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Reductions in shortfall penalties, the downward trend continues…. but for how long?

Tax Alert - November 2023

By Robyn Walker & Amy Sexton

Every year the Commissioner of Inland Revenue is required to report to the Minster of Finance under section 141L of the Tax Administration Act 1994 on the shortfall penalties that have been applied in that financial year. Earlier this year the Commissioner issued his report for the year ending 30 June 2022. The report showed that for the 2022 income year, the Inland Revenue imposed $22,122,067 (1,887 individual penalties) of shortfall penalties, compared with $13,922,752 (3,431 individual penalties) in 2021.

Shortfall penalties are imposed to encourage taxpayers to voluntarily comply with their tax obligations. The penalties have a progressive level of severity, depending on the nature of the breach and are imposed as a fixed percentage of a tax shortfall identified in a voluntary disclosure from a taxpayer or an Inland Revenue investigation/audit.

The shortfall penalty regime

When a taxpayer takes a tax position that the Inland Revenue later determines to be incorrect, the taxpayer may be charged a penalty on the tax shortfall. The table below summarises the shortfall penalty framework:

The framework aims to assess the taxpayer’s level of culpability for the tax shortfall and ensure the penalty is proportionate to the seriousness of the breach. In some circumstances the amount of shortfall penalty may be reduced, including:

  • 100% reduction (in cases of not taking reasonable care or unacceptable tax position) when a full unprompted voluntary disclosure is made
  • 75% reduction (in the case of other penalties) when a full unprompted voluntary disclosure is made
  • 75% reduction if there is a “temporary shortfall” when a taxpayer has reversed or corrected a shortfall permanently
  • 40% reduction when a voluntary disclosure is made post notification of an investigation/audit but before the investigation/audit starts
  • 50% reduction for taxpayers with “prior good behaviour”

Trends in shortfall penalties imposed

Since a peak in 2017, there has been a steady drop in the total number of shortfall penalties imposed, which coincides with the Inland Revenue’s Business Transformation project and from 2020, their COVID-19 pandemic response work. The total dollar value of the penalties imposed has however fluctuated over time, with the Inland Revenue advising the increase in 2022 being influenced by penalties imposed on one taxpayer involved in an avoidance arrangement.

GST remains the tax type with the highest number of shortfall penalties imposed and the decline in GST penalties from 2017 is dramatic when compared to the other main tax types. This drop in GST penalties again corresponds with the Inland Revenue’s focus on Business Transformation and the pandemic. Income tax remains the tax type with the highest “dollar value” of shortfall penalties imposed.

When looking at the type of shortfall penalties imposed the numbers show that if a penalty is imposed it is most likely to be for evasion (150%), gross carelessness (40%) or not taking reasonable care (20%). However, when looking at the actual dollar value, these types of penalties are dwarfed by the abusive tax position (100%) penalty. This is due to the fact that tax avoidance cases, while not common, usually deal with very large tax shortfalls, for example, the Trinity forestry schemes, and the use of mandatory convertible notes and optional convertible notes, in which tax shortfalls were in the millions.

Overall, the trend shown in these charts is that the has been an ongoing reduction in the shortfall penalties imposed. There are likely to be a number of factors that have influenced this trend, including the reduction in Inland Revenue staff numbers, the reallocation of resources at Inland Revenue arising from both Business Transformation and the response to the pandemic, as well as an increased focus on taxpayer education and processes to help taxpayers get their tax positions “right from the start”.

Increasing investigation/audit activity

Now that both the Business Transformation programme and pandemic work have finished, Inland Revenue is now shifting its focus back to investigations. This has been demonstrated by the increase in GST return reviews we have seen being initiated by the Inland Revenue recently. Time will tell whether this shift back to “business as usual” for the Inland Revenue will result in an upward trend in shortfall penalties when we review the next few shortfall penalty reports.

If you have any concerns about tax positions you have taken or increased Inland Revenue audit activity, seek advice from your usual Deloitte advisor as prompt action can help mitigate future penalties.

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