Late last week I was involved in presenting with Bevan Miles – General Manager, Group Taxation, ASB and Tony Morris – Investigations and Advice Manager, Investigations – Large Enterprise, IRD at the New Zealand Institute of Chartered Accountants National Tax Conference. The topic was “Penalties: The Real Oil”.
What has come out of presenting this course are some very interesting statistics about what is actually going on in terms of dealing with the IRD. I thought it would be appropriate to share with you a few thoughts of my own on the topic so here goes:
1. The IRD has been very targeted with its audit activities in the last few years.
2. The aim of the penalties regime is to ensure compliance by penalising tax payers who don’t comply with a fine that is commensurate with the level of their non-compliance. In the past, whether you were a mass murderer or a pick pocket you used to get the same basic penalty and that wasn’t appropriate.
3. The use of money interest regime whereby taxpayers pay interest on late paid tax, possibly as well as late payment penalties, is just a compensation for the government for you having their money. However, the rates are long overdue for review and far too expensive relative to the real cost of funds for both small taxpayers and large corporates, and as such need to be significantly reduced.
4. The IRD has made a real effort in the last few years to ensure consistency of penalties across audits. They have got processes in place for this with thresholds and escalations and on the whole apart from slowing down the process to resolve penalties, it has actually made them generally more consistent in my experience.
5. What has been interesting however is that in fact the amount of penalties being imposed actually has decreased over recent years. The actual number of cases is decreasing together with the amount of penalties imposed in each situation. This is despite the fact that there have been the high profile avoidance tax audits around Penny & Hooper together with the cash economy.
6. What I found most interesting however is that on average the IRD issues about 30 NOPAs per month. These notice of proposed adjustments are the start of the formal dispute process and one would have expected it to be a lot higher, particularly given the IRD has around 6500 employees in total. Remember also that over the years the amount of them involved in processing has significantly reduced, meaning that a lot more of them as a proportion work in audit and similar activities.
7. Around two-thirds of these actually get resolved at the conference phase by mutual agreement and settlement, with very few then running through to the adjudication and ultimately court phase.
8. The number of voluntary disclosures where taxpayers go to the IRD to tell them they have made a mistake has gone up in recent years. This in itself is not surprising as there are concessions in terms of penalties where taxpayers do make a voluntary disclosure. However, the figures mask the true trend which is that the IRD is doing what it calls “risk reviews” instead of audits. By doing risk reviews the IRD can go in and have a look at a company without formally starting an audit. Often they will be analysed because they fall outside some industry ratio or average. If something is identified, tax payers still have the opportunity to make a voluntary disclosure before a formal audit is commenced, meaning that in voluntary disclosure is recorded. The IRD has been better able to identify taxpayers that fall within their interest, and to quickly review them with a view to resolving the matter before a formal dispute process takes place.
9. In my experience, the best way to avoid penalties is to identify tax risk. Taxpayers need to understand what they are doing and the risks involved in it.
10. The only real way to avoid tax risk entirely in situations where there is no clear answer, is to look at getting an IRD binding ruling. These are confidential to a taxpayer, and while they cost, provide a taxpayer with certainty of tax position relative to the IRD. In the last 2 years we have done 4 major IRD rulings applications and 3 out of the 4 of these have turned out successfully for our clients, who were more than satisfied with the result and the cost. The alternative of getting an opinion from us or another tax professional doesn’t necessarily mean that the taxpayer is immune from penalties or IRD dispute later on. For a similar cost obtaining a binding ruling can be a far better solution in many situations.
11. With greater uncertainty around tax law, the question of penalties is going to remain one on the minds of many taxpayers going forward. What we thought was acceptable practice 5 years ago prior to Penny & Hooper and the other avoidance cases, is clearly not the case any more. There has been a fundamental shift which has gone in favour of the IRD. Hopefully in 5 years that balance will be restored slightly but in the meanwhile there is a lot of uncertainty around the ability to give tax advice and what is and isn’t acceptable tax planning in the current environment. Taxpayers need to be very wary of penalties in taking any tax position. What this means in reality is that instead of ultimately advising taxpayers how to get out of tax, we are simply spending more time advising them what the correct amount of tax to pay actually is.