Taxing times for IRD

By BRIAN FALLOW

The tax department will never be loved. But it should not be detested either, not when the tax system depends on voluntary compliance.

Since he took over in February last year the commissioner of Inland Revenue, David Butler, has done a lot to change the culture and image of the IRD.

But, to judge by a broadside delivered yesterday by leading tax accountant John Shewan of PricewaterhouseCoopers, much remains to be done on that score.

The two squared off on the issue of the integrity of the tax system at the Institute of Chartered Accountants' tax conference in Christchurch.

"There is something fundamentally wrong with the New Zealand tax system when a small business which owns up to a small mistake in a GST return, or an error in a depreciation schedule, faces weeks if not months of aggressive questioning and correspondence with the IRD on the application of shortfall penalties," Shewan said, "but the business across the road which deliberately flouts the law by undertaking cash jobs ... suffers no penalty."

The signal to the compliant taxpayer, he told a gathering of tax practitioners in Christchurch, was "You're a mug, mate".

The way the IRD administered the shortfall penalties regime, including the penalties for lack of reasonable care - the lowest level of culpability in the regime - seriously undermined voluntary compliance, Shewan said.

The vast majority of errors were not picked up by the IRD and taxpayers took this into account when weighing the risk of not disclosing that they had made an error but later being found out, against disclosing but suffering significant compliance costs debating penalty issues with the IRD, and paying use-of-money interest on the shortfall (at nearly 12 per cent) as well.

In most cases, Shewan said, the penalty for lack of reasonable care (20 per cent of the shortfall) was not imposed in the end. But that outcome gave no indication of the time, cost and sheer hassle involved in dealing with the IRD on the lack-of-reasonable-care penalty.

Many of the IRD staff responsible for making decisions on the lack of reasonable care clearly lacked the commercial experience to pass judgment on the taxpayer's systems and processes, but the questioning would be no less aggressive for that.

"There is often a significant emotional cost involved in rebutting IRD contentions that reasonable care has not been exercised.

"For a CFO or senior accountant in a mid- to large-sized corporate the imposition of a penalty for failure to exercise reasonable care is tantamount to a finding of negligence - the result being the possibility of dismissal or resignation and/or requests by the employer that the employees pay the penalty. At a minimum it constitutes a blot on the employee's record."

It might be salutary, Shewan suggested, for the IRD to consider how it would like it if taxpayers could receive a penalty payment for mistakes the IRD made.

"If IRD applied the rules and current methodology to their own organisation they would rapidly recognise their approach to the administration of the lack-of-reasonable-care penalty is absurd."

Butler said he was happy to work with John Shewan and the Institute of Chartered Accountants to see if the department needed to change its work practices.

"It has not been raised by the institute as a systemic issue for accountants," he told the Weekend Herald later.

"The law does require taxpayers to show they have taken reasonable care, so where you have a large corporate with sophisticated accounting practices the test for them is probably at a higher level than for a small-business person operating a corner shop."

Central to the integrity of the tax system is treating all taxpayers equally.

While there was some scepticism about the amount of tax paid by large corporates - and the Winebox helped foster that impression - the statistics on the amount of tax paid by the corporate sector indicated that most corporates were paying their fair share, Shewan said.

But the cash or black economy is a different story.

Research by Professor David Giles has estimated the size of the hidden economy in New Zealand to be around 9 per cent, which would equate to $10 billion.

Not all of this escapes the tax net.

Butler said that in the past year additional tax of $170 million had been assessed in respect of evasion cases, which includes cash jobs.

He has initiated an "industry partnership" approach, based on a collaboration between the IRD and trade associations, intended by the end of next year to cover most of the industries where cash jobs are common.

Unveiling the scheme in May, the commissioner insisted it was not a dob-in-the-cowboys programme.

But it reflects a common interest between the tax authorities and bodies representing law-abiding, taxpaying businesspeople, who are at a competitive disadvantage against those doing under-the-counter jobs.

Shewan advocates a tax amnesty to allow erring taxpayers who would prefer to re-enter the tax system to do so.

The severity of the penalties regime and the use-of-money interest regime put them off, he said.

Butler did not reject the idea out of hand.

"If it is seen in a particular industry that it might move things forward we would be prepared to raise it with the Government. It's their decision because the law would have to be changed."

But any benefits in an amnesty would need to be weighed against the adverse reaction from compliant taxpayers, who had done the right thing.

IRD has also argued in the past that an amnesty would set a dangerous precedent; if taxpayers thought there would be amnesties they could afford to relax.

Butler and Shewan agree, however, that part of the burden of protecting the integrity of the tax system rests with tax accountants.

"The decision to help clients evade their income tax by deliberately not disclosing a portion or all of their profits would not be a choice made by people in this audience," Butler told the conference.

"Similarly, the tax profession makes choices about advice it gives to taxpayers on participating in aggressive tax planning or tax schemes ... I am sure the pitfalls and risks are described, as well as the possible penalties which may be imposed."


The integrity of the tax system requires the IRD to be fair, impartial and respect the confidentiality of taxpayers' affairs.


It also requires taxpayers to comply with the law.
Public confidence in the integrity of the tax system has taken a hammering in recent years, with the Winebox saga and the 1999 parliamentary inquiry which followed claims that IRD heavy-handedness in debt collection had driven a taxpayer to suicide.


While the inquiry did not endorse, or explicitly reject, the proposition that there was a culture of punishment and fear within the department, the select committee did conclude that an attitudinal shift from senior management was required.


"It does appear to have prompted changes within IRD," Shewan said.


But his appraisal of the overall integrity of the tax system would only be five or six out of 10.
Butler, unsurprisingly, puts it higher at about eight out of 10.


Since he became commissioner the IRD has issued a taxpayer charter, setting out their rights to confidentiality, reliable advice and consistency.


A code of conduct for IRD staff followed that.
Butler said that among tax authorities IRD ranked among the lowest for cost of collection.