The Tax Administration Act, No 28 of 2011 (TAA) introduces the 'understatement penalty' in Chapter 16.

Section 223 contains an 'understatement penalty percentage table'. According to the SARS Short Guide on the TAA (Guide) the penalty will be determined by placing each case within the table which assigns a percentage by objective criteria. SARS carries the onus of proving that the grounds exist for imposing the understatement penalty.

One of the 'behaviours' contained in the TAA s223(1) table refers to "Reasonable care not taken in completing return." The Guide (at par 16.5.3) gives limited content to what exactly SARS expects of a taxpayer. It merely states that "reasonable care means 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 fulfil his or her tax obligations." Furthermore, "the reasonable care standard does not mean perfection, but refers to the effort required commensurate with the reasonable person in the taxpayer's circumstances." This merely restates the well-known 'man on the Clapham bus' test.

Many South African tax cases have referred to the taxpayer's obligation to submit honest and accurate tax returns. Melamet J in ITC 1331 43 SATC 76 held (with reference to the repealed 200% penalty): "The prescribed penalty is heavy – twice the difference between the tax charged and that which should have been charged – but it is so by design to ensure honest and accurate returns by taxpayers." (See also CIR v De Ciccio 47 SATC 199.)

But how much effort should actually go into the completion of a tax return before a taxpayer can be said to have met the 'reasonable care' yardstick?

SA taxpayers should perhaps consider the Australian Tax Office's (ATO) guidance in Miscellaneous Tax Ruling (MT 2008/1). This deals extensively with the meaning of "reasonable care, recklessness and intentional disregard." For this article we shall confine the discussion to the meaning of 'reasonable care' as set out in MT 2008/1.

Similar to the position in SA, the concept of 'reasonable care' has not been defined by the ATO. Hence, it takes its ordinary meaning.

The ATO points out that taking 'reasonable care' in the context of making a statement to the Commissioner means giving appropriately serious attention to complying with the obligations imposed under a taxation law. Reasonable care thus requires of a taxpayer to take the same care in fulfilling his tax obligations that could be expected of a reasonable ordinary person in the same position.

Although the standard of care is measured objectively, it takes into account the circumstances of the taxpayer. The effort required is one commensurate with all the taxpayer's circumstances, including the taxpayer's knowledge, education, experience and skill. The question is whether a reasonable person of ordinary prudence in the same circumstances would have exercised greater care, or not?

There is no 'one size fits all' standard of 'reasonable care'. A professional person with specialist tax knowledge will be subject to a higher standard of care reflecting the level of knowledge and experience that a reasonable person in such circumstances would possess. The objective standard of reasonableness that applies is commensurately lower for a new entrant to the tax system who has little tax knowledge or experience in interacting with the tax system. This ensures that a person's behaviour is only penalised if it fails to measure up to the standard of a reasonable person with the same level of knowledge and experience.

The ATO emphasises that the fact that the person has tried to act with reasonable care is not the test. The issue is whether, on an objective analysis, reasonable care has been shown. It consequently follows that, because an objective test applies to determine whether reasonable care has been taken in making a statement to the Commissioner, the actual intention of the taxpayer is irrelevant.

According to the ATO, 'reasonable care' does not connote the highest possible level of care or perfection. For example in Maloney v Commissioner for Railways (NSW) (1978) 52 ALJR 292 at 292; (1978) 18 ALR 147 at 148 it was held: "Perfection or the use of increased knowledge or experience embraced in hindsight after the event should form no part of the components of what is reasonable in all the circumstances. That matter must be judged in prospect and not in retrospect."

The ATO does not intend the 'reasonable care' test to be overly onerous for taxpayers. An earnest effort to follow the Tax Pack instructions would normally be sufficient to pass said test.
[The TAA has behaviour "no reasonable grounds for 'tax position' taken." Its Australian equivalent is 'reasonably arguable position.']

The ATO makes the following differentiation between 'reasonable care' and 'reasonably arguable position'.

Whereas the reasonably arguable position test focuses solely on the merits of the position taken, the reasonable care test has regard to the taxpayer's efforts to comply with his tax obligations. The reasonably arguable position test applies a purely objective standard involving an analysis of the law and application of the law to the relevant facts. Consequently it excludes a consideration of the taxpayer's personal circumstances as part of the test. It follows that the reasonably arguable position test imposes a higher standard than that required to show reasonable care. A taxpayer may therefore not have a reasonably arguable position in relation to a matter, despite having satisfied the reasonable care test.

The ATO states that there is no presumption that the existence of a shortfall amount (in SA the 'understatement' amount) caused by a false or misleading statement necessarily or automatically points to a failure to take reasonable care. The evidence must support the conclusion that the standard of care shown has fallen short of what would be reasonably expected in the circumstances (refer to Reeders v. Federal Commissioner of Taxation [2001] AATA 933; 2001 ATC 2334; (2001) 48 ATR 1170 where it was decided that the entity and its tax agent had demonstrated reasonable care in relation to a claim made to deduct self-education expenses.)

In determining whether 'reasonable care' has been taken the ATO considers the following factors, among others:

• Understanding of tax laws: To determine the standard of care that is reasonable and appropriate in the circumstances, factors such as the complexity of the law and whether it involves new measures are relevant. Where the taxpayer is uncertain about the correct tax treatment, reasonable care requires that appropriate enquiries be made to arrive at the correct tax treatment. An interpretative position that is frivolous might indicate a lack of reasonable care since it reflects that little or no effort was made to exercise sound judgment.
• Likelihood that a statement is false or misleading: The likelihood of the risk that a statement is false or misleading is a relevant factor in deciding whether reasonable care has been exercised in making a statement to the Commissioner. However, a failure to respond to every foreseeable risk will not necessarily mean that reasonable care is absent. In each case the seriousness of the risk must be weighed against the cost of guarding against it.
• Relevance of the size of a shortfall amount: The size of a shortfall or the proportion of a shortfall to the overall tax payable, arising from making a false or misleading statement, are indicators pointing to the magnitude of the risk involved in making the statement. A taxpayer dealing with a matter that involves a substantial amount of tax or involves a large proportion of the overall tax payable is required to exercise a higher standard of care because the consequences of error or misjudgement are greater.
• Use of a tax agent/adviser: Using the services of a tax agent/adviser does not of itself mean that a taxpayer discharges the obligation to take reasonable care. It remains the taxpayer's primary responsibility to properly record matters relating to his tax affairs and to bring all of the relevant facts to the attention of the agent/adviser to show reasonable care.
• Relying on information provided by a third party: A statement may be false or misleading because it relies on incorrect information obtained from a third party. Whether such reliance indicates a failure by the taxpayer to exercise reasonable care depends on an examination of all facts. Where, for example a taxpayer returns interest income based on incorrect information provided by a bank, there will not be a failure to take reasonable care, that is unless the taxpayer knew or could reasonably be expected to have known that the information was wrong. Whether a tax agent/adviser shows reasonable care by relying on information provided by a client that is incorrect also depends on an examination of all the circumstances. The reasonable care standard is not so demanding as to require a tax agent to extensively audit, examine or review books and records or other source documents to independently verify the information provided by the taxpayer. Whilst it is not be possible or practical for an agent to scrutinise every item of information supplied, reasonable enquiries must be made should the information appear to be incorrect or incomplete.

The TAA penalty percentage table imposes a 50% penalty where reasonable care has not been taken in completing a return (that is with regard to a 'standard case').

SA taxpayers should appreciate what the 'reasonable care' standard requires of them when they prepare their tax returns.

Written by Johan van der Walt, Director, Tax, Cliffe Dekker Hofmeyr