Shortfall penalties in respect of agreed adjustments (September 2001)

We have been asked whether shortfall penalties should be determined at the same time as an agreed adjustment and included on the agreed adjustment form.

Background

During an audit, Inland Revenue may identify discrepancies in respect of taxpayers' returns, the effect of which will be an alteration to the amount of a taxpayer's liability to tax as stated in the return.

In most instances, both the taxpayer and Inland Revenue will come to an agreement as to what adjustments are to be made to the return, thus avoiding the necessity to enter the disputes process.

As a result of this agreement, both the taxpayer and Inland Revenue sign an "agreed adjustment" form which lists the item and amounts that have been agreed upon as requiring adjustment.

However, where the agreed adjustment will result in an increased tax liability for the taxpayer, the taxpayer may also incur shortfall penalties as provided for in section 141 Tax Administration Act 1994 (TAA).

Section 94A(3) TAA allows the Commissioner to make the shortfall penalty assessment either before or after unpaid tax has been assessed, or has become assessable or payable, or has been paid.

The legislation does not prevent the Commissioner from assessing the shortfall penalty at the same time as the adjustments are being determined or finalised.

Tax Information Bulletin, Vol 6, No 3 (August 1996), states (at page 16):

One of the objectives of the new disputes resolution process is the prompt and efficient resolution of disputes. To be consistent with this objective, the Commissioner will raise the issue of penal tax or shortfall penalties as soon as is practicable, which in most cases will be at the same time the substantive issues are being discussed.

Practice

The Commissioner's practice is to reach agreement with the taxpayer on any shortfall penalties at the same time as other tax adjustments and to include these shortfall penalties on the agreed adjustment form unless the taxpayer advises otherwise, or circumstances exist where it is inappropriate to do so, eg prosecution.

Where the shortfall penalty is not included in an agreed adjustment, Inland Revenue will inform the taxpayer that shortfall penalties may still apply. This will allow the taxpayer to know "up front" his or her potential total liability at the time agreement is reached in respect of the adjustments.

The Commissioner considers it is desirable, from the view of both the taxpayer and Inland Revenue, that there is a swift resolution to taxation matters in dispute. A swift resolution also provides certainty to the taxpayer that all matters have been dealt with.