Compliance and penalties review discussion document out
A Government discussion document released today contains the first of a series of proposals arising from the review of the compliance and penalty legislation in the Tax Administration Act. Proposals include replacing the debt and hardship rules, reducing the penalty for lack of reasonable care in certain circumstances, and introducing a penalty on promoters of tax avoidance schemes. The discussion document also deals with problems raised by the Finance and Expenditure Committee in its 1999 inquiry into the powers and operations of the Inland Revenue Department. The discussion document, "Taxpayer compliance, standards and penalties: a review", is published here and is available at Bennett's Government Bookshops.
Under-Secretary to the Minister of Revenue
Fairer tax treatment proposed by discussion document
People who get into difficulty with their taxes are likely to benefit from proposals in a Government discussion document released today.
Associate Revenue Minister Paul Swain and Under-Secretary to the Revenue Minister John Wright released the document - the third in a series of four tax simplification discussion documents. They say the tax rules should reflect society's standards.
"Rules that are too harsh will not be perceived as fair, nor will rules that are too lenient," Paul Swain said.
"The proposals in this discussion document attempt to strike a balance between the two extremes, to encourage voluntary compliance with the tax laws in the best possible way.
"We want to replace the current tax rules that provide relief to taxpayers in debt who face hardship," Paul Swain said.
John Wright said the government intends reducing the penalty for lack of reasonable care for first-time offenders, and generally make things a bit easier for those who do get into trouble.
"The new rules will give Inland Revenue greater flexibility in dealing with taxpayers' debt problems, and will encourage taxpayers to contact the department about their debt problems as early as possible," he said.
"For example, if a taxpayer enters an instalment arrangement for paying off tax debt, late payment penalties will stop as soon as the taxpayer contacts Inland Revenue.
"The discussion document also deals with problems raised by Parliament's Finance and Expenditure Committee in its 1999 inquiry into the powers and operations of the Inland Revenue Department.
"We have already acted upon several of the changes recommended by the committee, including reducing late payment penalties. This discussion document makes a number of proposals to complement that work, such as ensuring that taxpayers are given more information in their dealings with Inland Revenue," John Wright said.
Associate Revenue Minister Paul Swain said another main proposal in the discussion document is to impose a penalty on promoters of tax avoidance schemes.
"The rationale is that promoters of these schemes should be clearly accountable for their actions," he said.
"Other proposals would strengthen Inland Revenue's information-gathering powers and generally clarify the law for people who overpay their tax and want to transfer the excess.
"The issue of who is liable when an agent doesn't take care is also discussed and options considered in the document.
"This discussion document is part of the consultation process in the continuing review of the compliance and penalty legislation in the Tax Administration Act. The point of the review is to determine if the relatively new legislation, enacted in 1996, is working as intended, and where it could be improved," Paul Swain said.
The closing date for submissions on the proposals on debt, hardship and transfers of excess tax is 21 September. Legislation arising from these proposals will be included in a taxation bill to be introduced later this year. The closing date for submissions on the other proposals is 21 November.
The discussion document, Taxpayer compliance, standards and penalties: a review, is available at Bennett's Government Bookshops and on the web sites of the Policy Advice Division of Inland Revenue at www.taxpolicy.ird.govt.nz and the Treasury at www.treasury.govt.nz.
Kerry Lamont [ Press Sec for Paul Swain ] 04 4719889/021 270 9106 / [email protected]
For other releases by Paul Swain go to:
Taxpayer compliance, standards and penalties: a review - Questions and answers
The discussion document in general
1. Why is the review taking place now?
The current compliance and penalties legislation was introduced with effect from the 1997-98 income year. As part of the generic tax policy process the post-implementation review began as scheduled in late 1999. The need for the review was highlighted further during the Finance and Expenditure Committee inquiry into the powers and operations of the Inland Revenue Department. Many of the recommendations made by the Committee were included in the review's terms of reference.
2. How does the review fit into the tax simplification process?
This discussion document is the third in the tax simplification series. The first two were More time for business and Maori Organisations. This discussion document is intended to reduce compliance costs by providing rules that are clearer and fairer.
3. This document focuses on the recommendations made by the Finance and Expenditure Committee, and there is no discussion of technical issues. Are there no technical issues?
