Unacceptable interpretation (Mar 98) (Withdrawn from 1 April 2003, in relation to tax positions taken on or after 1 April 2003)

Introduction

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:

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 fall within the shortfall penalty category of "unacceptable interpretation".

Application

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).

Purpose

The purpose of the unacceptable interpretation shortfall penalty is to ensure that in a self assessment environment taxpayers who take a position which has significant tax consequences take extra care.  It ensures that the conclusions they reach on their tax liability are sound.

Legislation

Section 141B of Tax Administration Act 1994:

Unacceptable Interpretation -

1. In relation to a tax position taken by a taxpayer, an unacceptable interpretation –
   1. Is an interpretation or an interpretation of an application of a tax law; and
   2. Viewed objectively, that interpretation or application fails to meet the standard of being about as likely as not to be correct.
2. A taxpayer is liable to pay a shortfall penalty if –
   1. The taxpayer's tax position involves an unacceptable interpretation of a tax law; and
   2. The tax shortfall arising from the taxpayer's tax position exceeds both –
      1. $10,000; and
      2. The lesser of $200,000 and one percent of the taxpayer's total tax figure for the relevant return period.
3. For the purposes of this section, a taxpayer's total tax figure is –
   1. The amount of tax paid or payable by the taxpayer in respect of the return period for which the taxpayer takes the taxpayer's tax position before, in the case of income tax, any group offset election or subvention payment; or
   2. Where the taxpayer has no tax to pay in respect of the return period –
      1. Except in the case of GST, an amount equal to the product of –
         1. The net loss of a taxpayer in respect of the return period, ascertained in accordance with the provisions of the Income Tax Act 1994, are to be used in this subsection as if they had a positive value; and
         2. The basic rate of income tax for companies in the relevant return; or
      2. In the case of GST, the refund of tax to which the taxpayer is entitled for the return period, -
      
      that is shown as tax paid or payable, or as net losses of the taxpayer, or as a refund to which the taxpayer is entitled, in a tax return provided by the taxpayer for the return period.
4. Where subsection (2) applies, the shortfall penalty is 20% of the resulting tax shortfall.
5. For the purposes of this section, the question whether any interpretation of a tax law is acceptable or unacceptable shall be determined as at the time at which the taxpayer takes the taxpayer's tax position.
6. For tax positions involving an interpretation of a tax law or laws that have been taken into account in a tax return, the time the taxpayer takes the taxpayer's tax position is when the taxpayer provides the return containing the taxpayer's tax position.  If the taxpayer does not provide a tax return for a return period, the taxpayer takes the taxpayer's tax position on the due date for providing the tax return.
7. The matters that must be considered in determining whether the tax position taken by a taxpayer involves an unacceptable interpretation of a tax law include –
   1. The actual or potential application to the tax position of all the tax laws that are relevant (including specific or general anti-avoidance provisions); and
   2. Decisions of a court or Taxation Review Authority on the interpretation of tax laws that are relevant (unless the decision was issued up to one month before the taxpayer takes the taxpayer's tax position).
8. For the purpose of determining whether the resulting tax shortfall is in excess of the amounts specified in subsection (2)(b), -
   1. A tax return provided by –
      1. A partnership; or
      2. Any other group of persons that derive or incur amounts jointly or are assessed together, -
      
      is to be treated as if it were a tax return of every taxpayer who is a partner in the partnership or person in such group; and
   2. The tax rate in a return period applying to a partnership is deemed to be the same as the basic rate of income tax for companies for the relevant period.
9. The amounts or the percentage specified in subsection (2) may be varied from time to time by the Governor-General by Order in Council.

Threshold

A taxpayer is liable to pay a shortfall penalty if the tax shortfall arising from the taxpayer's tax position exceeds both $10,000, and the lesser of $200,000 and 1% of the taxpayer's total tax figure for the relevant return period.

Interpretation or application of a tax law

The unacceptable interpretation test applies only to tax shortfalls caused by a taxpayer treating a tax law as applying in a particular way.

