined, with the result that no understatement penalty need be paid for a default in rendering a return. The court held that the appellants have identified apparent anomalies in the wording employed in both subsections (2) and (3) of section 222 of the TAA.

The proper approach to interpretation when anomalies are apparent is set out in Panamo Properties (Pty) Limited and Another v Nel and Others NNO 2015 (5) SA 63 (SCA) at paragraph 27 where the court said that a court must consider whether there is a sensible interpretation that can be given to the relevant provisions that will avoid anomalies.

The apparent anomaly arising from section 222(2) is solved if one reads the word “in”, where it appears in the phrase “in a return”, to denote an understatement “in or in connection with” a return. In the court's view, a reading of the whole of Part A of Chapter 16 justifies the resolution of the apparent anomaly in that fashion. The court therefore held that SARS has proceeded upon a correct understanding of the legislation.

Prejudice to SARS or the fiscus and administrative penalties

Finally, the appellants questioned whether SARS had discharged the onus of establishing that prejudice to SARS or the fiscus had occurred. The court rejected this argument stating that prejudice to SARS and the fiscus is implicit because the failure to pay taxes when they are due prevents the state from having access to money that is necessary to fund state expenditure.

The appellants also contended that the application of administrative penalties under Chapter 15 of the TAA, coupled with the charging of interest, extinguishes any prejudice which might otherwise be caused by failing to submit a return. This contention was rejected as a penalty is by definition a punishment; which may also be compensatory in effect, but that is not why it exists.

The court concluded that SARS had established a prima facie case from which the only inference that could be drawn was that the tax returns were withheld intentionally throughout and without any discernible excuse. The contentions raised by the Appellants were thus found to be insufficient to counter SARS’s prima facie case, and the court decided that the burden of proof placed upon SARS had been satisfied. The appellants were ordered to pay an understatement penalty of 100% for each VAT assessment and income tax assessment.