Tax advisors and the shortfall penalty for not taking reasonable care

2007 legislation gives the circumstances in which a shortfall penalty for not taking reasonable care can be imposed when taxpayers have used a tax advisor.

Section 141A(2B) of the Tax Administration Act 1994

The legislation prescribes the circumstances in which a shortfall penalty for not taking reasonable care can be imposed when taxpayers have used a tax advisor.

Background

Taxpayers who rely on the advice of a tax agent will usually be considered to have exercised reasonable care. This principle was not set out in the legislation but had developed over time through practice. The practice was that taxpayers who use an agent may still be exposed to a penalty for not taking reasonable care if they:

  • failed to provide adequate information when seeking advice;
  • failed to provide reasonable instructions to a tax agent; or
  • unreasonably relied on a tax advisor or on advice that they have reason to believe is not correct.

Outside these exceptions, the shortfall penalty for not taking reasonable care was generally not assessed if the taxpayer had used a tax agent. This does not apply to the unacceptable tax position shortfall penalty, which is assessed if the tax position taken does not meet the standard of "being about as likely as not to be correct" and the tax shortfall is greater than the prescribed thresholds. In this case, the penalty might have been assessed, irrespective of whether an agent is used.

Because the scope of the unacceptable tax position shortfall penalty was being reduced it was seen as necessary to also clarify the scope of the penalty for not taking reasonable care. The standard of "reasonable care" is not excessive and does not require perfection. However, many taxpayers use an agent because agents have more knowledge about the requirements of the tax system.

The discussion document, Tax penalties, tax agents and disclosures, noted that there needed to be a better balance, however, between recognising that tax agents are not infallible, while providing a greater incentive for them to, as far as possible, determine the taxpayer's correct tax position. Accordingly, the legislation has been amended to prescribe the circumstances in which a shortfall penalty for not taking reasonable care can be imposed when taxpayers have used a tax advisor.

As well as incorporating current practice, the amendment takes into account the situation of the taxpayer having had a tax shortfall previously and the same error or action being repeated in relation to the same tax type. In this situation the taxpayer may have been expected to be aware that there was a known risk associated with a particular action. Depending on the facts, it may have been reasonable for the taxpayer to check that the correct tax position had been taken in the second instance.

Key features

The legislation prescribes the circumstances in which a shortfall penalty for not taking reasonable care can be imposed when taxpayers have used a tax advisor. The circumstances include:

  • failing to provide adequate information to the advisor;
  • failing to provide adequate instructions to the advisor;
  • unreasonably relying on an agent or advisor; and
  • having, in the past four years, had a previous tax shortfall for the same error or action.

The general principle, that a taxpayer who relies on the services of a tax advisor, does not apply if the advisor is an employee of the taxpayer.

The amendment also applies where a tax advisor has been engaged by a company in the same group of companies as the taxpayer.

Application date

The amendment applies to tax positions taken on or after 1 April 2008.