NZ has a self-assessment tax system. Taxpayers who derive income from which tax is not fully deducted at source file an annual return of their income and tax liability to Inland Revenue (“IR”). Most tax controversies arise when IR disputes the position returned by a taxpayer, usually as a result of some anomaly detected by audit. However, tax controversies can also be initiated by the taxpayer, when a taxpayer wishes to adjust an earlier tax position or disclose previously undeclared income. Tax controversies can also arise from administrative decisions, such as registration for Goods and Services Tax (“GST,” the equivalent of VAT) or refusal of financial relief. Inquiries by IR, investigations and audits can all give rise to controversy because of IR’s wide powers.
For most NZ taxpayers, tax is collected unobtrusively on their behalf. A “Pay As You Earn” (PAYE) withholding system ensures that employed taxpayers correctly pay tax on wages and salaries, because it is withheld by their employers. Similarly, some contractor payments and all bank interest income are subject to tax withholding. GST is included in the price for most purchases, and levies are included in fuel prices. This results in a system where correct compliance is straightforward and automatic for most taxpayers. Most tax controversy arises in relation to taxes whose collection relies on voluntary compliance by taxpayers, especially company and business taxpayers.
The statutory tax disputes process, which is summarised at 3 Administrative Litigation below, exists both to reduce the instances of tax controversy, and to facilitate resolution when tax controversy does arise.
NZ has embraced BEPS initiatives enthusiastically. It has adopted the updated OECD model tax convention and signed the multilateral convention. It has also legislated an all-encompassing approach to prevent multinationals from aggressively reducing their NZ tax liability. From 1 July 2018, new laws introduced a permanent establishment anti-avoidance rule, strengthened the transfer pricing and thin-capitalisation rules, introduced new rules to tax hybrid and branch mismatch arrangements, and increased IR’s already broad information gathering powers. Restricted transfer-pricing rules for inbound party-related debt were also introduced, departing from the arm’s-length principle in favour of prescriptive interest rate rules aimed at preventing a ‘BEPS risk’. More recently, the Government announced the imminent introduction of a digital services tax aimed at multinational providers of digital platforms in NZ.
It is too early to say how BEPS initiatives will affect tax controversy in NZ. However, it is widely accepted that the new legislation is complex and likely to lead to an increase in compliance issues and costs. Its complexities may well offer avenues for challenge.
In most cases, a taxpayer does not need to pay a tax reassessment before being able to challenge it, although if a taxpayer is unsuccessful in a challenge, late payment penalties and interest will continue to be charged until payment. Where there is a risk of eventual non-payment, IR can require some or all of the tax to be paid. In some extreme cases, IR can apply to freeze assets pending the disposition of a pre-assessment dispute or a challenge. Before being able to challenge a default assessment (ie, an assessment raised in the absence of a tax return), both the relevant return and a Notice of Proposed Adjustment must be filed to provide a threshold explanation of the taxpayer’s position.
Criminal law consequences can arise from non-payment of tax. Civil disputes are normally suspended pending the outcome of criminal proceedings. In these proceedings, whether or not tax has been paid (albeit late) is an important factor in sentencing upon conviction. Criminal proceedings often, therefore, prompt payment even if civil liability has yet to be fully determined.
IR applies its investigation resources carefully. In theory, it may audit any taxpayer subject to a time bar. In reality, however, most taxpayers are never audited – primarily because of the efficiency of the PAYE, withholding and GST collection mechanisms. Structurally, IR focuses on three taxpayer categories: individuals, small-medium enterprises and significant enterprise businesses.
IR uses increasingly sophisticated diagnostic tools to identify taxpayers for audit in each category, together with information from third parties such as banks and the oft-quoted anonymous "tip-off". Public records, social media, business filings and advertising all contribute to "tax intelligence". A poor compliance or payment history can increase the likelihood of an audit, and certain taxpayers and industries that are considered 'high risk' because of their relative ease of suppressing income may be targeted more often. These include businesses trading significantly in cash, such as tradespeople, taxpayers trading in land, and taxpayers with overseas bank accounts. IR may also audit taxpayers in a particular geographic area. As an example, businesses in certain agricultural and horticultural regions may become targets because of the prevalence of tax evasion amongst certain work groups with which the businesses may operate.
High net worth individuals and significant enterprises are a perennial target of IR. For these taxpayers, risk reviews and audit are more likely to be prompted by unusually complex structures, unorthodox financing transactions, uncertainty over compliance by controlled foreign companies and foreign trust structures, transfer pricing or BEPS issues.
IR does not need to give notice of an audit in order to require taxpayers to supply records. For example, IR officers can make unannounced visits to check payroll and GST records. Audits are often preceded by a "risk review", where IR requests information to review, with a view to assessing the risk of non-compliance. If a risk is detected, the taxpayer will be notified that an audit will commence. The formal notification of the commencement of an audit is an important step in relation to possible discounts from civil penalties.
