Settlement is often the most sensible resolution of any dispute. It is, however, more difficult to reach a settlement of a dispute with the Commissioner than it is to settle an ordinary commercial dispute. The first part of this two-part article explores why settlement is often an attractive way of resolving a dispute, and the reasons why settling tax disputes is not as easy as settling other disputes.
The second part, to be published next month, will look at the Commissioner’s practice in this area, suggest ways in which advisors can improve their chances of reaching a sensible and lasting settlement of their clients’ disputes at a reasonably early stage, and suggest ways in which the Commissioner could open the door to more settlements of genuine disputes without compromising the integrity of the tax system.
Why settle?
While a few tax disputes involve taxpayers “trying it on”, most involve reasonably and sincerely held views as to the factual and/or legal correctness of a position. Quite often, those views eventually turn out to be more correct than the Commissioner’s views: the Commissioner and taxpayers both face risk in tax disputes.
In any civil dispute, any responsible advisor will bear in mind those risks inherent in litigation (formal or otherwise), and the costs involved. The costs are not confined to the direct monetary costs (which can run to literally millions of dollars in large disputes) but extend also to the indirect costs occasioned by diversion of resources from gaining income towards running litigation, the emotional costs (which are often severely underestimated beforehand) and the damage to any continuing relationship between the parties. Those costs mean that the gain to the winner in a civil dispute is always less, and proportionately less the longer the dispute lasts, than the loss to the loser. So it makes sense to see if a settlement can be reached, the earlier the better, and tax disputes are no exception.
Rule 11 of the lawyers’ International Code of Ethics recognises the societal benefit of settling disputes (if possible) by saying that “Lawyers shall, when in the client’s interest, endeavour to reach a solution by settlement out of court rather than start legal proceedings”.
The Commissioner’s ability and obligation to settle
Prior to the enactment of section 6A of the Tax Administration Act 1994 (“TAA”) it appears that the Commissioner was obliged to assess and collect 100% of all taxes imposed by the tax legislation. It followed from this that he had no power to settle tax litigation in which his assessments were challenged or to amend the assessments for the purpose of accepting payment of less than 100% of the taxes imposed by the legislation[1]. Parliament, in enacting section 6A, intended to make a significant change in the law and confer on the Commissioner power to settle tax litigation and accept less than 100% of the tax assessed. This is clear from –
- The April 1994 Report to the Minister of Revenue by the Inland Revenue Department Organisational Review Committee, chaired by then Court of Appeal judge, later President, Sir Ivor Richardson. This was the basis for the enactment of section 6A;
- The language of section 6A itself; and
- The decisions of the Court of Appeal in Auckland Gas Co. Ltd v CIR [1999] 2 NZLR 409 and Attorney-General v Steelfort Engineering Co. Ltd (1999) 1 NZCC 61,030.
The Court of Appeal reconsidered this issue last year in Accent Management Ltd v CIR (2007) 23 NZTC 21,366 and confirmed the Commissioner’s ability to settle tax disputes, including the ability to settle with some parties to a dispute and not with others (providing the Commissioner remained equally willing to settle with taxpayers in similar situations). The Supreme Court has recently indicated that it would not be disposed to grant leave to appeal against that decision, so for all practical purposes the law in this area is settled: Ben Nevis Forestry Ventures Ltd v CIR; Accent Management Ltd v CIR [2007] NZSC 82.
The same provision which gives the Commissioner the power to settle also imposes obligations on him to promote voluntary compliance, and to minimise taxpayers’ compliance costs[2].
From these propositions, it follows inevitably that the Commissioner should
- be willing, where appropriate, to settle tax disputes at all levels
- formalise a process for applying for a settlement, and the process by which such a settlement will be considered/negotiated and
- publicise it so that taxpayers know.
When is it appropriate to settle?
Of course, not all cases are capable of settlement. In an ordinary civil dispute a settlement will occur when the following conditions are present:
- Each side’s estimation of the risk they each face is roughly the same, or each side thinks the other’s chances are better than the other side does. If I think I have a 20% chance of winning, but my opponent thinks I have an 80% chance, then there is a wide range of settlement figures which we would both find attractive. Conversely, if I think I have an 80% chance and my opponent thinks I have only a 20% chance, we are most unlikely to find any settlement which we are both happy with.
- Each side can afford to settle. A litigant with a net worth of say $1 million but being sued for $200 million, with a risk of losing at 50%, would not be prepared to settle at $100 million or even $10 million, because the compromise is unaffordable.
- Each side’s estimation of the costs of litigation makes continuing sufficiently unpalatable.
- There are no emotional issues such as pride, a desire for revenge, or overweening stubbornness which preclude a sensible settlement.
In tax disputes, these same factors apply to taxpayers and to the Commissioner. Applying them to the Commissioner’s position:
- If he settles at or above his estimate of litigation risk, then he maximises net revenue recovery over time (fulfilling his obligation in section 6A TAA).
- The Commissioner can always afford to settle. Where a taxpayer cannot afford to settle, a different set of considerations may apply – essentially centred around the relief provisions in Part XI of the TAA.
