How to handle an IRD audit

What to do if the IRD come calling

Atainz Conference

March 2013

Terry Baucher, Baucher Consulting Ltd

Tauber & Ors v Commissioner of Inland Revenue

Investigation began 2008, raid 16 March 2011

Three houses and three other premises in Remuera, Helensville and Hobsonville raided simultaneously

Homes of Tauber, Webb & accountant (who worked from home) raided together with registered offices of several related companies and a boatshed at Hobsonville

Ten officers involved in search of Tauber’s house. They were there for 8 ¼ hours.

IRD Powers - Information Gathering

Part III of the Tax Administration Act 1994

Sec 16: Commissioner may access premises to obtain information

Sec 16B: Power to remove and copy documents

Sec 16C: Power to remove and retain documents

Sec 17: Information to be furnished on request

IRD Powers – “Document”

“document” means— a) a thing that is used to hold, in or on the thing and

in any form, items of information:b) an item of information held in or on a thing

referred to in paragraph (a):c) a device associated with a thing referred to in

paragraph (a) and required for the expression, in any form, of an item of information held in or on the thing.

When the IRD come calling…

“A taxpayer (and its [advisors]) needs to be the "good guy"..., not an obstructive, unco-operative, whining and potentially non-paying tax guy, as they will characterised to be by the Revenue at any step in the investigative process if the Revenue's demands are not complied with in full as required by law."

Denham Martin, Tax Barrister

Why is this important?

Net audit discrepancies identified in 2011-12 year - $1.2 billion; $400 million from SMEs

Additional tax assessed in 2011-12 year $758.4 million

Every dollar IRD spends on investigations recovers an average of $5 additional revenue. Therefore in 2012 Budget IRD given extra $78.4 million over next four years for increased compliance activities

IRD Compliance Focus 2012-13

Released August 2012: four key themes

Everyone pays and receives the right amount

IRD receives the right information at the right time

Everyone files and pays on time

IRD provides confidence and certainty to taxpayers

IRD Compliance Focus – Tax Agents

About 5,200 tax agents registered with IRD

Tax agents handle tax affairs of nearly two million clients

Responsible for filing about 83% of all tax returns

IRD taking a harder line on agents not meeting filing percentages. Particularly concerned with those agents who are behind on own affairs.

Industry Benchmarking (1) Launched April 2012 after development in

conjunction with Statistics New Zealand

Sixteen industries included in nine sectors

Benchmark detail is for 2009/10 and 2010/11 years

Benchmarks identified include gross profit ratio, stock turnover, salaries and wages as percentage of turnover, return on total assets, return on equity

Industry Benchmarking (2)1. Cafes, restaurants, pubs, takeaway food outlets2. Gardening services3. Nursery production4. Landscape construction, painting and decorating5. Preschool education6. Electrical services, electrical and electronic

wholesalers and retailers7. Hairdressing and beauty services8. Passenger car rental and hiring and real estate

services9. Fruit and vegetable retailing, dairies & superettes

Industry Benchmarking (3)Median benchmarks for cafes and restaurants in 2010-11

Financial ratio

Business size

Small Medium Large

$60,000 - $300,000

$300,000 - $800,000

$800,000+

annual turnover

annual turnover annual turnover

Gross profit ratio 56% 61% 64%

Stock turnover per annum23 times 29 times 28 times

Salaries and wages/turnover ratio

23% 33% 34%

Balance sheet ratios

Return on total assets-1% 0% 3%

Return on equity 1% 2% 14%

Current ratio 78% 64% 66%

Quick ratio 42% 37% 47%

Liability structure 50% 21% 21%

Industry Benchmarking (4)Range of benchmarks for cafes and restaurants in 2010-11

Financial ratio

Business size

Small Medium Large

$60,000 - $300,000

$300,000 - $800,000

$800,000+

annual turnover

annual turnover annual turnover

Gross profit ratio 47 to 63% 54 to 65% 59 to 68%

Stock turnover per annum12 to 41 times 17 to 48 times 18 to 45 times

Salaries and wages/turnover ratio

  9 to 34% 24 to 40% 28 to 40%

Balance sheet ratios

Return on total assets-29 to 7% -14 to 5% -3 to 19%

Return on equity-11 to 47%   -8 to 40%  0 to 64%

Current ratio18 to 270% 20 to 168% 25 to 133%

Quick ratio5 to 180% 7 to 126% 12 to 109%

Liability structure-11 to 94% -17% to 74% -7 to 58%

Managing risk of IRD review

KNOW YOUR CLIENT

Build risk profile: is Industry Benchmarking data available for client, or is client one of groups already being targeted by IRD

Use annual accounts and/or GST return preparation to identify risk areas for clients

If errors identified, bite the bullet and make a voluntary disclosure

Consider Audit Shield or similar product

Review or Audit?