The length of audit depends on the issues and tax types involved, the records to be reviewed, the complexity of the taxpayer’s affairs, the quality of the taxpayer’s records and the co-operation of the taxpayer. Complicated audits may run for several years.
There is no time limit for initiating an audit, but a time bar on IR’s ability to increase a taxpayer’s liability means that an audit must be started and concluded in a timely way. Usually, IR can only increase an assessment within four years of the end of the income year, or other tax period, in which the relevant tax return was filed. Thus, if an income tax return is filed in the year to March 2020 for the income year ended March 2019, an assessment increasing the liability for 2019 cannot normally be made after 31 March 2024. That time bar can be lifted in the case of fraudulent or willfully misleading returns, or if a particular type or source of income was not originally declared.
If the time bar is lifted, there is legally no time limit on IR’s ability to reassess, but administratively IR will not normally reassess for more than ten years. The four-year time bar is generally considered to be positive for taxpayers and IR as it offers certainty for when an assessment will be considered final, but it can also drive an audit to a conclusion when IR wants to prevent an income tax year 'falling out' of time, and that can be disadvantageous. Because of this, a process of time bar waiver applies.
As more taxpayers move to exclusively digital record-keeping, off-site audits have become more common. Taxpayers are often asked to provide digital information (including computer hard drives) as part of an initial information request. When IR makes unannounced visits to obtain records, computer hard drives are routinely copied, subject to steps being taken to protect material that could be subject to claims of legal professional privilege or tax advice non-disclosure. The interrogation of such information, assisted by audit software, allows IR to target later information requests. While this shift to digital audits is underway, many audits are still carried out by exchange of paper documents. Sometimes IR will still review information at a taxpayer’s premises for ease of communication and accessibility of documentation. The questioning of taxpayers may occur voluntarily or compulsorily, with different legal consequences applying in each case. Compulsory interviews will normally occur on IR premises and under oath.
Threshold administrative requirements apply to some aspects of IR’s audit inquiries. For example, a private dwelling may not be entered without a court-issued warrant, and removal of records while IR has access to any premises also requires a warrant. These processes are subject to general law governing search, seizure and surveillance in NZ. Tax auditors must take special care over these matters, and they are also prime considerations for advisers assisting taxpayers under audit. Rights of silence, privilege and tax advice non-disclosure must be respected by IR and, again, are a focus.
IR will usually start by reviewing accounting records, contracts, invoices and bank accounts. IR often contacts third parties, such as accountants, banks, suppliers and employees, if it needs further information. It is worth noting that private activities and information are not 'off limits' in an audit. IR may review private activities and records to substantiate a taxpayer’s correct tax position. In most cases, auditors place importance on meeting taxpayers, including company officers, face to face. This begins as an opportunity to understand the way in which the subject business operates and who is responsible for tax compliance. Such face-to-face dealings can be extensive, though many taxpayers prefer to limit 'exposure' to IR by working through their tax agents or advisers.
NZ has committed to the OECD’s Automatic Exchange of Information (“AEOI”) regime, and the Common Reporting Standard (“CRS”) came into effect in NZ on 1 July 2017. Affected banks and other financial institutions were expected to identify foreign tax residents and report their financial account information for the initial reporting period ending 31 March 2018, due to IR by 30 June 2018. The first exchange of information between the revenue authorities from reportable jurisdictions occurred on 30 September 2018. While likely, it is still too early to know if the new cross-border exchanges of information will increase audit activity. It is more likely that voluntary disclosures will increase, to pre-empt an audit and reduce associated penalties.
The following 12 points summarise some key considerations during a tax audit in NZ.
If a tax issue cannot be resolved informally, it is dealt with under a prescribed statutory tax disputes process. This can loosely be called the 'administrative phase'. Except for certain cases, IR cannot make a new tax assessment until the disputes process has substantially been carried out. This process is designed to refine tax disputes, identify issues, disclose facts and ensure communication between the taxpayer and IR. The aim is to resolve disputes without litigation if possible, but if litigation is necessary, to avoid either side being ambushed. The tax disputes process can be initiated by either the taxpayer or IR and is largely the same, regardless of who starts it. If the tax disputes process does not resolve the issue, the affected taxpayer may litigate the resulting assessment. The process is mandatory in that a taxpayer may not challenge an assessment unless the parties have engaged in the disputes process, at least to the point where their respective positions have been established to a minimum extent.
