Term of reference C
To review the debt management practices and the adequacy of the powers of the Inland Revenue Department to remit tax liabilities or enter into arrangements for deferring the payment of tax and the department’s operation of its powers
- Department needs to take action on outstanding debt more quickly
- Cancellation of penalties
- Instalment arrangements
- Serious and financial hardship provisions require review
- Ministerial approval threshold in cases of serious or financial hardship
- Bankruptcy proceedings
- Department’s statutory preference in liquidation proceedings should be reviewed
- Tax amnesty
The department has a difficult job to perform when dealing with taxpayers who are in debt to the department. The department differs from other creditors in three important aspects:
- Creditors can generally chose who they deal with. The department must deal with all taxpayers. Often the department’s debtors choose to pay trade creditors in preference to the department to ensure that their supply of essential business needs continues.
- Unlike other creditors, the department has no general discretion to compromise on payment of established tax liabilities.
- Some forms of tax debt (such as PAYE and child support) are given preferential status in the statutory priority of distribution following insolvency.
Debts owing to the department arise when the department has issued a default assessment if the taxpayer has failed to file a return, or the department has issued an assessment showing an amount owing and the taxpayer has failed to pay the full amount by the due date.
A large number of submissions indicated to us that the system for informing taxpayers of debts is inadequate. Once a debt has arisen in a taxpayer’s account, the taxpayer gets notice of that debt by a variety of ways, by Notice of Assessment, Statement of Account and reminder letters.
If the debt remains unpaid and there is no prospect of immediate payment, the department needs to consider debt management options available to it. Although the department’s preference is to recover debt by voluntary payment in full, recovery can also be by way of voluntary time payment (for example, an instalment arrangement), or by compulsory deduction. If a taxpayer is in financial difficulty the department can, in limited circumstances, provide relief from debt by way of write-off, cancellation or remission.
Some submissions were approving of the department’s general approach; for example, Denham Martin and Associates states:
Our clear impression is that in this area the Commissioner and his staff have adopted a fair and compassionate approach to applying penalties and assisting taxpayers with their outstanding tax obligations. The cases where this has not been done would be the exception rather than the rule.
This sentiment was shared by others who acknowledge that the department has a difficult job to perform, but many submissions also suggest that significant improvements could be made to the department’s debt management practices. Following our examination of the department’s debt management practices we make the following comments and recommendations.
PricewaterhouseCoopers states the debt recovery division within the department should become involved in collecting outstanding tax at an earlier stage than at present. Under current policies and procedures, situations are often beyond retrieval before they reach debt recovery. In many cases the first contact with a taxpayer in relation to unpaid taxes is several months after the due date has passed, at which time the department issues a statement recording the unpaid tax together with accrued penalties. Many taxpayers who get themselves into this situation are unaware of the effect of penalties, and by the time they are made aware of it, substantial penalties have accrued, plus interest.
Many other submissions state that a contributing factor in the accumulation of debt is that the department is too slow in identifying and following up on debt. PricewaterhouseCoopers suggests that the department should adopt practices common to trading banks and institute prompt follow-up procedures for overdue debts. Arguably the department should have more sophisticated follow-up procedures than banks as the imposition of late payment penalties and UOMI will generate a higher debt and can result in what are initially relatively small debts escalating into amounts which are beyond the ability of taxpayers to ever pay back. When debt is recognised early there is a better chance of recovering the debt (from the department’s perspective), and the debt will be more manageable (from the taxpayer’s perspective); therefore, a ‘win-win’ situation is achieved. We concur with this analysis.
We understand the department is working on ways to identify outstanding debt earlier and that it is working towards utilising its call centres to make outbound calls to taxpayers in arrears. We welcome these initiatives.
The department accepts the validity of the above concerns and is refocusing its debt management resources on two broad priority areas:
- Debt which has risen to a significant level (over $10,000) irrespective of age.
- PAYE and GST. This debt tends to be newer debt and has significant potential to escalate.
This approach recognises the need to balance the use of resources across both new and old debt. Performance standards in the departmental forecast report focus on the department collecting new debt as quickly as possible.
ICANZ submits that the experience of its members suggests that there are cases where a defaulting taxpayer is “put to the wall”. ICANZ has no problem with a firm and fair approach being adopted towards debt collection, but is concerned with the lack of commercialism that sometimes is displayed by debt collection personnel, probably as a result of “punishing” operational guidelines set down for them.
