Discretion to cancel or not assess shortfall penalties for taking an unacceptable tax position (April 2006) (WITHDRAWN)

This statement also appears in Tax Information Bulletin, Vol. 18, No. 5 (June 2006).

Introduction

1. This Standard Practice Statement (SPS) sets out Inland Revenue's practice for exercising the Commissioner's discretion to:
   • cancel a previously assessed shortfall penalty for taking an unacceptable tax position, and/or
   • not assess a shortfall penalty that would otherwise be assessed for taking an unacceptable tax position
   in circumstances when the Commissioner is satisfied that certain criteria are met.

2. For the purpose of this SPS, the term "UTP penalty" refers to a shortfall penalty assessed for taking an unacceptable tax position under section 141B of the Tax Administration Act 1994 (TAA).

3. Unless specified otherwise, all legislative references in this SPS refer to the TAA.

Application

4. This SPS applies to taxpayers:
   • who have been assessed a UTP penalty before 1 April 2006, and/or
   • who may (but for exercise of the discretion) be assessed a UTP penalty on or after 1 April 2006
   for tax positions taken after 1 April 2003.

Standard Practice

5. From 1 April 2006, pursuant to section 141KB, the Commissioner can determine:
   • whether or not to cancel a UTP penalty that has been assessed before 1 April 2006, and
   • whether or not to assess a UTP penalty that would otherwise be assessed on or after 1 April 2006.

6. In order for the Commissioner to consider cancelling a UTP penalty that has been assessed prior to 1 April 2006, the taxpayer must make a request in writing. The request must be received by Inland Revenue before 1 October 2006.

7. The Commissioner will cancel or decide not to assess a UTP penalty if satisfied that the following three criteria of section 141KB(2)(a) are met:
   • that "a clear mistake or simple oversight" caused the taxpayer to take the unacceptable tax position to which the UTP penalty related, or would relate if the UTP penalty were to be assessed, and
   • either:
     • the tax shortfall is voluntarily disclosed to the Commissioner prior to the notification of a pending tax audit or investigation (in terms of section 141G(1)(a)), or
     • the tax shortfall is a temporary tax shortfall (in terms of section 141I(3)), and
   • it is appropriate that the taxpayer not be liable to pay a UTP penalty.

8. When the Commissioner cancels or decides not to assess a UTP penalty under section 141KB(1), the Commissioner may consider that the taxpayer is instead liable to pay a shortfall penalty for lack of reasonable care under section 141A. The date of imposing a shortfall penalty for lack of reasonable care, if applicable, is the same as the date of the Commissioner's decision under section 141KB(1).

Background

9. The UTP penalty legislation (section 141B) was enacted (as an amendment to the former "unacceptable interpretation" penalty) in 2003, because under the former penalty (for taking an unacceptable interpretation) taxpayers could choose not to interpret the legislation on a complex tax issue as a means of avoiding possible shortfall penalties. However, experience with the UTP penalty has shown that it gives rise to some unintended penalty outcomes. In some cases, the penalty discourages voluntary compliance by taxpayers who discover a clear mistake or simple oversight.

10. The government has recognised the problems caused by the UTP penalty and introduced section 141KB to give the Commissioner discretion in the assessment of a UTP penalty when the tax shortfall has arisen from a clear mistake or simple oversight. In exercising this discretion in practice, the Commissioner's intention is to ensure the discretion is applied consistently with the background to its enactment and to encourage voluntary disclosure of mistakes and oversights, and their efficient correction, and thus promote voluntary compliance.

11. Section 141KB applies from 1 April 2006, but to overcome previous unintended outcomes, the section has retrospective effect to 1 April 2003.

12. Taxpayers are still obliged to ensure that, when viewed objectively, their tax positions meet the standard of being about as likely as not to be correct. However, section 141KB means that, generally, taxpayers who make a pre-notification voluntary disclosure in relation to tax shortfalls that have arisen from clear mistakes or simple oversights will not be liable for UTP penalties.

