For years, the South African Revenue Service (Sars) has taken a strict view of what constitutes a “bona fide inadvertent error” – a golden ticket that allows taxpayers to avoid understatement penalties ranging from 10% to 200% of the tax shortfall.
However, in 2022, this stance shifted when Sars, before the Supreme Court of Appeal (SCA) in CSARS v The Thistle Trust, conceded that the Trust’s reliance on a tax opinion amounted to such an error. The Constitutional Court has now also had its say on understatement penalties and has taken a view largely favourable to taxpayers.

There’s some uncertainty as to whether the SCA’s ruling in the Thistle case, handed down in 2022, established a binding precedent on the interpretation of “bona fide inadvertent error.”

Since Sars conceded the point, the matter was not argued before the court. Nonetheless, the SCA affirmed Sars’ concession, adding weight to the idea that reliance on a professional tax opinion may indeed qualify as such an error. This challenges Sars’ earlier stance, which limited bona fide inadvertent errors to typographical mistakes, asserting that such errors could never arise when adopting a deliberate tax position.

The debate progressed in 2023 when the SCA ruled in CSARS v Coronation Investment Management SA (Pty) Ltd, again excusing the taxpayer from penalties, despite Coronation not disclosing the advice it relied on. Both cases, Thistle and Coronation, were appealed to the Constitutional Court, and these judgments have now been delivered.

What the Constitutional Court has to say

Coronation
In the Coronation case, the Constitutional Court found in the company's favour on the merits, ruling that the foreign business establishment (FBE) exemption applied to its controlled foreign company (CFC).

Consequently, Sars’ cross-appeal regarding understatement penalties was not considered. This was a significant victory for Coronation, also given that the penalties Sars sought would have been substantial.


Thistle Trust
The majority of the Constitutional Court in The Thistle Trust v CSARS, handed down on 2 October 2024, upheld the SCA’s decision that the ‘conduit pipe’ principle did not apply in this case, therefore ruling in Sars’ favour on the merits.

Interestingly, Sars attempted to backtrack on its earlier concession regarding understatement penalties, claiming it never conceded that the Trust’s reliance on expert advice amounted to a bona fide inadvertent error.

However, the Constitutional Court dismissed Sars’ application for a cross-appeal, deeming it not to be in the interests of justice to hear the cross-appeal since Sars had no strong case for penalties and the court would have been interpreting the term for the first time without the issue having been fully argued in lower courts.

Penalty behaviour categories

Importantly, the court made significant remarks about two key penalty behaviour categories, at least one of which Sars argued should apply.

The court found there were indeed reasonable grounds for the tax position adopted by The Thistle Trust, and the Trust had taken reasonable care in completing its return, especially considering it relied on professional legal advice (not to mention that the position was initially upheld by the Tax Court). These comments, supported by eight judges, suggest that simply adopting a position contrary to Sars should not automatically lead to penalties.

For Sars to successfully impose penalties, it must demonstrate that the taxpayer’s actions fall within one of the behaviour categories outlined in section 223 of the Tax Administration Act. These range from “substantial understatement” to “intentional tax evasion.”

If a taxpayer fully discloses an arrangement to Sars and relies on a professional opinion that meets specific requirements, Sars is unlikely to prove the presence of any of the behaviour categories and then only in cases involving impermissible avoidance arrangements might Sars succeed in imposing penalties.

While the Constitutional Court did not define what constitutes a bona fide inadvertent error, the SCA’s rulings provide valuable guidance. Sars’ previous narrow interpretation requires an update, especially when taxpayers act on professional advice.

This emphasises the importance of obtaining tax opinions that meet the requirements of section 223 – a safeguard that should not be overlooked by taxpayers.

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