Report to the Treasurer and Minister of revenue - by a committee of experts on tax complianceBill Birch Treasurer
Report to the Treasurer and Minister of revenue
By a committee of experts on tax compliance
CHAPTER 8 -
8.1 In this chapter, the committee looks at the role of disclosure in a self-assessment environment. Self-assessment relies on taxpayers voluntarily meeting their tax obligations. This concept is recognised in section 15B of the Tax Administration Act 1994, which sets out taxpayers' primary obligations, and clearly spells out that taxpayers are required to determine the amount of tax payable correctly and to pay it on time.
8.2 Disclosure in this context serves two main purposes. First, it is necessary to provide information for audit selection. Secondly, disclosure is relevant to the issue of the abatement of penalties.
8.3 Taxpayers have a statutory obligation to disclose to the Commissioner in a timely and useful way all information required to be disclosed under the tax laws139. Disclosure here covers items specifically required to be disclosed by statute140, and items for which disclosure is required by the Inland Revenue Department. For income tax, under section 33 of the Tax Administration Act 1994, the department requires a complete statement of the taxable income of the taxpayer for the preceding year, together with such other particulars as may be prescribed. The department's disclosure expectations cover any requirements set out in a particular tax return, in the guide accompanying a particular tax return, or matters for which a specific disclosure form is prescribed. The Commissioner can also require specific taxpayers to disclose particular information under provisions such as section 17 of the Tax Administration Act 1994. These categories are referred to below as required disclosures.
8.4 The committee recommends that section 15B(e) of the Tax Administration Act 1994, which states that taxpayers must disclose to the Commissioner in a timely and useful way all information required to be disclosed under the tax laws, should be amended to identify the different categories of required disclosures: information specifically required by statute, information required by the department in a prescribed form, and information requested by the department from specific taxpayers.
8.5 Generally, apart from required disclosures, taxpayers are not obliged to disclose information, but anything that is disclosed must not be misleading. Sanctions may be imposed for deliberately misleading disclosures, and taxpayers open themselves up to the risk that a deliberately misleading disclosure could suggest tax evasion on their part.
8.6 An intent to evade may also be inferred from a failure to disclose relevant information to the Commissioner141. The risk also arises that defaults of this nature may preclude the application of a time bar.
8.7 Even for required disclosures, some real issues arise, including the way in which the obligations to disclose are affected by e-filing procedures, and the use of e-filing under self-assessment. In practice, under e-filing, it appears that the Inland Revenue Department accepts that if the approved software does not ask for the information, it is sufficient that the information is on the taxpayer's own files and available for examination by the department.
8.8 This acceptance leaves open, however, whether, and to what extent, availability must be within a reasonable proximity to the taxpayer's own tax-file. Many advisers insist on forwarding to the Inland Revenue Department hard copies of documents making any required disclosures not accommodated by the e-filing software, to avoid any risk the department will state later that disclosure was not made as required. Clearly, that taxpayers and their advisers consider they may have to act in this way is unsatisfactory, as it defeats the benefits in efficiency contemplated by e-filing.
8.9 Disclosure requirements must be consistent with self-assessment. Generally, at the time the return is filed, the Commissioner will be given only information that is necessary for the Inland Revenue Department's audit selection process. The committee recognises, therefore, that business taxpayers should keep information on file to assist Inland Revenue Department investigators if they are selected for audit.
8.10 The requirement for disclosure differs between groups of taxpayers. For example, before the recent reforms, only minimal disclosure was necessary for wage and salary earners, because the department already had the necessary information about this group from their employers. Audits of large corporations are ongoing and, therefore, for the purposes of audit selection, disclosure is not necessary. Disclosure mainly affects small and medium-sized business enterprises.
8.11 The committee has no doubt that with the introduction of full self-assessment procedures the government will address issues of disclosure. However, the committee would encourage the department to focus not only on the information that it needs to process tax assessments, but also on ways in which the department can be kept informed of issues relating to individual taxpayers that may be relevant to its audit selection, and on ways in which the department might assist taxpayers in suitably recording all key information on tax positions taken.
