Archive of Speeches and Presentations

Corporate Insolvency - Taxation Risk Management
06 September 2006

Address by David Butler at the New Zealand Law Society Taxation Conference

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In my role I wear two hats. One as the Chief Executive of a large government department. The other as the Commissioner of Inland Revenue.

This is made clear by section 6A(1) of the Tax Administration Act 1994, where it is stated "...the person appointed as chief executive of the [Inland Revenue] Department under the State Sector Act 1988 is designated the Commissioner of Inland Revenue."

Both aspects of my role carry significant responsibilities and accountabilities.

As the Chief Executive and leader of 5500 people in 17 locations throughout New Zealand and with an annual appropriation of $531 million, there is a strong and appropriate expectation from the Minister of Revenue, the Parliament and the community, that we will conduct ourselves efficiently and effectively. This includes creating an environment within Inland Revenue where our people are challenged, developed and rewarded for their efforts and success.

As the Commissioner of Inland Revenue, I am given broad and important powers to ensure taxpayers meet their obligations under our taxation laws and the other laws we administer. With these powers, however, comes great responsibility to make decisions which directly impact on a business or an individual with care, consistency and with an eye on creating an environment which promotes compliance.

Dr Geoff Harley, the Chair for this conference, states in his overview in the conference brochure that "The Commissioner has formidable enforcement powers, but the objective of an enlightened tax administration is the promotion of community wide accurate self-assessment."

In my paper today I want to:

• Describe our approach to compliance which I believe is consistent with Geoff"s comment of an "enlightened tax administration";
• Discuss the powers of the Commissioner;
• Raise awareness of the need to have a clear focus on taxation risk management within your client"s governance arrangements; and
• Provide some ideas and information which may assist your clients to avoid the issues Geoff Clews will spend some time on namely, corporate insolvency.

Our approach to Compliance

To give some context to Inland Revenue"s approach to compliance it is important that I first set out our overall framework for maintaining and improving compliance with the laws we administer.

Like many other countries, the New Zealand tax laws are based on the premise that taxpayers have an obligation to voluntarily comply with the Inland Revenue Acts. It is only when this fails to happen that Inland Revenue would step in. It is how we step in that I want to now describe.

If you were to access the website for the Organisation for Economic Cooperation & Development and search for "Compliance Model", you will be taken to several areas on the site where the Compliance Model we use in New Zealand is referred to as best practice. We have used the model since 2001 and it is set out below.

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This model is based on research of regulatory agencies such as nursing home regulators, environmental protection agencies and tax authorities.

The model depicts the factors that we should take into account when considering what influences customer decisions and behaviour (the circle on the left). These include the economic environment, industry profile and business profile, amongst others.

The model has a pyramid shape on the right where the base is made up of people who are "willing to do the right thing" or "try to, but don"t always succeed". The shape of the pyramid is to represent that most customers sit at the base of the pyramid where our approach needs to be "make it easy" to comply or "assist to comply" for those who do not always succeed.

On the other hand there are some customers (few in number) who have deliberately decided not to meet their obligations. They are at the top of the pyramid and our response will be to use the full force of the law. This is what the community would rightfully expect of us where there has been deliberate steps taken to avoid or evade an obligation or responsibility.

The key for ongoing success for a revenue agency I believe is to ensure that the legislative framework, administration systems and enforcement activities are always directed at the long term objective of encouraging as many people as possible to be at the bottom of the pyramid. Here they are voluntarily meeting their obligations which will be at a lower cost to them and the administrator. However, this will only occur if the revenue agency is also skilled at taking steps to ensure there is compliance where this is needed. Overall, the community needs to respect the agency for the way it goes about aspects of its work.

Our Powers

To enable us to carry out the ensuring or enforcement aspects of our work, the New Zealand Parliament has given us broad and important powers. These include:

• We can access a business premise to obtain information (section 16 of the Tax Administration Act);
• We can remove and copy documents (section 16B of the Tax Administration Act);
• We can require that information be provided in writing (section 17 of the Tax Administration Act);
• If a customer fails to provide information we seek we can apply to a Court for an order requiring that information to be supplied (section 17Aof the Tax Administration Act);
• If we believe it is necessary to hold an inquiry to obtain information we can apply to a District Court Judge for such an inquiry (section 18(1) of the Tax Administration Act); and
• We can require people to attend and give evidence before a delegated officer of the department and this may be required to be under oath (section 19 of the Tax Administration Act).

While exercising our powers and in fact in all that we do, we are required by section 6 of the Tax Administration Act to maintain the integrity of the tax system. This includes an obligation to act fairly, impartially and of course legally. Integrity is defined to include taxpayer perceptions of integrity thus, this is a broad responsibility.

