Mark Keating: IRD interest rate review long overdue

The IRD has been allocated additional funding in order to collect that unpaid tax.

The New Zealand Reserve Bank indicated this week it will keep the official cash rate (OCR) at near historic lows. Inflation is nearly non-existent and domestic economic growth is subdued, so a further cut in the OCR from its present 3.5 per cent remains possible.

Banks are falling over each other to win customers with low home lending rates. While not exactly a price war, competition between lenders ensures borrowers can obtain loans at interest rates for home loans (both floating and fixed for many years) of about 6 per cent. Standard business overdraft rates are below 8 per cent .

In that economic climate it is remarkable that the Inland Revenue Department has bucked the trend and actually increased the interest rate it charges taxpayers on any tax shortfall. From this month the interest rate charged by IRD on underpaid tax rose from 8.4 per cent to 9.21 per cent.

Compared to prevailing home and business lending rates, only high-risk borrowers face higher lending costs than those charged by IRD.

So how does IRD justify this increase?

The short media statement accompanying the increase simply stated: "The rates are reviewed regularly to ensure they are aligned to market interest rates and were last updated in May 2012."

But the statement doesn't explain how the increase is justified when market rates remain low and may yet fall further. So it appears that by increasing its interest rate on unpaid tax, IRD is actually going against prevailing market trends.

Tax legislation stipulates that interest imposed on unpaid tax "is not a penalty". However, both the Law Society and the Chartered Accounting Association have repeatedly complained to IRD that its interest rates are punitive - but to no avail.

Interest charged by IRD must be set under the Act at a rate:

To compensate the Commissioner for being out of the money through taxpayers paying too little tax on the due date, and

To encourage taxpayers to pay the correct amount of tax on time.

By increasing its interest rates this month IRD is charging taxpayers a much higher rate of interest than required to compensate the Government for being out of the unpaid tax. The Government borrows funds by issuing bonds to investors at rates of less than 3.5 per cent. So it is difficult to justify IRD charging interest of more than 9 per cent. It is tempting to suspect this differential has more to do with raising additional tax revenue than compensating for any increased costs from unpaid tax.

This high interest cost often comes on top of the penalty 1 per cent imposed each month on tax that is overdue. Figures provided by IRD confirm the compounding effect of both interest and penalties on unpaid taxes is 26.5 per cent for the first year and 25.3 per cent for each subsequent year the tax remains unpaid.

The cost to taxpayers is crippling. In a recent case, Thompson v CIR, the Court of Appeal noted with alarm how a taxpayer's original GST assessment of $365,000 had increased with interest and penalties to more than $2 million. More famously, the original tax avoidance assessment of approximately $5 million imposed on John George Russell has now compounded to more than $200 million, and is still rising.

In its annual report for 2014, IRD confirmed that interest and penalties make up approximately $3 billion, or almost half of total outstanding taxpayer debt of $6.2 billion.

The IRD has been allocated additional funding in order to collect that unpaid tax. However, it also conceded that "from June 2012, the main driver of the increase [in overdue debt] was penalties and interest charges".

So unpaid tax is not increasing, only the interest and penalties charged on that unpaid tax is causing the total debt to increase.

As a result, the IRD "have started reviewing the implications of our penalties and interest regime, particularly its effect on compliance". Such a review is overdue. The IRD is already profiting unduly from late tax payments, but increasing the interest rate it charges taxpayers simply makes it worse.

Mark Keating is a senior lecturer in tax law at the University of Auckland Business School.