Legislation

13. The relevant legislative provisions are:
    • the definitions of "tax position", "disputable decision" and "response period" in section 3(1),
    • sections 14, 89D, 141A, 141B, 141FB, 141G, 141H, 141I, 141KB, and
    • sections CC 8 and EF 4 of the Income Tax Act 2004.

Discussion

Operation of the UTP penalty

14. Section 141B provides that a shortfall penalty will be imposed if a taxpayer takes an unacceptable tax position.

15. An unacceptable tax position is one taken by a taxpayer that, when "viewed objectively, fails to meet the standard of being about as likely as not to be correct". This standard has been recognised as applying to a wide range of tax positions including tax positions that are simply incorrect as a result of inadvertence.

16. For a UTP penalty to be assessed, the tax shortfall must be more than both:
    • $20,000, and
    • the lesser of $250,000 and 1% of the taxpayer's total tax figure for the relevant return period.

17. The shortfall penalty payable is 20% of the resulting tax shortfall. However, the penalty may be reduced because of:
    • a voluntary disclosure under section 141G, and/or
    • a temporary tax shortfall under section 141I, and/or
    • the taxpayer's previous behaviour under section 141FB, and/or
    • disclosure of an unacceptable tax position under section 141H.

18. Please refer to Interpretation Statement IS0055 titled Shortfall penalty - unacceptable interpretation and unacceptable tax position (which was published in Tax Information Bulletin Vol. 17, No. 9 (November 2005) and is available on Inland Revenue's website at www.ird.govt.nz) for further details on Inland Revenue's practice in assessing UTP penalties.

The Commissioner's discretion under section 141KB

19. The Commissioner may exercise the new discretion under section 141KB(1) to cancel a previously assessed UTP penalty (i.e. assessed before 1 April 2006) or not assess a UTP penalty that would otherwise be assessed from 1 April 2006 in respect of a tax position taken after 1 April 2003.

20. Section 141KB reads:
    
    

    (1)	The Commissioner may decide in the circumstances given by subsection (2) that a taxpayer is not liable to pay a shortfall penalty that would otherwise be imposed by section 141B in relation to a tax position.
    (2)	The Commissioner may exercise the discretion given by subsection (1) if-
    	(a)	the Commissioner is satisfied that-
    		(i)	the tax position is taken as a result of a clear mistake or simple oversight; and
    		(ii)	the tax shortfall arising from the tax position is or would be subject to a reduced penalty under section 141G(1)(a) as a result of a voluntary disclosure or is a temporary tax shortfall under section 141I(3); and
    		(iii)	it is appropriate that the taxpayer not be liable to pay a shortfall penalty under section 141B in relation to the tax position; and
    	(b)	the Commissioner-
    		(i)	does not assess the shortfall penalty before exercising the discretion:
    		(ii)	assesses the shortfall penalty before 1 April 2006 and receives before 1 October 2006 a written request from the taxpayer for a decision under subsection (1).
    (3)	If the Commissioner decides under subsection (1) that a taxpayer is not liable to pay a shortfall penalty that the Commissioner has assessed, the assessment of the shortfall penalty is treated as not having been made.
    (4)	If the Commissioner decides under subsection (1) that a taxpayer is not liable to pay a shortfall penalty that would otherwise be imposed by section 141B in relation to a tax position, the taxpayer is not excluded from liability to pay a shortfall penalty under section 141A in relation to the tax position.

Taxpayers' requests for cancellation of UTP penalties assessed before 1 April 2006

21. A taxpayer may request cancellation of a UTP penalty assessed before 1 April 2006. Their request must be:
    • made in writing, and
    • received by Inland Revenue before 1 October 2006.
    The taxpayer's request should be sent to their nearest Inland Revenue office. The addresses of Inland Revenue offices can be obtained from Inland Revenue's website at www.ird.govt.nz.

22. To enable the Commissioner to consider all relevant information in exercising the discretion under section 141KB, the written request should include:
    • a description of the circumstances leading to the tax shortfall, including the relevant background facts that led to the assessment of the UTP penalty under section 141B,
    • references to any relevant correspondence with the Commissioner, and
    • any other information that the taxpayer considers relevant to the Commissioner's decision under section 141KB.

