How to manage shortfall penalties
April 27th, 2008, 6:10 pm Teen Hobbies
A tax shortfall (and therefore a tax shortfall penalty) can arise from either overstating deductions or understating income. For the purposes of this article I will use a situation where the taxpayer is unsure whether a prepaid marketing expense is fully deductible. The issue is whether some, or all, of the expenditure is non-deductible as the prepayment element should be added back.
There are various approaches that can be taken, including:
Claim all of the expenditure in calculating the taxable income, but disclose this fact to the Inland Revenue when filing the tax return.
If there is a subsequent tax shortfall penalty that penalty will be reduced by a factor of 75 percent. The potential shortfall penalties of unacceptable interpretation (20 percent) or gross carelessness (40 percent) would be reduced to 5 percent and 10 percent, respectively.
It is probable that they would be further reduced to 2.5 percent and 5 percent.
Claim all of the expenditure in calculating the taxable income, but if IRD states that it will commence a tax audit disclose the tax shortfall.
Technically, the disclosure must be of a known discrepancy. If there is a subsequent tax shortfall penalty that penalty should be reduced by a factor of 40 percent. The potential shortfall penalties of unacceptable interpretation (20 percent) or gross carelessness (40 percent) would be reduced to 12 percent and 24 percent, respectively. It is probable that they would be further reduced to 6 percent and 12 percent, respectively.
Do not claim any of the marketing costs. Once the IRD has issued an assessment file a Notice of Proposed Adjustment claiming the marketing cost. The potential advantage of this approach is that there is no exposure to shortfall penalties.
Murray McClennan is tax director at WHK Cook Adam Ward Wilson, chartered accountants and business advisers.
Related posts