The tax disputes process follows prescribed steps. Either party will issue a notice of proposed adjustment ("NOPA") outlining proposed adjustments to a tax position and detailed factual and legal reasons for them. The other party then has an opportunity to respond with a notice of response ("NOR"). When the parties disagree, this initial exchange is followed by a conference, often facilitated by a senior IR officer not connected with the case. If the taxpayer opts out of the conference stage (with the permission of IR), or the conference does not reach a satisfactory resolution, then IR will issue a disclosure notice and a statement of position ("SOP") to the taxpayer. The SOP outlines the facts, documentary evidence and law that supports IR’s position. The taxpayer supplies a responding SOP. The disclosure notice triggers a statutory limitation on the issues and the propositions of law that can be contested in any subsequent judicial litigation. Because the taxpayer bears the burden of proving its case, it is crucial at this stage that all appropriate facts, evidence and legal arguments are put forward by it. In most cases, SOPs exchanged by the parties are then referred to IR’s disputes review unit ("DRU") for adjudication. The DRU is independent of IR’s investigators and must decide whether or not the IR position is correct. Should the DRU decide in the taxpayer’s favour, the matter is closed. However, if the DRU upholds IR’s position, the taxpayer may challenge a resulting assessment in the Taxation Review Authority ("TRA") or the High Court, discussed further at 4 Judicial Litigation: First Instance, below. The imposition of penalties in respect of any assessment is discussed at 7 Administrative and Criminal Tax Offences, below.
Although there are strict deadlines as part of the tax disputes process, there is no time limit for it to conclude, apart from the statutory four-year time bar for tax reassessments. In 2018, the average disputes process took 651 days to complete, not including the initial information requests and investigation. A brief summary of the key time periods for the tax disputes process follows, but exceptions and variations are numerous and very fact-dependent. Many of the timeframes referred to below are administrative targets set by IR. Statutory timeframes apply to the exchange of formal notices and statements of position.
If IR is initiating the tax disputes process, it will alert a taxpayer that a NOPA will be issued about five days beforehand, and will confirm receipt about ten days after it has been sent. The taxpayer will be required to file their responding NOR within two months of the NOPA’s issue. IR will confirm if the taxpayer intends to file a NOR about two weeks before the response period expires. If IR considers that exceptional circumstances have prevented the taxpayer from responding in time, then it can deem the response to have been received 'in time' and has a month to issue a determination to that effect or decline to do so. If out of time, the taxpayer is deemed to have accepted IR’s NOPA. The taxpayer’s NOR is otherwise assigned to an officer within about five working days of receipt, and receipt of the NOR is acknowledged within ten. Within a month, IR will advise the taxpayer if the NOR is accepted, rejected, or still being considered. Acceptance at this stage would finalise the tax disputes process and an amended assessment can be issued if the agreed position requires it.
If the NOR is rejected or under consideration, IR can invite the taxpayer to participate in a conference, and to have that facilitated by an independent IR officer. The taxpayer usually responds to this invitation within two weeks, though on more complicated matters this can take substantially longer. The taxpayer has the right to request to opt out of the tax disputes process and proceed straight to litigation by way of a tax challenge within two weeks of the end of the conference phase. IR has three months to decide if it will allow the request to bypass the tax disputes process and proceed directly to litigation. If the taxpayer accepts the invitation to a conference, IR will come back within about two weeks to confirm the structure of the meeting and when it will occur. The conference phase usually takes about three months.
If the conference phase is unsuccessful, IR will usually issue a disclosure notice within three months, and its SOP (although there is no requirement for it to do this within any timeframe). The taxpayer must issue their responding SOP within two months of receiving IR’s SOP; the applicable timeframes can be extended if the circumstances justifying the taxpayer’s delay are sufficiently 'exceptional'. Exceptional circumstances are usually outside of the taxpayer’s control. Failure by a taxpayer to issue a responding SOP within time, without an extension, will result in deemed acceptance of IR’s SOP.
If the SOP is received in time from the taxpayer, IR has two months to provide an addendum to its SOP. The taxpayer can request to add further information to their SOP, at IR’s discretion. Within one month of the addendum, IR will usually determine if the matter will be further escalated to the DRU. The materials to be sent to the adjudicator will be agreed with the taxpayer; if no agreement is reached after ten days, IR will supply the materials to the DRU. Importantly, the DRU considers matters only 'on the papers', and will not independently assess witness credibility.
If IR and the taxpayer cannot reach agreement through the tax disputes process, judicial tax litigation "challenge" proceedings can be commenced by the taxpayer within two months of the relevant tax assessment being confirmed. There is a right of challenge against most decisions of IR following the tax disputes process. However, a taxpayer cannot challenge an assessment without first completing at least part of the tax disputes process. As outlined at 3 Administrative Litigation above, an opt-out request can be made within two weeks of the conference phase ending, so that a challenge can be commenced without completing the disputes process.
On rare occasions, a taxpayer may seek judicial review if IR has reached a decision or exercised a discretion based on irrelevant considerations or without taking relevant considerations into account. Judicial review can also be available where a matter cannot be subject to a tax challenge. Review must be brought in the High Court, as it is beyond the TRA’s jurisdiction. The TRA and the Court generally require a procedural claim to be brought alongside any substantive tax challenge, to avoid the risk of taxpayers artificially 'gaming' the system to delay a substantive decision on tax liability.