23. The request for a cancellation of a UTP penalty should include a discussion on how the three criteria of section 141KB(2)(a) in paragraphs 28 to 66 relate to the facts and circumstances of the case at hand. The commentary below will assist.

24. When the taxpayer makes a written request for the Commissioner to exercise the discretion under section 141KB, the Commissioner will advise the taxpayer in writing of his decision. The matter will be subject to a degree of priority, depending upon the volumes and the need to maintain consistency.

The criteria for cancelling UTP penalties

25. The Commissioner must be satisfied that the following three criteria are met in order to exercise the discretion and cancel a UTP penalty that has been assessed. The three criteria are:
    • that a "clear mistake or simple oversight" caused the taxpayer to take the tax position to which the UTP penalty relates (please see paragraphs 28 to 42 for details on what the Commissioner considers constitutes a "clear mistake or simple oversight" in the context of section 141KB), and
    • that the tax shortfall is voluntarily disclosed prior to the notification of a pending tax audit or investigation under section 141G(1)(a) or is a temporary tax shortfall under section 141I(3) (please see paragraphs 43 to 55 for details), and
    • that it is appropriate that the taxpayer not be liable to pay the UTP penalty (the meaning of "appropriate" in the context of section 141KB is explained further in paragraphs 56 to 66).

Assessment of UTP penalties from 1 April 2006

26. From 1 April 2006, the Commissioner has discretion in determining whether or not to assess a UTP penalty if certain criteria are met. As stated in paragraph 10 of this SPS, the Commissioner will exercise the discretion in the spirit in which section 141KB was enacted, to make sure that tax shortfalls which meet the criteria can be properly identified and corrected without incurring a UTP penalty. In considering whether or not to assess a UTP penalty, the Commissioner will always consider the objectives of section 141KB and whether he is satisfied that the three criteria set out in section 141KB(2)(a) are met (please see paragraph 25 for details).

27. However, if taxpayers do not believe that the discretion has been properly considered, and a UTP penalty is to be assessed, they should draw the matter to the attention of Inland Revenue as soon as possible following receipt of the Commissioner's notification of a UTP.

The three criteria in section 141KB(2)(a)

Criterion 1: the tax shortfall is caused by "a clear mistake or simple oversight"

28. The term "a clear mistake or simple oversight" is not defined in the TAA. To the extent that the term relates to the assessment of a UTP penalty under section 141B, or the non-assessment/cancellation of a UTP penalty under section 141KB, the term should be read in the context of that provision's objective, and the Commissioner will adopt a broad approach to the words.

29. However, not all mistakes or oversights will qualify for the application of section 141KB. The Commissioner considers that the sort of mistake or oversight contemplated must be an inadvertent one. That is, had the taxpayer known of the mistake or oversight, they would not have taken the tax position that they took. A tax shortfall which is the result of a deliberate interpretation will not qualify. Furthermore, the existence of the mistake or oversight should be plain and obvious on review.

30. The term "clear mistake or simple oversight" can also apply to situations when a particular outcome is intended, but that outcome later turns out not to be achieved, as a result of a miscalculation, misunderstanding or unintentional omission.

31. The Commissioner considers that the words "clear" and "simple" apply to the mistake or oversight, and not to the underlying transaction to which the mistake or oversight relates. That is, it is possible for section 141KB to apply in respect of a complex transaction, when an incorrect tax position is taken as a result of a clear mistake or simple oversight. For example, in a company shareholder restructure, a breach of shareholder continuity was not identified as a result of a mistake in determining the change in shareholding percentages with the result that tax losses were incorrectly carried forward. The restructure was complex, but a clear mistake resulted in an incorrect tax position.

32. Whether the Commissioner is satisfied that the taxpayer's tax position is caused by a "clear" mistake or "simple" oversight will be determined on a case-by-case basis. As the nature of the enquiry is in determining whether there is a mistake or oversight, the Commissioner expects that, once discovered, the reason for the mistake must be clearly identifiable and understood. Similarly if a matter is an oversight, it should be an uncomplicated process to explain that and how the mistake led to the tax shortfall.