As I have already noted, customers have responsibilities to comply with the law. This includes paying on time, keeping all necessary records and information, cooperating with the Commissioner and correctly determining the amount of tax payable under New Zealand"s self-assessment system (section 15B of the Tax Administration Act).

In the year ended 30 June 2006 we collected over $50 billion net in revenue. Of this amount about $1 billion was from audit activities and our debt collection efforts amounted to $1.8 billion cash being received. As you can see from these figures most of our revenue collection comes from activities other than audit and debt collection. Consequently, most New Zealanders will never be subject to the use of our formal powers.

It is also relevant to note that we will only use our powers to the extent necessary to achieve our objectives. It is important, I believe, that we are efficient in the use of our powers.

Another way of viewing our revenue collection functions which shows how important they are to all New Zealanders is, the net GST collections roughly equates to the amount needed to fund Education and the total of tax paid by companies and tax paid through withholding is about the same as that needed to fund Health.

Returning to our audit and debt collection activities, clearly the ongoing success of these activities is important to us. As would therefore be expected we are constantly striving to improve our performance in these areas.

We are now very well advanced in reshaping the whole of our audit operations. We have significantly strengthened our ability to identify tax compliance risk through more coordinated use of data and intelligence and we now target compliance risks on a national basis.

We have deepened our understanding of customer groups to enhance our ability to tailor our responses to the particular nature and level of risk. We have also invested in the induction, training and development of our audit staff as well as strengthening our quality assurance processes. We now better share our expertise across New Zealand and this is particularly the case with our technical and legal support functions.

Looking forward and as is the case for many other developed countries, our compliance concerns are likely to be increasingly related to identity, evidence and jurisdiction. These are concerns that revenue agencies around the world have with identity fraud. This puts real pressure on our registration systems to ensure they are robust. Evidence is also becoming more of an issue. With businesses operating globally and with significant foreign investment in jurisdictions around the world, we now are much more likely to be working with other revenue authorities on cases of similar interest or as a means of obtaining information of New Zealand taxpayer activities in other countries. Finally, jurisdiction is an issue which we will increasingly face in the future. International rules of sovereignty will continue to be challenged and the debate about what part of the international tax pie will be New Zealand"s will also increase.

In the area of debt collection we have also enhanced our operations in recent years. We have been working with our colleagues around the world to share best practice. In particular, in New Zealand, we have been given greater ability to write off a debt where there is hardship and greater legislative freedom to negotiate a payment plan. At the same time we have strengthened our overall practices.

We now have dedicated Complex Debt Teams. Our people in these teams are skilled in dealing with cases where there are complex structures often involving inter-related or controlled entities and complex commercial structures. Our people now commonly work with our investigators and lawyers to ensure we are in the best possible position to recover any tax and penalties due at the end of an investigation.

We are now more active and proactive, in our approaches to what we believe are persistent fraudulent practices. Where appropriate, we are taking action under the Companies Act where:

• A director has misapplied or retained money or property or where there may have been reckless trading or failure to keep adequate records (section 301 of the Companies Act);
• There is a need to actively work with a liquidator to assist with the recovery of tax debts; and
• It is believed that the independence of a liquidator may be an issue. In these cases we have taken steps to remove or replace a liquidator, or at the very least ensure there is active compliance with the requirements of the Companies Act.

Clearly these sorts of examples are not the bulk of our collection activity but rather show the efforts we go to where someone has decided to deliberately frustrate our recovery efforts.

It is timely that I now turn to what you may be able to do to assist your clients strengthen their governance arrangements to have a stronger focus on tax risk management.

Tax Risk Management

In the September 2004 edition of Internal Auditing and Business Risk, Mr Tony Elgood, a UK partner of PricewaterhouseCoopers, stated that very few tax organisations actually have a tax risk management policy and even fewer have written it down.

With the recent strengthening of governance arrangements and expectations following notable world events, there does seem to be a slowly increasing focus on management of tax risks. However, following discussions I had with chairs and directors of companies in New Zealand, several people approached me and said they did not have any clear understanding of what would be best practice tax risk management. I expect this is the case for a number of organisations operating in New Zealand.

Given this situation we have commenced discussions with the New Zealand Institute of Directors, the New Zealand Institute of Chartered Accountants and the New Zealand Law Society to explore how we can work together to increase awareness of the importance of managing tax risks effectively. In the meantime today I want to explore what a tax risk management policy may be.

Several commentators suggest that tax management risk should be categorised under the following areas:

• Transactional risks.
• Operational risks.
• Compliance risks.
• Financial accounting risks.

