Bringing up the rear: final two shortfall penalty guidance documents published

By Amy Sexton and Robyn Walker

Earlier this year we detailed how the Inland Revenue had published a number of draft guidance documents on shortfall penalties. What was missing from those drafts were guidance covering the evasion and abusive tax position shortfall penalties. Inland Revenue has now published these last two for consultation. 

Abusive tax position

An abusive tax position shortfall penalty can be imposed when a taxpayer has taken an unacceptable tax position where there is a tax shortfall and the taxpayer took the tax position in respect or as a consequence of an arrangement entered into with a dominant purpose of avoiding tax (commonly called 'tax avoidance'). The shortfall penalty is 100% of the tax shortfall. 

The draft guidance is consistent with the previous guidance (IS0061, published in 2006), but has been updated to reflect legislative changes and a number of significant tax avoidance cases, including Ben Nevis, Krukziener, Alesco and Frucor. While the technical analysis may not be controversial, what may give a few tax practitioners and accountants pause for thought is the inclusion of an example (Example 2, excerpt below), which Inland Revenue describes as an example of an arrangement that is caught by an anti-avoidance provision and which should be subject to an abusive tax position penalty. This example is also topical with the recent announcement of the proposed changes around shareholder current account loans.

The Inland Revenue consider the facts as they stand in this example show an arrangement with a dominant purpose of avoiding tax in the 2020 to 2025 years. In considering whether the abusive tax position shortfall penalty applies, the Inland Revenue states that the Example 2 scenario is consistent with the decision in Krukziener, where the arrangement was caught by s BG 1 (the general anti-avoidance provision in the Income Tax Act) and the shortfall penalty applied. Given it is not uncommon to charge and capitalise interest on shareholder loans it’s a timely reminder that simply charging interest on a loan is not an adequate substitute for a business owner receiving income in their own right through either a shareholder salary or a dividend and this type of approach could be challenged by Inland Revenue. The facts in this example are much tamer than what occurred in the Krukziener case which involved a property developer receiving ‘loans’ from a number of different single purpose (property development) trading trusts involving vast sums of money (millions) over a 10-year period.

If the outcome of this example concerns you, submissions can be made on the draft guidance until 15 December 2025.

Evasion

Tax evasion is the action to evade the assessment or payment of tax and requires intention and actual knowledge, wilful blindness or subjective recklessness. The penalty is the 150% and unlike other shortfall penalties, the onus of proof is on the Commissioner of Inland Revenue to prove the taxpayer is liable for the penalty. The draft guidance is consistent with the original 2006 guidance as the legal test for evasion has not changed. What is new, however, is guidance on the exception where a person is liable to pay an employer’s withholding payment penalty and the new penalty and offences concerning electronic sales suppression tools. 

The submission deadline for the evasion guidance is also 15 December 2025.

If you would like advice on tax disputes or penalties, please contact your usual Deloitte advisor.