The TRA and the High Court (each called a "hearing authority" for tax purposes) are the first judicial forums available to a taxpayer wishing to contest the outcome of the tax disputes process. The TRA is a tribunal that hears only tax challenges. Its proceedings are not open to the public, and published decisions have all identifying details removed. The current TRA is a District Court Judge. The TRA can receive any evidence it considers may assist in its decision, even if such evidence would not be admissible in the High Court. Costs cannot generally be awarded against an unsuccessful litigant in the TRA. The cost of litigating in the TRA can be less than in the High Court, though that is not always so.
The High Court is not a specialist tax court but is the forum in which all significant and/or complex litigation should be heard at first instance. The High Court is not obliged to deal confidentially with tax matters and generally the principle of open justice prevails. In this Court, costs are routinely awarded against the unsuccessful party.
Both hearing authorities have all of the powers, duties, functions and discretions of IR when hearing and determining a tax challenge. Although advocates must adhere to the usual rules of evidence, in both forums a taxpayer may appear for themselves, often with considerable assistance from the Bench.
Judicial tax litigation follows the same procedure as other civil claims. The timetable for a hearing in either the TRA or the High Court is set by the Judge, usually in accordance with a proposal by the parties. Written briefs of evidence are filed with the court and served on the opposing party in advance of a hearing to outline the evidence in chief, and bundles comprising documentary evidence and legal authorities are usually agreed by the parties. Most hearings continue to be paper-based, but electronic document management is being introduced in the High Court and is already more prevalent in the appellate courts.
Very briefly summarised, the steps for first instance tax litigation are as follows. The language reflects the High Court but similar procedures apply in the TRA.
A notice of proceedings, with a statement of claim and key documents from the tax disputes process is submitted to the Court by the taxpayer, who is plaintiff in the proceedings, and is served on IR as defendant. The statement of claim outlines the general nature of the challenge, including a brief factual background (usually by reference to the dispute documents already exchanged between the parties), and concludes with the remedy sought.
IR files a statement of defence, responding to the taxpayer’s case. Once these statements are with the Court, a timetable is set as part of standard case management. This can extend to the full range of interlocutory steps, including the pleading of particulars, orders for discovery and interrogatories. The parties then collate and file evidence. Written summaries of the evidence in chief to be given by witnesses, together with any documentary exhibits, are submitted by each party to the Court. Expert witnesses usually file a technical report supporting their findings. Special rules apply to their evidence.
At the hearing, following an opening statement from the taxpayer, evidence at the trial is presented orally, with briefs of evidence usually being read into the record by the witnesses under oath, including references to exhibited supporting documents. It is not unusual for briefs or summaries of evidence to be supplemented by further evidence in chief, led orally. This is followed by cross-examination and re-examination. The same pattern then follows for IR. Closing statements presented to the Judge signal the end of the trial. The Judge will normally take time to deliberate, sometimes in the order of months, before a detailed written decision is issued.
As noted in 4.2 Procedure of Judicial Tax Litigation above, evidence in chief must be provided in written brief to the courts and the other party in advance of the hearing. These are read into the record during the trial, and documentary evidence is produced by way of exhibit. This evidence is crucial for presenting a party’s argument or rebuttal, and is usually the only opportunity to produce the evidence on which the taxpayer relies. In complex tax avoidance cases, it is not unusual for the Court to receive a great deal of evidence, including expert evidence on matters such as valuation, business orthodoxy, commercial outcomes and rationale. All necessary evidence should be produced at first instance because the opportunities to introduce further evidence on appeal are very limited.
The burden of proof in civil tax matters rests with the taxpayer (except for certain civil penalties outlined below where it rests with IR), to establish their case on the balance of probabilities. The burden of proof in criminal matters rests with the prosecution, which must prove its case beyond reasonable doubt.
As with every kind of complex civil proceedings, there are myriad strategic matters to consider in preparing for and conducting tax litigation. The following paragraphs are not exhaustive:
Choice of forum – It is the taxpayer’s choice to commence a tax challenge in the TRA or the High Court. The relevant factors have been canvassed.
What does success "look like?" This will shape the way litigation is undertaken, particularly if a negotiated outcome is preferred.
Preparation and presentation of witnesses – Crucial when the burden lies with the taxpayer. Do not assume the taxpayer knows anything or, if they do, that they know how to explain it!
Expert witnesses – In a small country, the catchment for some witnesses is small and their evidence well known. Care is required and expert testimony from outside NZ may be needed. Be careful not to have experts usurp the court’s role.
No surprises litigation means that – Do not try to ambush with unseen documents or evidence. The system is designed to exclude this, so this type of strategy will count against the side that tries it.
