Refining the scope of the unacceptable tax position shortfall penalty

2007 amendments remove GST and withholding-type taxes from the scope of the unacceptable tax position shortfall penalty.

Sections 141B(2) and (3)(b), and 141KB of the Tax Administration Act 1994

The amendments remove GST and withholding-type taxes from the scope of the unacceptable tax position shortfall penalty. The thresholds for the assessment of the unacceptable tax position shortfall penalty have been increased.

Background

An unacceptable tax position shortfall penalty of 20 percent of the shortfall is assessed if, viewed objectively, a taxpayer's tax position fails to meet the standard of being "about as likely as not to be correct". The penalty is applied only in cases where the tax shortfall is significant - which before the current amendments was a tax shortfall of more than $20,000 and the lesser of either 1 percent of the total tax figure or $250,000. The penalty does not apply to tax shortfalls that arise from mistakes in the calculation or recording of numbers in a return.

Taxpayers who make and acknowledge errors in taking a particular tax position cannot be regarded as having met the standard of being "about as likely as not to be correct". If the standard is not met, unacceptable tax position shortfall penalties may apply. The legislation has had an adverse effect on taxpayer behaviour by proving to be a disincentive to disclosing errors to Inland Revenue. To counter this problem, a recent amendment, section 141KB, provided Inland Revenue with the discretion to either cancel or not impose the unacceptable tax position shortfall penalty if:

  • the tax position taken is the result of a clear mistake or simple oversight;
  • the shortfall arising from the tax position is or would be subject to a reduced penalty because the shortfall was voluntarily disclosed before notification of a pending tax audit or investigation, or is a temporary shortfall; and
  • it is appropriate that the taxpayer not be liable to pay an unacceptable tax position shortfall penalty in relation to the tax position taken.

Section 141KB applied retrospectively from 1 April 2003. When introduced, the discretion was signalled as a short-term solution only because:

  • it gave rise to significant increases in administrative and compliance costs;
  • it did not fit well with the self-assessment environment; and
  • the words "clear mistake and simple oversight" in the penalties context were uncertain and could create a revenue risk if interpreted more broadly over time.

The amendments limit the penalty to income tax only and apply higher thresholds. Consequently section 141KB has been repealed.

Key features

The discretion allowing Inland Revenue to cancel or not impose the unacceptable tax position shortfall penalty in some situations has been repealed and replaced with other measures that narrow the scope of the penalty.

GST and withholding-type taxes have been removed from the scope of the unacceptable tax position shortfall penalty so that the penalty applies only to tax positions relating to income tax. For other types of tax, the shortfall penalty for not taking reasonable care may apply in appropriate cases.

The thresholds above which the unacceptable tax position shortfall penalty is assessed have been increased. The penalty will apply when the tax shortfall arising from the taxpayer's tax position is more than both:

  • $50,000; and
  • 1 percent of the taxpayer's total tax figure for the relevant return period.

As well as increasing the minimum threshold to $50,000 (from $20,000), the amendment removes the upper threshold of $250,000, thus significantly further increasing the thresholds. Removing the $250,000 limit is intended to ensure that the penalty will not apply to what may be regarded as everyday transactions for some large corporates.

Application date

The amendments apply to tax positions taken on or after 1 April 2008.