33. For example, a taxpayer purchased some land and was informed by the vendor's solicitor that the vendor was registered for GST and a tax invoice was to be issued. The taxpayer's accountant relied on this advice and filed a GST return claiming the full amount of input tax. It was later established that while the vendor was GST registered, the land did not form part of the vendor's taxable activity, but was held in the vendor's personal capacity. In this example, the taxpayer's tax position in claiming the input tax was deliberately taken, but the taxpayer had acted on a misunderstanding that resulted in an incorrect tax position. The Commissioner is satisfied that the incorrect tax position taken was as a result of a clear mistake.

34. A "clear mistake" in the context of sections 141B and 141KB could include (but is not limited to) "a mistake in the calculation or recording of numbers in a return." Such mistakes, however, should be considered in terms of section 141B(1B), and do not result in a UTP penalty in the first place. If section 141B(1B) applies, there should be no need to consider section 141KB in these types of cases.

35. For further details on mistakes "in the calculation or recording of numbers in a return", please refer to an article entitled "Tax compliance, standards and penalties" in the Tax Information Bulletin, Vol. 15, No. 5 (May 2003) and Interpretation Statement IS0055 titled Shortfall penalty - unacceptable interpretation and unacceptable tax position. Both the article and the Interpretation Statement are also available on Inland Revenue's website at www.ird.govt.nz.

A mistake of law or mistake of fact may be "a clear mistake or simple oversight"

36. Section 141KB(2)(a)(i) does not distinguish between a "mistake of fact" and a "mistake of law". The Commissioner does not intend to draw a distinction between these concepts (which can often be merged), so that overlooking or completely misunderstanding a statutory requirement could qualify as a clear mistake.

37. For example, a taxpayer changed their GST accounting treatment from the payments to invoice basis, and incorrectly assumed the change took effect from the commencement of the GST return period in which the election was made, rather than the GST return period immediately following approval by the Commissioner.

38. As stated in paragraph 29, a tax position that was inadvertent or that was taken in circumstances when, had the taxpayer known of the mistake or oversight, they would not have taken the tax position they took, will often suggest that there was a mistake.

39. The Commissioner also considers that, generally, no "clear mistake or simple oversight" will be present in the following circumstances:
    • Not knowing the law: there is no clear mistake or simple oversight simply because a taxpayer does not know the law. Taxpayers have a duty to be aware of their obligations. Furthermore, knowingly choosing not to refer to the relevant tax law when taking a tax position, i.e. knowingly turning a blind eye to the law, is also something not contemplated by the discretion. However, knowingly choosing not to interpret the law would not apply to circumstances when the taxpayer can show they have taken steps to find out what the law requires but have genuinely overlooked a relevant law.
    • Knowing the law but choosing to ignore it: in the same vein, a taxpayer cannot be said to have made a clear mistake or simple oversight if they were aware of their responsibilities but chose to ignore them. For example, a taxpayer was aware that they were not permitted to value closing trading stock at market value unless the value was less than the cost, and did not adjust the closing trading stock value back to cost when completing their income tax return.

"Timing" differences may be "a clear mistake or simple oversight"

40. By way of a further example, the Commissioner considers that a "clear mistake or simple oversight" may include mistakes or oversights resulting in "timing" differences for taxation purposes. The inclusion of "timing" differences in what might constitute a "clear mistake or simple oversight" is in any event implied by the reference to "a temporary tax shortfall" in section 141KB(2)(a)(ii).

The discretion may apply to mistakes or oversights that relate to multiple tax types, tax periods or other taxpayers in some cases

41. To avoid doubt on the issue, a taxpayer's mistake or oversight can relate to one or more revenue types, or one or more tax periods, or taxpayers. For example, as mentioned in paragraph 31 above, the breach of shareholder continuity may have meant that tax losses have been incorrectly carried forward for several income years. They may have also been incorrectly applied against the taxable income of other companies in the same group of companies. Despite this, so long as the Commissioner considers the criteria of section 141KB are met, the Commissioner will exercise the discretion and either cancel or not assess the UTP penalties.