Generally refer to initial approach as “risk review”

Triggered by any one of the factors mentioned above

Many GST refunds go into “review” but no clear rule as to what triggers a review

Approach is to “encourage” voluntary disclosure with carrot of penalty remission

If escalated to audit voluntary disclosure option no longer available

Risk Reviews (1)

“A risk review is a preliminary review of your clients’ records to determine whether or not a formal audit is necessary. While this may also involve a discussion to clarify information provided, this letter does not constitute notice of a pending tax audit under section 141G(1) of the Tax Administration Act 1994. Following my review a decision will be made as to whether an audit is needed and you will be notified accordingly in writing.”

Risk Reviews (2)

“Our records show that during the 2010 income year your client:

Acquired from his employer unrestricted shares valued at NZ$60,000 in Vodafone Group Plc for no consideration;

Worked as a consultant for ABC Consulting”

Managing Reviews & Audits (1)

Keep client informed – meet with him/her and discuss frankly risk areas and response strategy.

Advise client of potential risks of criminal prosecution. In 2000 IRD prosecuted 314 cases for “criminal” breaches of TAA. In 2008 the number was 9,563 and in 2009, 8,316

Keep control of the audit. IRD have extensive powers but don’t be intimidated.

Keep copies of ALL materials sent to the IRD

Keep to timetable and keep pressure up on IRD to respond once information submitted

Managing Reviews & Audits (2)

Not all reviews/audits will involve a site visit but if so ensure that has own office away from other staff. Warn staff that IRD are on premises.

Alternatively, accompany IRD investigator to visit of client premises but then conduct the review at your office.

Do not allow IRD investigator to wander around client’s premises or free access to photocopying. Keep copies of ALL material copied.

If review stalls, suggest meeting to resolve issues/understand IRD’s concerns.

Managing Reviews & Audits Problems with investigators?

Meet with IRD investigator and determine what is causing concern

If unhappy with how investigation is being handled involve Team Leader (should be identified on any designated audit)

If still not satisfied can escalate to Investigations Manager or their superiors

Ultimately can be referred to the IRD Case Director

If it doesn’t end well… If tax shortfall is found then income tax/GST liability

Generally IRD will usually be prepared to issue a reassessment (if an assessment has been made previously)

But…

Use of money interest will still apply from original due dates as will late payment penalties

Can apply for remission of late payment penalties

Interest: the IRD’s secret weapon

As interest will be accumulating in any dispute therefore wise to resolve/settle early.

For example, I recently acted for company which failed to declare rental income for the 2007 to the 2011 years. Mistake only found when property sold.

Tax due for 2007 $3,400; the UOMI was $2,200.

Total tax due for 2007 to 2011 years: $19,260; the total UOMI was $8,350

Mitigating Interest Risk

Quantify risk as soon as possible

Consider making voluntary payment as soon as possible

Alternatively, deposit funds in general tax pool with Tax Management New Zealand Ltd (or similar provider). Funds can then either be transferred as a “normal” payment or used to purchase tax if IRD issue a reassessment

Shortfall Penalties

Type of penalty

Sec 141A Not Taking Reasonable Care

Sec 141B Unacceptable Interpretation

Sec 141C Gross Carelessness

Sec 141D Abusive Tax Position

Sec 141E Evasion or Similar Act

Sec 141K Increased Penalty for Obstruction

20% of tax shortfall

20% of tax shortfall

40% of tax shortfall

100% of tax shortfall

150% of tax shortfall

25% increase in penalty

Penalty

Reductions in Shortfall Penalties

Under 141G Commissioner has option to reduce shortfall penalty for voluntary disclosure if, in the Commissioner’s opinion, the taxpayer makes a full voluntary disclosure of all the details of the tax shortfall.

If pre audit notification disclosure is made the reduction is:

i. 100%, if the shortfall penalty is for not taking reasonable care, for taking an unacceptable tax position, or for an unacceptable interpretation; or

ii. 75%, if subparagraph (i) does not apply (gross carelessness):

If disclosure is made post-notification of audit reduction is 40%.

Finalising Audit

If any adjustments are determined the IRD investigator will request that the client sign an Agreed Adjustment Form

Don’t sign this until position of shortfall penalties clear. IRD have been known to impose shortfall penalties AFTER agreed adjustment form signed – there is no way to protest about the penalties in that situation

How not to run an audit:Krukziener v C of IR

20091991 1999

Investigation begins

TRA Hearing

First year in question

2005-6?

Reassessment 1997-

2000

2004

KPL voluntaryDisclosure

If you can’t agree – Disputes Process

1. Notice of Proposed Adjustment

2. Notice of Response

3. Conference stage (optional)

4. Statement of Position

5. Adjudication

6. Challenge proceedings

Conclusions

Prevention is better than cure – know your client identify risks and make voluntary disclosures if appropriate

Familiarise yourself with IRD Compliance Focus programme

Check clients against Industry Benchmarking information

In event of review, be firm but co-operative and expect surprises!

“And remember, let’s be careful out there”