In order to improve the department’s debt collection philosophy ICANZ suggested that the department must ensure that:
- the department’s systems immediately identify situations where a taxpayer is “in arrears”
- if the amount of the arrears is significant, the department is promptly in direct contact with the defaulting taxpayer, with a view to alerting them and seeing whether there is a situation calling for departmental help and assistance (or indeed, fast track recovery action)
- in all cases, if immediately the debt is say three weeks in arrears, contact be made with the taxpayer to alert them to the situation, and (where appropriate) to formally invite them to come and discuss the situation (including any required instalment arrangements)
- in the case of continuing default, thereafter continue to follow-up routinely on the default with the taxpayer, and be prepared to take appropriate action (which need not necessarily be recovery action).
ICANZ also suggests that the department consider passing the debt on to be dealt with by another body, perhaps a separate arm of Government to deal with unaddressed debts.
At the moment no personal contact by the department’s debt collecting staff is made until the debt is several months overdue. By this time, if the taxpayer has serious financial problems there will be a further two to three months of unpaid taxes (PAYE and GST, etc.) along with mounting late payment penalties and interest charges. This kind of debt compounding over a few months for a small business can be devastating.
Accordingly, ICANZ believes that if such an approach were to be introduced and the approach was accompanied by a positive, focussed, friendly but firm cash flow management approach on the part of the department’s debt management staff, there would be considerable advantages for taxpayers, the perception of the department in the minds of taxpayers, and the community at large, in particular:
- debt problems would be identified promptly, and consequentially managed better
- the penalty and interest exposure of defaulting taxpayers could be minimised
- if a suitable debt management arrangement was not concluded within a (say) six month period, then the troublesome debt not in dispute could pass out of the hands of the departmental officers (who otherwise would be considered “the bad guys”) onto another Government department for debt collection.
We consider that the ideas raised have merit and should be closely investigated by the department. The next Finance and Expenditure Committee should consider following up with the department what action has been taken in this regard. However, we do see a problem in passing the debt on to another body, in that this would just transport the problem somewhere else, rather than resolve it.
A write-off is an accounting concept whereby a debt is written off the books of a creditor. The debt still exists but no action is being taken to collect it. The debt can be reinstated if the taxpayer’s position improves. The write-off provisions are not contained in legislation. They are an administrative practice adopted by the department in line with the Public Finance Act 1989. UOMI and penalties continue to accrue. Debts that can be written-off can generally be reinstated at anytime (except in cases of bankruptcy or liquidations).
Many submitters were concerned that the term “write-off" is not fully explained. Many taxpayers believe their debt has been permanently wiped and they are often subsequently unprepared in cases where the debt collection is reinitiated. Another submitter raised the problem of its de-motivating effect on taxpayers. If a taxpayer knows the debt will be reinstated once he or she is in a better financial position, the incentive to find work is removed. In this situation a “lose-lose” outcome is the result because not only is the department failing to maximise net revenue over time by not collecting money to pay the debt, but the taxpayer is not working to pay tax in the interim.
We recommend that the Government review the whole area of write-offs and in doing so consider:
- whether there should be a time limit on reinstatement of a debt
- whether, if the present policy is to continue, the term “write-off” should be replaced by wording that more accurately describes the policy (for example “provisional write-off”)
- whether it is necessary for the write-off provisions to be contained in the Inland Revenue Acts.
Penalties may be cancelled subject to the successful completion of a specified action such as an instalment arrangement. If the action is successfully completed the remaining debt is cancelled.
The purpose of the penalty cancellation provisions is to encourage taxpayers to enter into repayment arrangements at an early stage and to make repayment of debt by instalments more rapid. ICANZ, in its submission, included the department’s practice statement about the application of the cancellation provision:
Provided taxpayers fully comply with an approved arrangement entered into before the due date, Inland Revenue will cancel 60% of the initial late payment penalty and all the subsequent late payment penalties. This cancellation does not however extend to use of money interest, which will still be charged (emphasis added).
However, section 183B (2) of the TAA states in relation to the cancellation provision:
(b) the taxpayer complies with the taxpayer's obligations under the arrangement.
The word “fully” does not appear in the legislation. The department’s explanation of the inclusion of the word “fully” in the practice is:
By fully we mean the taxpayer has to see an agreed arrangement through to the end—they cannot bail out part way through and still expect to get cancellation of the penalties under section 183B.
However, as stated, the taxpayer can vary the arrangement by mutual agreement and still stay within the ambit of section 183B.
