Amending return errors: Taxpayer friendly High Court ruling

By Virag Singh and Brad Bowman

Section 113 of the Tax Administration Act 1994 (section 113) gives the Commissioner of Inland Revenue (the Commissioner) the power to “amend an assessment as the Commissioner thinks necessary in order to ensure its correctness”. The recent High Court case of Westpac Securities NZ Limited v Commissioner of Inland Revenue (Westpac case) considers the application of the Commissioner’s power to amend assessments under section 113.

Background
Westpac Securities NZ Limited and Westpac Trust Securities NZ Limited (profit companies) had operations in the United Kingdom. In accordance with the tax laws of the United Kingdom, the profit companies both paid tax on the profits derived from their United Kingdom operations. These companies were also required to file their New Zealand income tax returns within six months of the end of its financial year. However, at the time of filing their New Zealand tax returns, final details regarding the tax paid in the United Kingdom were not available. As such, the New Zealand tax returns were filed without claiming a foreign tax credit for tax paid in the United Kingdom.

The Income Tax Act provides for an irrevocable election for one company to elect to make losses available to another company within the same group. In this case, four companies within the Westpac group (loss companies) elected to make losses available to the profit companies. This loss offset had the effect of eliminating any taxable income of the profit companies.

Upon finalising their United Kingdom tax obligations, the profit companies did not have any taxable income to utilise foreign tax credits for overseas tax paid. The profit companies were now unable to utilise the foreign tax credits that would otherwise have been available.

The Westpac group subsequently asked the Commissioner to exercise her power under section 113 to amend the income tax returns by reversing the loss offsets made to the profit companies to allow for the utilisation of foreign tax credits. The Commissioner declined this request for the following reasons:

•  Allowing such a request would not be consistent with Inland Revenue’s published Standard Practice Statement 07/03 – Requests to amend assessments (“2007 SPS”) because the loss offsets made by the loss companies did not constitute a “genuine error” and did not fall within her power of amendment under section 113; and
• That because the loss offsets are “irrevocable” neither the taxpayer nor the Commissioner could revoke a valid election.
  

This was an application for judicial review by the Westpac Group seeking a declaration that the Commissioner was able to amend the relevant assessments and an order requiring the Commissioner to reconsider Westpac’s request.

Outcome and reasoning
Section 113 gives the Commissioner the power to amend a taxpayer’s assessment “in order to ensure its correctness”. In assessing the first reason given by the Commissioner in declining Westpac’s section 113 request, the High Court held:

1. The wording of section 113 contains no reference to an error being a requirement for the exercise of the Commissioner’s power.
2. The definition of “correctness” goes further than merely being free from error; rather the ordinary meaning is “free from error; accurate; in accordance with fact, truth or reason”.
3. An assessment being free from “genuine error” does not preclude amending the assessment to ensure it is the most appropriate for the situation.
4. The broader application of section 113 is supported by case law.
   

The High Court held that the scope of section 113 is wider than instances of “genuine error”, as currently prescribed in the 2007 SPS.

Regarding the Commissioner’s secondary reason for declining Westpac’s section 113 request, the High Court said, while a taxpayer is precluded from revoking an irrevocable election, there is nothing preventing the Commissioner from amending an irrevocable election.

Clifford J of the High Court held that the Commissioner had, in her 2007 SPS, erred in her interpretation of section 113. The High Court went on to say that the Commissioner may exercise her discretion under section 113 to correct Westpac’s returns; however whether the Commissioner considers that she should exercise her discretionary power was a matter outside the scope of this case.

At [62] of the judgment, Clifford J went on to say:

… it is difficult to see why amending an assessment in a manner which results in an outcome clearly available under applicable tax legislation is necessarily problematic simply because it is more favourable to a particular taxpayer.

We wish to emphasise that, while the High Court held the Commissioner may consider using her powers under section 113, her powers are still discretionary and there is no guarantee that the Commissioner will amend assessments on this basis.

Standard practice statement
In the 2007 SPS, the Commissioner set out situations in which she will and will not use her powers under section 113. It is worth noting that in early-2014 the Commissioner released an updated draft standard practice statement (draft SPS) for public consultation. This draft SPS was largely the same as the 2007 SPS, however its finalisation has been put on hold pending the outcome of the Westpac case.

Under the 2007 SPS and draft SPS, the Commissioner said she will not amend assessments under section 113 in the following cases:

• Regretted choice – this situation arises when a decision is made to use a certain tax policy, but retrospectively it is discovered that using another legitimate option would have led to a more (or less) favourable outcome.
• Disputed law – occurs where the taxpayer wishes to change their assessment based on a disagreement with the law.
  

Conversely, the Commissioner will amend assessments under section 113 where the taxpayer has made a genuine error. These primarily arise through accounting errors and oversights.

Having disagreed with the Commissioner’s interpretation of section 113, it is clear that the outcome in the Westpac case is contradictory to the Commissioner’s standard practice as outlined in the 2007 SPS and draft SPS. The High Court has concluded that the Commissioner could use her power under section 113 to correct the returns of a taxpayer where there was no genuine error. This means instances where the Commissioner can legally amend assessments under section 113 extend beyond instances currently prescribed by the 2007 SPS and draft SPS.

Deloitte comment
Overall this is a positive outcome for taxpayers and confirms that section 113 has a wider application than what the 2007 SPS and draft SPS allows for.

While the Commissioner is likely to argue that the outcome of the Westpac case was one-off and fact dependent, we believe this ruling alters the focus of section 113 requests. Rather than the Commissioner focusing on whether a “genuine error” was made, the focus should be placed on whether the return is “correct” (i.e. whether the return was the most appropriate for the situation).

We wait with interest to see how this case is reflected in the updated SPS and whether it will expand the instances where the Commissioner can legally amend assessments under section 113. At the end of the day, the right to amend assessments is entirely at the discretion of the Commissioner. The ball is still in Inland Revenue’s court in regard to section 113 requests, and even with a legitimate argument, a request may still be denied by the Commissioner. That being said, it is also the Commissioner’s duty to uphold the integrity of the New Zealand tax system which equates to equitable treatment of taxpayers’ requests. While the power remains at the Commissioner’s discretion, this discretion can be challenged via a judicial review.

For taxpayers that find errors subsequent to filing returns, there are a few options available. The choice depends on the quantum and type of the adjustment and the length of time between filing the return and finding the error. If for example, the error is discovered within 4 months of filing the tax return, the need to rely on the Commissioner’s discretion under section 113 is avoided as the taxpayer is able to file a notice of proposed adjustment. When the tax payable as a result of the error is $500 or less, there is an option to correct the error in the next return.

The key message is not to delay if you believe you have discrepancies in current year returns filed or prior year returns that may require an amendment. Please contact your usual Deloitte tax advisor to discuss what options are
 

March 2015 Tax Alert contents

New Tax Bill introduced

GST and Bodies Corporate

"Cash out" of R&D tax losses

Amending return errors: Taxpayer friendly High Court ruling

Consultation sought on related party debt remission

Tax treatment of life insurance policies

Draft re-issue of rulings for interest deductibility