This document represents the work done to date. It is anticipated that another discussion document will be released next year and will, amongst other things, address numerous technical issues relating to the detail of the legislation. Submissions on issues that people would like considered in the next stage of the review are welcome now.
4. Why are there two closing dates for submissions?
The legislation for the proposals relating to debt and hardship and transfers of excess tax will be included in a taxation bill to be introduced late this year. So that submissions can be considered before the bill is introduced, the closing date for submissions for these proposals is 21 September 2001. The closing date for submissions on all other matters is 21 November 2001.
Finance and Expenditure Committee recommendations
Debt and hardship
5. What is proposed?
The Government is proposing that the current debt and hardship rules be clarified and in particular:
- propose that Inland Revenue's role be to maximise the recovery of outstanding tax, but not if:
- recovery represents an inefficient use of Inland Revenue's resources; or
- a taxpayer is placed in serious hardship;
- "serious hardship" will be defined and will list both circumstances which meet that test and circumstances which do not;
- if Inland Revenue can collect more of the debt over time through an instalment arrangement than from bankruptcy or liquidation, then Inland Revenue would be required to enter the instalment arrangement and any amount not recovered will be written off as unrecoverable;
- there will be fairer instalment arrangements including provision that late payment penalties will stop when a taxpayer contacts Inland Revenue stating they want to negotiate payment of the debt;
- amounts not recovered will be written off permanently and will not be able to be reinstated.
6. Will these proposals apply to all taxes?
Yes, with the exception of child support. Child support payments may be passed on to the custodial parent and are paid for the support of children. If child support debt was written off the children involved would suffer and the principles of the scheme would be undermined.
7. Who would the proposal affect?
Any taxpayer who finds they have tax debts that they are unable to pay. The rules have been designed to encourage taxpayers who find they cannot pay their tax on a due date, to contact Inland Revenue at the earliest opportunity.
8. Why is the change needed?
A number of deficiencies were highlighted during the Finance and Expenditure Committee Inquiry, especially in the area of write-off of tax debt. The current legislation was designed in the 1930s and hasn't been reviewed since it was introduced. The Government concluded that there are a number of problems with the current rules in that they are unclear and due to their uncertainty may lead to taxpayers being treated inconsistently.
9. One of the major concerns of the Committee was in relation to "write-off". What are you proposing in this area?
As currently applied by Inland Revenue, "write-off" means that no action is taken to collect the debt. However, late payment penalties and use-of-money interest continue to accrue. If Inland Revenue finds that a taxpayer's financial position has improved, action can be taken to recover the amount written off, including any penalties and interest accrued. The Government is proposing that the legislation list the situations where a tax debt may be written off. Once an amount is written off there will be no grounds for the amount to be reinstated.
10. When will tax debt be written off?
Under the proposal the legislation will detail a number of circumstances in which tax may be written off:
- a company being struck off the Companies Office register;
- confirmation of the distribution of a deceased taxpayer's estate;
- a taxpayer cannot be found;
- the debt relates to a taxpayer that cannot be identified;
- administrative error; and
- situations where Inland Revenue considers there is a limit on the amount recoverable.
The final criterion includes debts written off if this would result in serious hardship for the taxpayer or it is not practicable to collect the full amount. Amounts will also be written off if Inland Revenue considers the tax unrecoverable.
11. What are some examples of serious hardship?
The discussion document proposes that "serious hardship" be defined to include:
- deprivation of necessities according to normal community standards; or
- not being able to acquire a basic standard of food, clothing, medical supplies, accommodation, education for children or dependants, and other basic requirements.
"Serious hardship" will also be defined to exclude:
- the mere imposition of an obligation to pay tax;
- the prospect (or likelihood) of bankruptcy or liquidation;
- the limitation of social activities and entertainment; and
- the loss of access to goods or services of an expensive nature or standard.
12. What is the proposal?
The Committee recommended that a past history of good behaviour be taken into account when deciding whether to impose a penalty. Rather than simply providing that the penalty not apply if a taxpayer has a past history of good behaviour, the Government is proposing that the lack of reasonable care penalty be reduced to 10 percent, if the breach is the taxpayer's first breach of a required standard of behaviour. If the taxpayer subsequently does not take reasonable care within seven years, the shortfall penalty for any subsequent breach would be imposed at 20 percent.
