Unacceptable interpretation - non application of a tax law (Mar 98) (Withdrawn from 1 April 2003, in relation to tax positions taken on or after 1 April 2003)

Summary

In the case where a tax shortfall has been identified and the Commissioner is satisfied that the taxpayer did not apply their mind to the tax laws or make an interpretation, the unacceptable interpretation standard will not apply.

Where a taxpayer has taken the advice of a tax advisor, or a tax advisor has prepared their tax return the Commissioner has the expectation that the tax advisor applied his/her mind to the tax laws and exercised his/her judgment. The unacceptable interpretation standard will apply unless the Commissioner is satisfied that the tax advisor did not apply his/her mind to the tax laws or make an interpretation.

This Standard Practice Statement amends SPS INV-205 to the extent that a taxpayer must have turned their mind to the tax laws or made an interpretation to have taken an unacceptable interpretation.

Application

This practice applies to assessments of the unacceptable interpretation shortfall penalty issued on or after June 1998.

Legislation

Section 141B(1) of the Tax Administration Act 1994 defines an unacceptable interpretation as follows:

"In relation to a tax position taken by a taxpayer, an unacceptable interpretation -

(a) Is an interpretation or an interpretation of an application of a tax law; and

(b) Viewed objectively, that interpretation or application fails to meet the standard of being about as likely as not to be correct."

Background

Inland Revenue practice- SPS INV-205 set out the policy with respect to "non-application of a tax law" as follows:

"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."

Inland Revenue took the view that, in being liable for a penalty for taking an unacceptable interpretation of the law, taxpayers do not have to put their minds to the particular tax position taken.

This policy has now been reviewed and will not apply to assessments of the unacceptable interpretation shortfall penalty issued on or after 1 June 1998.

Practice applicable from 1 June 1998

In the case where a tax shortfall has been identified and the Commissioner is satisfied that a taxpayer did not apply their mind to the tax laws or make an interpretation, the unacceptable interpretation standard will not apply.  Therefore, no consideration will be given to whether or not the taxpayer has breached the unacceptable interpretation standard.  However, consideration will be given to whether or not the taxpayer has been culpable under the reasonable care, gross carelessness or evasion standard

Where a taxpayer has taken the advice of a tax advisor, or a tax advisor has prepared the tax return, Inland Revenue has the expectation that the tax advisor has interpreted the tax laws and exercised his/her judgment and the unacceptable interpretation standard will apply.  This is a rebuttable presumption and Inland Revenue will take this position unless the tax advisor can demonstrate that this is not the case.

Inland Revenue considers that the following is appropriate to each case:

(1) Taxpayers who prepare their own returns without the assistance of an advisor
A taxpayer takes a tax position that results in a tax shortfall that is based on a tax law and exceeds the threshold for consideration of a penalty for taking an unacceptable interpretation.  The taxpayer asserts that he/she did not apply the law because he/she did not consider the issue.

If, by their actions, it can be confirmed that the taxpayer looked at the legislation and demonstrated that they have considered the tax laws with respect to the transaction, Inland Revenue can consider the unacceptable interpretation penalty.

If Inland Revenue is satisfied that the taxpayer did not make an interpretation, the unacceptable interpretation standard will not be considered.  However, the taxpayer may have breached the reasonable care, gross carelessness or evasion standard and this would need to be considered.

This does not mean that just because Inland Revenue cannot penalise a taxpayer under the objective unacceptable interpretation standard the penalty for lack of reasonable care, gross carelessness or evasion will automatically be imposed.  It means that Inland Revenue will consider whether or not those standards have been breached.

(2) Taxpayers who have in house tax professionals
A corporate taxpayer employs tax professionals to make decisions upon the tax treatment of its transactions.  The tax employees, also, prepare all of the taxpayer's tax returns.  The taxpayer takes a tax position that results in a tax shortfall that is based on a tax law and exceeds the threshold for consideration of a penalty for taking an unacceptable interpretation.

In this case, Inland Revenue will take the view that the tax employees will have interpreted the law with respect to the tax positions taken, and the unacceptable interpretation standard applies.  The exception would be if the Commissioner were satisfied that the tax employees did not make an interpretation, in which case, the unacceptable interpretation standard will not apply.

However, the taxpayer may have breached the reasonable care, gross carelessness or evasion standard and this would be considered.

(3) Taxpayer seeks advice from an advisor
A taxpayer is unsure of the tax position to take regarding a transaction.  The taxpayer seeks the advice of a tax advisor, and that advisor puts his/her mind to the issue and makes an interpretation.  In this case, the unacceptable interpretation penalty can be imposed.

This same result would occur if the taxpayer engaged a tax advisor to prepare his/her tax returns.  Inland Revenue has the expectation that during preparation of the return, the tax advisor has applied his/her mind to the tax laws and exercised judgment when deciding to take the various tax positions in that return.

The exception would be if the Commissioner were satisfied that the tax advisor did not make an interpretation, in which case, the unacceptable interpretation standard will not apply.  To be satisfied that a tax agent did not make an interpretation or exercise judgment, Inland Revenue staff will be making inquiries with respect to the tax treatment of transactions in returns prepared by the advisor.

In this case, if the taxpayer has taken reasonable care with the advisor, the taxpayer will have taken reasonable care.

Tony Bouzaid
National Manager, Operations Policy

Examples

Business taxpayer - deduction claimed for capital item
A business taxpayer employs an office person to complete its tax returns.  The office person has a knowledge of the tax laws with respect to deductible expenditure.

