IRD has an ever increasing focus on audit activity including the so-called “hidden economy”.
In this article we comment on IRD’s current areas of interest, some challenges with IRD’s approach, and how you should respond.
We have also announced a new service that provides client structural and land transaction information in a user-friendly format.
IRD key compliance focus
From time to time IRD publishes its key compliance focus areas -see:
www.ird.govt.nz/taxagents/compliance/key-focus-areas/
The latest report includes as areas of focus;
- Aggressive tax planning,
- People with high-wealth or high-income,
- The “property business” (including residential property trading and one-off speculation, with a focus on new and infill developments), and
- Under-reporting income and operating outside the system
This is consistent with IRD’s obligation to collect tax, and appropriate in the context of all taxpayers paying their fair share.
Notification of audits, and opportunity to make voluntary disclosures
IRD sometimes notifies an audit or investigation and invites a voluntary disclosure. A voluntary disclosure made after an audit has been notified but before it actually commences provides a 40% reduction in any penalty that may otherwise apply, and a reduced exposure to prosecution.
An audit is generally regarded as commencing at the end of the first formal interview with the taxpayer. It is very concerning that IRD correspondence does not make that clear and taxpayers sometimes stumble into an interview without realising they have given up the opportunity to make a disclosure. We have raised this many times with IRD (right up to Commissioner level); at best our comments are “noted”, at worst appear to be ignored and the issue continues. Know your rights!
Sometimes IRD instead notifies a risk review and provides an opportunity to make a pre notification voluntary disclosure of a shortfall, with a minimum 75% reduction in any penalties and immunity from prosecution. We welcome this approach; unfortunately, IRD is inconsistent between different offices and between different investigators.
IRD information demands
Either way, IRD generally kicks off with a request for bank statements, financial statements, and a wealth of other detailed information. IRD’s standard is generally to allow four weeks for the taxpayer/advisors to respond but then IRD can take several months to chase up. Then they issue a demand for the same information, or another tight deadline, but insufficient follow-up. Or alternatively the taxpayers provide all the information, IRD then sits on it for six months, and then asks for different information. In our view IRD should make a standard information request, provide a firm and consistently applied deadline of eight weeks (not four or three), and then get on with the job. Otherwise taxpayers may think they can ignore the demand – and they can until the hammer falls a few months later.
Under-reported cash income
Looking at underreporting of income in respect of some industries, IRD has developed a very strong focus on the percentage of sales it expects to have been received in the form of cash, based on other businesses in the same or similar sector (restaurants, cafes, takeaways, bars etc), geographical area (urban, suburban, city, country), clientele (wealthy, not so wealthy, professional, student), size of transactions (smaller being more likely to be cash) etc.
We consider that IRD sometimes over engineers the analysis (we have seen IRD run overly sophisticated analysis over individual transactions where a mutually agreed percentage is all that is required), and sometimes rather overbakes the conclusion (“we know that competitors return 30% cash and that proves that your 15% is only some of your income”).
IRD then needs to consider what has happened to any underreported cash receipts:
- it could be paid to staff or contractors (in which case should they gross up for notional withholding tax or simply deny a deduction),
- it could be used for supplies – markets, security etc (in which case should IRD pursue the payees or deny at least part of the deduction), or
- it could be consumed or invested personally (in which case non-deductible to the business, or an undeclared bonus to the proprietors).
We have our view as to appropriate outcomes; what is disappointing is the lack of consistency in how IRD treats such issues.
IRD sometimes has insufficient regard to economic reality. Accumulating significant assets or sending money overseas while reporting low income is a good indication of underreported cash. However, if debt is increasing and assets not increasing, then perhaps IRD’s assertion of significant missing cash is unrealistic. In past years some IRD staff used asset accretion or source and disposition calculations as an indicator; some IRD offices still use those tools but others reject the concept, another sign of lack of consistency and guidance in these processes.
We are very concerned that IRD appears to have no consistent set of analysis tools, instead building spreadsheets from ground up every time (and different approaches from different staff), often complete with both structural and calculation errors. In our view this is an appalling waste of resource – IRD needs to have one set of tools that are tried, tested and agreed with advisors, with any variation in approach clearly documented, justified and agreed in advance.
IRD is proud of its ability to collect $9 or $10 in extra tax for every $1 spent on audit activity. In our view this is a shameful ratio – IRD should get $100 for every $1 spent, or (putting it another way) collect $10 and (through consistency and efficiency) only spend 10c.
There is a huge variation between the approaches, attitude and efficiency of different IRD staff. Many are very cooperative and efficient, some are adversarial and/or inefficient.
Property transactions
Uninformed taxpayers continue to have an impression that as long as they document that land was not purchased with the intention of resale then they are safe from tax on a subsequent gain on sale– no doubt at least partly due to IRD and media emphasis on that concept. The tax rules around property transactions are of course undeniably complex, generally do NOT focus on intention at time of acquisition, and also change from time to time – for example the recently implemented two-year bright line test.
If you have any concerns about the tax treatment of a property transaction – whether or not triggered by an IRD enquiry – it is critical to get immediate expert tax advice.
Taxpayer fact scenarios
We continue to be concerned about lack of knowledge of taxpayer factual situations – identity and control of associated individuals, companies and trusts, property and other major transactions. In a major turnaround from the past I find that IRD often has better knowledge of such facts than the taxpayers’ own professional advisors.
It is critical to not rely just on what our clients have told us – taxpayers are notoriously unreliable when distinguishing between different entities (“I contracted through the trust” when they really mean a company owned by a trust, or “the trust bought some land and leased it to the company” when it was the other way round, don’t disclose land transactions because “they are not relevant”, or (especially in some cultures) use alternative spelling of names, swap first and last names, or use a different name altogether (a birth name vs a ‘kiwi’ name). Advisors need to be on top of all of this, and often are not.
In this regard Owens Tax Advisors has recently launched a standalone service for fellow professionals [members of accounting and legal professional bodies] to provide detailed information in respect of their clients’ structure and transactions. Because of the number of reports we have prepared we are able to offer them at a very competitive charge – much less than the value of the time you would spend if you were building them from scratch. For further information, see the following link: www.owenstax.com/what-we-do/partner-support/
Services of Owens Tax Advisors Limited
Many taxpayers have come to us for assistance with such issues, when IRD comes knocking and sometimes unsolicited, and both via their accountant or lawyer, or direct. We have an excellent track record of keeping matters focused, coming to conclusions in a reasonable time period, and with good outcomes for clients, sometimes under trying circumstances.
Conclusion
- IRD audit activity continues to increase
- Mostly IRD do a reasonable job, sometimes under trying circumstances, but could be much more effective and efficient
- Advisors need to be fully aware of their clients’ circumstances and transactions
- When in doubt, seek expert assistance!