A taxpayer treats the tax law as applying in a particular way where he or she concludes that, on the basis of the facts and the way the law applies to those facts, a particular consequence follows.  For example, an amount of expenditure is deductible.  In some cases a taxpayer's tax position may not represent conclusions of the taxpayer, but instead reflect calculation or transposition errors.

As a broad rule, where a tax shortfall was caused by an error in calculation or a transposition error, section 141B will not apply, since the taxpayer will not have treated a tax law as applying in relation to a matter in a particular way.  However, in such a case consideration would need to be given to the reasonable care standard.

Non-application of a tax law

There may be instances where a taxpayer argues that he or she did not apply a section of the Act, therefore, did not interpret the particular section as applying.  Accordingly, the taxpayer contends that the unacceptable interpretation standard does not apply.  The non-application of a tax law will in all cases be considered to be applying the tax law.

What is an unacceptable interpretation?

Level of standard

The taxpayer's case does not have to be so balanced with the Commissioner's that no real preference can be given to one over the other.  The test is not more likely than not, nor is it as likely as not; such wording would imply a 50 percent or better chance of success.  Rather the standard is about as likely as not correct.  In addition, the word "likely" implies a degree of latitude.

The upper boundary of probability for a position to be an acceptable interpretation is a 50/50 likelihood of success; but the lower boundary is not quite so clear.  However, guidance can be obtained from establishing where the interface with the standard sufficient for the exercise of reasonable care lies.

Accordingly, the standard is less stringent than that of "more likely than not", but is more stringent than the "reasonable care standard".

Significant emphasis should be given to the word "about".  The standard is not intended to remove the right of a taxpayer to take up issues with the Commissioner, rather, it must be a position to which a court would give serious consideration, but not necessarily agree with.  This means that the prospect of the taxpayer's interpretation being upheld by the court must be substantial, although not necessarily 50 percent.  The taxpayer's argument should be sufficient to support a reasonable expectation that the taxpayer could succeed in court.

An example would be where a taxpayer's position was upheld in the TRA, however, later lost in the High Court.  In such a situation it would be considered that the taxpayer clearly had an acceptable interpretation.  However, in saying this, a taxpayer is not required to take a case to the courts to determine that they had an acceptable interpretation.

If a taxpayer adopts one of several equally likely interpretations this will generally satisfy the standard, as each position is about as likely as any other position to be the correct tax position.

The level is more easily reached if there is no case law on the area and the statute law is ambiguous or unclear.

Taxpayer effort

The unacceptable interpretation standard is an objective test involving an analysis of the law to the relevant facts.  This means that it is not relevant that a taxpayer believes that the position taken was an acceptable interpretation.

The unacceptable interpretation standard does not take into account taxpayers' efforts in resolving unclear issues.  The standard is intended to focus on the merits of an argument in support of a particular position, rather than the taxpayer's effort in resolving issues.  The strength of the argument is weighed by considering the existence and reasoning of relevant authorities.  Relevant authorities have not been defined in the legislation, however some matters that must be considered are listed.

Matters which must be considered

Section 141B(7) provides that the matters that must be considered in determining whether the tax position involves an unacceptable interpretation of a tax law include -

• The actual or potential application to the tax position of all the tax laws that are relevant (including specific or general anti-avoidance provisions); and
• Decisions of a court or a Taxation Review Authority on the interpretation of tax laws that are relevant (unless the decision was issued up to one month before the taxpayer takes the taxpayer's tax position – see "Timing").

Relevant tax laws

Tax law is defined in section 3(1) of the Tax Administration Act 1994 as:

1. A provision of the Inland Revenue Acts or an Act that an Inland Revenue Act replaces:
2. An Order in Council or a regulation made under another tax law:
3. A non-disputable decision:
4. In relation to an obligation to provide a tax return or a tax form, also includes a provision of the Accident Rehabilitation and Compensation Insurance Act 1992 or a regulation made under that Act:

Section 141B(7)(a) makes specific reference to the antiavoidance provisions.  This ensures that it cannot be argued that a tax position or interpretation is an acceptable interpretation in terms of a particular legislative provision irrespective of the operation of other provisions such as general anti-avoidance provisions.

