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IR’s Operational Guidelines: Pre-Litigation Settlements

Tax Alert - December 2016

By Campbell Rose and Vyshi Hariharan

Thankfully, plenty of water has passed under the bridge since the days when there was a question as to whether, and on what basis, the Commissioner of Inland Revenue (Commissioner) could “settle” disputes with taxpayers.

In a welcome development, Inland Revenue has recently released guidelines on its operational approach to settling tax disputes prior to litigation commencing, "Operational Guidelines: Section 6A Settlements" (Guidelines) – for a copy of the guidelines, click here.  The Guidelines set out the internal approach taken in exercising the Commissioner’s discretion under sections 6 and 6A of the Tax Administration Act 1994 to settle disputes at any stage up to filing challenge proceedings: this can include prior to the disputes process formally commencing with the issuance of a notice of proposed adjustment.

We commend Inland Revenue for publishing the Guidelines, which in one form or another have been operating (unpublished) for the last nearly four years in practice.  Tax disputes take a very heavy toll on the precious human, financial and other resources of taxpayers, as well as on the Commissioner’s limited resources.  Where there are tenable arguments and taxpayer/Commissioner “agree to disagree”, it is comforting to know that there is some structure around Inland Revenue’s internal decision-making processes in terms of whether a dispute is most sensibly dealt with by resolution on a mutually acceptable basis.

Helpfully, the Guidelines confirm which Inland Revenue staff are authorised to accept or reject a settlement proposal in different circumstances.  Knowing upfront whether you are dealing with the decision-maker is obviously critical for taxpayers seeking to achieve a reasonable resolution of their dispute with the Commissioner.  

The Guidelines also note that the Commissioner should withdraw from the dispute where it is considered that the taxpayer’s position clearly represents the better view of the law.  In practice, we have recently seen Inland Revenue make sensible decisions to “walk away”, for both legal/merits and procedure-related reasons.  Again, this is to be commended: although in our experience it has usually taken the involvement of Inland Revenue staff independent from the investigation team to achieve this.

As a starting point, the Guidelines state that the law should be applied correctly and Inland Revenue should seek to recover all of the tax which is due in those circumstances.  However, it is recognised that this will not always be the case, and so the Guidelines detail the key factors to be evaluated when a settlement is being considered:

Inland Revenue’s resources: The focus here is on the resources necessary to develop the dispute, against the revenue to be gained.  In the Guidelines’ examples, this factor is described as potentially being more relevant where “a historic dispute involving a single taxpayer with little tax at stake and no precedent value is still likely to require significant Inland Revenue resources”; whereas if may be “a more neutral factor where the dispute will not require significant additional resources (e.g. the dispute builds on work previously done by the Commissioner)”.

Likelihood of success in the dispute: Inland Revenue weighs the likelihood of succeeding where there is uncertainty as to the law or facts relevant to a case.  A number of factors are considered, including issues surrounding factual or expert opinion evidence.  The Guidelines note that “there may be uncertainty where the taxpayer’s expert is at odds with (Inland Revenue’s)”.  As with any litigation, there is often not a great deal to be gained for either party where matters descend into a ‘battle of the experts’, assuming that both parties’ experts’ positions are credible (valuation being an obvious example).

Promoting voluntary compliance: Essentially, “a settlement that is too low does not encourage voluntary disclosure”. Probably unsurprisingly, the Guidelines note that the past compliance record and the future compliance of those involved in the dispute can be considered. Other factors taken into account include whether the dispute relates to alleged tax avoidance or evasion, and whether the decision to settle may affect the behaviour of other taxpayers.  In relation to assertions of tax avoidance, our observation is that these can themselves sit in a “spectrum”, and so merely because the Commissioner considers that general anti-avoidance is in issue should not necessarily adversely influence a decision on whether to settle.

The integrity of the tax system: The overarching principle here is the public’s perception about the tax system’s integrity, i.e. whether taxpayers will view the Commissioner’s approach to settlement as reasonable, overly lenient or unduly harsh.  The Guidelines acknowledge that where a settlement is rejected which is comparable to another that was accepted in relation to a materially similar dispute, in order to maintain integrity, appropriate reasons would need to be provided.  Of course, however, Inland Revenue will keep terms of specific settlements confidential in the interests of taxpayer secrecy.

Precedential value of the dispute: The Guidelines note that where Inland Revenue consider that a “dispute will formally or indirectly determine the Commissioner’s position in relation to either a number or category of taxpayers or of the issue generically, then it is often not desirable that such a dispute should be settled”.  Further the Guidelines state that where the law is unclear and obtaining clarity on the law will promote voluntary compliance, Inland Revenue may pursue a dispute.  While in principle it is understandable, and probably quite laudable, that Inland Revenue may pursue a dispute in the interests of clarifying the law for the general body of taxpayers, this would be more acceptable if New Zealand had a funded test case system, and the litigation process was quicker.  The tax disputes process is not for the faint-hearted, be they individuals, privately-owned businesses or multi-national corporates: it is expensive, time-consuming and materially disruptive.  This means that falling into the category of a case with “precedential value” (sometimes quite by accident) more often than not results in burn-off and taxpayer-adverse settlements, rather than a principled development of the law.

Quantum of tax in dispute: Predictably, the amount of tax involved is also considered, and the greater amount of revenue at stake the more compelling the other reasons for settlement need to be.  This factor often feeds into the other criteria, such as “Inland Revenue’s resources” above.  

Taxpayer’s capacity to pay: It is relevant to consider whether Inland Revenue would eventually recover the full tax where a settlement with the taxpayer for a reduced assessment and the payment of that assessment now may increase the revenue collected - compared with an assessment and payment in the future without the settlement in place.  

The Guidelines also confirm Inland Revenue’s general policy to not accept the use of income tax losses to settle disputes (i.e. only in limited circumstances).  While the commentary on this area is insightful, anecdotally we have not seen Inland Revenue acting consistently in this area.  

Nor have we seen consistently sensible approaches taken to settlement discussions more generally.  In one case, Inland Revenue’s Disputes Review Unit (DRU) found that no unacceptable tax position penalty should apply (i.e. the taxpayer’s position was “about as likely as not to be correct”) – but Inland Revenue inflexibly insisted in settlement discussions that only 10% of a GST refund should be paid out.  In another case, Inland Revenue’s representative in settlement discussions sought to revisit the DRU’s findings, and even suggested (once challenge proceedings were on foot) that a section 17 notice should be issued to gather further information.  So it does appear that some focus on adopting principled and consistent approaches in settlement negotiations is an area that could be improved upon within Inland Revenue.

There is also discussion in the Guidelines surrounding the role of Facilitators in the conference phase of a dispute. Although Facilitators are trained in mediation techniques, and thereby seek to help the participants understand their respective positions, in our experience this rarely assists in moving disputes towards what in many cases should be principled settlement discussions.  We do wonder whether more use could be made of this valuable independent insight, where there are obvious candidates for settlement.

 

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