13. Why not simply provide that the penalty not apply if a taxpayer has a past history of good behaviour?
We are concerned that the "norm" for taxpayers could become one of only taking care after having been audited, or taxpayers would breach the standard now and then but not sufficiently to be seen as a "bad" taxpayer. This approach would be seen as inequitable by those taxpayers who do maintain compliance standards. The Government is concerned that such a proposal would also reduce voluntary compliance.
Flexibility in the application of shortfall penalties
14. Why is there no change proposed in this area?
The Committee was concerned that shortfall penalties were being imposed on all tax shortfalls. This is not the case and it was never the intention of the compliance and penalties legislation. For a shortfall penalty to be imposed there must be both a tax shortfall and a breach of a required standard, for example a taxpayer not taking reasonable care. Statistics kept by Inland Revenue show that shortfall penalties are only imposed on approximately 14 percent of tax shortfalls. The Government is not proposing any change in policy or legislation in this area.
15. If there is a tax shortfall, why would no penalty be imposed?
There are a number of reasons why a shortfall penalty is not imposed. For example the tax shortfall arose from an inadvertent error by the taxpayer, or their agent; or the tax shortfall arose from an incorrect interpretation, but one that is not unacceptable.
16. Why is there no change proposed in this area?
The Committee was concerned that shortfall penalties were being imposed on inadvertent errors. This is not the case and it was never intended that shortfall penalties be imposed where the taxpayer makes an inadvertent error. The cornerstone of the compliance and penalties legislation is a standard of reasonable care. When considering whether a taxpayer has breached this standard Inland Revenue considers what is expected of that taxpayer, and therefore the standard expected of a large corporate is higher than, say, the corner grocer. The Government is not proposing any change in policy or legislation in this area.
Consistency in applying shortfall penalties
17. Why is there no change proposed in this area?
The Finance and Expenditure Committee indicated that it was concerned that shortfall penalties were not being applied consistently. Consistency committees within Inland Revenue review a percentage of completed audits, including audits where no shortfall penalty has been imposed, to ensure that the penalties legislation is applied consistently. The Government is not proposing any change in policy or legislation in this area, but is interested to hear of any further ways in which consistency could be improved.
Penalties for taxpayers who have not interpreted the legislation
18. What the Committee recommended?
The shortfall penalty for unacceptable interpretation is imposed if there is a significant amount of tax at stake and the taxpayer hasn't made an interpretation that is as likely as not to be correct. The Finance and Expenditure Committee recommended that the Department reinforce that if a taxpayer or adviser has not interpreted legislation a penalty for unacceptable interpretation cannot apply.
19. What is the problem?
The legislation allows taxpayers to avoid the penalty for unacceptable interpretation by deliberately not determining what the law is. This is contrary to the original intention, which is that taxpayers should endeavour to take a tax position that is "at least about as likely as not correct".
20. What is the proposal?
Legislation will provide that a shortfall penalty for an unacceptable interpretation can be imposed in cases where a tax position taken is unacceptable but the taxpayer has not interpreted the law.
21. Why is this penalty only imposed where there is a significant amount of tax at stake?
The penalty is meant to signal to taxpayers who are taking tax positions where there is significant amounts of tax at stake that they should take extra care. The minimum threshold at which this penalty applies is also being increased.
Other FEC recommendations
22. What did the Committee recommend?
The Committee asked that the legislation be amended to provide a clear four-year time bar in relation to all taxes except where the Commissioner of Inland Revenue has reasonable grounds to suspect a return to be fraudulent or wilfully misleading.
23. What is proposed?
As this issue relates to the disputes process, the issue be considered as part of the post-implementation review of disputes.
24. When will that review take place?
The review started recently and a discussion document is due to be released in the first half of next year.
Burden of proof
25. What did the Committee recommend?
The Committee recommended that we consider establishing a "test" for the Inland Revenue Department to meet to ensure that only properly calculated and substantiated amended assessments are issued to complying taxpayers.
26. What is the proposal?
The Government isn't proposing that a "new" test be introduced as the disputes resolution process provides a "test" to ensure that assessments are properly calculated and substantiated. We are proposing other amendments. For example, if Inland Revenue issues a default assessment we propose that the taxpayer should also receive an explanation of what the default assessment is, why it has been issued, and what responses are available to the taxpayer.