42. To continue the example in paragraph 31, the losses had been offset against foreign dividend withholding payments. The same mistake caused the taxpayer to take incorrect tax positions in more than one revenue type. Despite this, so long as the Commissioner considers that the criteria of section 141KB are met, the Commissioner will exercise the discretion and either cancel or not assess the UTP penalties.

Criterion 2: the taxpayer makes a voluntary disclosure or the shortfall is a temporary tax shortfall

43. In order to satisfy the Commissioner that the criterion of section 141KB(2)(a)(ii) is met, a taxpayer must be able to show that the tax position to which the UTP penalty relates:
    • is subject to a voluntary disclosure prior to the notification of a pending tax audit or investigation ("pre-notification disclosure") under section 141G(1)(a), or
    • is a temporary tax shortfall under section 141I(3).

Voluntary disclosure

44. For a UTP penalty assessed before 1 April 2006 or a UTP penalty that would otherwise be assessed on or after 1 April 2006, section 141KB(2)(a)(ii) is met if the tax position to which the UTP penalty relates has been or would be reduced by 75% for a pre-notification disclosure under section 141G(1)(a).

45. Section 141G(1)(a) reads:
    
    

    A shortfall penalty payable by a taxpayer under any of sections 141A to 141EB may be reduced if, in the Commissioner's opinion, the taxpayer makes a full voluntary disclosure to the Commissioner of all the details of the tax shortfall, either-
    (a)	Before the taxpayer is first notified of a pending tax audit or investigation (referred to in this section as "pre-notification disclosure") …

46. The following SPSs set out the Commissioner's practice on reducing shortfall penalties for voluntary disclosure and pre-notification disclosures:
    • INV 251 Voluntary Disclosures, and
    • INV 260 Notification of a Pending Audit or Investigation
    These SPSs were published in Tax Information Bulletins Vol. 14, No. 4 (April 2002) and Vol. 12, No. 2 (February 2000) respectively and are available on Inland Revenue's website at www.ird.govt.nz. Note that SPS INV 260 has expired, but still generally indicates current practice.

47. As noted in SPS INV 251, the tax system is based on voluntary compliance, and relies on taxpayers meeting their obligations under the tax laws. The voluntary disclosure system provides an incentive to taxpayers to determine their correct tax liability. It is also recognised that the tax system also benefits from voluntary admissions of irregularities and other co-operation by taxpayers.

48. Inland Revenue now also allows taxpayers to make full voluntary disclosure of tax shortfalls by email on Inland Revenue's Online Correspondence Service. In the context of this SPS, it has been decided that disclosures by email or ordinary correspondence will be accepted, provided that they are clear in their terms. That is, form IR281 need not be used.

Notification of audit or investigation

49. It is the Commissioner's intention to give sufficient opportunities for taxpayers to disclose mistakes in the period before a decision is taken to commence an investigation (and before it commences). Clear wording is to be used in any communication to taxpayers when a decision to investigate has been made. Requests for information to enable the Commissioner to decide whether to investigate are not themselves part of an investigation.

50. The Commissioner's practice of undertaking an audit activity after a return has been filed, such as some GST refund checks, may limit the opportunity for a taxpayer to make a pre-notification disclosure under section 141G(1)(a). Taxpayers and agents filing returns will therefore have to be aware that section 141KB may not give relief in all cases. However, if taxpayers and/or their agents can show that they have taken steps to permanently reverse or correct the tax shortfall (prior to the notification of the audit or investigation), the tax shortfall may be a temporary tax shortfall pursuant to the Commissioner's current practices. Provided that all other criteria in section 141KB(2)(a) are met, the Commissioner will exercise the discretion to cancel or not assess the UTP penalty. (Please see the discussion on temporary tax shortfalls in paragraphs 52 to 55.)

51. The Commissioner may give notice of a pending tax audit or investigation by post. In such cases the taxpayer will be regarded as having been notified of the audit or investigation if the notice meets the requirements of section 14(8) and section 14(9).

