Chapter 24 – Penalties, Binding Rulings & Disputes Resolutions
24.1 Overview
Failure to meet tax obligations may result in civil penalties, criminal penalties (discussed below) or both. Further, the penalties are not deductible for taxation purposes!
24.1.1 Penalties
24.1.2 Summary of Regime
24.1.2.1 Late Filing Penalties
24.1.2.2 Late Payment Penalties (TAA s 139A-139BA)
24.1.2.3 Non-Electronic Filing Penalties
24.1.3 Use of Money Interest
24.1.4 Shortfall Penalties (TAA s 94A)
24.1.5 Lack of Reasonable Care (s 141A)
24.1.6 Unacceptable Tax Position (s 141B)
24.1.7 Gross Carelessness (s 141C)
24.1.8 Abusive Tax Position (s 141D)
24.1.9 Evasion or Similar Act (s 141E)
24.1.10 Remissions of Penalties and Interest
24.1.11 Instalment Arrangements
24.1.12 Criminal Penalties
24.1.13 Practical Hints
24.2.1 Overview
24.2.2 Procedures
24.2.3 Practical Hints for Rulings
24.2.3.1 Professional Advice on Rulings
24.2.3.2 Stopping the Binding Ruling Process
24.3.1 Overview
24.3.2 Disputes Resolution Procedure
24.3.3 Practical Hints
24.1.1 Penalties
Overview
The penalty regime provides a “reward” for good taxpayer compliance. The “reward” is a reduction in penalty rates that would otherwise apply.
The approach of filing tax returns with minimal review and taking your chances on a tax audit is not an effective strategy. The IRD has a record of imposing considerable penalties for both inadvertent and intentional tax errors.
In light of both the exceptionally high rate of the penalties and the numerous acts for which penalties are imposed, it is prudent to consult a tax advisor about your tax obligations. Your first interview is, in most cases, complimentary.
Consider the following situation. A company taxpayer allows a senior employee to use a company owned four-wheel drive vehicle for business and private purposes. The business taxpayer claimed that the vehicle was “a work related vehicle” and therefore FBT exempt. In reality, the vehicle was not sign-written, and the private use was extensive. The employer was not aware of the lack of compliance.
In an Inland Revenue Department investigation, the following assessments were made:
FBT assessed, on an annual basis on GST inclusive value of the vehicle (due by 31 May and overdue two months)
Assessment: $9,216
Late Payment Penalty: (5% x $9,216) = $461
Incremental late payment penalty: (1% x ($9,216 + $461)) = $97 (scrapped from 1 April 2017)
A 20% failure to take reasonable care penalty ($9,216 x 20%) = $1,843*
Use of money interest on underpaid tax at approximately 11.93% for 61 days = $232 (This rate has subsequently decreased)
Total cost: $9,216 FBT plus a minimum of $2,645 in penalties and interest
Thus, total tax exposure for an error can easily add up to a considerable sum.
*Note,certain“good behaviour” penalty reductions could apply-See Appendix.
The key message is that tax obligations and liabilities filed in error (whether innocent or not) will result in expensive penalties. You cannot afford to get returns wrong.
Inland Revenue’s investigators are divided into three areas.
Non-business investigations. This area carries out audits of people who are not in business
Business investigations. This area carries out audits of business with a turnover of up to $100 million
Corporates. This covers audits of corporate customers with a turnover of $100 million or more and industries with specific tax legislation, e.g. banking and insurance.
Staff in each of these areas may simply audit a single tax type, e.g. GST or income tax; or perform full investigations covering all tax types.
The penalty rules together with effective Departmental audit procedures spell trouble for businesses that submit incorrect tax returns.
24.1.2 Summary of Regime
The compliance and penalties provisions apply to income tax and PAYE, withholding taxes, GST, gift duty, ACC levies and premiums, student loans and child support.
At a glance, the compliance and penalties regime contains the following features:
Civil Penalties, including:
late filing penalties
late payment penalties
shortfall penalties
Criminal Penalties
Use of money interest penalties
Detailed below are the main features of each component of the regime.
24.1.2.1 Late Filing Penalties
IRD practice is to notify the taxpayer 30 days before charging a late filing penalty on IR 3 and IR 4 rincome tax returns. Penalties for filing your income tax return late range from $50 to $500, depending on your net income. If you haven’t filed a return, the penalty is based on your previous year’s return. When you file the late return, the penalty will be adjusted to reflect your actual income figure.
A $250 late penalty is applied automatically for late filing of the Employer Monthly Schedule.
The late filing penalty for GST is $50 for payments basis and $250 for invoice or hybrid basis. The IRD will issue a warning for the first late filing occurrence, if within the following 12 months another return is not filed on time the fee will be charged.
