Gross carelessness (Mar 98) (Withdrawn from 1 April 2003, in relation to tax positions taken on or after 1 April 2003)

This statement applies to tax positions taken before 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 "gross carelessness".

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 gross carelessness shortfall penalty is to cater for breaches that fall just short of the evasion category but beyond a lack of reasonable care.  The old regime of penal and additional tax failed to cater for these situations.

Legislation

Section 141C of Tax Administration Act 1994:

Gross Carelessness-

1. A taxpayer is liable to pay a shortfall penalty if the taxpayer is grossly careless in taking a taxpayer's tax position (referred to as "gross carelessness").
2. The penalty payable for gross carelessness is 40% of the resulting tax shortfall.
3. For the purposes of this Part, gross carelessness means doing or not doing something in a way that, in all the circumstances, suggests or implies complete or a high level of disregard for the consequences.
4. A taxpayer who, in taking a taxpayer's tax position, has used an acceptable interpretation of tax law is also a taxpayer who has not been grossly careless in taking the taxpayer's tax position.

Gross carelessness similar to recklessness

Gross carelessness is similar to recklessness.  In fact it is identical to the objective test for recklessness as discussed by the House of Lords in R v Caldwell [1982] AC 341, [1981] 1 All ER 961.  In this case the House of Lords found that the test of recklessness was objective and may be found to exist where a person whose behaviour is in question fails to give any thought to the consequences of his behaviour.

However, the New Zealand Courts seem to support that the statutory forms of recklessness ought to be given a subjective meaning.  This is supported in Case P29 (1992) 14 NZTC where his

Honour stated:
"Where recklessness is alleged the Commissioner must prove that the facts which were actually known to the taxpayer were such that they must have put him on enquiry that the income returned for tax purposes was understated.  Faced with those facts the Commissioner must then show that the taxpayer made the conscious decision to ignore them and to return the understated income without making any further enquiry."

It was considered that as the category was within the civil penalties it was appropriate that the test be objective rather than subjective, with the fixed penalty rate being set to reflect this.  It was for this reason that the new term of gross carelessness was used rather than recklessness.  This was also consistent with the aim of the penalty, being to cater for breaches that fell just short of the evasion category (because of lack of proof of intent) but well beyond not taking reasonable care.

Boundary between gross carelessness and other shortfall penalties

The definition for gross carelessness is more akin to evasion than not taking reasonable care.  The only essential element keeping them apart is that, for evasion it must be shown that the taxpayer had the necessary "mens rea" (intent) to evade tax.  This is not a necessary element in determining whether a taxpayer has been grossly careless.

Therefore, to determine whether a tax shortfall is the result of gross carelessness consideration should be given to the boundary between evasion and gross carelessness, not failing to take reasonable care.

It is at this end of the spectrum that the distinction becomes clearer, due to the fact that there is a change between the two categories, moving from an objective test (for gross carelessness) to a subjective test (for evasion).  Further to this there is a change in the onus of proof, moving from the taxpayer to the Commissioner, in the case of evasion.

General rules

Lack of reasonable care or gross carelessness
If it is uncertain whether the tax shortfall is the result of not taking reasonable care or gross carelessness, generally the penalty will default to the not taking reasonable care category.  This is because gross carelessness occurs only where a taxpayer's behaviour displays a high degree of carelessness and disregard for the consequences.

Gross carelessness or evasion
In determining whether to impose a penalty for gross carelessness or evasion the decision will generally rely on the evidence available and whether it is sufficient to discharge the Commissioner's onus of proof for evasion.  If the evidence is insufficient the penalty will default to the gross carelessness category.

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 shortfall penalties, rests with the taxpayer.  They must show that on the "balance of probabilities" they have not been grossly careless.

Standard rate of penalty

The standard rate of penalty payable for gross carelessness is 40% 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 141C of Tax Administration Act 1994 provides for a penalty of gross carelessness, at the rate of 40%, where a default falls just short of the evasion category but well beyond not taking reasonable care.

The definition for gross carelessness is more akin to evasion than not taking reasonable care.  The only essential element keeping them apart is that, for evasion, it must be shown that the taxpayer had the necessary "mens rea" (intent) to evade tax.

Typically, a high level of carelessness will be characterised by conduct which creates a high risk of a tax shortfall occurring where this risk and its consequences would have been foreseen by a reasonable person in the circumstances.

The penalty is non-negotiable and where a default meets the considerations for gross carelessness the penalty must be imposed.

Tony Bouzaid
National Manager, Operations Policy
March 1998