The Reform of the Tax Disputes Process: The Story Continues

Jarrod Walker, Senior Associate | Tuesday 24 August 2010

First published in Taxation Today, July 2010.

This is the first of two articles by Bell Gully examining key aspects of Inland Revenue's recently accounced review of the tax disputes procedures. In particular, the articles consider the recommendations of the issues paper and accompanying Standard Practice Statements released by Inland Revenue in July 2010 as part of that review.

Introduction

Earlier this month the Inland Revenue Department released an issues paper entitled "Disputes: a review". The paper is a review of aspects of the tax disputes procedures in Parts IVA and VIIIA of the Tax Administration Act 1994 (TAA 1994) and certain Inland Revenue practices in relation thereto. The issues paper was accompanied by revised versions of Inland Revenue's Standard Practice Statements (SPSs) relating to disputes initiated by both Inland Revenue and the taxpayer.¹

This process is the most significant review of the tax disputes process since 2003 and is likely to be of interest to many taxpayers.

This article is published in two parts. The first part addresses the suggested reforms to the (pre-challenge) disputes process in Part IVA of the TAA 1994 and the second part addresses the proposals in relation to the challenge procedures in Part VIIIA of the TAA 1994.

Background to the issues paper

The issues paper and draft SPSs were published in response to a joint submission of the New Zealand Law Society (NZLS) and New Zealand Institute of Chartered Accountants (NZICA) to the Minister of Revenue and the Commissioner of Inland Revenue in August 2008. The background to that submission was the concern that problems with the tax dispute/challenge process identified by the Organisational Review Committee (the Richardson Committee) in 1994 had not been solved by the enactment of the modern disputes regime in 1996 and subsequent reforms in 2004.

Key aspects of the dispute procedure identified by the NZLS and NZICA as giving rise to concerns to taxpayers included:

(a) The quality and usefulness of the Inland Revenue's Notice of Proposed Adjustments (NOPAs) and Notice of Responses (NORs).

(b) The absence of an effective internal review by Inland Revenue of a taxpayer's case early in disputes process.

(c) The scope of the "evidence exclusion rule".

(d) The discretionary nature of the conference stage and the punitive cost of "use of money" interest.

(e) The absence of binding time frames on Inland Revenue at certain stages of the disputes process.

Quality of disputes documentation

The NZLS and NZICA submission was particularly critical of Inland Revenue's NOPA and NOR documentation, which were seen as often overly long and including many ultimately irrelevant issues. Rather than promoting the understanding of the tax issues at hand, Inland Revenue's documents were seen as leading to misunderstanding and entrenchment of positions. Some taxpayers were viewed as being "burnt off" by the NOPA/NOR process, as the costs of interpreting and replying to Inland Revenue's extensive documentation quickly outweighed the tax in dispute.

In light of these issues, the NZLS and NZICA called for increased oversight by experienced Inland Revenue staff to improve the quality of NOPA / NOR documentation. They also suggested a word limit be imposed to increase readability and improve the focus of the documentation on relevant issues.

In its reply, Inland Revenue notes various measures by which it intends to improve the quality of its NOPA/NOR documents. These include:

(a) The adoption of a co-ordinated approach to drafting within Inland Revenue;

(b) Ensuring that the length of the NOPA is proportionate to the dispute, including a 30 page guideline for most cases (excluding discussion on shortfall penalties and any schedules showing calculations or diagrams and, importantly, subject to exceptions in complicated matters, where there are multiple issues or where the tax in dispute is significant); and

(c) Avoiding lengthy quotations from cases.

Inland Revenue recognises that the Statement of Position (SOP) stage is the appropriate place for more detailed analysis of the facts and issues.

Mark Twain (apparently) once apologised for writing a long letter on the basis that he didn't have time to write a short one instead. That justification has no doubt provided comfort to many tax practitioners over time, and probably a few in Inland Revenue also. Nevertheless attempts, promoted through guidelines such as those proposed by Inland Revenue, to make NOPA/NOR documentation more concise and focused are to be applauded. However, whether these revised guidelines are successful in reducing taxpayer "burn-off" remains to be seen. Strict compliance with Inland Revenue's own guidelines, without undue recourse to the several exceptions to those rules (the interpretation of which is left to Inland Revenue's discretion), should be encouraged.