- The Commissioner’s resources for litigation, while adequate, are not excessive. Of course the Commissioner has obligations to use the funds voted to him in a prudent and careful manner. Moreover the Commissioner also has obligations to minimise taxpayers’ compliance costs. So the savings of costs from settlement is doubly important for the Commissioner.
- It should go without saying that the Commissioner and his officers must be scrupulously fair and impartial. He is above the emotions that plague lesser mortals.[3]
Additional factors which impact on Commissioner’s ability to settle
Although, for the reasons above, it is attractive for the Commissioner to settle disputes, he faces additional obstacles (some self-imposed):
- He must be consistent;
- His compliance model, and the effect it has on officials’ behaviour, does not promote settlement;
- He is an institutional litigant, and has interests beyond a particular case;
- He may consider that some allegations are so serious that they cannot be settled.
The Commissioner has responsibilities to uphold the integrity of the tax system in section 6 of the TAA. The most relevant of those responsibilities is to treat taxpayers with no greater or lesser favour than other taxpayers. In the context of settlement this means that if the Commissioner is willing to settle at X% with one taxpayer, then he should be equally willing to settle at the same level with every other taxpayer in the same situation. As the Accent judgment noted above shows, this consistency obligation is determined at any given time – a settlement reached before trial with some taxpayers would not mean that the same settlement should remain available for those who elect not to settle, continue to litigate, and lose.
An issue which will be explored in the second part of this article is the extent to which the absence of Commissioner’s guidelines and policies make it more difficult for him to settle consistently.
The Commissioner’s approach to policing the tax system is based on a “compliance model”, developed by the Australian Tax Office[4] and subsequently enthusiastically embraced by our administration[5]. In essence, the model divides taxpayers into four different categories based on their tax compliance and mandates appropriate types of response for each category, ranging from “making it easy” for the good taxpayers who are “willing to do the right thing” through to “using the full force of the law” for those really naughty taxpayers who “have decided not to comply”. The diagram is in the form of a pyramid, showing that there are far more good taxpayers than really naughty taxpayers, which is reassuring.
While the model represents an interesting and often useful way of looking at society and the Department’s appropriate way of interacting with taxpayers, a criticism which might be levelled at it is that legitimate differences can arise as to what is the correct tax position in any given situation. These legitimate differences arise because tax law is legally complex, complexity breeds ambiguity, and because facts in tax disputes are often poorly and incompletely understood, especially by the tax inspectors at the start of an audit. A model which regards the application of the law as always clear and labels taxpayers as “non-compliant” if they disagree with the Commissioner does not promote compromise.
It is an observable fact that taxpayers’ and advisors’ perceptions of the reasonableness of the Commissioner’s conduct of a dispute affect their future attitudes towards voluntary compliance, and towards what one might call working with the Commissioner. The compliance model does not seem to reflect this fact adequately.
Because the model, and/or the training which accompanies it, do not sufficiently recognise these factors, there is a common reluctance on the part of the Commissioner’s staff to consider settlement, or to entertain settlement offers in a serious way, even when a serious and genuine dispute exists. This is especially the case when the Commissioner’s proposed assessment involves an allegation of tax avoidance, thereby promoting the hapless taxpayer to the naughty category of “decided not to comply”.
Many litigants go to court only once in their lives. The Commissioner on the other hand spends a lot of time down at the Courts, and tax litigation is a major way in which tax law is clarified. The Commissioner may well wish to progress a particular dispute so as to achieve certainty for all similar disputes, of which there may be many. This fact is recognised by the test case challenge provisions in sections 89O, 138Q and 138R TAA. And therefore, in a situation where a piece of litigation may provide a precedent which will resolve other disputes, the Commissioner may wish to continue to litigate despite an otherwise attractive settlement offer. When the Commissioner takes such “wider interest” litigation he has been known to make a contribution to the taxpayer’s costs, e.g. Chapman v CIR (2002) 20 NZTC 17,950 HC.
Finally, the Commissioner may consider that some allegations (for example, sham or evasion) are so serious that it would be a dereliction of his duty not to put the matters before the Courts for determination. While this concern for integrity is commendable, law enforcement agencies commonly bargain over substantive criminal charges (for example, accepting a guilty plea on a lesser assault charge) and, provided adequate safeguards exist, there should be no cause for concern about the integrity of settlement of any dispute, regardless of its subject matter.
Conclusion
A dispute can often be resolved more satisfactorily for everyone by settlement. The Commissioner can and (where appropriate) should settle tax disputes. There are reasons why he is less willing to settle disputes than an ordinary commercial litigant is. Some of those reasons are more valid than others.
Next month’s article will examine the Commissioner’s practice in settlements, advise on how to maximise chances of reaching settlement, and suggest ways in which the Commissioner’s processes could be improved.
[1] Brierley Investments v Bouzaid [1993] 3 NZLR 655 CA, Reckitt and Colman (NZ) Ltd v TBR [1966] NZLR 1,032 CA
[2] Section 6A(3) TAA
[3] See also section 6 TAA
[4] Details at www.ato.gov.au/corporate/content.asp?doc=/Content/5704.htm
[5] See for example http://www.ird.govt.nz/aboutir/media-centre/smt-speeches/speech-butler-ttbc-september2005.html