Temporary shortfall - permanent reversals (Sep 99)
INV-231 (Sep 1999) sets out information on permanent reversal as it applies to a temporary shortfall.
This SPS replaces the Standard Practice Statement INV-230 which was issued in the Tax Information Bulletin, Volume Ten, No.5, May 1998. Standard Practice Statement INV-231 is effective from the date of publication.
This Standard Practice Statement sets out the Commissioner's position on permanent reversal as it applies to a temporary shortfall.
The Commissioner will accept that a tax shortfall has been permanently reversed if:
- It appears from the taxpayer's actions that steps taken will remedy the tax shortfall, or
- Through operation of law or circumstances, the matter will reverse itself.
This statement does not apply to corrections, as the Commissioner cannot be satisfied that they will be corrected in a later period.
This Standard Practice Statement applies to assessments of shortfall penalties issued on or after 1 May 1998.
If you have been assessed with a shortfall penalty between 1 May 1998 and the date of this statement, please contact the Inland Revenue officer concerned and, if applicable, your assessment will be adjusted to reflect the 75% reduction to the shortfall penalty.
Inland Revenue's practice has been to restrict the temporary shortfall reduction to instances where Inland Revenue has received the return containing the correction or reversal before the taxpayer has been notified of a pending audit or investigation.
An issue has arisen concerning the timing of GST input credits. Many of the resulting refunds claimed can be quite substantial and could be subject to GST checks before the release of the refunds. GST refund checks are undertaken very quickly after the returns are received which means that the taxpayers may not have had an opportunity to furnish a following return which would permanently reverse the overclaim made in a previous period.
The tax shortfall is actually a timing shortfall but Inland Revenue's practice, prior to 1 May 1998, was not to allow the temporary shortfall reduction unless the return containing the reversal had been furnished prior to notification of audit or investigation.
This situation could also arise in other tax types, for example, income tax, FBT or PAYE.
A temporary shortfall is defined in section 141I of the Tax Administration Act 1994. If a taxpayer is considered liable for a shortfall penalty and the tax shortfall is a temporary shortfall, the penalty warranted will be reduced by 75%.
Subsection (3) defines a temporary shortfall as follows:
A tax shortfall is a temporary tax shortfall for a return period if the Commissioner is satisfied that
- The tax shortfall has been permanently reversed or corrected in an earlier or later return period, so that (disregarding penalties or interest) the taxpayer pays the correct amount of tax or calculates and returns the correct tax liability in respect of the item or matter that gave rise to the tax shortfall; and
- No tax shortfall will arise in a later return period in respect of a similar item or matter; and
- No arrangement exists in any return period which has the purpose or effect of creating a further related tax deferral or advantage; and
- The tax shortfall was permanently reversed or corrected before the taxpayer is first notified of a pending tax audit or investigation.
Practice applicable from 1 May 1998
The Commissioner's new interpretation of a temporary shortfall
The Commissioner considers that a tax shortfall has been permanently reversed or corrected if:
- it appears from the taxpayer's actions that steps taken will remedy the tax shortfall, or
- through operation of law or circumstances, the matter will reverse itself.
To reverse a situation does not necessarily mean to achieve a complete remedy - it only means to take steps that will lead to the remedy in due course. For example, when a ship goes off course, one remedies it by turning it back towards the right heading. The mistake has been remedied when the turn is made but getting the ship back to the position it should be in takes some time to take effect.
Using this rationale, when the taxpayer claims the entire GST input claim in the first GST return, the taxpayer has made the reversal because no claim for an input credit relating to the same property purchase will be made in a later return. This means the reversal will be treated as made when the full input claim is made in the earlier return. The same would apply to income tax or any other revenue.
In these scenarios, the taxpayer would be entitled to a 75% reduction for a temporary shortfall. This is because the taxpayer has made the claim in the earlier return period so they cannot make the claim again in the later period.
The case may not be so clear when gross income is not returned in a correct return period. For example, an auditor ascertains that a taxpayer should have returned a sale in the return being audited.