The NZLS and NZICA suggestion for oversight of the preparation of Inland Revenue's NOPAs and NORs was not expressly adopted by Inland Revenue. Inland Revenue does suggest that review of the NOPA/NOR documents should be undertaken by an Inland Revenue legal officer. However, review by the legal team in the same office as the Inland Revenue auditor in charge of the NOPA / NOR process was noted by the NZLS and NZICA as often not providing the necessary level of objectivity. In some cases, their submission noted, review by the National Office in Wellington should be undertaken (where the NOPA / NOR was to be issued by an office outside of Wellington).

On a wider level, independent review of a taxpayer's case during the early stages of a dispute was noted by the NZLS and NZICA as being an important factor in achieving the objectives of the Richardson Committee in proposing the current regime. They noted that Inland Revenue was still both a "player" and the "referee" in disputes. They expressed concern that the same Inland Revenue officer who conducted the taxpayer audit was also responsible for preparation of disputes documentation and the review (and rejection) of the taxpayer's submissions in that process. The involvement of Inland Revenue's Litigation Management Unit at the SOP stage was seen as being too late to provide an effective review. Similarly, referral to the Adjudication Unit at the end of the disputes process was regarded as being too late to be much practical help.

This aspect of the joint submission was not expressly discussed by Inland Revenue. This is unfortunate, as many taxpayers would share the view that active oversight of the early stages of the disputes process by a senior Inland Revenue officer not previously involved in the audit process would be helpful. This might, for example, assist in preventing entrenchment of views which can occur early in a dispute (particularly after a lengthy audit) and the resulting diminution in usefulness of the subsequent processes in terms of resolution of the dispute.

Evidence exclusion rule

Rather than encourage Inland Revenue and the taxpayer to refine and narrow the basis of their dispute, this rule has, in the view of NZLS and NZICA, led to the addition of ultimately irrelevant arguments, facts and evidence to disputes documentation (specifically, at the SOP stage), for fear of potentially relevant points later being excluded from the challenge procedures. This was seen by the NZLS and NZICA as a key factor in increasing the cost and complexity of the disputes process for taxpayers (a view no doubt shared by many taxpayers), and leading many to withdraw from the disputes process where the tax in dispute was at risk of being dwarfed by the costs of the process.

In their submission the NZLS and NZICA called for limitation of the evidence exclusion rule to propositions of law (the key change being that facts and evidence would be excluded from the ambit of the rule). The submission noted that if the conference stage was mandatory and clearly focused upon reaching a resolution, both the taxpayer and Inland Revenue would in any event be given an incentive to put their best case on the table. No separate need would exist for the evidence exclusion rule.

In principle Inland Revenue agrees in its issues paper with this proposed reform. It acknowledges the "kitchen sink" approach that has developed in the preparation of SOPs. Its reform proposal differs from that of the NZLS and NZICA in that it proposes that the rule be limited to also to issues to be resolved. In practice this does not appear to be a significant point of difference.

The proposed narrowing of the evidence exclusion rule to issues and propositions of law is a significant and worthwhile reform. Taxpayers (and Inland Revenue) will continue to need to prepare their cases carefully during the early stages of the disputes process. Not being under the obligation however to compile and refer to every piece of evidence at the SOP stage should represent an important saving to taxpayers in terms of cost and administrative time, especially given that the process is then essentially repeated at the court stage.

Confusingly however, Inland Revenue states in its issues paper that there would still need to be a requirement for an SOP to contain an outline of the facts and evidence on which the party producing the SOP intends to rely. It notes that factual certainty could be achieved by Inland Revenue through the use of its ss 16 and 17 (of the TAA 1994) information-gathering powers and the conference stage. Exactly what is intended by Inland Revenue in relation to the inclusion of facts and evidence in SOPs should be clarified.

Inland Revenue also agrees with the NZLS and NZICA suggestion that where the evidence exclusion rule applies, it should apply to both parties. It suggests methods by which the current anomaly of the rule only applying (in certain circumstances) to the taxpayer can be removed.

Discretionary nature of the conference stage

The discretionary nature of the conference stage was seen by the NZLS and NZICA as inconsistent with the goal of the Richardson Committee reforms in promoting early resolution of disputes. In their submission they noted that the experience of many taxpayers was that the conference was often not held. If it was held, it was not given significance by Inland Revenue officials, who appeared to regard the conference simply as a chance to gather more information, rather than as a true opportunity to understand the taxpayer's position and attempt to reach an early resolution.

Key reforms called for in the NZLS and NZICA submission included:

(a) Making at least one conference mandatory;

(b) Requiring an independent mediator or personnel from the Litigation Management Unit or Office of the Chief Tax Counsel to be present at that conference; and

(b) As an incentive to constructive participation by the taxpayer in the conference stage, either the suspension of use of money interest, or a reduction in the rate of that interest, while the conference stage was underway.

