Advice and Opinion

When is an error a bona fide inadvertent error?

Legal generic

On 4 November 2016 judgment was handed down by the Tax Court of South Africa (held in Cape Town) in the matter of ABC Holdings (Pty) Ltd v The Commissioner for the South African Revenue Service, Case number ITI13772.

In this case the court had to consider whether the taxpayer, ABC Holdings (Pty) Ltd, was entitled to claim a deductible allowance of enhancement income of R9,354,458.00 received in terms of a contract for future expenditure in terms of s24C of the Income Tax Act, No 58 of 1962 (Act) for its 2011 year of assessment. The other issue that arose in this case and which is the focus of this article, was whether the South African Revenue Service (SARS) was correct to levy an understatement penalty in the circumstances.

The facts of this matter, briefly, are that the taxpayer conducts the business of administering and managing retirement villages and their frail care centres. It claimed the s24 allowance in its 2011 year of assessment. Subsequently, SARS conducted an audit during January 2014 and notified the taxpayer that the s24C allowance was incorrectly claimed by the taxpayer. As a result of the disallowance by SARS, the taxpayer was held liable for the income tax payable on the above amount as well as an understatement penalty in the amount of R261,924.80.

After the court found that the taxpayer was not entitled to claim a deduction in terms of s24C, it had to consider whether SARS was correct in levying an understatement penalty in terms of the provisions of s222 and s223 of the Tax Administration Act, No 28 of 2011 (TAA). The taxpayer submitted that the understatement arose as a result of a bona fide inadvertent error, contemplated in s222(1), in which case no understatement penalty would be payable by the taxpayer. In considering whether the understatement penalty arose due to a bona fide inadvertent error, the court noted that the taxpayer was assisted by Mr E of LL Accountants and that a tax opinion was obtained from a Professor T, which was attached to the notice of objection and in which Prof T concluded that the s24C allowance could be claimed.

In terms of s221 of the TAA, an “understatement” means any prejudice to SARS in respect of a tax period as a result of a default in rendering a return, an omission for a return, an incorrect statement in a return, or failure to pay the correct amount of tax where no return is required. Such understatement penalty would not be payable if it arose due to a bona fide inadvertent error, as stated in s222(1). As the TAA does not define the meaning of the phrase “bona fide inadvertent error” the court considered the dictionary meaning of these words. It concluded from these dictionary meanings that a “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 court found that on the facts of the present matter, there was no doubt that the taxpayer had acted in good faith and with no intention to deceive. Since Prof T had gone as far as interpreting case law on the interpretation of contracts, some of which was relied on by the taxpayer’s counsel in his argument, it could have given the impression that his interpretation of s24C would more than likely be upheld in court. It could therefore be argued that Prof T strayed into offering a legal opinion, which would make the taxpayer’s argument less plausible. The court held, however, that there was merit in excusing the taxpayer for its reliance on Prof T’s opinion on the basis of it being lay on issues of tax and the law and therefore ordered that the understatement penalty be remitted.

By Louis Botha, Heinrich Louw and Mark Morgan, Cliffe Dekker Hofmeyr