Temporary tax shortfall

52. For a UTP penalty assessed before 1 April 2006 or a UTP penalty that would otherwise be assessed on or after 1 April 2006, section 141KB(2)(a)(ii) is met if the tax position to which the UTP penalty relates has been or would be reduced by 75% for a temporary tax shortfall under section 141I(3).

53. The term "temporary tax shortfall" is defined by section 141I(3) as follows:
    
    

    A tax shortfall is a temporary tax shortfall for a return period if the Commissioner is satisfied that-
    (a)	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
    (b)	No tax shortfall will arise in a later return period in respect of a similar item or matter; and
    (c)	No arrangement exists in any return period which has the purpose or effect of creating a further related tax deferral or advantage; and
    (d)	The tax shortfall was permanently reversed or corrected before the taxpayer is first notified of a pending tax audit or investigation.

    
    SPS INV 231 Temporary Shortfall - Permanent Reversal sets out Inland Revenue's practice on what constitutes a temporary tax shortfall. This SPS was published in Tax Information Bulletin Vol. 11, No. 8 (September 1999) and is available on Inland Revenue's website at www.ird.govt.nz.

54. The Commissioner considers that a tax shortfall has been permanently reversed or corrected if:
    • it appears from the taxpayer's actions that the steps taken by the taxpayer have or will remedy the tax shortfall, or
    • through operation of law or circumstances, the matter will reverse itself.

55. The Commissioner's practice has been to accept that the tax shortfall is temporary if on inquiry (not being an audit or investigation) he is satisfied that steps are being taken to correct the shortfall in the next relevant return. For example, an incorrect input tax credit claimed in respect of a transaction that was zero-rated. If the tax shortfall is corrected and the tax is paid in the next GST return period, or earlier, the initial tax shortfall will be regarded as being temporary.

Criterion 3: the Commissioner is satisfied that it is "appropriate" to cancel or not to impose a UTP penalty

56. The discretion under section 141KB(1) will be exercised if the Commissioner is satisfied that all three criteria in section 141KB(2)(a) are met. Pursuant to section 141KB(2)(a)(iii), the Commissioner may decline to exercise the discretion if the Commissioner is satisfied that it would not be appropriate to do so, although the circumstances in which this will arise will be rare.

57. The legislation does not define what is meant by "appropriate". In considering whether it is appropriate to exercise the discretion under section 141KB, the Commissioner will have regard to the facts of each case, in light of the purpose of section 141KB, which is a concessionary discretion.

58. The Commissioner will also consider the overriding obligations in section 6 to protect the integrity of the tax system and in section 6A(3) to collect the highest net revenue over time, and in particular the importance of promoting voluntary compliance by all taxpayers.

59. The Commissioner considers that it is very important to create the right conditions for encouraging voluntary disclosure in particular and compliance in general. The following factors (not being an exhaustive list) could be relevant on a case-by-case basis in deciding whether or not to apply the discretion under section 141KB:
    • the steps taken to rectify the incorrect tax position to which the UTP penalty relates. For example, requesting a reassessment to reflect the correct tax position and/or meeting any payments due, and
    • whether and the extent to which the taxpayer has been assessed for similar shortfall penalties, and the nature of those penalties. If the taxpayer is consistently incurring shortfall penalties, this may illustrate the taxpayer's general approach to tax compliance, which is not consistent with the exercise of the discretion in the taxpayer's favour.

Taxpayers' efforts to rectify the incorrect tax position to which the UTP penalty relates

60. It is envisaged that the taxpayer will make a voluntary disclosure of the tax shortfall as soon as practicable, and take reasonable steps to rectify the position (for example, by paying the correct amount of tax.) There are instances of this occurring before the original due date for filing. In such cases, where the other criteria of section 141KB(2)(a) are met, it can be assumed that it is appropriate to cancel or not to impose the UTP penalty.

Taxpayer repeatedly makes similar clear mistakes or simple oversights

61. Section 141KB is intended to promote voluntary compliance by taxpayers. In cases when the taxpayer repeatedly makes similar clear mistakes or simple oversights, there is unlikely to be any reason to positively exercise the discretion.

