Every business decision carries commercial risk and most businesspeople appreciate that obtaining a professional tax opinion before implementing a significant transaction is prudent. What is less well known is that competent tax advice may also protect a taxpayer against understatement penalties if SARS later proves that the advice was legally wrong.

Recent judgments, culminating in IT 76725, provide important guidance on the meaning of the phrase "bona fide inadvertent error" in section 222(1) of the Tax Administration Act (TA Act). Together with the Thistle Trust and Coronation decisions, they send a reassuring message to taxpayers: not every incorrect tax position deserves to be punished.

That is an important distinction.

Section 222 imposes understatement penalties where a taxpayer understates tax. Depending on the circumstances, these penalties can range from 10% to 200% of the tax understated. The provision, however, contains an important qualification: no understatement penalty is payable if the understatement resulted from a bona fide inadvertent error.

For years there has been uncertainty about what those words actually mean.

The recent case law provides valuable guidance.

In Thistle Trust, the taxpayer adopted a tax position based on a legal opinion obtained from respected tax advisers. The courts ultimately found that the opinion was incorrect and that the trust was liable for the capital gains tax. Yet both the Supreme Court of Appeal and, indirectly, the Constitutional Court accepted that the taxpayer had genuinely believed its tax treatment to be correct. The Supreme Court of Appeal held that, although the trust had made an error, it had acted in good faith and unintentionally, with the consequence that SARS was not entitled to impose understatement penalties. The Constitutional Court likewise observed that the taxpayer had relied on legal advice and that SARS had failed to establish that the taxpayer lacked reasonable grounds for the tax position it adopted.

The Coronation litigation reached a similar result.

Coronation relied on advice from leading tax specialists in concluding that its Irish subsidiary qualified for a foreign business establishment exemption. Although both the Supreme Court of Appeal and later the Constitutional Court ultimately rejected that interpretation of the Income Tax Act, neither court considered the taxpayer deserving of understatement penalties. The SCA held that there was nothing to suggest that Coronation had not honestly believed it qualified for the exemption and that reliance on expert tax advice demonstrated bona fides rather than culpability. The Constitutional Court went even further, observing that a taxpayer cannot be criticised merely because it follows legal advice that differs from SARS' own interpretation of the legislation. If that were the law, SARS would effectively become the final authority on every arguable interpretation of a tax statute.

These principles recently found practical application in IT 76725.

In paragraphs 114 to 122, Francis J considered the taxpayer's liability for understatement penalties after referring extensively to Thistle Trust and Coronation. The court recognised that the taxpayer had acted on professional tax advice, had disclosed the relevant facts to its advisers, and had honestly implemented the advice received. Although SARS ultimately succeeded on the substantive tax issue, the court accepted that the taxpayer's conduct fell within the protection afforded by section 222(1). The judgment reinforces the proposition emerging from the higher courts: a genuine mistake, honestly made after obtaining competent professional advice, is not the type of conduct that understatement penalties are intended to punish.

The lesson for business is straightforward.

Obtaining tax advice does not guarantee that SARS or the courts will agree with the advice. The taxpayer may still have to pay the tax, together with interest. But there is an important difference between being wrong and behaving culpably.

Professional advice demonstrates that the taxpayer attempted to comply with the law rather than avoid it. It is powerful evidence that the taxpayer acted honestly, carefully and in good faith.

Of course, this is not a blanket immunity. Simply obtaining an opinion does not protect a taxpayer who withholds material facts from the adviser, shops around for a favourable opinion while ignoring contrary advice, or participates in an aggressive scheme knowing that it is unlikely to withstand scrutiny. Courts will always consider the surrounding facts.

But where a taxpayer fully discloses the relevant facts, seeks advice from competent advisers, and genuinely follows that advice, the recent jurisprudence suggests that understatement penalties should ordinarily not follow merely because a court later adopts a different interpretation of the law.

That is a sensible outcome.

Tax law is often uncertain. Even experienced judges, counsel and tax specialists disagree, as the lengthy litigation in Thistle Trust and Coronation illustrates. The purpose of understatement penalties is to discourage careless or blameworthy conduct, not to punish taxpayers for responsibly obtaining professional advice on genuinely debatable legal questions.

For businesses, the message is clear: obtaining quality tax advice is not merely good tax planning. It may also become your strongest defence against understatement penalties if SARS later proves that the advice was wrong.