Shortfall Penalty Regime

New Zealand tax system is following the self-assessment concepts. The penalties are there to encourage voluntary compliance with the law. The foremost idea behind the shortfall penalty is to make sure the taxpayer have taken reasonable care when calculating their tax. Shortfall penalty is incurred when there is a difference between the Commissioner’s assessment and the tax position taken by the taxpayer leading to an understatement of tax. A shortfall penalty is charged as a percentage of the tax shortfall. The Commissioner will consider 5 categories of behaviour below before deciding what percentage to charge for shortfall penalty.

• Not taking reasonable care (20 percent penalty; TAA s 141A)
• Unacceptable tax position ( 20 percent penalty; TAA s 141B)
• Gross carelessness (40 percent penalty; TAA s 141C)
• Abusive tax position (100 percent penalty; TAA s 141D)
• Evasion or similar act (150 percent penalty; s 141E)

1. Not taking reasonable care: A taxpayer deemed not taking reasonable care when making their tax assessment is charged at 20% on their tax shortfall. The Commissioner will look at the taxpayer’s skill and prudence and the likelihood of them linking with the cause of the tax shortfall. Moreover, these factors are taken into consideration when the Commissioner determines a failure to take reasonable care: Nature of the business and business bookkeeping practice, complexity of the transactions, seriousness of the tax shortfall, background of the taxpayers etc.
2. Unacceptable tax position: This means that the taxpayer takes a position that is likely to no be correct “A taxpayer takes an unacceptable tax position, if, viewed objectively, tax position fails to meet the standard of being about as likely as not to be correct”  This penalty applies only to income tax. Although there is no requirement for the tax position to be always 100% correct, the taxpayer must seriously considered their tax position. The taxpayer is liable to a penalty of 20% payable on the resulting tax shortfall.
3. Gross carelessness: Under this penalty, a tax of 40% is imposed of the resulting tax shortfall. Gross carelessness is defined as doing or not doing something in a way that, in all the circumstances, suggests or implies complete or a high level of disregard for the consequences breaches for gross carelessness fall just below evasion but beyond a lack of reasonable care.
4. Abusive tax position: The high percentage of 100% is imposed on the resulting tax shortfall showing the seriousness of the penalty. The purpose of this penalty is to penalise taxpayers who enter into arrangements with a dominant purpose of taking a tax positions that reduce or remove tax liabilities or give tax benefits. Thus, for tax arrangement or tax avoidance scheme, there will be a charge of 100% for taking abusive of tax position.
5. Evasion: Highest penalty is charged at 150% if the taxpayer carries out a tax evasion scheme. The taxpayer will be charged penalty under evasion if they purposely or knowingly mislead or evade the tax system to gain benefit from it.

If you have any queries about the shortfall penalty charged or you think IRD charged you too much penalty, please seek professional advice.

Reference: Tax Administration Act 1994

Disclaimer: The following answer necessarily sets out general principles only. The facts of particular cases always need to be considered carefully, and it may be necessary to obtain advice from a tax expert.

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