Binding Tax Rulings from the IRD – Flaws, Pitfalls, and Better Outcomes
Given the massive shift in Governments legislative programmes to combat perceived ‘sharp’ tax practices, and also with tax departments stepping up their audit and investigative approaches, a company’s tax position has never been so magnified and transparent to authorities. Like other tax authorities, the IRD is firmly on the front foot when it comes to testing taxpayer positions and re-examining how tax law should be interpreted.
In this era of greater uncertainty, the ability of taxpayers to seek certainty on matters with binding rulings from tax authorities is an attractive pathway where the stakes are high, and the issues are thorny (as tax law is increasingly so). A successful and complete binding ruling can provide management and directors with certainty about tax positions adopted, eliminate high penalty and interest costs, avoid the need for material dispute resolution costs, and distractions, and, avoid negative public scrutiny on IRD challenged tax positions.
However, management and directors need to be aware that tax rulings can be precarious, and can provide a false sense of security. Tax rulings are only as good as they actually apply, and demand active ongoing management. In some sense, the situation of insurance policies comes to mind here, where readers will be aware that the ‘devil is in the detail’ as to whether claims are covered, or not.
In this article, I canvass:-
- What tax rulings can be sought from the IRD?
- What are the main points of a tax ruling?
- What are some of the pitfalls in seeking binding rulings?
- Developments from IRD on issuing and challenging their tax rulings;
What tax rulings can be sought?
First, binding rulings can provide certainty about a particular tax position. The IRD is bound to apply the tax law in the manner set down by the binding ruling. This is a non-disputable decision.
Given the binding nature of a tax ruling, the regime involved in obtaining a ruling is a detailed and formal process. Different categories of tax rulings are provided for, including Public Rulings, Private Rulings, Product Rulings, Status Rulings, and Advanced Pricing Agreements. For the purposes of this article, I only focus on Private and Product Rulings, although the lessons here do apply to the other rulings.
Private Rulings are common for companies seeking clarification and certainty on a particular transaction or arrangement. The ruling is specific to the transaction, and the person(s) involved, and is confidential. A simple, yet significant example, is where a ruling may determine whether a particular transaction is revenue in nature and taxable, or, whether it is capital and non-taxable.
Product Rulings, set out how the tax laws will apply to ‘consumers’ of a particular product that an organisation or promotor may wish to market.
What are the main points of a tax binding ruling?
This is important, to understand the dependencies and vulnerabilities of your tax ruling.
First, the designated parties to the arrangement are clearly identified.
Secondly, and most importantly, the arrangement to which the ruling applies is set out in very specific detail, with all key facts, assumptions, and relevancies addressed.
Thirdly, and also of great importance, the ruling will set down “conditions” that the IRD regard must be satisfied in order for the ruling to be valid.
Lastly, the ruling will set out how the taxation laws apply to the arrangement.
All of the above components must be carefully thought about, and meticulously crafted into the binding ruling to ensure that organisations have the most reliable binding agreement with the IRD.
What are some of the pitfalls in seeking binding rulings?
Material omission or misrepresentation
A Private or Product Ruling will not be binding on the IRD if the application is found to materially omit or misrepresent information. In this sense, the application must represent all matters on a strictly objective basis, and not ‘sugar coat’ any positions. From my experiences, it is well worth while conducting an adversarial peer review of a draft application to uncover any and all potential ‘softness’ in the arrangement description (since IRD investigators can adopt quite different lenses and interpretations in their review).
Material difference with the arrangement actually entered
The IRD is not bound where there is a material difference between the arrangement identified in the ruling, and the arrangement actually entered. The key here is just what is a “material” difference. The IRD consider that any difference that is capable of affecting the tax outcomes referred to in the ruling will be considered to be a material difference. With reference to Australian case law, the IRD indicate that it is not necessary to substantiate that a different tax outcome must result from the changed circumstances, but that the tax outcome is capable of being, or is likely to be, different to that provided for in the ruling.