NZ follows an English common-law litigation tradition. Precedent is important. When considering an international tax matter, a NZ Court will consider international jurisprudence, doctrine and commentary. However, the persuasiveness of such material can vary. Decisions of foreign courts are rarely directly relevant to NZ tax litigation, although analogies can often be made. Australian tax cases are often considered persuasive, depending on the status of the court, because Australia and NZ have overlapping areas of tax law and a similar colonial legal history. Similarly, UK and Canadian case law is often considered persuasive by the courts, depending on the subject at hand. An advocate must carefully consider the relevance of international case law in tax litigation, particularly if it relates to 'classic' issues such as the revenue/capital distinction.
Double taxation agreements ("DTAs") are part of NZ’s domestic law and have an overriding effect on it. As a result, if domestic law and a DTA conflict, the DTA takes precedence. NZ courts will usually consider OECD commentary when interpreting DTAs, as most NZ DTAs are based on the OECD model commentary.
A decision of the TRA can be appealed to the High Court. A decision of the High Court can be appealed to the Court of Appeal, and then, with leave, to the Supreme Court. The Supreme Court is NZ’s final appellate court.
An appeal of a TRA decision to the High Court will only lie if the amount of tax involved is greater than NZD2,000, or the net loss is at least NZD4,000. Otherwise, TRA decisions are final. An appeal to the High Court must be commenced within one month of the disputed TRA decision.
An appeal from the High Court to the Court of Appeal can be on a question of fact and/or law. Either party can appeal from the High Court to the Court of Appeal as of right, but the Court of Appeal seldom receives new evidence, or takes up a point of law not previously raised. An appeal must normally be brought within 20 working days of the appealed decision.
An appeal to the Supreme Court requires leave. The Supreme Court will only hear matters of general commercial significance, or general or public importance. If leave to appeal is declined, the Court of Appeal’s decision is final.
The appeal procedure follows the general appeal process already summarised, with some deviation for interlocutory matters. An intended appellant must file a notice of appeal, specifying the findings of fact and rulings being appealed. The appellant then collates a case on appeal, comprising all the material before the lower court. Both the appellant and respondent then file a synopsis of their submissions. Further evidence can be supplied in exceptional circumstances – namely, if something that substantially changes the correct application of the law has arisen since the lower court heard the case.
In most cases an appeal is by way of a rehearing. That does not mean, however, that the case is actually reheard. Instead, the appellate court undertakes a full review of the record of evidence and submissions relating to the case and arrives at a fresh determination of the matter. One downside of this system is that judges in the appellate court will not necessarily be able to assess the credibility of witnesses and instead rely on written transcripts of evidence.
At first instance, civil tax cases are heard by a single judge in the High Court or TRA. Appeals to the High Court from the TRA are heard by a single High Court Judge. Criminal tax cases are heard by a single judge in the District Court, though more serious criminal tax matters may be heard before a Jjdge and jury. In the Court of Appeal, the bench usually consists of panels of three to five judges, often with two High Court Judges seconded to support a Court of Appeal Judge. If the Court of Appeal is being asked to overturn one of its own judgments or is dealing with a particularly precedential matter, a bench of five judges can be requested. In the Supreme Court, a full bench of five judges considers all matters.
The allocation of judges to a matter is usually in the hands of the executive judge in each court or the relevant Head of Bench, and will take into account the overall capacity of the Court and the capacity of the individual judges. There are no specialist tax judges in the High Court, Court of Appeal or Supreme Court, although one sitting Supreme Court Judge practised as a tax partner in a major law firm some 20 years ago.
The disputes process, specifically the conference phase described at 3.1 Administrative Claim Phase above, is closest to arbitration, mediation and other alternative tax dispute mechanisms. NZ does not have any other alternative dispute resolution regime covering tax matters. This has been criticised by some tax commentators. However, NZ has a comprehensive binding ruling system to avoid the need to take a tax position that IR could contest. This is further outlined at 6.2 Avoiding Disputes by Means of Binding Advance Information and Ruling Requests, below.
Any taxpayer can apply for a binding ruling, seeking IR’s confirmation that the taxpayer’s interpretation of tax law applicable to a specified actual or contemplated transaction is correct. However, this is an expensive and time-consuming process, requiring in-depth analysis of tax law. As a result, IR recommends using a tax professional. Therefore, most binding rulings are sought for complicated matters with substantial sums in issue. A binding ruling is, as the name suggests, binding on IR. It is therefore crucial that the facts and law of the situation are very clearly explained in the ruling application, and then followed to avoid a later reversal. IR is not bound by a ruling if the facts of the arrangement as implemented materially differ from those in the ruling, or if there has been an omission or misrepresentation by the applicant, or if assumptions prove to be incorrect or a stated condition is not complied with. While IR must otherwise comply with a binding ruling, the taxpayer can dispense with it at any time.
Because of the barriers to obtaining binding rulings, a simplified procedure is shortly to be introduced, which will be less costly and allow small businesses to apply more easily for a ruling on any tax matter.
Any breach of a tax obligation can lead to a civil penalty and criminal liability, or both.