Transactional Risks

There is a theme amongst literature on the Internet, that the highest level tax risks for an organisation arise where transaction are occurring specifically for taxation purposes. Major transactions entered into will often be examined by a revenue authority and clearly these deserve close attention by chairs and directors. The process to be used to govern these sorts of decisions should be well documented as well as having an agreed framework against which to judge acceptable risk for instance whether tax avoidance rules could affect the transaction.

Operational Risks

These risks relate to the routine day to day business operations. Again the literature suggests there are different levels of risks depending on say whether it is a routine domestic transaction (for example, sale of trading stock) or a cross border, related party transaction.

Compliance Risks

These sorts of risks relate to compliance with statutory obligations to file, pay etc. Included in this category are the internal processes adopted to ensure obligations are met and any questions from a revenue authority are answered in accordance with agreed timelines.

Financial Accounting Risk

This risk relates to proper internal controls over financial reporting. As you would be aware this is now clearly directed at a "no surprises" approach to the preparation of financial reports, including tax provisioning.

Tax issues which may be examined by Inland Revenue

As I have already noted, information related to Tax Risk Management is readily available on the Internet. However, you may find the following checklist of help when considering the tax risks faced by your clients:

1. Financial or tax performance that varies substantially from industry patterns
   • Inland Revenue now more systematically considers these issues and makes comparisons both within New Zealand and with other jurisdictions.
2. Significant variations in the amounts or patterns of tax payments compared to past performance and relevant economic indicators and industry trends.
   • Inland Revenue routinely scrutinises payment patterns and compares these to economic and industry trends.
3. Unexplained variations between economic performance, industry performance and tax payments.
   • Inland Revenue will examine internal structures, loans between companies, interest deductions and make comparisons between accounting and taxation treatments of transactions.
4. Unexplained losses, low effective tax rates, and any instances of an entity consistently paying relatively low tax.
   • Clearly losses can arise but if these appear to be unexplainable Inland Revenue will likely seek further information. Patterns of tax payments over time will also be considered.
5. A history of unacceptable tax planning by a company, a group, board members, key executives or advisers.
   • Inland Revenue will take all of these issues into account when considering what further scrutiny of an entity may be necessary.
6. Weaknesses in structures, processes and approaches to tax compliance.
   • If it is evident to Inland Revenue that there are weaknesses in practices this will attract our attention.
7. Tax outcomes that are inconsistent with the policy intent of any legislative reform.
   • The impact and consequences of legislation changes will be considered by Inland Revenue. This will particularly be the case where change is directed at an unacceptable tax practice.

How you may assist your client

Given that Inland Revenue has and will continue to focus on risks to tax compliance, how may you assist your clients who are chairs or directors of companies. The following questions would, I believe, be worth further consideration:

• What level of confidence does your client have in the correctness of advice received?
• Is the advice based on the actual transaction or on an expectation of how the transaction will be implemented?
• Is your client satisfied that the factual basis for an opinion to the board has been properly checked?
• How likely is it that Inland Revenue will take a different view of the application of the law and assess a company accordingly?
• If Inland Revenue takes a different view and the matter proceeds to litigation, what is the risk of a court deciding the matter in favour of Inland Revenue? If litigation were to arise how well equipped is the company to deal with this?
• What is the potential downside if the company is unsuccessful in litigation with Inland Revenue including interest and penalties?
• If there is a dispute, what is the likelihood of Inland Revenue being prepared to settle the dispute and, if so, on what terms?
• How likely is it that Inland Revenue will identify the tax issues that arise from the proposed course of action? Allied with that, to what extent will embarking on the proposed course of action increase the tax risk profile of the company and increase the possibility of audit scrutiny?
• In light of the potential risk, would it be desirable to approach Inland Revenue for guidance in the form of a binding ruling?
• Where a position has been taken on a tax issue, would it be desirable to constructively handle any disagreements which may ensure?

Conclusion

I often say to our people in Inland Revenue that the most important touchstone related to our performance is that we must operate in a way which is consistent with the expectations of the New Zealand community. Our Compliance Model provides a framework for our responses to any compliance concerns. As noted already most New Zealanders are willing to do the right thing and we aim to make it as easy as possible for them to do this. Clearly the community would expect this.

However, there are situations where New Zealanders have decided not to meet their obligations and the community expects us to effectively and efficiently deal with this. We are now more able to skilfully respond to these issues.

In addition to describing our approach to ensuring there is compliance with the laws we administer, I have attempted to describe some steps which you and your clients could take to develop a tax risk management policy. Furthermore, the checklist and questions I have put forward could assist.

My goal in doing this is to alert you to the importance of these issues and to encourage you to reflect on what you may be able to do to support your clients to comply with New Zealand's taxation laws.

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Corporate Communications
Inland Revenue

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Phone: (04) 890 1936
Email: corpcomm@ird.govt.nz
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Date published: 06 Sep 2006

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