Selected for Tax Investigation

How selected for investigation

Here are some of the situations that can “red flag” for an investigation of your tax affairs:

From a manual analysis of your business accounts or tax returns.
From a computer analysis of your business accounts or tax returns.
Information received from another investigation which suggests that your records should be looked over.
When checking someone else’s tax records and the information doesn’t match up with yours.
Information or suspicions that other people supply to IRD about you.
Local knowledge from local media, competitors or other sources suggesting that you may have gained wealth that was not taxed.
The area where you live or run your business is known for tax non-compliance.
From following through particular issues or problems that have arisen and affecting a certain group of taxpayers.
When an audit is done of a particular industry.
Where your payment records to IRD do not tie up.
Where your compliance records show that you have consistently ignored tax regulations in the past.
You are chosen strictly at random as part of testing compliance and tax fraud etc.

Questions that can spark a tax investigation

Inland Revenue has a risk based strategy when deciding who to investigate. Not every audit or enquiry will result in an investigation. However if any or all of the following factors are present in a tax scheme you are involved in IRD may ask you for further explanations and information.

None of the factors in themselves determine tax avoidance and the list is not exhaustive so there may be other factors that come into play which lead to an investigation.

Critical questions may include:

Is the tax affect the same as the economic affect
Has the taxpayer suffered the intended economic consequences
While a transaction may be cash flow negative, or arrived at a loss before tax, does it become profitable after tax is taken into account
Pricing of goods and services as well as other assets such as IP and royalties where the value is difficult to justify on an arm’s length basis
Low effective tax rates for taxpayers involved
Other parties to the arrangement paying too much or too little under the transaction
Is the pricing of the transaction one where tax benefits are shared
If the transaction involves two independent parties does the bargaining reflect what would normally be expected
If persistent losses or low profits subject to tax don’t correspond with the nature of the business
Other significant variations in profitability from previous years
Is there a lack of documentation where transactions are between associated parties
Where high value assets such as property, boats, cars, aircraft, artworks etc. exist while low levels of income are reported
Where tax indifferent or tax exempt entities are involved. E.g. Charities or offshore entities
Is the arrangement more complex than necessary to achieve a non-tax goal (e.g. if you have a business meeting in Los Angeles yet you have made travel arrangements so you can fly via London and on return via Hawaii). A closer look is made for any arrangement that generates tax credits or benefits that result in the tax not being paid or refunds being made incorrectly.
Any corporate restructuring that doesn’t appear to have any commercial benefit or sense but reduces tax.
Using non-commercial fees or contrived financial arrangements to avoid group loss offset or shareholder continuity requirements
Financial or other transactions which create deductions under the rules with no underlying economic cost to New Zealand are of concern where it involves a tax haven entity and where the financial arrangement income is not declared in New Zealand.
Circular or non-commercial funding – are the lender and promoter related? And does the taxpayer pay out in one form and but get the receipt in another? And is a payment obligation nullified by a corresponding asset creation?
Paper transactions without underlying cash transfers- is payment changing hands? And is the payment permanent
The tax effect is not the same as the economic effect – has the taxpayer suffered the intended economic consequence?
Transactions that are cash flow negative or loss making pre-tax but are profitable after tax is taken into account.
Parties to the arrangement are paying too much or too little under the transaction or the pricing of the transaction appears to share tax benefits. The bargaining does not reflect what would be expected involving two independent parties.
Pricing of goods, services and intellectual property including royalty payments where the value is difficult to justify on an arm’s-length basis.
Low effective tax rates for taxpayers or groups.
Persistent losses or low taxable profits not corresponding with the nature of the business.
Significant changes in profitability from previous years.
Lack of documentation especially where transactions are between associated parties.
High value assets (e.g. property, boats, cars, aircraft, art etc) with low levels of reported income.
Tax indifferent or tax exempt entities are involved. For example, charities or offshore entities.
The arrangement is more complex than is necessary to achieve a non-tax goal. For example, would you fly to Sydney via Vanuatu, Jersey and Panama?
Arrangements that generate tax credits or benefits where the underlying tax has not been paid, or where paid, refunded to the taxpayer or associate.
Corporate restructuring that doesn’t appear to generate any commercial benefit but reduces tax.
Use of non-commercial management fees or contrived financial arrangements to avoid group loss offset or shareholder continuity requirements
Financial or other transactions which create deductions under the rules with no underlying economic cost to New Zealand are of concern where it involves a tax haven entity and where the financial arrangement income is not declared in New Zealand.
Circular or non-commercial funding – are the lender and promoter related? And does the taxpayer pay out in one form and but get the receipt in another? And is a payment obligation nullified by a corresponding asset creation?
Paper transactions without underlying cash transfers- is payment changing hands? And is the payment permanent

Reasons why IRD will investigate

Inland Revenue may select you for investigation for any one of the following reasons:

to look over your business accounts and/or tax returns
to check someone else’s records (your employer or a bank) to match to your records
due to information received in another audit which recommends your records should be checked
due to your past compliance track record (whether you have consistently complied etc)
to check your payment record (payment of tax or GST taxes on time in the past)
from planned selection of a particular industry (and you are in that industry)
when examining particular issues and problem affecting a group of taxpayers
because you live or run your business in a selected area being audited
matters arising from media reports
due to unexplained wealth
due to information IRD gets from other people
or you may be chosen totally at random

IRD review their methods regularly. Unfortunately and maybe a little unfairly IRD does not have to give you any reason for their selection of you for audit.

Consider making voluntary disclosures

A taxpayer may make a voluntary disclosure either before being notified of a pending tax audit or investigation (“pre-notification disclosure”) or after the first notification but before the audit or investigation starts (“post-notification disclosure”). The disclosure must be full and complete.

It is not up to the Commissioner to try and obtain the required information from the taxpayer. This does not necessarily mean disclosing the discrepancies to the last dollar but does require providing enough information to enable the auditor, investigator or officer to make an assessment.

Each case may have to be considered on its own merits. If a taxpayer is not able to provide full details at the first point of contact with Inland Revenue, the Commissioner will allow the taxpayer reasonable time to obtain more information. The time period for obtaining this information will be negotiated between the taxpayer and the Inland Revenue officer.

Where this information is not provided, the IRD may consider on a case by case basis whether the information provided is sufficient to satisfy the full and complete disclosure requirements

Making a voluntary disclosure to IRD is far better than waiting for any discrepancies to be found out during an audit or investigation. A major advantage is that the penalty charged on any related tax shortfall may be reduced by 75% or even 100% in some instances.

If you are considering making a voluntary disclosure please read our booklet “Putting your tax affairs right” (IR280).

Never too late to make disclosure during investigation

If you have already received a notice from Inland Revenue to say that you have been chosen for an audit it is still not too late to make a voluntary disclosure.

You can tell us what is wrong with your (or your organisation’s) tax affairs at the initial interview or at the inspection of records stage (whichever is earlier). If you do this, the amount of any related penalties charged may be reduced by 40%.