AVOIDANCE & EVASION

Avoidance & Evasion

A commonly asked question is what is the difference between tax avoidance and tax evasion? And then there is legitimate tax mitigation.

Despite being New Zealand tax residents, some believe that offshore income is not taxable in New Zealand and/or that Inland Revenue will not obtain information about foreign investments.  Please refer to our blog items on tax residency and worldwide income.

Tax Evasion

Tax evasion is fraud that involves the use of illegal methods to conceal income or information from Inland Revenue, or other tax authorities, to avoid the assessment or payment of taxes.

Examples of tax evasion include: 

• Intentionally under-reporting or failing to report income; and
• Claiming tax deductions or tax credits you’re not entitled to.

Tax evasion can result in the imposition of interest, shortfall penalties of 150% of the tax shortfall and has the potential for prison time or home detention. If convicted of tax evasion, a taxpayer’s name will be published. 

If there is tax evasion Inland Revenue may issue a revised assessment irrespective of how many years have elapsed since the income year or GST return period in which the avoidance occurred.

Tax avoidance

Some, usually foreign,  literature refers to tax avoidance as legitimate steps taken to minimise tax. In New Zealand, the generally accepted meaning of tax avoidance is using legitimate steps in an artificial manner to reduce or avoid tax. 

Tax avoidance includes directly, or indirectly, reducing or postponing the amount of income tax or GST payable now or in the future.

The Income Tax legislation has a general, and many specific, anti-avoidance provisions.  The GST legislation has its own anti-avoidance provision.

Determining whether a tax avoidance arrangement exists involves considering various factors, including the: 

1. Manner in which the arrangement is carried out; 
2. Role of all relevant parties and their relationships; 
3. Economic and commercial effect of documents and transactions; 
4. Duration of the arrangement; 
5. Nature and extent of the financial consequences; 
6. Presence of artificiality or contrivance; 
7. Presence of pretence; 
8. Presence of circularity; 
9. Presence of inflated expenditure or reduced levels of income; 
10. Undertaking of real risks by the parties; and
11. Relevance of an arrangement being pre-tax negative.

Inland Revenue takes a tough approach with taxpayers using tax avoidance arrangements and advisers who promote tax avoidance arrangements. There are separate potential penalties for promoters of avoidance schemes and company officers who implement avoidance schemes.

Tax avoidance can result in the imposition of interest and shortfall penalties of 100% of the tax shortfall.

If there is tax avoidance Inland Revenue may issue a revised assessment irrespective of how many years have elapsed since the income year or GST return period in which the avoidance occurred.

Tax Mitigation

Not all tax planning is tax avoidance. Bona fide tax planning and minimisation are tax mitigation. The basic rule is that tax planning and tax minimisation are lawful as long as the transaction does not trigger an anti-avoidance rule or is not a mere sham. 

We have seen purported tax planning by accountants and lawyers that is clearly tax avoidance.  It is possible that those proposing the advice do not realise that what they are proposing is tax avoidance; in which case they shouldn’t put themselves and their clients at risk.  Others are fully aware of the risks involved but rely on non-detection or being able to convince Inland Revenue that there is no avoidance arrangement.

Inland Revenue has recently released an Interpretation Statement on tax avoidance and the application of the income tax anti-avoidance provisions following a recent decision that upheld Inland Revenue’s stance that a company had entered into an avoidance arrangement. At 135 pages it is a comprehensive document. See:

https://www.taxtechnical.ird.govt.nz/-/media/project/ir/tt/pdfs/interpretation-statements/is1301.pdf?modified=20200316220016&modified=20200316220016

In our experience some Inland Revenue staff raise the spectre of applying anti-avoidance provisions as part of a tax audit or similar activity. This could reflect either:

• A poor understanding of the legislation; or
• A negotiating position to pressure a taxpayer into accepting a proposed revised assessment.

If you are unsure about advice that you have received or what a mate may have told you, it may be prudent to obtain specialist advice. If you are party to an avoidance arrangement, or have evaded income tax or GST, you can make a voluntary disclosure and reduce the prescribed penalties. See our blog item on managing tax risk.

The application of tax law can be very fact specific. The comments above are of a general nature only and are not intended as tax advice. 

Copyright: Tax Central Limited – murray@taxcentral.co.nz