Mr Dunne admitted the system was "fully stretched" and a 10-year project to upgrade the system was required.
He said he wanted to make sure a Novopay-like situation could be prevented in the roll out.
"It's fair to say the revenue system is at capacity, and the Government recognises the need for a substantive transformation programme to shape Inland Revenue to best serve New Zealand in the future."
A risk assessment briefing prepared for ministers last August showed the department's "systems and processes were not able to sustain or improve tax collection or social policy disbursement".
The upgrade is scheduled to take 10 years, but could be longer. An exact timeframe and precise cost are unclear, according to the minister.
Mr Dunne said IRD's functions had changed since its computer systems were launched in 1991.
IRD was set up to administer the tax system, now it managed and administered a share of social policy programmes like KiwiSaver, student loans, child support, working for families, family tax credits and paid parental leave.
Another document showed "First has approximately 40 million lines of highly intertwined software code, which means it is expensive and time-consuming to adapt the system to new customer requirements, such as smartphone access."
In February last year Prime Minister John Key signalled the upgrade, saying it could cost $1b and some of the money could come from asset sales.
Labour's former revenue spokesman David Clark believed the Government had already spent millions on consultants for the project, including appointing Capgemini in November 2011 to work on a business transformation plan.
He said a privacy breach of 6300 New Zealanders' details last year could have been prevented by a better computer system.
Over 14 months New Zealanders have faced privacy breaches at the Accident Compensation Corporation, Work and Income, Ministry of Education, Talent2, Immigration New Zealand and the Earthquake Commission.
