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Unacceptable tax position

The legal definition of an unacceptable tax position is one that fails to meet the standard of being about as likely as not to be correct.

This means the position taken need not necessarily be the correct position, or one that has a 50% chance of success, but must be one capable of being seriously considered by a court.

The penalty for a tax shortfall resulting from an unacceptable tax position is 20% of the resulting tax shortfall.

When is a penalty charged?

A penalty will be charged if all of the following conditions are met.

For tax positions taken on or after 1 April 2008

  • The tax shortfall resulted from a tax position that was not about as likely as not to be correct.
  • The tax shortfall is in income tax.
  • The tax shortfall is more than both $50,000 and 1% of the taxpayer’s total tax figure for the relevant return period.

For tax positions taken before 1 April 2008:

  • The tax shortfall resulted from a tax position that was not about as likely as not to be correct.
  • The tax shortfall exceeds both $20,000 and the lesser of $250,000 or 1% of your total tax figure for the relevant return period (for example, if your total tax was $30 million, the $250,000 cap would apply, since 1% of $30 million is $300,000).

The purpose of this is to establish higher standards for tax positions where a large amount of tax is being considered. This is why thresholds have been adopted in respect of the amount of tax involved.

Note  
You haven't taken an unacceptable tax postition if the tax shortfall is the result of a calculation mistake or by misrecording numbers on a return.

 

Example  
Unacceptable tax position
When Kate completes her latest tax return, she claims the purchase of an expensive item as deductible expenditure. Kate contends that, in terms of tax law, the item is deductible.

After an audit, Inland Revenue considers that, under the law, the particular item is clearly capital expenditure, a position supported by case law.

Kate can't demonstrate her interpretation of the law was "about as likely as not" to be correct, so she doesn't have an acceptable tax position. Kate's actions result in a penalty of 20% of the tax shortfall.

Partnerships

To establish whether a tax shortfall incurred by a partnership is over the threshold for charging a penalty, the partnership is treated as a single entity. Shortfalls relating to the partnership activities are added together and the total is compared with the threshold.

Example  
How a partnership shortfall resulting from an unacceptable tax position will be applied

Walter and Mark have formed a two-person partnership. Each partner's tax position includes income from partnership activities on which tax of $550,000 is payable.

An Inland Revenue audit reveals a tax shortfall of $12,000 in each partner's income from the partnership activities. The shortfalls are the result of an unacceptable tax position.

In applying the threshold, Walter and Mark's tax positions are amalgamated. The total tax on the amalgamated tax position is $1.1 million, and the amalgamated tax shortfall is $24,000.

Because the amalgamated tax shortfall is over $20,000 and more than 1% of the partnership's total taxable income, a penalty will apply.

Walter and Mark are each individually assessed for $12,000 tax plus a $2,400 penalty for having an unacceptable tax position of the law (20% standard penalty for an unacceptable tax position).

Trusts

A tax shortfall arising from a trust is assessed as trustee income and the trustee incurs any penalties. This is because the trust is a separate legal entity and the trustee is liable for tax on any income that isn't beneficiary income.

Joint ventures

Shortfall penalties are imposed on joint venturers separately.

Resolving disputes

If we decide that your tax position is unacceptable, you have the right to disagree. If you disagree, and invoke the disputes process, the case is referred to our Disputes Review Unit for further consideration before assessments are issued. If you still disagree, you have the normal rights of review through the courts.