Inland Revenue’s 2014 Annual Report: some reading between the lines

By Virag Singh and Jesse Pene

Introduction

Inland Revenue (IR) recently released its annual report for the year ended 30 June 2014 (the report).  Consistent with previous years, IR has continued to focus on achieving more of its performance targets, operating more efficiently, recovering more debt and winning more cases.

The report notes that IR is making tax simpler, more open and more certain.  There has been an emphasis on building a tax system for the future as IR simplifies and streamlines the tax system, transforms tax policies and makes use of new technology to modernise the tax system.

We have outlined some highlights from the report, as well as commenting on some areas where the arguably more interesting points are to be drawn from what the report does not say, rather than what it does in fact state.

Key facts and figures

Key facts and figures noted in the report include:

What the report tells us

Overall, the statistics convey that IR is becoming more efficient and more successful in its investigation activities.  Achieving more of its performance goals compared to last year and turning around rulings relatively quickly paints a positive picture as a starting point.

Efficiency

Efficiency is evident in the return on investment (ROI) figures as reported.  ROI did vary across activities, however the returns have been generally very positive.  These figures may indicate that taxpayers under investigation are more or less likely to concede, or to reach an agreed outcome (with some tax to pay), depending on the nature of the investigation and the issues covered.  ROI has been greatest at the sharpest end of the spectrum (aggressive tax planning) and this reflects an environment in which IR has been winning on avoidance cases in the courts.  However, given the size of the hidden/cash economy, it does raise the question of whether greater ROI could be achieved in that area – recognising that the costs of detecting and collecting outstanding liabilities may be greater in relation to wholly non-compliant taxpayers.

IR has also been able to create efficiencies by entering into information sharing agreements with other government agencies, including the Department of Internal Affairs, New Zealand Customs, Ministry of Education and Ministry of Social Development.  By sharing information with other agencies, IR has been able to easily check whether individual taxpayers are paying what they are required to (and getting what they are entitled to in terms of assistance).

Success

The statistics also tell us that IR has been even more successful on the disputes front recently, which is reflected by the Commissioner’s 83.3% win rate in litigation.  IR’s success is also illustrated by out-of-court settlements of $355.8m, relating to the use by taxpayers of optional convertible notes, which the Court of Appeal had ruled to be tax avoidance.  Eleven other companies agreed to be bound by the outcome of the Alesco proceedings because of their similar use of optional convertible notes.  This shows that IR is effective at implementing “project-type” investigations and co-ordinating investigations resources across the board in circumstances where similar arrangements have been entered into by various taxpayers, and even when the legal principles relied on may not be fully settled.  

IR has also experienced success by identifying $49m of discrepancies from the “hidden economy”, with a key focus on the hospitality, construction, inbound tourism and independent contracting sectors.  The more than $1bn of investigation discrepancies identified in the 2014 year is also a sizeable contributor to the annual statistics.

Customer satisfaction

In addition to the above, the report notes that 85% of taxpayers dealing IR by phone and correspondence are satisfied with IR’s service.  A recent IR Satisfaction Survey conducted by Colmar Brunton confirms that there is overall increased satisfaction with IR.  At face value it seems IR has performed exceptionally well in respect of both its KPIs and in terms of customer satisfaction, but the question remains; does the report paint the full picture?

What the report does not tell us

Arguably, what is omitted from the report can be just as insightful as what is covered. 

Unreported disputes-related statistics

The report notes that 83.3% of court judgments found in favour of the Commissioner. 

What the report does not provide, however, is the number of cases that were abandoned due to taxpayer burn-out/fatigue (i.e. taxpayers settling solely to avoid any further disputes or challenge proceeding costs).  The statistics also do not confirm the number of cases which did not ultimately progress through to our courts.  These include cases that were settled at the “conference” stage – whether for or against the taxpayer – as well as instances where the Disputes Review Unit found in favour of the taxpayer.

Unfortunately it remains the case that, in its current form, the disputes process is weighted in favour of the IR.  We are aware of cases where taxpayers have agreed to settle during the disputes process, not based on a principled application of relevant law, but rather due to the costs and business disruption that a prolonged disputes process (and, in some instances, aggressive investigators) brings.  We are also encountering scenarios where IR is expressly relying on decisions made by its Disputes Review Unit to justify its position, which in the absence of a publication of redacted Disputes Review Unit reports leaves taxpayers with a significant information imbalance and therefore difficulty in fully assessing the risk profile of their own position.

Stunted tax law jurisprudence

The abandonment of either the disputes process or appeals through the courts (and the non-publication of Disputes Review Unit decisions) has led to a risk that tax law is not developing as fully or effectively as it could.

One example is the area of penalties, where it is reasonably widely accepted in the tax adviser community that the courts have yet to deal effectively with the abusive tax position penalty in a case involving an assertion of tax avoidance by IR.  Another example is the curious judgment in Concepts 124 Limited v CIR, which has not been appealed and has arguably left the law in an unsatisfactory state where parties may be associated with each other for tax purposes despite having no real or substantive connection (and, most likely, not even being aware that the other exists).  Perhaps it is timely again for officials to consider the development of an effective test case regime although of course, apart from design issues, the question of funding such a system is potentially challenging in the current fiscal climate.

Penalties

Another interesting area not dealt with by the report is the application of shortfall penalties.  A separate report recently released by officials noted that IR identified 5,245 cases of tax shortfalls during the 30 June 2013 year (up from 4,158 in the prior year), of which 1,736 cases (33%) were actually subjected to a tax shortfall penalty.  

Our experience suggests that penalties are still being imposed without proper consideration and application of relevant tax law, and in some instances do appear to be utilised as a tactical measure in terms of what may be ‘conceded’ by IR as part of settlement discussions.  In particular we are seeing some investigators applying the abusive tax position penalty in cases where the threshold of unacceptable interpretation arguably has not been met (or the analysis in that regard is scant or poorly supported from a legal/factual perspective).

Future areas of focus

In addition to the report, IR has also recently released its Compliance Focus document for the 2014/2015 income year.  

This document notes that IR will continue its focus on investigating aggressive tax planning arrangements, including an increased interest in the use of trusts in tax planning, particularly structures involving trusts that do not appear to make commercial sense, and that deliver “unusually favourable tax advantages”.  There will also be a focus on high net worth individuals and tax issues associated with residential property trading and one-off speculation.  This focus comes as no surprise.  It essentially confirms IR’s continued scrutiny of areas where significant discrepancies have been identified in the report, and presumably those where greatest ROI has been achieved to date (which, again, is to be expected from a Government department with limited resources).

Summary

IR’s Annual Report is a welcome document which provides transparency on how funds are used to generate tax revenue. 

IR’s drive to simplify and streamline the tax system, and transform tax policy, business process and customer services, is certainly commendable. 

However, reading between the lines of the report, there remains plenty of food for thought and areas for future focus.

December 2014 Tax Alert contents

• Inland Revenue’s 2014 Annual Report: some reading between the lines
• Briefing for the Incoming Minister of Revenue
• New Zealand Revenue Minister releases update on taxation of multinationals
• The Commissioner’s power of reconstruction: No day at the beach for taxpayers
• What are the tax compliance issues that Inland Revenue is focusing on?
• VAT on Supplies of Services to the EU