During an audit of the company's 1998 income tax return, it is ascertained that a large item of plant that was purchased during the return period was claimed as deductible expenditure.  The expenditure is disallowed and a tax shortfall results which is based upon the application of a tax law and exceeds the threshold for consideration of an unacceptable interpretation penalty.

The taxpayer contends that, when they took their tax position, they did not consider the tax laws with respect to the item purchased but that they just claimed the total amount of expenditure as noted in the ledger.  They contend that the unacceptable interpretation penalty cannot apply, as they did not make an interpretation of the tax laws.

The company has good systems in place from which the tax returns are prepared.  The particular purchase was coded to repairs and maintenance.  At the time of preparing the tax return, the office person did not check to ensure that items of expenditure that are not deductible for tax purposes were not included.  Also, as the total repairs and maintenance for this year was substantially larger than it was the previous year, the office person should have been put on notice that it may not be correct.

The taxpayer did not put its mind to the tax laws relevant to the claim - they did not make an interpretation.  Therefore, the unacceptable interpretation standard will not apply.

However, a taxpayer in that category of taxpayer would be aware that they should have reviewed their accounts with respect to expenditure to ensure that capital expenditure was not included in the claim for deductible expenditure.  The company did not do this and is considered to have not taken reasonable care.

Accordingly, the 20% penalty for not taking reasonable care would be imposed.

New business taxpayer with professional advisor - GST input claimed early
A taxpayer has purchased a franchise to undertake garden maintenance and landscaping.  The taxpayer is new to this type of business and is not familiar with the tax laws relating to self-employed people.  The taxpayer also registers for GST.

The taxpayer engages the services of a tax advisor to provide tax law advice for both income tax and GST and also to prepare the income tax returns.

During a GST return period, the taxpayer purchased a section that is intended for use in the taxable activity.  The taxpayer was told that a tax invoice would be made available soon, as the property was being purchased from a GST registered person.  During the return period, the deposit had been paid and the contract became unconditional.

All of the relevant information was provided to the tax advisor.  The advisor told the taxpayer to make the claim for the GST input credit for the entire purchase price of the section in the GST return.  The tax advisor told the taxpayer that a tax invoice needed to be held but as it was to be made available shortly, the input claim could be made.

After the GST return is furnished, the taxpayer becomes aware that the vendor of the property is not GST registered.  Therefore, the taxpayer has purchased a second hand good from an unregistered person.

The GST return is audited and the GST input claim relating to the unpaid portion of the property is disallowed.  The tax shortfall is based upon the application of a tax law and exceeded the threshold for requiring an acceptable interpretation.

Even though the taxpayer had not put his mind to the provisions of the law when taking his tax position, he had put his affairs in the hands of an advisor.  The test is objective, so the efforts of the taxpayer are not taken into consideration.

The tax advisor asserts that the tax laws were not interpreted when the claim for the entire GST input credit was made.  However, it is clear from the conversation with the taxpayer that the tax advisor had put his/her mind to the tax laws.  The tax advisor was aware that the tax invoice was required when the advice was given.  Therefore, the tax advisor had turned his/her mind to the tax laws.

The tax advisor, for the taxpayer, had clearly taken an unacceptable interpretation of the law.  Accordingly, the 20% penalty for unacceptable interpretation would apply.

Business taxpayer with tax advisor
The taxpayer is a property developer.  He has been in business for a number of years and purchases houses and sections for development.  He considers that the proceeds of one particular property that he has purchased and developed is not taxable as he and his family have lived in the property for a short period of time prior to sale.

The taxpayer consults the advisor who advises, after reviewing the tax laws, that sale of the property is covered by the exemption in section CD1(3) of the Income Tax Act 1994 and, therefore, not taxable.

Inland Revenue considers that, as there has been a pattern of buying houses and living in them while renovating them prior to sale, that sale of the particular property is part of the taxpayers gross income.

A tax shortfall is ascertained which exceeds the threshold for requiring an unacceptable interpretation, is based upon the tax law and is a tax position which, viewed objectively, is not about as likely as not to be correct.  In this case, the tax advisor has turned his/her mind to the tax laws.

Accordingly, the 20% shortfall for taking an unacceptable interpretation penalty is imposed.

No apportionment of GST input claim for assets not used in taxable activity
A taxpayer registers for GST and purchases a farm that will be used in the taxable activity.  Upon completing the first GST return, the taxpayer claims 1/9 of the total purchase price of the property.  No apportionment is made for the fact that part of the property will not be used in the taxable activity.

The return is audited and the portion of the GST input claim relating to non-taxable supplies is disallowed.  The tax shortfall is based upon the application of a tax law and is over the threshold requiring the taxpayer to have an acceptable interpretation.

When questioned, the taxpayer advises that they did not know that they could not claim a GST input credit for the portion of the property that did not relate to the taxable activity.  The taxpayer claims that they did not interpret the law and did not consider it at all.

As the taxpayer did not interpret the law, the unacceptable interpretation penalty does not apply.

When completing the first GST return, a reasonable person in the taxpayer's circumstances would have inquired about which GST input credits could be claimed.  A reasonable person would be expected read Inland Revenue's GST guide or consult a tax advisor.  By not doing this, it is considered that the taxpayer did not take reasonable care.  Accordingly, a 20% penalty for not taking reasonable care would apply.