A taxpayer claims a GST input deduction for an expense that appears business-related but is in fact private. The deduction was made in good faith, based on incomplete records. When Inland Revenue (IR) reviews the return, the issue is not just whether the deduction is denied, but whether a shortfall penalty should apply. Did the taxpayer take “reasonable care”? Was the position “unacceptable”? Could the behaviour amount to “gross carelessness”?

These are the types of scenarios considered in IR’s latest consultation package PUB00500. 

Current framework

Shortfall penalties are imposed under the Tax Administration Act 1994 in addition to core tax and use-of-money interest. The penalties apply to different types of behaviour:

• Not taking reasonable care (s 141A) – 20% penalty. Whether reasonable care has been taken depends on the taxpayer’s circumstances, size, and resources.
• Unacceptable tax position (s 141B) – 20% penalty. This applies where a tax position is not “about as likely as not to be correct” (reasonably arguable), and the shortfall exceeds both $50,000 and 1% of the total tax figure for the period. Currently applies to income tax, GST, and withholding-type taxes. 
• Gross carelessness (s 141C) – 40% penalty. This applies where conduct falls significantly below the expected standard of care, representing a serious or persistent lack of attention.

Reductions are available for:

• Voluntary disclosures – up to 100% for pre-notification disclosure.
• Previous good behaviour – 50% reduction for first-time failings.
• Temporary shortfalls (s 141I) – a 75% reduction applies if the shortfall is permanently reversed or corrected within the statutory timeframe (4 years from the time the tax position was taken).

What is different

The draft statements have been streamlined to assist readability and updated to reflect the current legislative position and case law on shortfall penalties. Key changes include:

Clarifying “tax shortfall” and “tax position”

A tax shortfall arises when tax payable is reduced or refundable tax is increased compared with the correct position. An error with no effect on liability is not a shortfall.

Example: If deductible legal fees are misclassified as “stationery,” no shortfall penalty arises because the deduction is correct. By contrast, if the fees are capital in nature and claimed as deductible, a shortfall arises.

A tax position is broadly a position or approach regarding tax under a tax law.  The position can be taken in a tax return (including a pre-populated account of an individual’s income held by Inland Revenue when finalised).

Scope of the unacceptable tax position penalty

This penalty applies only to income tax. GST and withholding-type taxes (PAYE, NRWT, RWT, etc.) are specifically excluded.   The tax shortfall thresholds mentioned above must also be satisfied.

Meaning of reasonable care

The updated statement on the reasonable care penalty highlights the relevance of various factors such as:

• the size of the tax shortfall or error (relative to the taxpayer’s tax liability or assessable income), 
• complexity of the transaction, and the tax law, and 
• the size of business or taxpayer.     

Broadly, the key criterion is whether a reasonable person would have seen the risk of a tax shortfall arising and taken appropriate action to prevent it (i.e. to comply with the law). 

Reductions and other matters

Included in the bundle of draft items are a new draft statement and fact sheet outlining shortfall penalties reductions.  The draft statement also discusses what happens when a taxpayer could be liable for more than one penalty, and the assessment, payment and disputing of shortfall penalties.  

Practical considerations

Every taxpayer is subject to the shortfall penalty regime. Members should refresh their understanding of:

• The various shortfall penalties that can be imposed and in what circumstances, relevant penalty rates, and the availability of penalty reductions.
• The distinction between an error that changes liability (a shortfall) and one that does not.
• Use of the voluntary disclosure regime to mitigate penalties, and all relevant requirements (including timing).

The importance of documenting reasoning cannot be understated and taxpayers should be encouraged to obtain professional advice, particularly for complex or high-value positions.

Submissions close on 31 October 2025. CA ANZ will be preparing a submission and encourages members to share practical insights. Once finalised, the new guidance will replace earlier statements and become Inland Revenue’s primary reference for shortfall penalties.