The ability to vary the arrangement by mutual agreement is not widely known. The use of the word “fully” is inconsistent with this position. Obviously, if a repayment arrangement can be varied once agreed to, the original arrangement does not have to be fully complied with to attract cancellation. We consider that partial failure to comply with an arrangement should not result in a disproportionate penalty.
We consider that it is important that the department be very clear as to the rights of the taxpayer under repayment arrangements. We recommend the department issue clear directions to taxpayers as to their options, rights and obligations with respect to repayment arrangements.
Under section 177 of the TAA the Commissioner can provide relief by way of granting an instalment arrangement when a taxpayer is in financial difficulties. The provision is restricted to income tax and fringe benefit tax, but we understand that under the care and management provisions instalment arrangements have been entered into for other types of taxes. While we consider that it is appropriate for instalment arrangements to be available for all tax types, the current legislative framework does not establish clearly that the Commissioner is empowered to do this. This can lead to inconsistent treatment for taxpayers seeking an instalment arrangement for tax types other than income tax and fringe benefit tax. We note that following these concerns being raised during our inquiry the Government intends to clarify this situation.
The department generally limits instalment arrangements to periods of less than 12 months (commonly six months). We consider the restriction may lead to unrealistic instalment arrangements if taxpayers are required to pay debt within rigid time frames rather than within the taxpayer’s financial budget. The factors that may determine whether an instalment arrangement is an acceptable course of action for the department include:
- is the repayment proposal realistic?
- can the taxpayer meet future tax liabilities?
- has the taxpayer previously had and adhered to an instalment arrangement?
- has the taxpayer filed all required returns or are there any current default assessments?
- has the taxpayer been granted other relief in the past?
In practice a complicated calculation must be done to ensure that the department receives the best possible return from the action taken, thereby maximising the “Net Present Value” (NPV). This value will be maximised if the debt can be repaid over as shorter period as possible. However, we consider that rigidly imposing time limits for instalment arrangements of six or 12 months, as some local offices have been doing, is far too inflexible and is not consistent with the Commissioner’s duty to maximise revenue collected over time.
Many submitters wrote or told us of the frustration at not being kept fully informed of what was required of them, and of the department's tardiness in communicating with taxpayers who were asking for help or were asking for clarification regarding their tax affairs. One submitter told us he had desired to enter into an arrangement and offered payment of $600 per month to help clear some of the debt as the department was threatening bankruptcy. This offer was refused.
The department agrees with many of the sentiments expressed by those who made submissions. The department acknowledges that some local offices have been seeking to impose time limits on instalment arrangements. National Office has recently sent out a memorandum to all staff which emphasises that there is no time limit for instalment arrangements.
The department adopts a policy that instalment arrangements will not generally be entered into if a taxpayer can pay the debt using other sources or means. This satisfies the principle that immediate recovery of the full amount of the debt is the optimum outcome in terms of NPV. Lengthy instalment arrangements are unlikely to maximise the NPV of any recovery, so a number of factors need to be taken into account when long-term instalment arrangements are being considered. Following legitimate concerns raised in submissions to this inquiry, a standard practice statement on instalment arrangements is being produced that is intended to improve consistency across departmental offices. This will be completed following both internal and external consultation. We are pleased the department is taking steps to enhance a consistency of approach. We expect the department to be more flexible in its approach to instalment arrangements, and make its intentions clear to the taxpaying public.
The Commissioner has discretion to remit income tax or fringe benefit tax if a taxpayer is in financial difficulties or to remit income tax if satisfied that serious hardship exists. The NPV calculation applies to these provisions. In practice the department uses the financial hardship provision for taxpayers in a continuing business who are in genuine financial difficulties and do not have the ability to pay arrears, but do have the ability to account for future taxation requirements.
Many submitters believe the department is reluctant to grant remission for serious and financial hardship, and that it is unclear as to when the provisions are granted and under what circumstances. The hardship provisions are very limited at the moment, and applying them across all tax types was suggested in many submissions. Submitters argue the hardship provisions should be used more widely to avoid bankruptcy in many situations where there is a realistic option of the business being able to pay its current and future tax obligations if relief is granted.
The department instigated a review of the hardship provisions in October 1998, having had concerns about possible deficiencies in the provisions for some time. There are philosophical reasons why remission should be agreed to only rarely. These are based on fairness and the perception remitting for some taxpayers gives to other taxpayers who have paid their tax. It also erodes the ethos that all taxpayers have an obligation to pay their tax. Effectively a delicate balance must be reached between remitting tax for those taxpayers in serious and financial hardship and the impression this gives the compliant taxpayer.