A tax default will usually result in late payment penalties ("LPP") and short-fall penalties ("SFP"). Additionally, use of money interest ("UOMI") applies, but this is expressly not a penalty under statute.
SFPs are a one-off charge calculated as a percentage of the tax shortfall according to the perceived culpability of the taxpayer’s default. Not every default attracts a penalty but, in practice, most do. SFPs range between 20% and 150% of the tax shortfall to which they relate. SFPs are assessed after an investigation has been completed and are subject to internal "consistency" oversight by IR. They can be disputed and challenged in the same way as substantive tax.
Criminal charges can be laid by IR alongside civil tax proceedings, although criminal proceedings will normally take priority, to avoid civil proceedings compromising a taxpayer’s fair trial rights.
Penalties arise in three categories of tax offending: absolute liability offences, knowledge offences and offences of or similar to tax evasion.
Absolute liability offences relate to basic expectations of compliance and are sanctioned by fine. Knowledge offences occur when a person knows of a tax obligation and fails to meet it. These offences are more serious and have a graduated fine regime. They can also attract a sentence of up to five years' imprisonment. Evasion of similar offending is the most serious class and occurs when an act or omission occurs knowingly, but also with the intent to evade assessment or payment of taxes. While these offences share the upper limit of imprisonment for knowledge offences, they are often charged under the Crimes Act, where potentially longer prison terms can be imposed.
Sentences for tax offending are imposed under comprehensive laws designed to apply a scale of sanctions from financial punishments at the lowest level, through non-custodial community work and home detention, to a term of imprisonment for serious offending. Company officers can be criminally liable as parties to any tax offence committed by their company.
The civil tax disputes process can run concurrently with a criminal process. However, to protect fair trial rights, the Court of Appeal has strongly indicated that a civil dispute or proceedings should not be conducted ahead of criminal proceedings. In practice, therefore, IR will usually stay the disputes process and any related civil proceedings, often after the NOPA and NOR have been exchanged, to first complete criminal proceedings.
The civil tax disputes process can lead to the imposition of civil penalties by way of SFPs and/or result in criminal charges being laid. The decision whether or not to prosecute is taken seriously within IR and is made against relatively well-publicised prosecution guidelines. The way the SFP regime and criminal offence provisions work together can lead to anomalies. If IR first imposes a SFP, it may not later choose to prosecute the taxpayer for the same default. However, if that taxpayer is first prosecuted, then a SFP can still be imposed even if the taxpayer has been acquitted in the criminal prosecution. Time bars do not normally apply to the imposition of SFPs, so the option to follow criminal proceedings with a civil penalty is usually available, though IR asserts this is seldom done.
A civil penalty will usually be proposed by IR, using the tax disputes process. It does not need to be resolved at the same time as a proposed substantive tax liability. The taxpayer can oppose the proposed imposition of the penalty through the tax disputes process and by a tax challenge in the TRA or the High Court.
Criminal charges are usually laid in and dealt with by the District Court. The TRA does not have a criminal jurisdiction. Once the charges are laid, the usual criminal process follows, under which the prosecution adduces evidence, which the defence tests. The prosecution carries the burden of proving any tax offence beyond reasonable doubt, and the taxpayer is not obliged to give evidence. In reality, if there is a contest over the extent of a tax liability in criminal proceedings (usually a matter for sentencing), that will be resolved in a disputed facts hearing. To establish criminal liability, IR does not normally have to show the precise and correct liability; it only needs to show that the taxpayer’s position was wrong and that this was taken with the requisite knowledge and intent.
While an upfront payment of tax will not result in a reduction of penalties other than LPP, SFP can be reduced by statutory reductions for prior good behaviour and voluntary disclosures. Voluntary disclosures can be either "pre-notification", if made before IR notifies the taxpayer of an audit, or "post-notification", if made after an audit has been notified but before investigation has commenced. A pre-notification disclosure usually comes with an assurance of non-prosecution; however, IR has indicated that this is under review and may no longer apply to future disclosures of serious, evasive or fraudulent behaviour. A pre-notification disclosure qualifies for a 100% reduction of lower level SFPs, and a 75% reduction for all higher penalties. For post-notification disclosures, a flat 40% deduction is given for all SFPs.
Further reductions are available if a taxpayer can show that financial hardship would arise from continued collection of outstanding tax or penalties. This includes illness, or if the taxpayer would not be able to meet minimum living standards, according to normal community standards of cost and quality. IR has tabulated the expected costs of minimum living expenses, against which applicants can judge their likelihood of success should they make a claim of serious hardship. Some SFPs cannot be written off other than in the taxpayer’s bankruptcy or liquidation.
While IR can write off interest, UOMI is very rarely reduced as it is intended to compensate IR for the loss of opportunity created by the late payment.