8.12 The committee considers that the government should recognise, when developing new disclosure requirements, that the move to self-assessment places significant obligations on taxpayers, the importance of which are reinforced by the penalties provisions. The government should also recognise that if the Inland Revenue Department wishes to be informed of particular situations, arrangements, or matters affecting the tax position of a taxpayer, under modern assessment processing procedures the department must use specific disclosure requests or pursue specific initiatives.
8.13 The Organisational Review of the Inland Revenue Department in 1994 identified that the tax system in New Zealand already operated substantially by means of self-assessment by which individual taxpayers are required to determine their own tax liabilities and account for them to the Commissioner.
8.14 In many situations, however, the law is drafted in such a way as to require the Commissioner to make the assessment. This system requires taxpayers to provide information that is then used to assess their liability. The key difference under self-assessment is that taxpayers are required to interpret the law, apply that law to their circumstances, and assess their own liability.
8.15 The government is considering the introduction of a comprehensive self-assessment system. As a result, it is timely to consider the purpose of the tax return in a self-assessment environment.
8.16 An annual tax return can be viewed as having one main purpose - it is the method by which taxpayers inform the Commissioner how much tax they are required to pay. This return allows the Commissioner to check that that stated amount of tax has been paid and, if not, to impose a late payment penalty.
8.17 Beyond this, a tax return can be a method of communicating with taxpayers, allowing taxpayers to update their personal details, and collecting information for forecasting and audit purposes. Also, tax returns, as they are designed at present, may educate taxpayers by leading them through the steps required to determine their tax liability.
8.18 A final indirect purpose of the tax return is to provide information for statistical purposes. This purpose is likely to become increasingly important as the emphasis on reducing compliance costs across the public sector places pressure for information to be collected only once.
8.19 The committee recommends that the department should consider reviewing each of the purposes of the tax return to decide whether the return remains the most appropriate vehicle for these functions. It may be that the tax return could simply be a pay-in slip, with the other purposes of a tax return being dealt with independently.
8.20 The committee looked at whether different levels of disclosure could be applied to different classes of taxpayer. For example, for large taxpayers with more sophisticated systems, disclosure of accounting information may involve little more in compliance costs than limited disclosure. Therefore, the committee considers that the review suggested should be coupled with a consideration of the application of increased use of technology. Technology provides many opportunities for low-cost high-volume transfer of information. The committee recommends that the Inland Revenue Department should examine the application of technology to its disclosure requirements.
8.21 If the government adopts the recommendation to review each of the purposes of the tax return, this review should be undertaken in conjunction with a consideration of the records that taxpayers must keep under self-assessment. Otherwise the risk arises that the information required by the Commissioner to verify an assessment made by a taxpayer will not be available. The committee recommends that such a review should be undertaken at the same time as the review of return filing obligations.
8.22 The committee also considers that if record-keeping requirements are increased, taxpayers should receive some education on the necessity for those requirements. To help in this matter, the committee notes that it would be eminently worthwhile to encourage taxpayers on their own initiative to record relevant information considered by them in adopting a particular tax position.
8.23 The committee suggests that the Inland Revenue Department should prepare forms designed to help taxpayers focus on the right issues, thereby reducing the risk of inadvertent error or omission. It remains for the Inland Revenue Department to identify the areas of tax compliance where the use of prescribed forms may yield the greatest dividends both for taxpayers and government. However, three areas which immediately suggest themselves as candidates for prescribed information forms include the approaches taken to tax aspects of the valuation of trading stock, the disposal of real property, and the disposal of shares. The committee considers the benefits of this concept apply more broadly and similar forms should be developed for all taxes, where such a need arises.
8.24 The committee envisages that these forms would be used by small taxpayers, mainly those without a tax agent. These forms would both guide taxpayers through the activities outlined above and would, if retained as the committee hopes, provide a permanent record, should the taxpayer be audited. Many tax agents may also find it prudent to complete and retain these forms as part of their evidence of having taken reasonable care. The committee considered recommending legislating for the preparation and retention of these forms, but taking into account the diversity of taxpayers' accounting systems and approaches, the committee concluded that the best approach was to consider methods of encouraging the use of the forms. The committee notes that failure to maintain on file either prescribed information forms or forms setting out tax positions would not imply lack of reasonable care of any other tax default. Retaining these records would reduce uncertainty, which might otherwise arise as to taxpayers' actions.