The policy reason behind not applying these provisions to all tax types is that certain tax types such as PAYE are deemed held in trust by the taxpayer. It is the taxpayer’s duty to withhold these taxes on trust and then forward them on to the department. They are not meant to be spent in the general course of every day business.
The department has acknowledged that the current application of the hardship provisions and the write-off rules can lead to inconsistency and there is some lack of clarity with their application. It is not clear when a write-off is granted rather than serious or financial hardship. These problems would be partially removed if the hardship provisions applied to all tax types. We note and welcome the Government’s intention to extend the provisions in this manner. However, we consider some clear statements as to when the provisions will apply are also needed.
PricewaterhouseCoopers in its submission included material contained in an April 1994 Report to the Minister of Revenue. The report specifically stated:
To ensure the proper and consistent use of managerial responsibility in these areas, the tax administration will be required to refine or develop internal guidelines for the exercise of care and management in the administration of the Inland Revenue Acts. The guidelines should be consistent with the objective of maximising net revenue over time according to the law and give guidance to staff on the proper procedures and consideration to take into account as they apply tax law.
The report went on to suggest that the application of these guidelines should be subject to an independent and periodic audit by the Office of the Controller and Auditor-General. The results of the audit should then be published in a report to Parliament. We believe this is a very good suggestion which may solve many of the problems raised by submitters, expressing their concern at the consistency of the provisions’ application.
The department points out that there are a number of problem areas in the current hardship provisions. These include whether the current tests are appropriate. The department is to review the provisions as part of the post-implementation review of the compliance and penalties regime. We consider the next Finance and Expenditure Committee should thoroughly assess the outcome of that review.
Under the TAA, ministerial approval must be obtained if the amount subject to an instalment arrangement or remission exceeds $50,000. In practice, however, the Commissioner told us the department had generally not been requesting ministerial approval for instalment arrangements of over $50,000. This kind of disregard for the law could severely damage the integrity of the tax system, if taxpayers perceive that the department can summarily disregard its statutory obligations. If in practice the approval thresholds are inappropriate or overly cumbersome, then the law should be changed, not merely ignored.
Many submissions express concern over the need for ministerial approval to remit, refund or enter into instalment arrangements for amounts exceeding $50,000. The Minister’s role is designed to provide an assurance that the Commissioner is appropriately applying the hardship provisions in the most significant cases. However, there are a number of disadvantages with the requirement to get ministerial approval:
- The process can be time consuming, causing considerably more stress to the taxpayer.
- Delays often affect the taxpayer’s economic circumstances and may act to reduce revenue collection.
- It impacts on the separation of the Commissioner’s statutory role of day to day tax administration from the Minister’s role of political oversight.
We are of the view that ministerial discretion should be removed. We consider that removing the threshold would be beneficial for a number of reasons. Primarily it would reduce the amount of stress on the taxpayer waiting to hear whether their application has been agreed to. It will result in administrative cost savings for the department and reduce compliance costs on taxpayers due to the faster processing times. We recommend that the ministerial approval thresholds for instalment arrangements and remissions be removed, but that the Commissioner be required to provide a regular report to the Minister outlining applications for remissions and instalments in excess of $100,000.
A large number of the submissions we received were from people who had been forced into bankruptcy by the department. Of these, a significant proportion were self-employed or sole contractors. The department states that legal proceedings are initiated as an action of last resort and only after careful consideration of all aspects of a case.
Many submissions claim that the department takes a heavy handed approach to debt collection, and pursues debt rigorously and without tact. Some submissions allege that the department uses standover tactics in the form of intimidation and threats to obtain payments. While we make no findings in respect of individual cases, we are concerned at the pattern they reveal.
In the period 1 July 1998 to 30 June 1999, the department referred 1000 individuals for bankruptcy and 995 companies for liquidation. In 44 percent of those cases the proceedings referred have subsequently been withdrawn mainly because the debt was paid in full or arrangements were made to pay the debt over time.
The department considers bankruptcy and liquidation as a last resort. Several submitters claim the department instigates or threatens bankruptcy proceedings too readily. Submitters are of the view that the department is not prepared to consider alternative strategies or options. Many bankruptcy proceedings could be avoided if the department became actively involved in taxpayers’ affairs sooner rather than later, to halt the growth of debt. By the time the department does get involved the debt is so large the department has no other choice but to bankrupt.
