How to deal with SARS understatement penalties

Few words strike fear into a taxpayer’s heart quite like “SARS understatement penalties.” These penalties can be severe, often imposed after an audit or verification process, and can quickly escalate a minor mistake into a costly dispute.

Understanding how these penalties work - and more importantly, how to respond to them - is critical for both individuals and businesses seeking to remain compliant and protect their financial position.

What Are SARS Understatement Penalties?

An understatement penalty is imposed by the South African Revenue Service (SARS) when it believes a taxpayer has, for example, understated taxable income, overstated deductions, or failed to submit accurate information that affects tax liability.

SARS understatement penalties are governed by section 222 of the Tax Administration Act (TAA) and can apply to a wide range of situations - from an innocent calculation error to intentional tax evasion.

SARS categorises understatement penalties based on the behaviour of the taxpayer, applying a percentage to the tax shortfall. These percentages can range from 0% (if voluntary disclosure applies) up to 200% in cases of intentional tax evasion.

Understanding How SARS Determines Penalty Levels

SARS uses a behavioural matrix to determine the applicable penalty rate as follows:

For example, if SARS believes you made an error due to lack of reasonable care - even unintentionally - you may still face a 25% understatement penalty on the understated tax.

Understanding where SARS has placed you on this matrix is critical in deciding how to respond.

Common Scenarios That Trigger SARS Understatement Penalties

Many taxpayers assume that understatement penalties only apply in cases of fraud or intentional wrongdoing. In reality, SARS frequently imposes these penalties for minor or technical errors, such as:

• Incorrectly claiming deductions or allowances
• Misclassifying income between personal and business streams
• Failure to submit supporting documentation during verification
• Inaccurate VAT or PAYE submissions
• Differences between what was declared and third-party data

This is why challenging the penalty correctly - with strong evidence and a clear legal argument - is often the key to having it reduced or waived.

Step 1: Understand the SARS Notice

When SARS imposes an understatement penalty, it typically issues a Letter of Audit Findings and/or Assessment Notice (ITA34 or VAT217). These notices typically indicate:

• The reason for the penalty
• The behaviour category applied
• The amount of tax shortfall identified

Many taxpayers make the mistake of either ignoring the notice or assuming SARS is always correct. However, understatement penalties are not automatic fines — they must be justified by SARS under law. In fact, SARS carries the burden of proving the facts on which they rely to accuse the taxpayer of one of the “behaviours” in the matrix referred to above. 

Carefully reviewing the notice with an experienced tax consultant is essential before taking the next step.

Step 2: Assess Whether the Penalty Is Justified

SARS bears the onus of proof when imposing understatement penalties. This means it must demonstrate that the taxpayer’s behaviour matches one of the categories in the penalty matrix.

Often, in our view, SARS applies these penalties without sufficient reasoning or supporting documentation - which makes them open to challenge.

Step 3: Lodge an Objection (If Applicable)

If you believe the SARS understatement penalty has been applied incorrectly, you have the right to dispute it. This is done through the objection and appeal process under the Tax Administration Act.

Having professional representation from expert tax dispute resolution experts and tax consultants is crucial here. They understand the legal nuances of SARS penalties and know how to construct objections that are both technical and persuasive and also understands how to hold SARS to their burden of proof. 

The fact that SARS carries the burden of proof in relation to understatement penalties is often overlooked by those who are not tax dispute resolution experts.  There are major strategic advantages from a tax dispute resolution perspective in this fact but knowing what it is and how to use it requires the trained and experienced eyes of tax dispute resolution experts. 

Unicus Tax Specialists offers elite-level Tax Consulting and tax dispute resolution  expertise to help taxpayers defend against understatement penalties and restore peace of mind. We specialise in SARS understatement penalties - from audit level all the way through to litigation in the tax court. Our deep technical expertise and hands-on dispute resolution experience ensure that every client has a strategic defence against SARS overreach.