Mitigating submissions are often made to IR as it considers whether or not to prosecute a taxpayer. As noted, that decision is made according to well-publicised guidelines to which submissions must be directed. Once the decision to prosecute has been made by IR or in serious cases by the Crown, payment of tax penalties and interest is not sufficient in itself to prevent a trial. The Supreme Court has made it clear that a payment to procure non-prosecution is void as against public policy. It is still possible to seek the withdrawal of a prosecution, once commenced, but there must be supporting grounds other than the payment of tax. These will usually be grounds that were not adequately considered at the time the original decision was made.
The appeals process for criminal trials follows the same steps as those outlined under 5 Judicial Litigation: Appeals for civil litigation; however, criminal matters are usually first heard in the District Court and can then be appealed to the High Court. An appeal in the High Court is by way of a rehearing and can result in a different decision. An appeal may be against conviction or sentence or both. Sentencing appeals are unlikely to be successful unless an appellant can establish that the sentence was manifestly excessive, or that material new information has come to light since the first instance trial. As judges have significant discretion when making sentencing decisions, appeals are allowed only in cases where it is clear that the court at first instance has made an error.
Tax avoidance and transfer pricing are not criminal offences under NZ law, but tax defaults can in both cases be subject to a civil SFP. The concept of tax avoidance only engages if the relevant position otherwise meets the requirements of tax law. It is normally too difficult to establish the necessary element of dishonesty for transfer pricing to give rise to an offence.
A taxpayer found to be in breach of the GAAR or a SAAR or transfer-pricing rules will therefore not face criminal charges but could challenge IR’s assessment of a SFP through the tax disputes process and challenge proceedings.
A promoter of a tax avoidance arrangement can be liable for special penalties, imposed if an abusive tax position has been offered, sold, issued or promoted to ten or more persons in a tax year. This penalty is the sum of all tax shortfalls resulting from the promotion of the abusive tax position.
There is a debate regarding whether something done that is so obviously tax avoidance that it will inevitably be set aside is done dishonestly so as to attract criminal sanction. That has yet to be resolved.
A taxpayer in NZ can initiate the domestic tax disputes process concurrently with an application to the competent authority under the relevant DTA, to engage the mutual agreement procedure ("MAP"). The MAP sets out how NZ’s competent authority will liaise with the competent authority of another affected tax jurisdiction to determine the correct application of the DTA to the taxpayer. Alternatively, IR can initiate this process with another contracting state to resolve foreseeable issues of interpretation. If the domestic tax disputes process results in a court decision, the NZ competent authority is bound by this decision, and must defend and explain the NZ position to other affected tax authorities.
Arbitration is available to NZ taxpayers when the applicable DTA contains the current model article 25(5). The only NZ DTAs with an arbitration clause are with Australia and Japan. If the competent authorities cannot reach an agreement within two years, the taxpayer can request arbitration. However, if the model article 25(5) is not present in the applicable DTA, the taxpayer can still apply for arbitration, granted at the discretion of the tax authorities involved.
Because of the complexities often involved, most taxpayers facing the prospect of double taxation as the result of IR action in NZ will try to have IR engage with an affected overseas tax authority sooner rather than later.
NZ’s DTAs and its general anti-avoidance rule ("GAAR") appear to conflict. DTAs may override domestic law. The GAAR voids for tax purposes any arrangement with a 'more than incidental purpose' of obtaining a tax benefit. IR considers a DTA to not override the GAAR, or an applicable specific anti-avoidance rule ("SAAR"), so both can apply to an international tax dispute. This approach does not align with the Australian, UK or Canadian approach, as these countries specifically legislate to allow DTAs to override their GAARs.
NZ’s transfer-pricing rules are enacted in domestic law. The recent extension of these rules following the OECD’s BEPS initiatives is briefly discussed at 1.4 Efforts to Combat Tax Avoidance, above. These would apply to an international transfer pricing adjustment challenge, and must be interpreted in light of the OECD’s transfer pricing guidelines, although they do not directly apply. Transfer-pricing issues are not often litigated because most taxpayers prefer to resolve issues between jurisdictions without resorting to litigation.
Unilateral advanced pricing agreements ("APAs") are obtained using the binding ruling regime (see 6.2 Avoiding Disputes by Means of Binding Advance Information and Ruling Requests, above). Bilateral APAs are issued following the relevant DTA’s MAP article. IR increasingly favours APAs for businesses dealing in intangibles, where the correct tax treatment could otherwise be contested.
The process for completing an APA involves a pre-application, which involves a short, written proposal outlining the factual background and the suggested transfer-pricing arrangement. This is usually followed by a brief meeting between the taxpayer and IR to discuss the proposal. The APA request is then formalised and submitted to IR for review. IR requests that an APA application should include the full functional analysis of the transfer-pricing arrangement, in addition to an analysis of the key profit drivers and value added, the choice of methodology, comparable arrangements and copies of inter-company agreements. Upon completion of the review, IR will arrange to meet with the taxpayer – or the international authority in the case of a bilateral APA – to reach an agreed position. Once a taxpayer has become party to an APA, they must submit annual compliance reports to IR, including financial statements reconciled with the transfer-pricing methodology, and confirmation that the taxpayer is complying with the agreement and that none of the critical assumptions have been breached. This full process usually takes six months for unilateral APAs, or bilateral APAs between NZ and Australia. Bilateral APAs take much longer to negotiate with other jurisdictions, and for this reason unilateral APAs are usually favoured by taxpayers, unless there is a risk of double taxation.