62. That is, there may be circumstances that may indicate that voluntary compliance by taxpayers in general, as well as the particular taxpayer, may not be promoted by exercise of the discretion, in particular when the mistake or oversight has occurred before, and has been drawn to the taxpayer's attention, yet the mistake or oversight has been repeated. (Generally this might also bring the matter into the realm of the shortfall penalty for lack of reasonable care.)

63. For example, a taxpayer imports a piece of machinery and pays GST to NZ Customs. In preparing the GST return, the taxpayer includes that GST paid to NZ Customs as an input tax adjustment in their return, but also includes the amount paid to their overseas supplier in their total purchases for the period - thereby claiming a GST input tax credit twice. The mistake is voluntarily disclosed and corrected. The discretion under section 141KB is applied and no UTP penalty is assessed. However, a few months later, when another piece of machinery is imported, the same mistake is made. In this second case, it cannot be presumed that because the mistake is disclosed and corrected that the Commissioner will consider it "appropriate" to apply the discretion.

64. This is not to suggest, however, that the provisions of section 141KB should be applied only once in respect of a particular type of mistake or oversight.

65. In some cases, it may still be appropriate for the Commissioner to cancel or not to assess a UTP penalty when the taxpayer concerned has a reasonable compliance history but has the occasional lapse - for example due to a change in staff. Sometimes there are special or unique circumstances giving rise to the tax shortfall, and the Commissioner will take this into account.

66. Whether a taxpayer makes similar mistakes is not determined by the wider tax compliance history of the taxpayer. For example a previously non-compliant taxpayer (for example, a taxpayer convicted of knowledge and evasion offences under sections 143A and 143B) now usually meets all their tax obligations, except on this occasion, when the taxpayer makes a clear mistake that results in a UTP penalty. Provided that the other criteria of section 141KB(2)(a) are met, it is appropriate for the Commissioner to decide not to impose the UTP penalty on the taxpayer.

Retrospective effect of cancellation of UTP penalties assessed before 1 April 2006

67. Pursuant to section 141KB(3), when the Commissioner cancels a UTP penalty that was assessed before 1 April 2006, the cancellation is retrospective. In other words, the cancellation has the same effective date as the date on which the UTP penalty was assessed. Thus, if the taxpayer has already paid the UTP penalty, the cancellation of the UTP penalty will result in an overpayment of tax as at that date and Inland Revenue will pay use of money interest ("UOMI").

68. Any credit UOMI arising from the cancellation of the UTP penalty forms part of the taxpayer's income under section CC 8 of the Income Tax Act 2004. It is allocated to the income year in which the Commissioner pays the UOMI under section EF 4 of the Income Tax Act 2004.

69. Inland Revenue will discuss with the taxpayer how the overpayment (including any late payment penalties if any) and the credit UOMI should be applied. This may include refunding the overpaid amount to the taxpayer or offsetting that amount against other outstanding tax (if any) or both.

70. If the taxpayer has not paid the UTP penalty, the Commissioner's cancellation of the penalty under section 141KB(1) means that any late payment penalties and debit UOMI accrued on the UTP penalty will be reversed.

Shortfall penalty for lack of reasonable care may still apply

71. Section 141KB(4) provides that when the Commissioner decides to cancel or not to assess a UTP penalty that would otherwise be assessed but for section 141KB(1), the Commissioner is not precluded from assessing a shortfall penalty for lack of reasonable care ("LORC" penalty) under section 141A.

72. Despite section 141KB(4) there is no ability to apply a LORC penalty retrospectively. Section 141A(5) states that when a LORC penalty applies, the liability for the shortfall penalty is treated as arising on the date of the Commissioner's decision to cancel or not to assess the UTP penalty under section 141KB(1).

73. Please refer to Interpretation Statement IS0053 titled Shortfall penalty for not taking reasonable care (which was published in Tax Information Bulletin Vol. 17, No. 9 (November 2005) and is available on Inland Revenue's website at www.ird.govt.nz) for further details on Inland Revenue's practice in assessing LORC penalties.