Also, if a taxpayer disputes the amount of tax legislation requires the taxpayer to pay 50 percent of the amount of tax that is being disputed. The justification for requiring this, however, was significantly diminished by the introduction of use-of-money interest. The requirement to pay 50 percent of the tax in dispute will be removed. Inland Revenue will be given the power to require payment of all the tax in dispute in those rare cases where there is revenue at significant risk - that is, where there is a risk that the amount in dispute might never be paid.
Time limit on Inland Revenue for responding to a Notice of Response
27. What is the issue?
The disputes resolution process relies on a series of information disclosures between Inland Revenue and the taxpayer. If Inland Revenue wants to adjust a taxpayer's return then Inland Revenue must issue a Notice of Proposed Adjustment which sets out the facts, the relevant legislation and any issue arising from the proposed adjustment. If the taxpayer does not accept the Notice of Proposed Adjustment then the taxpayer must issue a Notice of Response to Inland Revenue within two months. If Inland Revenue rejects the arguments in the taxpayer's Notice of Response, the issue will progress to the conference phase. However, there is no time limit on Inland Revenue for responding to the taxpayer's Notice of Response.
28. What did the Committee propose?
The Committee recommended that the Government review the process by which assessments can be challenged, placing particular emphasis on assessing the merits of establishing a time limit on the Commissioner of Inland Revenue when addressing a taxpayer's Notice of Response.
29. What is the proposal?
The Government recognises that Inland Revenue should be held responsible for its performance. We propose that performance standards for responding to a Notice of Response be included in the Department's purchase agreement with the Minister of Revenue, and in its annual report. The proposed standards will require Inland Revenue to correspond with the taxpayer at least every three months as to progress.
30. Why aren't you imposing a time limit on Inland Revenue?
The Government is concerned that if a time limit was imposed on Inland Revenue that some taxpayers would withhold the requested information. The Department would then have to accept the adjustment proposed by the taxpayer without all the facts and without being able to determine the accuracy of the adjustment.
Rates for use-of-money interest
What did the Committee recommend?
The Finance and Expenditure Committee recommended that the method by which use of money interest is calculated be reviewed to determine whether changes to the interest rates for overpayments and underpayments to reduce the differential between the rates are appropriate.
31. Are you proposing an amendment?
The use-of-money interest rates on underpayments are not inappropriately high. They are, in fact, lower than what the market charges for unsecured lending. There would be significant risks from reducing the margin between the two sets of rates.
The rates reflect the fact that the Government is an involuntary borrower if taxpayers overpay and an involuntary lender if they underpay. The underpayment use-of-money interest rate is roughly equivalent to the cost of unsecured bridging finance borrowed by small firms. Lowering this rate would reduce the incentives for taxpayers to pay tax on time. Increasing the overpayment rate might result in some taxpayers overpaying tax simply to have access to an interest rate better than that provided by the private sector.
What can the Government do about taxpayer's perceptions that the rates are unfair?
One of the goals of the recently released More time for business discussion document is to reduce the need to use use-of-money interest to ensure compliance. The document includes the following proposals:
- a voluntary withholding tax (via the banking system) on business income as a substitute for provisional tax, with taxpayers who used this option not facing use-of-money interest if they underpaid their tax during the year;
- provisional tax payments based on business turnover and made via the GST system, with no use-of-money interest applying; and
- allowing taxpayers to pool their provisional tax payments in a way that avoids penalties and reduces interest costs.
32. What is the proposal?
The Government is proposing that the legislation be amended, in line with the recommendations of the Committee of Experts on Tax Compliance, to:
- allow documents to be removed from premises for copying;
- clarify that third parties can be required to give reasonable assistance in an investigation; and
- allow Inland Revenue to requisition records held by offshore entities controlled by a New Zealand resident; and
- give Inland Revenue the discretion to require documents to be sent to a specified Inland Revenue office;
- make it clear that Inland Revenue can have access to computers and can copy information held on them.
The legislation will also be amended to clarify who may be given authority to enter a taxpayer's premises.
33. Why are you proposing these amendments?
The Committee of Experts made a number of recommendations to correct deficiencies in the Commissioner's information-gathering powers. They noted that several of those deficiencies were highlighted in the evidence given at the Winebox inquiry. The Government agrees with these recommendations.
