Penalties and interest: Shortfall penalties
Not taking reasonable care
Tax laws require you to take reasonable care in meeting your tax obligations.
Generally, this means you must take the same care that a reasonable person in the same circumstances would take. The standard doesn't require perfection on your part.
The penalty for not taking reasonable care is 20% of the tax shortfall.
In limited cases the penalty is capped at $50,000. The cap applies to tax shortfalls identified through voluntary disclosure or Inland Revenue audit within a certain period, being the greater of:
- three months, or
- the lesser of:
- one return period, or
- six months.
For business taxpayers, reasonable care means adequate record-keeping systems and procedures to ensure income and expenditure are properly recorded. An arithmetical error doesn't necessarily indicate lack of reasonable care.
A reasonable person would be expected to seek professional advice if they were uncertain about how to apply the law. However, the same standards of providing accurate and adequate information still apply. You must still give your tax agent the right information. If you don't, you may incur a penalty.
Different circumstances taken into account
In deciding if you have taken reasonable care, we take into account your circumstances. These include:
- the complexity of the law and the transaction, and the difficulty of interpreting the law
- the amount and seriousness of the shortfall
- the difficulty and expense of taking precautions against such a shortfall occurring
- your age, health and background.
Other circumstances that may be taken into account for a business taxpayer include:
- the size and nature of the business
- the internal controls in place
- the business's record-keeping practices
- any systems failures (although the reason for the failure is also considered).
Reasonable care - how different circumstances are taken into account
| Example 1 | |
|---|---|
| Susie is a salary earner who makes handmade notebooks at home during the evenings and sells them at local markets on weekends. Susie sets up a cashbook to record her income and expenditure, but sometimes forgets to record her weekly sales in her cashbook. An Inland Revenue audit reveals a tax shortfall. Susie incurs a penalty of 20% of the tax shortfall for not taking reasonable care. By failing to record sales carefully, Susie has not taken reasonable care. Alternative scenario Once, Susie sold a few of her notebooks to a neighbour and forgot to record it in the cashbook. She had, however, recorded all her regular weekly sales during the year. When preparing her tax return at the end of the year, Susie forgot the one-off sale to her neighbour. Susie doesn't incur a penalty in this case because the oversight is minor and doesn't detract from her generally careful approach to record- keeping. | |
| Example 2 | |
|---|---|
| Walter runs his own carpet laying business. When Walter completes his GST return he claims a credit for each invoice held for the GST period. An Inland Revenue audit reveals several of the invoices for one GST period are clearly not tax invoices because the suppliers didn't charge GST. Walter has a computerised bookkeeping system that can override automatic claims of input credits, but he doesn't use it. The penalty for not taking reasonable care is warranted in this case. Walter claimed GST on all invoices, whether or not they were supplied by GST-registered suppliers. If Walter had checked the invoices before entering them into his system he would have taken reasonable care. | |
| Example 3 | |
|---|---|
| Mark has a new general maintenance business that is growing rapidly. Mark has an accounting system he uses to help prepare his tax return. However, this accounting system has not kept pace with his expanding business. Inland Revenue audits Mark's business and finds several amounts of income have been omitted from his tax return. There are also overstated claims for deductions. The resulting tax shortfall could have been avoided if Mark had kept proper records. Mark incurs a penalty of 20% of the tax shortfall for not taking reasonable care. Alternative scenario Mark discovers the inadequacies of his accounting system before the end of the tax year and remedies them. The discrepancies involved are small and no errors occur after the new accounting system is set up. No penalty is charged. Mark realised the accounting system could no longer meet the demands of his growing business and took positive steps to resolve the problem as soon as it became apparent. This action meets the standard of reasonable care. | |
Arithmetical errors
An arithmetical error in a tax return doesn't necessarily mean failure to take reasonable care.
In determining if you have taken reasonable care we'll consider:
- the procedures you had in place to detect arithmetical errors
- the size, nature and frequency of the error
- the circumstances in which you made the error.
| Example | |
|---|---|
| Arithmetical error not penalised Max runs a nationwide outdoor equipment retail chain. During a stocktake of over 2,000 categories of stock, one of Max's employees transposes the cost price of one category. Max's normal checking procedures don't detect the error, but it comes to light during an Inland Revenue audit. The error is small in relation to the entire stock figure. No penalty is charged. Max took reasonable care in carrying out the stocktake, the procedures he has in place would normally have picked up the error, and there was only a small amount of tax at stake. | |
Interpreting the law
You must also take reasonable care in interpreting the law. If you're uncertain about the interpretation you're adopting you should ask a tax agent or contact us.
For questions of interpretation of law, reasonable care depends on:
- the efforts you made to resolve the question
- the type of advice you received
- the certainty of the law.
You're unlikely to have breached the reasonable care standard if any of the following circumstances apply:
- you've relied on information that, although misleading, came from reputable sources, or
- a reasonable person in the same circumstances would be likely to find the relevant information extremely complex or specialised.
Relying on professional advice
If you rely on the advice of tax agents or Inland Revenue, you'll usually be considered to have taken reasonable care. However, you may still be charged a penalty for not taking reasonable care if you:
- provided inadequate information when seeking advice
- failed to give reasonable instructions to a tax agent
- relied unreasonably on a tax agent or on wrong advice (when you had reason to believe that the advice was not correct), or
- have in the previous four years had a similar tax shortfall.
In other words, you don't satisfy your obligations to take reasonable care simply by using the services of a tax agent. You're still responsible for maintaining proper tax records during the year and for giving your agent all the relevant facts. You're expected to answer honestly any questions about your return the agent asks you.
For tax positions taken on or after 1 April 2008 legislation has been enacted that states that a taxpayer who relies on the action or advice of a tax adviser engaged by the taxpayer will have taken reasonable care except if the taxpayer:
- is the employer of the tax advisor
- does not provide to the tax advisor adequate information relating to the tax position
- does not provide to the tax advisor adequate instructions relating to the tax position
- has reason to believe that the action or advice is incorrect
- has previously, for a period ending less than four years before the beginning of the period to which the tax position relates, had a tax shortfall for the same type of tax arising from a corresponding tax position and does not take reasonable care to avoid the further tax shortfall.
| Example | |
|---|---|
| Not giving your agent all the facts David, a dairy farmer, has a small cottage on his property he lets to a student. He doesn't consider the rent taxable income. David doesn't inform his accountant of the rental income and the accountant omits it from his end-of-year accounts and tax return. David is charged a penalty for not taking reasonable care. Under general law principles, a reasonable person in the same circumstances would be expected to check with their agent about the taxable status of the rental income. | |
Date published: 26 Mar 2008
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