Report to the Treasurer and Minister of revenue - by a committee of experts on tax compliance

Bill Birch Treasurer

Report to the Treasurer and Minister of revenue

By a committee of experts on tax compliance

Chapter 12 -
Role of the penalties provisions in a self-assessment environment

12.1 The tax system involves the participation of hundreds of thousands of taxpayers, their agents and advisers. It is not practical for tax administrators to scrutinise and assess every individual tax return received each year and, like other modern tax administrations, the Inland Revenue Department has begun to rely increasingly on self-assessment to administer tax collection. The movement towards self-assessment of tax liabilities reflects the view that taxpayers are in a much better position than tax administrators to assess their tax liabilities, so long as they are given sufficient assistance and incentives to comply.

12.2 A self-assessment system relies heavily on taxpayers, who must take their obligations seriously and perform the various tasks required of them honestly and with reasonable care. Although most people do their best to comply voluntarily with their tax obligations, some do not. Taxpayers may fail to meet their obligations in many ways, ranging from honest mistakes through to negligence, tax avoidance and tax evasion.

12.3 Some administrative measures have improved compliance. New disputes resolution procedures aim to provide prompt and efficient resolution of disputes and to avoid expensive litigation. The design of withholding systems is intended to limit the potential for non-compliance. There is an increased Inland Revenue focus on education of taxpayers. Clear laws should help ensure that obligations are well understood. Improved audit strategies aim to increase the likelihood of detecting non-compliance.

12.4 Although the committee accepts that these measures all contribute to the success of a system based on voluntary compliance, the committee does not consider that they are sufficient by themselves. They must be reinforced by an effective statutory system of penalties, which provides taxpayers with the appropriate incentives.

12.5 The committee has reviewed the findings of the penalties study commissioned by the United States Internal Revenue Service in 1989191. The key findings of the study highlight the importance of penalties in a self-assessment environment. The study found that penalties can encourage those taxpayers who do not comply to do so, and can encourage those taxpayers who do comply to continue to do so, first, by setting and validating 'standards of behaviour' expected of taxpayers, secondly, by deterring departures from these standards, and, finally, by providing taxpayers who depart from these standards with their just deserts.

Evaluation of the current penalties provisions

12.6 The committee received a number of submissions on the penalties provisions. One submission suggested that the new penalties provisions should be allowed to operate for some time before consideration is given to changing them. As the government intends to undertake a post-implementation review of the penalties provisions in 1999, after they have been sufficiently tested in practice, the committee considers that it should not make any major recommendations for change. The review will be of great interest and importance to taxpayers and their advisers. The committee would, therefore, like to take this opportunity to raise a number of issues which it believes should be considered by the government as part of the proposed review.

12.7 The committee recommends that the government should specifically require the review team to report on:

whether the government's performance expectations of taxpayers are reasonable;

whether, and to what extent, a past record of 'good behaviour' should be taken into account in deciding to impose penalties or to escalate enforcement;

whether the fairness of the penalties provisions is apparent to all taxpayers, and whether taxpayers who comply can see that those who do not comply are adequately punished.

12.8 The committee envisages that the review team's report will be backed up by substantive evidence from behavioural scientists on the expected impact of alternative approaches. The report should canvas the views across the spectrum of taxpayers, and tax and accounting professionals. The committee also encourages the government to invite one or more tax professionals from the private sector to join the review team.

12.9 In the light of the government's intention to review the operation of the penalties provisions in 1999, after it has been sufficiently tested in practice, the committee recommends that no major changes should be made to the penalties provisions before this review. The committee hopes that the discussion in this chapter will raise public awareness of the penalties provisions and its importance in a self-assessment environment. For this purpose, an outline of the penalties provisions is included at appendix 6


191 United Sates Internal Revenue Service, Report of the Commissioner's Executive Task Force on Civil Penalties, February 1990