The following article comments on current IRD audit activity and some recommendations that may help mitigate the damage.
Current IRD focus
IRD investigation and audit activity continues unabated, with IRD’s current focus updated from time to time in compliance alerts.
IRD lists its areas of interest at http://www.ird.govt.nz/taxagents/compliance/key-focus-areas/, and those areas currently include:
- Aggressive Tax Planning – including diverting personal income, complex financing, loss generation and usage, habitual non-compliance, misuse of charities, offshore and international issues.
- Underreporting and operating outside the system – including the hidden economy, income from property, anonymous information, and voluntary disclosures.
- Getting it right at source – including Resident Withholding Tax and Non Resident Contractors
- Confidence and certainty – including Foreign Investment Funds (FIFs), Controlled Foreign Companies (CFCs), depreciation, leasing, property, transfer pricing, high wealth/income individuals and new immigrants.
Tilting balance of power
Of course, IRD listing the above focus areas as examples doesn’t mean IRD won’t extend or initiate investigations into other areas, and if a taxpayer has underreported income, over-claimed expenses, or made some other error – deliberate or otherwise, odds are increasingly likely that IRD will eventually pick it up.
See the following extracts from IRD’s most recent compliance update following the published 2011-12 Compliance Focus:
- In the 2010 budget we were given additional funding … We are using this funding to enhance our work in the fraud and evasion area by investing in compliance and intelligence tools. This is helping us identify and monitor individuals and businesses that fail to record all cash income, or find other ways to avoid paying the correct amount of tax.
- We are also continuing to contact and visit people conducting business through online trading and those providing short-term rentals…
- We collaborate with other tax authorities, other government agencies and private organisations to match data to identify individuals and businesses…
- With the support of improved telecommunications, such as an automatic dialler system, we have been able to contact many more customers than before.
- The amount of information we receive from overseas has increased, and is more detailed than ever before. Inland Revenue has close working relationships with major tax treaty partners and is an active participant in both bilateral and multilateral audit projects. We have signed tax
information exchange agreements with 20 offshore finance centres so far. Other agreements are in progress and will give us access to key ownership and banking information
With such clear focus and improved resources there is no doubt that, more than ever before, IRD are much more likely to “come knocking”.
Once IRD have “knocked” the process can be overwhelming.
Just because IRD says something is wrong doesn’t necessarily make it so; but unfortunately defending against IRD can be stressful and does require expertise, time and expense.
If a taxpayer has a business that has access to cash, the IRD often seeks to treat any cash deposits identified as taxable, unless the taxpayer can prove otherwise. This can become problematic with cultures that deal extensively in cash, especially private transactions from many years past.
In our experience, the longer a shortfall has taken to be identified, the higher the resulting cost – dealing with unreliable records, even more unreliable memories, and IRD’s usurious interest and potential late payment charges which can easily double or treble a backdated tax obligation.
Additionally, when a taxpayer has committed a defined behavioural “offence” – lack of reasonable care, unacceptable tax position, gross carelessness, or worse – shortfall penalties add another material chunk to the bill.
Tax matters often involve matters of interpretation, both factual and legislative. Generally IRD’s initial view of the extent of potential shortfalls, and the taxpayer behaviour giving rise to them, tends to be more unfavourable to taxpayers where it is IRD that first identifies that shortfall, as opposed to the taxpayer voluntarily coming forward at an early stage.
To avoid misunderstandings, you need to ensure that all discussions are recorded in writing, and as a backup you should record all discussions (independently of IRD).
Finally, IRD can be extraordinarily inefficient in managing investigations, asking or demanding large amounts of information and records be provided, subsequently analysing (or sitting on) them for months, coming back for more information, working on that for months, and so on and so on. We are often called to assist taxpayers that have been under audit for many months, and frequently, several years. In the meantime interest charges and the stress and the direct and indirect costs of managing the process keep piling up.
Make the first move
For all these reasons we consider it is to taxpayers’ significant benefit to be on the front foot in dealing with any potential tax shortfall.
In our experience the direct and indirect costs of any potential tax shortfall can be significantly mitigated by taking the lead and thoroughly reviewing any potential issues, preferably before any IRD contact at all, but if not, immediately after IRD first come knocking.
Should a tax shortfall be confirmed, the ideal is to have been upfront and provide a voluntary disclosure BEFORE IRD notifies a pending audit, ensuring that
- any potential shortfall penalties are eliminated or (for higher level penalties) reduced by at least 75%, and
- critically, if a taxpayer has intentionally or otherwise committed tax evasion, taking advantage of IRD policy to not prosecute.
When IRD expresses an interest in a taxpayer, by way of an information request or review, there may be a final opportunity for the taxpayer and advisors to identify a shortfall and submit a “pre audit notification” voluntary disclosure with the benefits noted above.
Once IRD has announced an investigation or audit of a named taxpayer, or if that is the first contact received from IRD, the window of opportunity gets less attractive and also much shorter. If a voluntary disclosure is made “post notification” but before the audit is deemed to have actually commenced (at the latest when the first interview with the taxpayer has concluded), penalties are only reduced by 40% and (in cases of tax evasion) IRD may still seek to prosecute.
Once the audit or investigation has formally commenced, apart from the benefits of signalling (albeit somewhat belatedly) a willingness to cooperate, there is no formal benefit in making a voluntary disclosure. IRD correspondence is sometimes quite muddy in this regard.
We are frequently engaged to assist in defending IRD audits where the job would have been much easier and had a much greater likelihood of a favourable outcome if we had been contacted at an earlier stage.
Tying it all together
The key messages are:
- IRD is increasingly focussed on targeted areas for potential tax shortfalls and has increasingly sophisticated resources available to help focus on that.
- The earlier in the process that expert assistance is engaged, tax, penalty, interest, fees and other indirect outcomes are invariably significantly more favourable.
- Conversely, the longer down the path of review/audit, the harder the process is, and the more expensive the tax and any penalties and cost of managing the process are likely to be.
- So, if you think IRD may see a taxpayer situation in a potentially unfavourable light, get in early with an expert review of the issue, and, if required, submission of any appropriate voluntary disclosures.
- As a minimum, an IRD enquiry or information request is a signal for an urgent review and perhaps a voluntary disclosure.