Owens Tax Advisors continues to deal with significant numbers of IRD reviews and audits of taxpayers who IRD allege haven’t returned all their cash income.
This is especially relevant if you or your clients are operating businesses in:
- Otherwise having material cash transactions
IRD has multiple sources of income that lead them to review and audit high risk industries, especially those that handle a lot of cash.
In this article we summarise key issues and how to handle them.
Summary of issues
Shortfall penalties can range up to 150% of the underlying shortfall, and interest and late payment penalties will increase the cost further. Prosecution for evasion of more than $100,000 can result in two years in jail.
A voluntary disclosure made before IRD announces an audit provides a minimum 75% discount on any penalties, and also immunity from prosecution no matter how much the shortfall
A disclosure made in the short window after an audit is announced but before the audit actually commences provides a 40% reduction in penalties and a reduced likelihood of prosecution.
It is sometimes not clear when an audit actually starts and even who is actually under audit.
There are also time limits on the ability to challenge assessments and also to purchase historical tax credits to reduce interest and late payment penalties
Expert advice is critical, and Owens Tax Advisors are here to help.
Risk of audit or investigation
If a taxpayer is operating in a high-risk industry (for example hospitality, trade services etc) or handles a lot of cash, there is a high risk they will be selected for audit by IRD and IRD will allege they haven’t returned all their cash income. This will likely affect not only income tax but also potentially GST and other tax types as well.
IRD tries to focus on the low hanging fruit and has multiple sources of information including statistical data, tipoffs and direct observation. If IRD announce a risk review or audit of such a taxpayer, IRD will invariably already be confident in taking a starting position that the taxpayer hasn’t returned all their income.
A lot of IRD’s sources of information are industry or other group-based statistics which in our experience lead to income assertions based on ‘averages’. Because of that, approaching IRD before they approach taxpayers, or certainly before an audit is commenced, with objective rationale to differentiate a specific taxpayer from the ‘average’ can result in a taxpayer achieving a materially better outcome.
Shortfall penalties for failing to declare income can range from 20% (lack of reasonable care) to 40% (gross carelessness) and – often in cash economy reviews – 150% for evasion. If the taxpayer has not incurred such a penalty in the last four years or so it is normally reduced by ½, but it can still be very expensive when combined with the underlying shortfall, use of money interest and potential late payment penalties. Prosecution for evasion of more than $100,000 can result in two years in jail.
Benefits of pre-notification voluntary disclosure
If IRD announces a risk review it is an immediate signal that the client should be seriously and immediately considering their previous tax positions and a potential voluntary disclosure. Note that the words ‘audit’ and ‘investigation’ are synonymous. A full and honest voluntary disclosure made before an audit has been announced (which IRD can announce immediately after announcing a risk review or even without advising of a risk review) provides a minimum 75% discount on any penalties. In addition, the disclosure provides immunity from criminal prosecution no matter how large the shortfall. We have saved a few taxpayers from likely prosecution and jail!
Post notification voluntary disclosure
If that deadline is missed, or if IRD doesn’t give the opportunity and goes straight to announcement of an audit, the taxpayer has a shorter opportunity to make a disclosure before the audit officially starts. Such a disclosure still gives rise to a 40% reduction in penalties and a reduced likelihood of prosecution.
Commencement of audit
Once the audit officially starts (generally end of first interview), there is no discount for voluntary disclosure and any wilful omission of income could lead to criminal prosecution for evasion.
IRD correspondence is often murky as to the status of the review. IRD uses phrases like ‘I have decided to conduct an audit’, ‘I am conducting an audit’ but doesn’t directly say when the audit is deemed to start nor the impact on ability to lodge a voluntary disclosure.
Who is under audit
It is also often not clear as to who is under audit – for example a company may be under audit but not the shareholders, even though shortfalls can apply to either. The distinction is often critical. Sometimes we can achieve post notification disclosure for some taxpayers in a group and pre-notification for others.
Once IRD issues amended assessments, a taxpayer has a maximum of four months in which to challenge them. After that they generally lose all appeal rights.
Purchase historical tax credits
The taxpayer also has a short window of opportunity to purchase historical tax credits from third parties and reduce interest charges and eliminate late payment penalties applying to unpaid reassessments.
Why you need expert advice
IRD reviews can be very time consuming and expensive, with IRD demanding large amounts of information with tight deadlines, asking difficult questions, taxpayers don’t know how best to respond and often make things worse.
It doesn’t have to be that way. You should ALWAYS get on board an expert who knows how to proactively lead IRD through any review or audit activity and navigate through the timeframes, language and relationships to get the best outcome available.
We frequently get excellent outcomes for such clients, often saving tens if not hundreds of thousands of dollars in potential tax, penalties and interest, and avoid prosecution. However, the most common factor limiting the savings we can generate is a delay in referral to an expert e.g OTA. Too often we see situations where taxpayers have missed out on the opportunity to make disclosures with corresponding benefits, including therefore risk of prosecution, missing out on the opportunity to use tax pooling, and even losing the ability to challenge assessments at all.
The sooner the better on all counts!