Taxpayer's right to dispute the Commissioner's decision under section 141KB(1)

74. The exercise of the Commissioner's discretion under section 141KB(1) is a "disputable decision" as defined in section 3(1). Thus, if a taxpayer disagrees with the Commissioner's decision not to cancel or wishes to dispute a decision to assess a UTP penalty, the taxpayer may issue a notice of proposed adjustment (NOPA) to the Commissioner under section 89D(3). The NOPA must be issued within the applicable response period. (Please refer to SPS 05/04 Disputes resolution process commenced by taxpayers. This SPS was published in Tax Information Bulletin Vol. 17, No. 3 (April 2005) and is available on Inland Revenue's website at www.ird.govt.nz).

Examples

75. The following examples are included for illustrative purposes only. They illustrate circumstances when the Commissioner will exercise his discretion positively under section 141KB.

Example 1 Unrelated third party mistake

76. Mr X is a property developer registered for GST on a two-monthly invoice basis. Mr X purchases commercial property on 1 March 2004 and settlement occurs on 31 March 2004. The vendor's solicitor prepares the tax invoice for the transaction and makes a mistake in calculating the GST amount on the tax invoice. The tax invoice is forwarded to Mr X's accountant who prepares the GST return including the incorrect GST amount. The accountant has no direct involvement in Mr X's property development business apart from preparing his GST returns. The accountant forwards the GST return to Mr X to sign and file. Mr X is required to pay GST for the period ending 31 March 2004 as a result of two commercial properties he has sold during the period. The mistake in the tax invoice is not detected and Mr X sends the GST return to Inland Revenue. Mr X discovers the mistake the following week when he is reconciling his bank statements for the period. Mr X immediately makes a voluntary disclosure to Inland Revenue. The Commissioner assesses a UTP penalty on Mr X.

77. Mr X makes a written request to the Commissioner to exercise his discretion under section 141KB of the TAA.

Application of section 141KB

78. Mr X has made a voluntary disclosure prior to any notification of a pending audit or investigation.

79. In the Commissioner's opinion, the unacceptable tax position taken by Mr X was made as a result of a clear mistake in his GST return. This mistake resulted from a mistake made by an unrelated third party in calculating the GST amount on the tax invoice for the sale of the commercial property.

80. The Commissioner would be satisfied that it is appropriate in this case for Mr X to not be liable to pay a UTP penalty.

81. Based on the above circumstances, the Commissioner would cancel the UTP penalty because he is satisfied that the three criteria in section 141KB are met. The cancellation would be effective on the same date as the UTP penalty assessment was made.

Example 2 Clear mistake by omission

82. The ABC Trust (ABC) sold some farm machinery through an auctioneer in September 2004. GST was charged on the sale. ABC accounts for GST on the payments basis and settlement occurred in September 2004 when the money was deposited in ABC's bank by the auctioneer, but a statement from the auctioneer was not received until 22 October 2004. ABC had filed its two-monthly GST return to 30 September 2004 on 20 October 2004 but omitted the sale of the farm machinery.

83. ABC made a voluntary disclosure as to the omission on 29 October 2004 and at the same time (on the due date) made the correct payment of GST.

84. Inland Revenue assessed a UTP penalty. The taxpayer has written to the Commissioner requesting the penalty be cancelled under section 141KB.

Application of section 141KB

85. ABC has made a voluntary disclosure of the tax shortfall and also made payment of the GST by the due date.

86. In the Commissioner's opinion, the omission of the sale of the farm machinery was the result of a clear mistake or simple oversight due to the delay in receiving the auctioneer's statement.

87. The Commissioner is satisfied that it is appropriate for the taxpayer to not be liable to pay a UTP penalty and would exercise the discretion under section 141KB.

88. Based on the above circumstances, the Commissioner would cancel the UTP penalty because he is satisfied that the three criteria in section 141KB are met. The cancellation would be effective on the same date as the UTP penalty assessment was made.

This Standard Practice Statement is signed on 27 April 2006.

Graham Tubb
National Manager
Technical Standards