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01 Mar 1998

Not taking reasonable care (Mar 98) (Withdrawn from 1 April 2003, in relation to tax positions taken on or after 1 April 2003)

Withdrawn INV-200-Not taking reasonable care (Mar 98). Statement provided for historical purposes only.


This statement has been withdrawn and is provided for historical purposes only.


A shortfall penalty is a penalty imposed as a percentage of a tax shortfall, or deficit or understatement of tax, which results from certain actions on the part of a taxpayer.  The law divides these actions into five categories of fault, or breach, with a specified penalty rate for each category as listed below:

Not taking reasonable care 20%
Unacceptable interpretation 20%
Gross carelessness 40%
Abusive tax position 100%
Evasion or similar offence 150%

These penalty rates are non-negotiable and where a default occurs the applicable penalty must be imposed.  A taxpayer does however have the right to challenge the decision to impose a shortfall penalty but not the amount of penalty.


This statement deals with defaults that breach the standard of "reasonable care".


The penalties apply to obligations relating to the 1997/98 and subsequent income tax years and to taxable or dutiable periods commencing on or after 1 April 1997.

Shortfall penalties apply when there is a deficit or understatement of tax, or where a refund or loss is reduced.  Defaults in employers' obligations are also considered under shortfall penalties.

The penalty provision is generic in application.  This means that it applies to all Inland Revenue Acts (but for Child Support and Student Loans, it applies only to employer obligations).


The purpose of the not taking reasonable care shortfall penalty is to increase voluntary compliance with the system.  The standard is the cornerstone of the penalties regime which requires all taxpayers to act reasonably in the conduct of their tax affairs.  It is a fluid concept which recognises the distinct characteristics of particular obligations and the different burdens placed on various taxpayers.

The standard recognises taxpayers' varying abilities and reflects a balance between the need for returns to be correct and the recognition of the difficulties that taxpayers may face in ensuring that they are correct.


Section 141A of the Tax Administration Act 1994:

Not taking reasonable care -

  1. A taxpayer is liable to pay a shortfall penalty if the taxpayer does not take reasonable care in taking a taxpayer's tax position (referred to as "not taking reasonable care") and the taking of that tax position by that taxpayer results in a tax shortfall.
  2. The penalty payable for not taking reasonable care is 20% of the resulting tax shortfall.
  3. A taxpayer who, in taking a taxpayer's tax position, has used an acceptable interpretation of the tax law is also a taxpayer who has taken reasonable care in taking the taxpayer's tax position.

Test of reasonable care

The test of reasonable care is whether a taxpayer of ordinary skill and prudence would have foreseen as a reasonable probability or likelihood the prospect that an act (or failure to act) would cause a tax shortfall, having regard to all the circumstances.

Whether the taxpayer acted intentionally is not a consideration.  It is not a question of whether the taxpayer actually foresaw the probability that the act or failure to act would cause a tax shortfall, but whether a reasonable person in the circumstances of the taxpayer, would have seen the tax shortfall as a reasonable probability.  It equates with the concept of negligence in the civil law of Torts, and the jurisprudence is well established.  "Negligence is to be measured objectively by ascertaining what in the circumstances would be done or omitted by the reasonable man" (Meulan's Hair Stylists Ltd v CIR [1963] NZLR 797).

In the tax context, reasonable care includes exercising reasonable diligence to determine the correctness of a return position.  It also includes the keeping of adequate books and records or to substantiate items properly, and generally making a reasonable attempt to comply with the tax law.

Appropriate to category of taxpayer
The reasonable care test is not intended to be overly onerous and does not mean perfection.  The effort required of the taxpayer is commensurate with the reasonable person in the taxpayer's circumstances.  Ordinarily what is expected is the achievement of a standard appropriate to the category of taxpayer, rather than that of the individual taxpayer involved.

The category of taxpayer will affect what constitutes reasonable care in each particular case.  The standard required of a salary and wage earner will differ from that required of a business taxpayer.  For most salary and wage earners, an earnest effort to follow the Tax Pack instructions will be sufficient to pass the reasonable care test.

Business taxpayers must meet the standard of the "reasonable business taxpayer".  The business taxpayer may be required to do more than the "reasonable wage earner".  For example, the amount of tax involved, and the complexity of the business taxpayer's affairs may require them to seek professional assistance in meeting their tax obligations.

Objective v subjective
Reasonable care is an objective test, however, it brings in subjective elements.  What is meant by subjective is that when considering whether the taxpayer has taken reasonable care, the circumstances of the particular taxpayer need to be considered "objectively" by looking at what a reasonable person would have done in those circumstances.

Factors to consider

Circumstances that may be taken into account when determining whether reasonable care has been exercised include:

  • the complexity of the law and the transaction (the difficulty in interpreting complex legislation);
  • the materiality of the shortfall (the gravity of the consequence and the size of the risk);
  • the difficulty and expense of taking the precaution;
  • the taxpayer's age, health and background.

In addition, for a business, reasonable care may also take into account:

  • the size and nature of the business;
  • the internal controls in place;
  • the business record keeping practices;
  • system failures (Year 2000 failure would not generally be considered to be an acceptable reason).

On questions of interpretation, reasonable care will depend on:

  • what efforts the taxpayer had taken to resolve the issue;
  • the types of advice received;
  • the certainty of the law.

Reasonable care requires a taxpayer to come to the same conclusions that a reasonable person would come to in the circumstances of that taxpayer.

The standard of reasonable care in interpreting the law applies to all matters, regardless of the amount of tax.