The penalty does not apply to FBT returns.
24.1.2.2 Late Payment Penalties (TAA s 139A-139BA)
An initial one-off penalty of 1% of the unpaid tax is imposed on the day after the due date for payment. A further 4% is imposed if any amount (including penalties) remains unpaid at the end of the 7th day after due date. These penalties do not apply to student loan or child support payments.
Additional incremental penalties of 1% per month have been scrapped for GST, provisional tax, income tax underpayments and working for families tax credit overpayments. Late payment penalties are not charged on unpaid tax of $100 or less.
A non-payment penalty may also be imposed if you file your employer monthly schedule but do not pay the amount calculated. This is 10% of the amount not paid when you file your employer monthly schedule. A further 10% is added each month the amount remains outstanding.
Note that interest is charged from the original due date on amounts outstanding including penalties.
If this is your first late payment in two years, you will be granted a grace period giving you more time to make the payment. If you do not pay the late payment, the penalty is imposed from the original due date and interest is charged from then.
Late payment penalties are not charged on unpaid tax of $100 or less, or on student loan or child support payments.
24.1.2.3 Non-Electronic Filing Penalties
Employers paying PAYE twice a month are required to file their Inland Revenue monthly employer schedules electronically. A penalty equal to the greater of $250 or $1 for each person employed during the relevant month will be imposed.
This penalty will not be imposed where employers’ accounting systems cannot provide the monthly employer schedules in an electronic format.
24.1.3 Use of Money Interest
A significant additional and often poorly managed tax cost is use of money interest. Use of money interest rules aim to penalise taxpayers and compensate the Commissioner if tax is underpaid. Interest is generally payable from the original date that the tax is due until the date payment is made. Interest is calculated on a daily basis on the amount of unpaid tax, including accumulated late payment penalties. The reason for the underpayment will in most cases be irrelevant. For example, your sales revenue in the last two months of your financial year increases substantially. As a result your provisional tax is underpaid (subject to your income thresholds) use of money interest will apply.
Use of money interest is paid by the IRD on overpayments of tax and is charged by the IRD on underpayments of tax. The rates vary and were updated with effect from 29 August, 2019:
8.35% on underpayments of tax (deductible)
0.81% on overpayments of tax (assessable)
It is generally uneconomic to use the Inland Revenue Department as a bank, making it important that you manage your exposure to use of money interest. See Chapter 17 “Provisional Tax” for Managing of Provisional Tax Payments and the Reduction of Use of Money Interest Charges.
The current interest rate is published in the FBA bi- monthly journal.
24.1.4 Shortfall Penalties (TAA s 94A)
Shortfall penalties apply for the following action or position taken by a taxpayer: The shortfall penalties for unacceptable tax position, not taking reasonable care, gross carelessness and abuse of tax position will be reduced by 50% if previous good behaviour applies. Generally speaking, previous good behaviour applies if a taxpayer has not been liable to pay a shortfall penalty in the four prior years. In the case of some taxes, this four-year period can be reduced to a two-year period.
A tax shortfall is treated as temporary if it is permanently reversed within 4 years of the taxpayer taking the tax position, and the correct amount of tax is returned or paid.
In all cases the penalty rate can be increased if the Department is hindered in its attempts to ascertain the taxpayer’s tax position. The penalty rates can be lowered where voluntary disclosure is made in the tax return or before or during an audit.
24.1.5 Lack of Reasonable Care (s 141A)
The reasonable care test requires you to exercise the same care that a reasonable person is likely to exercise in your circumstances to fulfil your tax obligations. Failure to meet this standard of care will result in a 20% penalty. It is not a question of whether you actually foresaw the probability that the act/failure to act would cause a tax shortfall, but whether a reasonable person in your circumstances would have foreseen the shortfall as a reasonable probability (i.e. your innocent mistakes will be penalised if a reasonable person would not have made the same mistakes).
See comments above relating to “good behaviour” penalty reductions.
Example
Consider the case of a property developer who claimed the GST on the purchase price of a property. The relevant return was filed a number of days before the tax invoice (the basis of the claim) was made available to the developer. In legislation, a GST claim (in a return) cannot be made unless the claimant holds the tax invoice at the time the GST return is furnished. After a tax investigation, this error was identified and the Department issued an assessment including penalties at the rate of 20%.
24.1.6 Unacceptable Tax Position (s 141B)
This penalty is targeted at people who take an incorrect tax position on an interpretation or application of a tax law. The standard requires that an interpretation be “about as likely as not to be correct”.
The unacceptable interpretation penalty of 20% will apply only if the tax shortfall exceeds both $10,000 and the lesser of $200,000 or 1% of the taxpayers’ total tax in question for the relevant period.