In its issues paper Inland Revenue reiterates its view that the conference is a vital part of the disputes process. However, it does not adopt the NZLS and NZICA suggestion that it be made a mandatory part of the disputes process. Views on the usefulness of conferences do differ (particularly where parties have become entrenched) - and not having a mandatory requirement for a conference will be seen by some taxpayers and their advisors as a positive, not negative, point.

The issues paper does adopt the suggestion of a facilitator being available to attend conferences. The facilitator will be a senior Inland Revenue officer not previously involved in the dispute. The facilitator's role is explained as being to assist in focusing the parties on the issues at hand, to explore options and to ensure that all relevant information is exchanged. The facilitator will not have a power to settle disputes (in the sense of passing judgment), but will be able to explore settlement by the parties, subject to Inland Revenue's settlement guidelines. The facilitator will have a role in clarifying the termination of the conference stage, including bringing it to a close where the conference is failing to meet its objectives.

The proposal to involve facilitators at conferences is sensible. Where parties have elected to meet to attempt to resolve or at least clarify the dispute, the oversight of a trained, experienced facilitator should be helpful. One would expect the presence of a facilitator to steer the conference towards resolution / settlement, even if this is not the sole aim of the reform.

Absence of certain time frames

In their submission the NLZS and NZICA were critical of the often lengthy delays in progressing tax disputes. They pointed to the absence of time frames binding upon Inland Revenue in certain circumstances (particularly the period between the NOPA/NOR and SOP stages and when disputes were referred to the Adjudication Unit) as a key cause of this failing. One goal of the Richardson Committee reforms was to prevent undue delay in tax disputes. The NZLS and NZICA noted that the current disputes process often operated just as slowly as the former regime. Use of money interest continues to accrue at all stages of the disputes process, including when the process appears to be stalled.

The NZLS and NZICA called for legislative time frames in relation to the period between the NOPA/NOR stage and the subsequent SOP stage. That is the period during which the conference usually takes place. They called for that conference (suggested to be made mandatory) to take place within 2 months from the date of the NOR, and any subsequent Disclosure Notice to be issued within two months following the end of the conference.

The NZLS and NZICA also called for strict administrative (but not legislative) guidelines around the referral of matters to the Adjudication Unit. The suggestion was that referral should take place within one month of the end of the SOP stage. Their submission also called for greater compliance with the expected turn-around time for the Adjudication Unit's report (4 months), noting that in contrast disputes were often stalled at the Adjudication stage for lengthy periods.

Inland Revenue discusses time frames in some detail in its issues paper. It acknowledges the significant downsides the absence of time frames can have, including the negative economic (and emotional) impact of a lengthy dispute on taxpayers, and the resulting potential undermining of the integrity of the tax system. Nevertheless Inland Revenue states its preference as being to retain the current flexibility in the disputes process and to address taxpayers' concerns by way of tighter administrative guidelines and increased compliance with those guidelines. It points to the divergence in the nature of individual tax disputes and suggests that the administrative, rather than legislative, approach allows individual cases to be handled more appropriately.

In its revised SPSs, Inland Revenue proposes a 7 month time frame between the NOPA / NOR stage and the SOP stage. For Inland Revenue initiated disputes this is broken down as:

(a) One month for Inland Revenue to consider the taxpayer's NOR;

(b) Three months for the conference stage; and

(c) Three months following the conclusion of the conference stage for Inland Revenue to prepare and issue the Disclosure Notice/SOP.

Notably, Inland Revenue does go on to discuss the codification of those time frames should a statutory "fix" in fact be preferred.

Many taxpayers would indeed prefer statutory reforms on this point. Administrative guidelines are too often not met and/or are subject to too many exceptions (the interpretation and application of which the taxpayer is not able to influence). The interests of the taxpayer in the efficient progress of tax disputes arguably outweighs Inland Revenue's need for flexibility in the management of those disputes. The issues identified by Inland Revenue in relation to statutory time frames (such as lack of flexibility) could be addressed by legislative mechanisms such as extensions by mutual consent.

Many taxpayers would in any event prefer to be able to opt out of the disputes process after the NOPA/NOR stage, by which time it is often obvious that no resolution will be achieved and there is little point in proceeding with the pre-court process. The ability of taxpayers to opt out and proceed directly to court will be discussed in the second part of this article.

 

¹ The new SPSs will replace existing SPS 08/01: Disputes resolution process commenced by the Commissioner of Inland Revenue and SPS 08/02: Disputes resolution process commenced by a taxpayer.