Amount of shortfall - materiality
Materiality is implicit in the standard of reasonable care.  In considering whether a taxpayer has taken reasonable care, consideration will be given not only to the nature of the shortfall, but also to the size of the shortfall in relation to the taxpayer.

If the amount is large, relative to the total overall tax liability, then, the taxpayer should have been aware that something was amiss.  For example, if a taxpayer with a returned income of $50,000, omitted income of $10,000 (which was clearly "income") from his or her return, it would be fair to say that the taxpayer should have been aware, regardless of the fact that the agent had completed the return, that not all of the income had been returned.

Contrast the above situation, to that of a large corporate taxpayer whose returned income for the year was $50,000,000.  An omission of income of $10,000 would more than likely not have been material enough to put the taxpayer on notice.  Therefore, depending on any other circumstances, this taxpayer may well have taken reasonable care to ensure that the return was correct.

Tax agents and advisers
A taxpayer who has relied on the advice of a tax adviser will usually be considered to have exercised reasonable care.

However they may still be exposed to a penalty for lack of reasonable care should they:

  • fail to provide adequate information when seeking advice;
  • fail to provide reasonable instructions to a tax adviser; or
  • unreasonably rely on a tax adviser or on advice (when they have reason to believe that the advice is not correct).

A taxpayer does not satisfy the obligation to take reasonable care simply by using the services of a tax agent or tax adviser.  It remains the taxpayer's responsibility to properly record matters relating to his or her tax affairs during the year, and to draw all the relevant facts to the attention of the agent or adviser, in order to meet the reasonable care test.

Previous audits
There may be cases where a taxpayer has been previously audited, a particular matter found to be in default but in a subsequent return prepared by an agent, the same matter results in a shortfall.  Depending on the exact circumstances, even though the agent prepared the return, the fact that the taxpayer had been alerted by the previous audit may indicate a lack of reasonable care on the part of the taxpayer on the second omission for not ensuring that the return was correct in that particular regard.

Complexity of the law
Reliance on an agent must be weighed against the complexity of the law relating to the matters at issue.  If a taxpayer seeks advice on a matter on which the tax law is extremely complex, they are more likely to rely on that advice without question.  A taxpayer would be required to support the argument that they accepted the agent's advice as correct.  The matter to be considered is whether a reasonable person in the taxpayer's circumstances would have been put on notice of agent error.

Agent fault
Agents have a responsibility to obtain relevant information about their clients.  Matters to be considered would include:

  • Whether or not a questionnaire was completed.
  • Was the information compiled accurately?
  • Was the questionnaire discussed with the client?

The taxpayer has a responsibility to advise the agent of matters affecting his or her income.  For example, advising the agent of all of their investments, bank accounts, second jobs, perk jobs, cash taken for drawings, etc.

Taxpayers have a responsibility to fully and comprehensively advise their tax agents of their tax affairs.

Language difficulties
There is a responsibility on both the agent and the taxpayer to ensure as far as is practicable, both parties have all the relevant information to ensure that the tax return is compiled as accurately as possible.  This means ensuring that any potential language problems are addressed where it is practical to do so.

Inland Revenue advice

It is unlikely that taxpayers will be considered to have breached the reasonable care standard if Inland Revenue has failed to provide adequate information in its guides on which the taxpayer has relied.

Where there is no apparent reason for a taxpayer to question information provided, the taxpayer will generally have taken reasonable care.

Advice provided to individual taxpayers
Where a tax shortfall arises and the taxpayer states that they were relying on advice from Inland Revenue the following general rule will apply:

Where the taxpayer has sought Inland Revenue advice and this can be verified then a penalty for not taking reasonable care will generally not be imposed.  Verification may take the form of a letter from Inland Revenue or the taxpayer being able to provide details of when and from whom the advice was sought.

This rule is however subject to the full circumstances and facts of the case.

Arithmetical error
Arithmetical errors may indicate a failure to take reasonable care but are not conclusive.  The decision will depend on the procedures in place to detect such errors, the size, nature and frequency of the error, or the circumstances in which the taxpayer made the error.

Defence to lack of reasonable care
In large adjustment cases when the matter turns on a matter of interpretation, the acceptable interpretation standard must be satisfied.  A taxpayer who can demonstrate that the position taken is an acceptable interpretation is deemed to have satisfied the reasonable care standard.

Burden and standard of proof
A taxpayer has the right to challenge the decision to impose a shortfall penalty through the disputes process.  If the issue can not be resolved through the disputes process the taxpayer has the normal rights of review through the courts.

The burden of proof in civil proceedings relating to the imposition of penalties rests with the taxpayer.  They must show that on the "balance of probabilities" they have taken reasonable care.  Accordingly, if the taxpayer can show that it is probable that they took reasonable care, they will have satisfied the standard.

Standard rate of penalty

The standard rate of penalty payable for not taking reasonable care is 20% of the resulting tax shortfall.

This rate may be adjusted by varying rates in the following circumstances:

  • voluntary disclosure before or during an audit
  • voluntary disclosure at the time of return filing
  • temporary tax shortfalls
  • obstruction

Other reference

An explanation and examples of shortfall penalties and other offences and penalties can be found in Tax Information Bulletin Volume Eight, No.7 (October 1996).


Section 141A of the Tax Administration Act 1994 provides that a taxpayer who does not take reasonable care in taking a tax position is liable to pay a shortfall penalty of 20% of the resulting shortfall.

The test of reasonable care is whether a person of ordinary skill and prudence would have foreseen as a reasonable probability or likelihood the prospect that an act (or failure to act) would cause a tax shortfall, having regard to all the circumstances.

Tony Bouzaid
National Manager
Operations Policy