Sloppy record-keeping can have expensive results

A recent Taxation Review Authority decision has highlighted the importance of clearly recording the nature of transactions between companies and their shareholders, and vice versa namely through resolution, correctly coding transactions in the relevant accounting system, and/or the timely documentation of agreements and payments/interactions.

This proceeding was filed by the taxpayer who, during the 2010 to 2014 tax years, was a shareholder or was associated with the four companies involved. In these tax years, the taxpayer received various payments from the companies, and had personal expenditure paid on her behalf by two of them.

The taxpayer filed nil returns for each of these years. The IRD subsequently reassessed the taxpayer to include the amounts that she had received from the companies as being taxable as wages, dividends and/or income under ordinary concepts (covering their bets). The taxpayer challenged the income tax and resulting shortfall penalty assessments, as she said that the amounts assessed as taxable were non-taxable repayments of loan advances, which are non-taxable/capital in nature (and thus she had no tax liability in relation to these amounts).

As a basic concept of our tax system, the onus is on the taxpayer to establish that the IRD's assessments are wrong, and, if so, why they are wrong, and by how much they are wrong. This means you must provide sufficient evidence to a court to prove the IRD view of matters is wrong.

The IRD had accepted that the taxpayer had borrowed funds secured over her residential property which were provided to two of the companies. However, there was not enough evidence to determine whether these funds were made available as loans to these companies and whether the amounts paid by the companies to the taxpayer, or on her behalf, were repayments of such loans.

The IRD assessed some amounts as taxable to the disputant as dividends, being amounts paid on the disputant's behalf as personal expenses and irregular deposits. The IRD was satisfied that, as these amounts were transfers of value from the company to the taxpayer because of her shareholding/association, then they were logically to be assessed as dividends.

The taxpayer failed to provide evidence that the amounts were loan repayments, in not providing company records, copies of loan agreements, her own accounting records, or any other relevant contemporaneous documentation. Saying it out loud without documentary evidence was not sufficient. I suspect there may have been a degree of "recharacterisation in hindsight' attempted, as well.

The outcome of this case emphasises that having loan agreements documented and an ongoing record of the nature of any payments is vital in asserting payments of a certain nature, i.e. loan repayments in this case. If there is no evidence to support the nature of payments made, then in the vacuum of detail, it is very likely that these could be deemed dividends, as occurred in this case.

During the investigation, it was also found that payments recorded on company bank statements made to the disputant were coded as wages. The taxpayer argued that these were wrongly coded because of an anomaly in the payroll system used by the companies. However, the taxpayer had stated in a previous interview that she did at least some work for the companies, and there were payments from the same payroll system in the same day coded as drawings (hence the coding could not necessarily be attributed to an error).

Although similar coding errors should be picked up in the ordinary course of business, business owners and administrators need to be diligent with ensuring that transactions are coded and accounted for correctly, including ensuring the underlying documentation exists and aligns with the proper accounting treatment. Although an automated accounting system may be involved in recording transactions, it is recommended that spot checks take place to ensure correctness, especially around related party transactions. A stitch in time would have saved more than nine, in this case.

 - Scott Mason is a Managing Partner and Tax Specialist at Findex (formerly Crowe Horwath) in Dunedin

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