Example
George pays a franchise fee of $150,000. George consults a retired accountant who advises that the payment should probably be depreciable. George is investigated three years later and the Inland Revenue Department does not accept the depreciation deduction. The payment is not within the technical provisions of the depreciation regime. Accordingly, George has not taken an acceptable interpretation in terms of that depreciation deduction and is liable for further tax, a 20% shortfall penalty and use of money interest over a three-year period (See comments above on “good behaviour” penalty reductions).
24.1.7 Gross Carelessness (s 141C)
Gross carelessness is defined “as doing or not doing something in a way that suggests or implies a complete or high level of disregard for the consequences.”
Example
Bill, who has not bothered to keep a motor vehicle logbook, tells his accountant that 75% of vehicle expenses are business related and deductible. The accountant claims 75% of expenses.
Inland Revenue later audits the accounts of the business and finds that no record supports the 75% claim and that 50% is more accurate.
Bill has been grossly careless, and is liable for a 40% penalty. He was completely indifferent to the consequence of whether the private use adjustment was correct or not.
24.1.8 Abusive Tax Position (s 141D)
Once you have come within the unacceptable interpretation arena, there is a risk you may be subject to the abusive tax position penalty of 100%. Consideration is given to whether the position taken had “a dominant purpose of avoiding tax”.
24.1.9 Evasion or Similar Act (s 141E)
Evasion is where the taxpayer knowingly avoids tax.
Example
Fred, a contractor, receives “cash payments” for approximately 10% of his work. Fred does not return this cash income. After detailed investigation of Fred’s tax affairs by IRD he is reassessed for the cash jobs.
The Department is likely to assess penalties of 150% for evasion. Depending on evidence available to Inland Revenue, Fred may also be criminally prosecuted.
24.1.10 Remissions of Penalties and Interest
Shortfall penalties cannot be remitted! The Commissioner has limited discretion to remit late filing, late payment and nonelectric filing penalties. Use of money interest will only be remitted if the underlying tax payable is remitted.
24.1.11 Instalment Arrangements
If you think you will have difficulty paying a tax liability, then prior to the due date for payment of the relevant tax, you can try to negotiate an instalment arrangement with Inland Revenue. Contact them as early as possible to notify them of your circumstances. The following outcomes may result:
No relief, requiring you to pay in full;
An instalment arrangement where you repay an agreed amount over time;
Writing off an agreed amount if the IRD is satisfied that full payment would cause you serious hardship; or
A combination of an instalment arrangement and a serious hardship write-off
Seeking an instalment arrangement.
These two options are discussed below:
1. Outstanding Tax may be Written Off
Some or all the taxpayer’s outstanding tax that cannot be recovered can be written off in the following circumstances:
the taxpayer is facing serious hardship through:
inability to meet minimum living expenses according to normal community standards; or
the cost of medical treatment for an illness or injury of the taxpayer or the taxpayer’s dependant; or
a serious illness suffered by the taxpayer or the taxpayer’s dependant; or
the cost of education for the taxpayer’s dependant.
Write offs will not be permitted if the taxpayer is liable for an abusive tax position or evasion shortfall penalty in relation to that tax.
2. Instalment Arrangement
If Inland Revenue can collect more of the debt over time through an instalment arrangement than from bankruptcy or liquidation, Inland Revenue would be required to enter the instalment arrangement.
If the taxpayer and Inland Revenue enter into an instalment arrangement, late payment penalties will not be imposed if the taxpayer complies with the arrangement.
24.1.12 Criminal Penalties
Criminal penalties can additionally be imposed for:
absolute liability offences
evasion or similar offences
aiding and abetting
obstruction
The maximum penalty varies according to the type of offence. For example, if you are convicted of evasion you can be imprisoned for up to five years and/or be fined up to $50,000.
24.1.13 Practical Hints
Under the penalties regime, innocent mistakes and misinterpretations are likely to be penalised. Accordingly:
Keep all receipts of business expenses claims
Keep logbooks supporting vehicle running percentages
Be particularly careful with fringe benefit tax matters
– see Chapter 19If you obtain advice from Inland Revenue, get the name and title of the employee
Have an Accountant, or perhaps even a tax specialist review your annual tax return before it is filed.
Tax is already a large percentage of your bottom line. Do not let penalties and interest further erode your after tax profit!
24.2 Binding Rulings
24.2.1 Overview
Under the binding rulings regime, you can go to the Department and seek a categorical ruling as to the tax treatment of a transaction. Assuming facts have been fully disclosed, this is effectively a cast iron guarantee that the Department will not change their mind on the matter for which the ruling is sought.
