Penalties for agents' errors wrong say tax practitioners

By BRIAN FALLOW

Inland Revenue is under fire for proposing penalties for taxpayers if their tax agents fail to display reasonable care.

A Government discussion document on taxpayer compliance and penalties puts forward a more forgiving regime for treating tax debts in cases of hardship. The measures are seen as taxpayer-friendly, if overdue.

But the document also includes proposals that have raised tax practitioners' hackles:

* One is the idea that taxpayers should be liable for shortfall penalties even when it is their agent's fault, which is seen as ignoring, and even undermining, the benefit the IRD derives from people using tax agents.

* Another is to drop the requirement that any information the IRD seeks be "necessary or relevant" for enforcement of the tax laws.

* And a proposal to penalise "promoters of tax avoidance schemes" is seen as having a potentially chilling effect on many activities the "knowledge wave" is supposed to foster.

Shortfall penalties apply when taxpayers breach one of five standards of behaviour - ranging in culpability from not taking reasonable care to evasion - and pay less tax than they are legally required to.

The IRD says that in two-thirds of the cases where there is a shortfall, there is no breach of any of those standards, and no penalty applies.

In another 14 per cent of cases the taxpayer is penalised.

But that leaves about 20 per cent where no penalty is imposed solely because the lack of reasonable care, or even gross carelessness, is on a tax agent's part.

"One of the advantages to a taxpayer from employing a tax agent should be a significantly reduced risk of penalties as a result of the care and skill of that tax agent," the discussion paper says.

"In fact the reverse is true: there is an incentive to employ tax agents who take less care and so can offer a lower (but incorrect) tax liability."

Not all tax agents are members of professional organisations, it notes.

It proposes that the taxpayer should be liable for shortfall penalties (20 per cent of the shortfall, in cases of lack of reasonable care) even when it is the agent's fault.

But it says that option is sustainable only if the agents then take responsibility for their acts. If they do not, the next best option would be to hold agents directly responsible.

"The IRD is just being lazy," says KPMG tax partner John Cantin. "If the issue is the quality of agents, the appropriate response would be to look at the qualifications for agency status - which are not particularly onerous - rather than saying: 'We will hit you if your agent makes an error'."

The tax system's reliance on voluntary compliance is in practice a reliance on agents, Mr Cantin says.

"The regime as it stands encourages people to use agents, in the expectation that they know the law and will get it right. That is preferable from the Government's point of view to dealing with individual businesses who may or may not know what they are doing.

"But if you are going to get hit with a shortfall error, if it's the agent's error, is there any incentive to use an agent?"

If not, he says, the IRD needed to think about what that would do to the quality of tax returns, and the costs of administering the tax system.

PricewaterhouseCoopers partner John Shewan objects to the proposal to drop as superfluous the "necessary and relevant" requirement from the IRD's information-gathering powers.

A 1992 Court of Appeal ruling interpreted the words and made it clear they had significant meaning, he says.

"Even if the requirement for the IRD to behave in a bona fide way effectively means the same thing. What is the harm in leaving those words there?"

If the words were removed, some tax inspectors would conclude that they could ask for whatever they wanted, whenever they wanted it.

Mr Shewan is also critical of plans to penalise promoters of tax investment schemes where the investment breaches anti-avoidance provisions of the tax laws.

At the moment, if a scheme is considered by the IRD to constitute tax avoidance, the taxpayer is liable to a penalty of up to 100 per cent of the shortfall.

But no penalties are imposed on the promoters of the scheme. The IRD proposes to rectify that.

Mr Shewan says the proposal, framed in terms of any investment which breaches anti-avoidance provisions, would "scare the living daylights" out of responsible people trying to ride the knowledge wave.

"In the past 25 years, we have had very little judicial guidance on what 'avoidance' means, yet we are about to have a promoter penalty regime which uses avoidance as its central turbine."

He says industries like biotechnology, software and film, which figure prominently in plans for a knowledge economy, have complex tax issues associated with them, and often involve losses in early years.

"For that reason, many of the investment proposals in those industries involve considerations of tax avoidance, defined very widely as the alteration of the incidence of tax.

"If you are promoting the development of a biotechnology resource in New Zealand and you know that if the IRD argues it is avoidance you might be penalised yourself, that is likely to slow you up."

The IRD would say that is what binding rulings are for, Mr Shewan says. "Well, 12 months and $50,000 later you may or may not get your binding ruling."

Mr Shewan and Mr Cantin are more complimentary about the discussion paper's proposals on debt and hardship.

Revenue under-secretary John Wright says the new rules will give Inland Revenue more flexibility in dealing with taxpayers' debt problems and will encourage taxpayers to contact the department about debt problems as soon as possible.

"For example, if a taxpayer enters an instalment arrangement for paying off tax debt, late payment penalties will stop as soon as the taxpayer contacts Inland Revenue."

Payment of a tax debt will not be enforced when it would cause un unacceptable level of hardship to the taxpayer.

That includes not being able to afford a basic standard of food, clothing, medical supplies, accommodation, or education for children or dependents.