Transfers of excess tax
34. What is the proposal?
The legislation will be amended to allow Inland Revenue to transfer tax overpaid by a taxpayer to another period or tax type of the taxpayer, or to another taxpayer. The legislation will set out the effective date of the transfer, which will differ depending on the relationship between the person transferring the tax and the person receiving it.
35. Why is this needed?
Sometimes taxpayers overpay their tax and ask Inland Revenue to transfer the excess to satisfy a future or past tax liability of their own. Alternatively, they may want to transfer the excess to another person. The rules relating to this are currently not clear. The Government proposes to clarify them.
36. Why is the effective date of the transfer significant?
Often taxpayers transfer excess tax to satisfy an unpaid tax liability of an associated taxpayer. Use-of-money interest may be accruing in relation to that unpaid tax. The effective date of transfer is important because it can affect the transferee's exposure to use-of-money interest. The proposals allow tax to be transferred between some associates as at the date of overpayment. This will mean that the transfer can reduce or eliminate the use-of-money interest on the unpaid tax.
Two further issues relating to shortfall penalties
Taxpayers with agents and breaches of standards of care
37. What is the problem?
A taxpayer who has relied on the advice of a tax agent will usually be considered to have taken reasonable care, regardless of the care taken by the tax agent. Therefore if a tax agent does not take reasonable care and this results in a tax shortfall, then no shortfall penalty is imposed on either party. This is also true if a tax agent is grossly careless.
38. What is the proposal?
That a shortfall penalty for lack of reasonable care or gross carelessness be imposed on the taxpayer irrespective of whether the taxpayer or their agent breached the standard.
39. Why is the change needed?
Legislation does not, and should not, require taxpayers or their agents to be right in everything they do. The current approach, however, clearly allows agents to take less than reasonable care in a client's tax affairs.
Not penalising these instances of lack of reasonable care and gross carelessness is unfair on taxpayers and agents who do manage their tax responsibilities correctly. It also means there is little incentive for tax agents to take care so that those who currently breach standards have no reason to improve their performance. Furthermore, the current approach encourages less honest tax agents to report errors by their clients as their own, thus ensuring that their client avoids a shortfall penalty. The overall effect is to erode the standards expected of taxpayers, endanger voluntary compliance, and decrease revenue.
40. Why impose the shortfall penalty on the taxpayer?
The discussion document sets out the pros and cons of imposing the penalty on the taxpayer, the agent, on both parties or for Inland Revenue to determine who is culpable. On balance it was determined that a better outcome is achieved where the penalty is imposed on the taxpayer.
41. But the reason many taxpayers go to agents is the agent's knowledge of tax?
Yes, however from our discussions with various agents we have concluded that if an agent is responsible for the breach they will take responsibility for their actions and pay the penalty. This is what currently happens if a late payment penalty or a late filing penalty is imposed or use-of-money interest is charged and the penalty or interest is the result of the agent's actions. The sustainability of this option, however, depends on agents taking responsibility for their actions. If this is not the case, the Government considers the next best option is seeking to hold the agent directly responsible.
Capping the penalty for lack of reasonable care
42. What is the problem?
The Government is concerned about the application of the lack of reasonable care penalty to very large errors which are speedily identified and corrected. Where a tax shortfall is large, the corresponding shortfall penalty is also large. Then the error is picked up quickly.
43. What is the proposal?
The Government is proposing the introduction of a $50,000 cap on the shortfall penalty for lack of reasonable care, in cases where the shortfall is identified within a two-month period through voluntary disclosure or an Inland Revenue audit.
44. What is the proposal?
We are proposing the introduction of a penalty aimed at holding promoters of tax avoidance schemes clearly accountable for their actions. A penalty will be imposed on promoters of tax investment schemes, in cases where:
- the investment breaches an anti-avoidance provision; or
- the investment leads to the investor having a shortfall penalty for an abusive tax position.
The penalty will be based on the total tax impact of the promoter's scheme. The promoter is usually the party with the greater knowledge of the scheme's tax effects. Often, the true impact of the scheme may be determined by features that the promoter is aware of but the investor is not. These undisclosed features may mean the scheme constitutes tax avoidance and may place the investor at risk of significant penalties.
45. Why is the penalty needed?
The proposed penalty is aimed specifically at reducing both the marketing of, and investment in, tax avoidance schemes.