IR investigation actively covers a number of cross-border situations, but these do not always lead to litigation. Investigations routinely examine withholding tax obligations in relation to offshore lending, status and liability as the result of the existence of a PE and the basis on which goods and services provided to a NZ entity have been priced by an associate. For the most part, cross-border tax-related litigation has been prompted by international information requests and has tested the scope and application of the mutual assistance provisions of DTAs. Recent litigation has also tested how DTA concessions such as tax-sparing relate to NZ’s CFC rules.
Outside these areas, APAs and binding rulings mitigate the need for complex and expensive tax litigation. However, practical barriers to these processes mean taxpayers continue to take positions without assurance.
Apart from professional fees, there are no administrative or filing costs involved in pursuing a tax dispute as outlined under 3 Administrative Litigation, above.
The administrative and filing costs for the TRA are outlined in its regulations. At the time of writing, the cost of filing an initiating document was NZD410.
The administrative and filing costs for the High Court are outlined in that court’s regulations. At the time of writing, the cost of filing an initiating document was NZD1,350, though only NZD540 for an appeal or judicial review. Filing a statement of claim costs NZD110. Hearing fees (essentially daily Court fees applicable after the first day of hearing) are also charged, and must be met by the taxpayer plaintiff.
The administrative and filing costs for the Court of Appeal are similarly set by regulation. At the time of writing, the cost of filing notice of an appeal was NZD1,100. Daily hearing fees also apply, and are borne by the appellant.
The administrative and filing costs for the Supreme Court are also set by regulation. At the time of writing, the cost of filing for leave to appeal was NZD1,100. Scheduling a hearing date and the first day's hearing costs NZD1,000, with each additional half day costing NZD500.
Except in proceedings in the TRA, an unsuccessful party must usually pay at least part of the other party’s legal costs. These are usually set by the Court, according to the stages of litigation and bands of complexity.
If a baseless claim is advanced, indemnity costs may apply, but these seldom if ever arise in tax cases where the IR position will be addressed on cogent grounds. The TRA may award costs against a party for bad conduct in the proceedings.
IR does not usually litigate without being confident of its case. In its 2018 reporting year, IR won 89.1% of the cases it litigated. It is therefore very uncommon for a taxpayer to be awarded indemnity costs. IR has successfully made indemnity cost claims against some taxpayers.
Save for elements of the tax disputes process, there are no tax-related ADR mechanisms in NZ. It is possible to mitigate the chance of a dispute arising by seeking an advance ruling, but that process can be time-consuming and expensive (see 6.2 Avoiding Disputes by Means of Binding Advance Information and Ruling Requests above).
Although IR is very active in auditing taxpayers, not many cases are litigated. As of 30 June 2017, IR reported it had 104 active civil cases involving interpretation of tax law. A number of these have since been decided or are progressing. According to a leading database, there are currently nine appeals pending from the TRA and a further 16 tax appeals pending from the High Court. Two appellants have sought leave to appeal from the Court of Appeal, but that has been denied. As to criminal cases, it is not possible to identify criminal prosecution numbers until they have been concluded and reported. In its 2018 reporting year, IR confirmed that it had commenced 121 prosecutions and, of those, 94 dealing with tax evasion or fraud were completed.
The number of tax cases initiated and completed annually is not publicly reported. A brief review of a leading database suggests that 31 tax cases were heard by the senior courts in 2018. The High Court heard 22 of these cases, 17 involving technical questions of law and five involving administrative and procedural matters. Most involved income tax, though five considered GST issues. Sums at stake in those High Court matters range from NZD100,000 to more than NZD60 million. High Court criminal appeals as to conviction and/or sentence are more numerous but are not easily collated.
The Court of Appeal considered five matters, three of which were procedural applications. The remaining two cases dealt with complex technical questions of law, relating to income tax and non-resident withholding tax. The Supreme Court heard and refused two tax-related applications for leave to appeal.
The TRA heard seven cases. Three dealt with a technical legal question and four with procedural matters.
There is no publicly available information about criminal cases in the District Court. However, IR has stated that in 2018 it completed 94 prosecutions for tax-related offending, which would have been heard in the District Court.
In the 2018 income year, IR reportedly won 89.1% of the cases it litigated, up from 80.8% in the 2017 income year.
The following guidelines are unlikely to be exclusive to NZ, and neither will they be exhaustive of the matters to be considered in advising and representing parties engaged in tax controversy.