International Tax Review (ITR): What advice would you give to companies about how to reduce the risk of becoming involved in a tax dispute with New Zealand's tax authorities?
Shaun Connolly (SC): As with most jurisdictions, the New Zealand tax system is complex and constantly changing, making tax a high risk area for companies and especially multinationals.
The consequences of getting things wrong can be severe, with civil penalties for taking an incorrect tax position ranging from 20% to 150% of the tax in dispute. It is therefore strongly advisable to have systems in place to monitor and address tax risk and to ensure tax compliance.
An important part of that strategy is for companies to have at least some degree of tax expertise in-house, whether in New Zealand, or within head office or the regional headquarters, rather than relying solely on external advisers. In-house advisers will naturally be closer to the business, more aware of transactions and able to identify tax issues at an early stage.
For complex, high value or cross-border transactions external tax advice should be sought.
That advice as to the tax consequences should be consistent with the legal documentation and based on a correct understanding of the terms of the transaction. Compliance systems should be put in place to ensure transactions are implemented consistently with the tax advice.
In certain cases it will be advisable to obtain a binding ruling from the Inland Revenue Department (IRD). The binding rulings regime allows taxpayers to seek agreement in advance from IRD as to the tax consequences of an arrangement.
For the ruling to be binding on IRD all material information regarding the arrangement must have been provided to it, the arrangement as implemented must not be materially different from that described in the ruling and all conditions and assumptions specified in the ruling must be complied with.
When incorrect tax positions are identified, by the taxpayer or Inland Revenue, it is advisable to proactively address them. Reductions in penalties – in some cases to 0% – are available where a voluntary disclosure is made.
ITR: What options do New Zealand taxpayers have to resolve disputes with the tax authorities other than litigation?
SC: New Zealand operates a self-assessment system whereby taxpayers file their own tax returns and those returns operate as an assessment.
If, as a result of an audit or investigation, IRD disagrees with a position taken by a taxpayer, it may issue an amended assessment. Before issuing an amended assessment a formal disputes process must be followed.
That process involves the exchange of various position papers, with strict timeframes imposed on taxpayers for responding. Those position papers are then usually referred to IRD’s internal Adjudication Unit for consideration.
If the Adjudication Unit finds in favour of the taxpayer, the dispute is resolved and IRD has no right of appeal. If the Adjudication Unit finds in IRD’s favour an amended assessment is issued and the taxpayer may challenge that assessment in the courts.
It is possible to settle a dispute with IRD at any time during the audit process, statutory disputes process or litigation process.
Settlement is commonly achieved before the formal dispute process starts; at the conference stage of the formal process – after initial exchange of position papers – and following commencement of court proceedings but before the court hearing.
In New Zealand, the Crown Law Office (not IRD) has the main decision-making power in respect of how to run the case and whether or not to settle a case for tax disputes that are litigated. Once a tax dispute becomes the subject of court proceedings, the ordinary rules of civil litigation – including document discovery and inspection, and evidence – apply with limited exceptions.
It is important for taxpayers in a material dispute to be familiar with the Crown Law Office's approach.
While most commercial parties understandably wish to avoid litigation, and to settle disputes on reasonable terms if possible, lack of familiarity with the litigation process, or lack of preparedness for court proceedings, can result in taxpayers having no choice but to reach a settlement on much less favourable terms than the merits of their position would otherwise justify.
ITR: Are you seeing any trends in the types of dispute cases thst IRD is taking up, and those where it is succeeding in the courts?
SC: The majority of significant tax cases decided by the New Zealand courts in recent years, particularly by the appellate courts, have involved issues of tax avoidance and in particular the application of New Zealand's general anti-avoidance provisions.
The Commissioner has been successful in the majority of recent avoidance cases, which have dealt with a range of transactions including forestry investment schemes (Ben Nevis), structured finance transactions (BNZ and Westpac), diverting personal services income through family trusts and private companies (Penny & Hooper [2011] NZSC 95) and cross-border related party funding using hybrid instruments (Alesco).
It is generally considered that the courts are upholding IRD’s use of the general anti-avoidance provision in a broader range of circumstances than before the abolition of the right to appeal to the Privy Council from January 1 2004.
The courts’ approach has caused uncertainty as to the extent to which transactions can be structured to achieve tax benefits and, consequently, most taxpayers are taking a conservative approach to tax planning.
It appears that IRD is taking a more expansive approach to the application of the anti-avoidance provisions, such that even conservative tax planning is commonly the subject of investigation or even dispute.
A lesson for taxpayers from many of the recent cases is that the way in which transactions are implemented, and associated documentation, can influence the courts' thinking on avoidance matters. For example, where structures or aspects of a transaction come from a template or have been marketed for their tax benefits by advisory firms or other intermediaries, courts are more willing to enter a finding of tax avoidance.
ITR: What do you think multinational taxpayers in New Zealand can expect from IRD in the future?
SC: Two key areas of focus for IRD in the next two years are expected to be financing transactions and transfer pricing.
Financing transactions, in particular cross-border financing and/or financing between related parties, have been a particular focus of IRD recently and will continue to be.
There have been a number of investigations and disputes regarding arrangements entered into by multinationals to finance their New Zealand operations, including the use of hybrid instruments.
These arrangements have sometimes involved taking advantage of differences in characterisation as between New Zealand's debt-equity rules and those of other countries.
Transfer pricing is expected to be a growing area of audit activity and tax disputes. This reflects the fact that many companies operating in New Zealand are subsidiaries of foreign companies and therefore have many cross-border dealings with related parties.
IRD is concerned to ensure profits are not being repatriated outside of New Zealand through excessive charges to the New Zealand operations.
Large corporates are typically subject to a risk review process with IRD where tax returns are reviewed and issues raised within a matter of months of the return being filed. Issues that are not resolved by the end of the risk review period are then moved to audit. The risk reviews are intended to result in the early identification and resolution of tax issues.
Inland Revenue encourages early and proactive engagement on transactions that may involve a high level of tax risk. However, such engagement is not necessarily always in the taxpayer's best interests as IRD will naturally take a revenue-friendly position. Advice should therefore be taken as to the appropriate level of engagement, if any, with IRD.
Further reading
What Australian taxpayers should know about the ATO's future strategy
Managing tax disputes in Hong Kong