In order to qualify for the temporary shortfall reduction, Inland Revenue would have to be satisfied that the sale would have been returned in a later return period. This will involve making enquiries of the taxpayer and checking the internal systems, bank statements, etc. If the sale is recorded in the system that the taxpayer normally prepares the tax return from, Inland Revenue could safely assume that the sale would have been returned in the next return period. In some situations consideration of the taxpayer's systems may indicate that the sale would have been returned in an even later return period. In both of these cases, Inland Revenue would allow the temporary shortfall reduction of any shortfall penalty warranted.
Arguably, a 5% penalty for a full year's deferral of income tax is much lower than a 5% penalty for deferral of GST for one, two or six months. Inland Revenue considers that the reason for shortfall penalties should not be confused; shortfall penalties address culpability. Interest will be charged to taxpayers for paying tax late. When the adjustment is made to the return, interest will be charged from the time that the taxpayer should have paid the correct amount of tax.
In summary, a taxpayer is not required to have furnished the return containing the reversal prior to notification of audit, but Inland Revenue must be satisfied that, the reversal would have been made in a following return.
The extended interpretation of temporary shortfall will be available for all tax types including income tax. This interpretation of the word "reversed" applies only to the definition of temporary shortfall.
GST Input tax claim
A property developer enters into an unconditional sale and purchase agreement for the purchase of real property. The full purchase price of the property is $750,000 and the property developer pays a deposit of $75,000 on 5 April 1998. The balance of the purchase price is payable on 5 May 1998.
The vendor of the property is not registered for GST, so the property developer is purchasing a secondhand good and is entitled to claim a GST input credit only on the amount actually paid. The property developer is registered for GST on an invoice basis and files GST returns every two months.
In the GST return for the period ended 30 April 1998, the property developer claims an input credit of $83,333 which is 1/9 of the total purchase price of the property. The correct claim in that period is $8,333, so there is a tax shortfall of $75,000.
As the matter relates to an issue of interpretation and is over the specified threshold, the developer must have an acceptable interpretation for the tax position taken. As the standard has been breached, they are liable to a shortfall penalty of 20% of the tax shortfall.
The taxpayer is entitled to claim 1/9 of the payment that will be made on 5 May 1998 in the GST return for the period ended 30 June 1998. The taxpayer has already made the claim in the previous GST return, and was not intending to make the claim in the June GST return. Therefore, at the time of making the full claim in the April return, the taxpayer had permanently reversed the tax shortfall, as they never intended to make a double claim, even though, due to the speed of the audit, the May/June return had not been received.
In this case, the 75% reduction for a temporary shortfall is available.
GST output tax not returned
As part of his taxable activity, a taxpayer entered into an unconditional agreement to sell real property.
The GST return for the period ended 31 May 1998 was audited and it was noted that output tax with respect to the deposit only had been returned.
The taxpayer is queried and advises that he is going to return the balance of the sale in the next return as that is when he will receive the monies outstanding for the property.
As the time of supply was triggered upon receipt of the deposit, a tax shortfall is ascertained for the balance of the property sale that was not returned.
The taxpayer advises that he wasn't sure whether he should return the entire sale and had intended making an inquiry but just didn't get around to it. It is considered that a reasonable person in the taxpayer's category of taxpayer, when unsure, would have obtained advice prior to preparing his GST return. Accordingly, the taxpayer is liable to a shortfall penalty for not taking reasonable care.
The taxpayer prepares his returns from his bank statements; therefore, the internal system will pick up the receipt of the balance of the sale of the property. It is clear that the output would have been returned in next period. Therefore, the tax shortfall has been reversed even though the following return has not been received because of the speed of the audit.
In this case, the 75% reduction to the shortfall penalty would be warranted.
A taxpayer prepares the GST return and claims a GST input credit for some overseas travel and personal expenses. An audit is undertaken and a tax shortfall is ascertained for the above mentioned claims.
There is no guarantee that the incorrect input claims will be corrected in the following GST return.Therefore, if culpability were established, no reduction for a temporary shortfall is available.