8.25 The committee, therefore, recommends that the Inland Revenue Department should prepare and send out to taxpayers, or where appropriate their agents, forms which guide them through their key annual income tax activities, and also act as a record for audit purposes. In forwarding the forms to taxpayers, the Inland Revenue Department should inform recipients of the benefits of completing and retaining the forms in fulfilment of expectations as to the exercise of reasonable care and other taxpayer performance standards.
8.26 As the committee has noted, proper disclosure is fundamental to the tax system. Limitations on the time and resources available to the committee precluded it making a detailed examination of this area. However, the disclosure expectations required by the tax system have to be married with the features and needs of the self-assessment process.
8.27 The whole issue of disclosure is of sufficient importance to be a matter for informed public debate. As the matter is one which is all-pervasive, the committee recommends that the issue should be considered as part of the review of penalties to be conducted in 1999. This review will involve public consultation.
8.28 The committee notes that under the law at present, different levels of culpability lead to different penalties. Significant reductions in penalties occur where taxpayers disclose their tax positions to the Commissioner before the tax shortfall is identified on audit or otherwise. Shortfall penalties are reduced by 75 per cent for voluntary disclosure before notification of an audit, and by 40 per cent for voluntary disclosure after notification of an audit but before the audit starts142. A shortfall penalty payable by a taxpayer for having an unacceptable interpretation or having taken an abusive tax position is reduced by 75 per cent if adequate disclosure is made at the time of filing the tax return143.
8.29 The committee favours increasing the incentives in the penalties provisions for taxpayers to disclose information as this seems the best way to encourage taxpayers to disclose doubtful positions before they are audited. This proposal may involve both greater reductions in penalties and increased levels of penalties in certain cases, for example, when a taxpayer takes an abusive position. The committee concluded that the best way to encourage taxpayers to be open about their tax affairs would be to develop the penalties provisions further by providing relief from shortfall penalties when appropriate disclosures are made by taxpayers.
8.30 In principle, a self-assessment system focuses on taxpayers making their own decisions on the tax positions they take. An objective is to avoid deluging the Inland Revenue Department with information which it does not need in order to carry out its functions. However, it remains appropriate that taxpayers are open about the tax positions that they take, particularly when they may be uncertain.
8.31 A compromise appears necessary. That compromise must focus on the need for the Inland Revenue Department to be made aware of matters of real potential significance, and for other information to be held on file for ready examination by the Inland Revenue Department during any audit or inquiry. The catalyst for achieving the objective would be the provision of further relief from penalties in situations where the taxpayer has taken all steps reasonably required in a self-assessment system.
8.32 As the committee has noted, proper disclosure is fundamental to the tax system. The issue is of sufficient importance to be a matter for informed public debate. The committee has not had the opportunity to develop its ideas to the extent it would have liked. However, the committee believes that the principles it has outlined form the basis for developing a workable solution to the important matter of disclosure by taxpayers. The issues should be considered as part of the planned penalties review in 1999.
8.33 The committee recommends that, among other issues, the penalties review should include consideration of:
The concept of encouraging the retention on file of particulars of tax situations and their rationale if some uncertainty is involved.
The issue of requiring disclosure if the tax at risk in a tax position exceeds a specified threshold. Such disclosure would be required to be accompanied by sufficiently informative statements on the tax situation at issue and the tax position taken.
The role of record-keeping versus disclosure to the Commissioner and the appropriate treatment of such disclosure.
139 Section 15B(e), Tax Administration Act 1994
140 For example, statutory elections required to be disclosed and details of subvention payments.
141 An intent to withhold information lest the Commissioner should consider the taxpayer liable to a greater extent than the taxpayer is prepared to concede may constitute evasion: Denver Chemical Manufacturing v Commissioner of Taxation (New South Wales) (1949) 79 CLR 296.
142 Section 141G, Tax Administration Act 1994
143 Section 141H, Tax Administration Act 1994