As stated earlier, the department is to take steps to be more proactive in identifying new debt more quickly. It will focus some of the debt collection follow-up from the call centres and use the benefit of the technology to more actively pursue debt. We welcome this initiative and hope this action will be a factor in lowering the number of department initiated bankruptcies. We consider this matter should be kept under review by the next Finance and Expenditure Committee.
The department has statutory preference in liquidations. The statutory preference is governed by section 312 of the Companies Act 1993 and the preferences are set out in the Seventh Schedule of the Act. The tendency is to pay out the department’s tax preference, including interest and penalties, which appear not to have a statutory preferential status, dispose of any remaining assets (frequently there are none) and wind up the company. Remaining unsecured creditors are advised that there is no dividend and no fighting fund with which to litigate to recover bad debts or pursue delinquent directors.
Research on liquidations in the Wellington region was submitted to us by Ian Caddis and Jane Laking. The statutory preference of the department was identified as a major contributing factor to the dismal result of only two cents in the dollar being paid out to unsecured creditors. This has a significant flow on effect. The researchers conclude that the department loses more revenue than it collects in the liquidation process and this has a domino effect on other creditors who often fail as a consequence. Further, it is not clear whether the statutory preference extends to the collection of penalties and interest as well as the core tax debt. We consider that these arguments are valid and we recommend that the Government review the preferential status of the department in liquidations.
Tax amnesties are commonly used when there is a major change proposed to a tax regime. Research indicates that a tax amnesty is most successful when changes are proposed to the method of detection or to the size of the penalties. PricewaterhouseCoopers submits the Government should promulgate a tax amnesty in which taxpayers with undeclared tax issues can pay off tax due from previous years without any penalties or interest being imposed. PricewaterhouseCoopers believes there are thousands of taxpayers living in fear of the consequences of not having declared income for tax purposes but who would like to bring their affairs up-to-date. People in this situation, however, feel unable financially and unwilling emotionally to approach the department for fear of significant penalties being imposed.
An amnesty was last held in New Zealand in 1988. The reason for this was to encourage people to come forward if they had failed to meet their tax obligations but also because the department had increased both its checks on tax evasion and the penalties for this offence. The amnesty ran for a two month period. Taxpayers who came forward at that time were still charged with a late penalty payment. This was done for reasons of fairness. If penalties had not been charged, non-compliers would have had the advantage of the use of that money and would have paid less tax than those who complied. Just over 16 000 taxpayers responded with an additional $26.6 million of revenue being assessed. The majority (80 percent) of respondents were non-business taxpayers disclosing additional income from interest and dividend tax. This has since been addressed through withholding taxes.
Arguments put forward to support a tax amnesty note the potential receipt of tens of millions of additional dollars for the revenue. Aspects of the black economy may also be brought into the regulated taxation regime by allowing people to come forward without fear of prosecution and penalties. An amnesty could provide a mechanism to draw attention to the implications of not complying with the taxation Acts, it could stimulate voluntary compliance, and recover tax which might otherwise never be paid to the department. PricewaterhouseCoopers submits that a tax amnesty be held under which people would pay core tax owing but not penalties or interest. Such an action, in the submitter’s view, would go some way to restoring faith in the integrity of the tax system.
There are several drawbacks to providing a tax amnesty, however. PricewaterhouseCoopers acknowledges that if an amnesty was introduced, it would need to be handled with due regard to all those taxpayers who have and continue to comply with their tax obligations. For this reason, PricewaterhouseCoopers does not recommend that any core tax amounts be remitted. The 1988 amnesty attempted to find a balance between complying and non-complying taxpayers by charging a late payment penalty. The need to achieve a balance of this sort is a key disadvantage with holding a tax amnesty. A further consideration is whether the changes in the tax regime are significant enough or provide a sufficient incentive for non-compliant taxpayers to come forward. One further disadvantage of tax amnesties is that if they become a reasonably frequent occurrence non-compliers might be discouraged from coming forward in anticipation of another tax amnesty at a later time.
We find the arguments for and against a tax amnesty both have merit. We have no doubt that there are many taxpayers with a strong desire to regularise their tax situation and make a fresh start with the department but are afraid to do so because of the effect of compounding penalties. There needs to be due consideration, however, given to those taxpayers who do comply with their tax obligations. We do not believe it is appropriate for us to make a recommendation as to whether a tax amnesty is desirable at this time. This is a matter for the Government to consider.