This situation is not uncommon, given that circumstances do alter over a 12 month or longer timeframe from inception of an idea, to formulation, to application and obtaining a tax ruling, to final implementation of a transaction arrangement.
But as the IRD point out, determining a material difference turns on the facts and circumstances of each case and so this dictates that such determination must be on a case-by-case basis rather than generically applied.
The lesson here is that a binding ruling must only be applied for when the particular facts of the arrangement are clearly identified and known, and there is confidence that the parties, entities, and transaction(s) will remain in place over the life of the ruling. Clearly, a rigorous evaluation of the precise facts of the relevant transaction arrangement is imperative.
Incorrect assumptions about future events and other matters
Related to the above, a ruling will be invalid and the IRD will not be bound to the extent that the description of the arrangement presents matters that are assumed or projected to occur, and these transpire as being incorrect and are “material” to the ruling.
Again, such factors must be rigorously tested before being identified in any ruling.
A condition stated in the ruling is not satisfied
A binding ruling will stipulate those conditions that must be complied with in order for the tax treatment to apply. These conditions must be examined closely and the precise wording must also be negotiated with the IRD to ensure that they are sufficiently tight, since they can represent ‘trap doors’ to failure.
For example, if a condition of the ruling is that all participants are at all times residents of New Zealand, what happens should a participant also become resident of Australia, ie., dual resident? It is postulated that this could render the ruling invalid in these circumstances.
IRD audit of rulings
The IRD investigative teams will specifically look at the validity of binding rulings – whether all conditions are satisfied; whether the identified arrangement facts match the described arrangement; whether the ruling has expired; and so forth. This investigative approach reinforces the need that management periodically review and self-assess the ongoing validity of binding rulings.
Rulings are party and transaction specific
Private and product rulings are only binding on the actual parties identified in the ruling, and not on any other person. Similarly, the IRD is only bound on applying the laws to the described arrangement, and not to any other arrangement, no matter how similar the facts maybe.
A classic and devastating example of this involved the New Zealand banks in the so called structured finance repo transactions (late 1990’s and early 2000) where the banks entered successive financial transactions in reliance on earlier binding rulings on similar arrangements, only to be challenged successfully by the IRD on the grounds of tax avoidance. The same structured finance arrangements completed under binding ruling were indisputable, whereas later transactions entered without binding ruling were challenged by the IRD. The cases went to Court, which found in favour of the Commissioner for Inland Revenue, with the result that the four major banks settled with IRD for a massive combined $2.2 billion.
This represents a stark and very poignant lesson to taxpayers.
IRD can change their mind – Rulings do not protect tax positions after the expiry period
From my experience, corporate executives will assert that a particular tax position is “good” because the IRD looked at it 8-to-12 years ago and cleared the treatment applied. This is a high-risk assertion, particularly when no binding ruling was ever obtained in the first place.
Even if a binding ruling had been obtained, the tax position adopted and followed by the company is still vulnerable since the IRD are only bound to apply the tax laws set out in the ruling for the period covered by the ruling (typically 4 years).
This exposure is reinforced by the IRD in a recent Exposure Draft, Binding rulings – Effect of Commissioner changing her mind in relation to the application of s BG 1, the general anti-avoidance provisions. The IRD consider that while they are bound to the tax treatment identified as applicable within a binding ruling, this only applies to the extent of the period covered by the particular ruling, and IRD is not restricted from changing their mind on how the tax avoidance generic (and specific) provisions apply. This change of mind can overturn the tax treatment of a transaction that continues beyond the term of the binding ruling.
In this instance, the IRD are preserving their right to adopt a differing interpretation or approach to transactions than that identified within a specific binding ruling. If a transaction runs for 7 years, and a binding ruling is obtained on the company’s tax treatment of that transaction, the company is not protected from the IRD changing their views and voiding the tax treatment for tax avoidance purposes once the ruling expires in 4 years.
In this respect, IRD reject that the existence of the binding ruling gives a legitimate expectation to the company that the IRD will continue with the same approach after expiry of the binding ruling.