24.2.2 Procedures
To apply for a private or product ruling, an Application for Private Ruling or an Application for Product Ruling form must be completed. Inland Revenue can supply these. Note, the process has now generally become costly and lengthy, and you would be well advised to see a tax specialist before embarking on this course.
24.2.3 Practical Hints for Rulings
24.2.3.1 Professional Advice on Rulings
Your professional advisor’s fees will depend on the complexity of the matter for which the binding ruling is sought. The most straightforward rulings will cost approximately $5,000 to $10,000 in professional and Inland Revenue time.
24.2.3.2 Stopping the Binding Ruling Process
A binding ruling only binds the Department. A taxpayer is not obliged to follow the ruling. If you disagree with the binding ruling you can choose to adopt a different tax treatment.
However, if you do not adopt the ruling you must disclose this to the Department!
For this reason it is important to discuss the Department’s response to your binding ruling application during the ruling process and before a formal binding ruling is issued. If the Department intends to issue an unfavourable binding ruling, you are able to stop the binding ruling process. If this is done, the disclosure provisions referred to above do not apply.
24.3 Disputes Resolution
24.3.1 Overview
The consequences of a tax investigation can be dramatic. In addition to being assessed for taxes owing, a substantial array of penalties and interest charges can also be imposed.
What should you do in a case of a Department audit? You should contact your business advisor immediately and discuss whether any disclosures should be made in order to reduce potential penalties. You should consider conducting a pre-emptive “mock tax audit” to identify any issues which should be voluntarily disclosed to the IRD to reduce penalties. You can also arrange a suitable time and place to conduct the audit. When the investigation is being conducted you should ensure that you only respond to what is specifically asked of you. You can request that difficult questions be put in writing. All questions and answers should be documented for future reference.
24.3.2 Disputes Resolution Procedure
The basic thrust of the regime is the requirement of a high level ofdisclosureanddiscussionbetweenthe Department and the taxpayer prior to the issue of an assessment or reassessment. The aim is for Inland Revenue to get the assessment as accurate as is practical the first time, and to achieve fair, efficient and rapid resolution of any disputes that may arise.
The process can be broken down into six phases:
pre-assessment, issue of notice of proposed adjustment
conference
“all cards on the table” disclosure notice
impartial adjudication within the IRD
assessment
litigation (hearing by the High Court, TRA or the small claims jurisdiction of the TRA)
This is how a disputes procedure may look:
Example
Your business is selected for a routine audit. An initial letter introduces the Department’s investigator dealing with the case.
The investigator reviews the files and then writes to you requesting further information about various items of expenditure that appear to be of a private nature. Your response further convinces the Department that the expenditure is of a private nature.
The investigator writes to you with a notice of proposed adjustment (NOPA) that denies the various items as a deduction. You issue a notice of response rejecting the IRD’s NOPA. Later that week the investigator holds an informal telephone conference with you and documents your response.
The supervisor and auditor further consider the matter and agree that a disclosure notice and statement of position should be made denying the deduction on the basis that it was private expenditure. You then issue your statement of position. It is then referred to the adjudication unit and an assessment is sent to you.
If you receive an assessment from the adjudication unit in favour of the Commissioner, you must file a notice of claim within two months to challenge the assessment in the Taxation Review Authority (small claims or general jurisdiction) or High Court. Filing fees are $410 for the Authority and vary up to $1,100 for the Court.
The difference between Taxation Review Authority small claims and general jurisdiction is that small claims jurisdiction is limited to claims which involve tax to pay of up to $30,000 and do not involve significant legal issues. Also, the decisions are not published and non-appealable.
In the above example you can challenge the assessment through the small claims jurisdiction of the Taxation Review Authority.
You do this by filing the standard letter (available from Inland Revenue) together with copies of relevant documents and $410 filing fee with the Taxation Review Authority, Ministry of Justice, in Wellington.
In due course you receive advice of the hearing date and represent yourself at the hearing. The Taxation Review Authority Judge supplies a brief oral decision at the end of the hearing. A brief written decision summarising the facts of law and the reasons for the decisions is issued the following week.
Please note, this is a technical area with strict time frames and evidence exclusion rules apply. Protect your rights. Obtain professional advice.
24.3.3 Practical Hints
Your best chance of achieving a sensible outcome with Inland Revenue is your early negotiations and discussions prior to “pre assessment” stage. You only have one chance and specialist tax advisors can be helpful here.
Ensure that you respond to the Department’s notice of proposed adjustment within two months. Otherwise you will be deemed to have accepted the adjustment and will have lost the opportunity to challenge the Department’s assessment.
The notice must be in the prescribed form, thus you should seek professional advice.