In trying to discern the scheme and purpose of the legislation, primary regard must be had to the words of the legislation.  It is Parliamentary intent, as expressed in the statute, which is crucial.  The increased complexity of tax legislation has resulted in some ambiguity, leading to confusion as to the meaning of particular provisions which makes the ascertainment of the true Parliamentary intent difficult.  The Government's consultative documents, the various consultative committee reports, Parliamentary discussion and debate, and Departmental interpretative guidelines may provide assistance in interpreting the legislation under review.

Relevant court decisions

Factors that affect the weight of an authority:

Publication - The decision must have been published or referred to in a reported commentary.

Source - This refers to the court or tribunal which made the decision on which the taxpayer relies.  The higher the source of a decision in the judicial hierarchy, the more precedential the decision.

Jurisdiction - Decisions by the New Zealand judiciary, will usually be given more weight than extra-territorial decisions of other countries.

Relevance - Authorities that have similar factual circumstances to the case asserted by a taxpayer are more relevant than those authorities which can be materially distinguished on the facts.

However, if a taxpayer has no authorities to support a case there may still exist an acceptable interpretation.  In such cases, a taxpayer needs a well-reasoned construction of the statutory provision which is about as likely as not to be correct.

Opinions expressed by tax professionals

Information which supports a reasonable argument may include such items as the contents of tax opinions, legal articles and related material.  However, the mere existence of an opinion from an adviser would not on its own indicate that an acceptable interpretation exists.  It is the content of the opinion and strength of the alternative views, not the fact of seeking advice, which will be relevant.

Other matters

Other matters which may be considered in particular circumstances include:

• binding public rulings on analogous issues and other published Inland Revenue statements,
• legal articles and related material and references made to statutes other than the Revenue Acts.
• statute other than tax law
• dictionary meaning or a definition in another statute.
• generally accepted accounting practice and commercial practice.

These matters carry more significance in areas where the law is unclear and there is no relevant case law available.

Timing

To determine whether an acceptable interpretation exists, consideration will be given to the authorities available at the time the taxpayer took the tax position.  This will generally be when the taxpayer files the tax return.  In addition, subsequent clarification or development of case law or public rulings in a particular area may confirm that a position taken is acceptable.  However, subsequent developments will not be used to argue that a position was an unacceptable interpretation.

The legislation does not require the taxpayer to document an acceptable interpretation at the time of taking the tax position.  Taxpayers will be able to substantiate their arguments when a dispute arises, after filing their returns.  However, in most cases taxpayers will need to consider the validity of an interpretation relating to a sizeable transaction when they take the position in their returns or earlier.

In addition, decisions of a court or the Taxation Review Authority which are issued up to one month before the taxpayer takes the tax position will not be used to argue that the taxpayer's position is an unacceptable interpretation.  For the purposes of this provision "issued" is considered to mean when the decision is published.

Binding rulings and the acceptable interpretation standard

The fact that a taxpayer adopts an interpretation that differs from that of a ruling or published Inland Revenue statements will not necessarily mean that the taxpayer has an unacceptable interpretation.  However, if there is a binding ruling supporting the taxpayer's position, there will be no tax shortfall.  A shortfall penalty cannot therefore be considered.

Relationship to the reasonable care standard

The aim of the acceptable interpretation standard is to ensure that taxpayers take care in considering their position.  This is required by the reasonable care standard, however, the acceptable interpretation standard takes away some of the so called "subjective elements" i.e. taxpayer effort, when there is a significant amount of tax at stake.

A taxpayer who satisfies the acceptable interpretation standard is deemed to have satisfied the reasonable care standard.

Standard rate of penalty

The standard rate of penalty payable for unacceptable interpretation 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).

Summary

Section 141B of Tax Administration Act 1994 provides for a penalty for taking an unacceptable interpretation, at the rate of 20%.

A penalty is charged where all of the following conditions are met:

• The shortfall was caused by a tax position involving an interpretation or application of a tax law.
• The tax shortfall exceeded both $10,000, and the lesser of $200,000 and 1% of the taxpayer's total tax figure for the relevant return period.
• The tax position taken fails to meet the standard of being, viewed objectively, about as likely as not to be correct.

Tony Bouzaid
National Manager
Operations Policy