This IRD Exposure Draft is a harsh reinforcement of the failure of the NZ banks in the structured finance repo cases alluded to above.
Regular monitoring of compliance with binding tax ruling
Common corporate behaviour is to file away the IRD binding ruling. This is high risk, and poor corporate governance. Binding tax rulings need to be regularly monitored as a part of sound risk management for the organisation.
Common questions here include:- Has the arrangement changed in any way? Have any facts changed or been adapted? Are the assumptions still valid? Are we still fully compliant with each and every condition? Have there been any tax law developments that might impact on the validity of the ruling?
On this last checkpoint question, if a tax law change occurs that alters the way the law applies in a ruling, a private or product ruling will cease to apply from the date that the tax law is amended or repealed. The ruling is rendered invalid from that date. Taxpayers can apply for a Status Ruling to determine the effect of any law change to their existing ruling.
CFO / Board fallacy – all tax rulings, are good tax rulings
Not all tax rulings are good tax rulings. Corporate complacency will assume that if the IRD have issued a binding ruling on a transaction or arrangement then safety is guaranteed and that is the end of the matter.
Just as questions are asked about the level and extent of insurance cover, so too should probing enquiries be made of tax rulings from the IRD. Over recent years, incorrect tax positions by corporate have attracted adverse media and public scrutiny. The negative inferences and brand effect from getting tax wrong now demands that CFO’s and Boards do pierce the corporate ‘tax veil’ and more deeply test the sufficiency of a binding ruling, and just how well the organisation is protected.
Developments to make the binding ruling regime more accessible
IRD is examining Government proposals to widen the scope of the rulings regime, make it more flexible, and make if more affordable for SME organisations.
Several points bear merit here. The Government proposals include rulings on the “purpose” of taxpayers (this is currently unavailable as this is a subjective status). Rulings may extend to quasi-factual situations, such as the residence of a company or individual, despite not being an ‘arrangement’. Proposals also advocate clarifying the role of assumptions and conditions within rulings, when they should be used, and when a breach invalidates a ruling.
These developments are welcome, particularly in a climate where more and more corporates are looking to resolve uncertainties in how tax law is interpreted and applied by the IRD, and gaining upfront clearances on tax positions.
Binding tax rulings are an essential and invaluable mechanism for corporates to gain certainty about their tax positions. When a company’s tax treatment is expressly mandated by the IRD, executives and Board members should be highly confident that they are doing the right thing and that they should not appear in newspaper headlines.
However, this level of confidence may well be ill-afforded where the ruling process itself has flaws and deficiencies. Directors will feel undermined. From the above it can be seen that there are many pitfalls inherent in obtaining tax binding rulings, however with appropriate expertise and process, and with Board level due enquiry, management and Directors will not be lulled in to a false sense of security about the tax positions they are signing off in the financial statements.
CAVEAT: While the above commentary provides insights and guidance on corporate tax best practice, as always, every scenario carries its own facts and circumstances that will influence the particular position and approach that is best, and therefore it is imperative that you seek specific advice to your own situation.
Andy Archer, Director, ACUMEN Limited
 This is a global phenomenon and notably with the Australian Tax Office; Her Majesty’s Revenue and Customs Office in the UK; and in New Zealand with the Inland Revenue Department.
 There are Public Rulings, which set down how tax laws apply to a specific type of arrangement that impacts on a wide group of persons, and these are initiated by the IRD to set out their position on matters of general application. (For example, BR Pub 17/04 on the treatment of alteration to rights attached to shares which concludes that the alteration of share rights does not result in a disposal of any shares to create taxable income, as the shares continue in existence with altered rights). There are Status Rulings, which re-examine existing rulings against subsequent changes in Tax Law. There are Advance Pricing Agreements (APA’s) which are specific to multinationals that trade with their associates across border, and the transfer pricing regime.
 By way of example, BR Prd 17/01 was issued to Kiwibank relating to a mortgage offset product being offered to customers whereby customers can elect to use credit balances of eligible savings and investment accounts to offset against home loan accounts, to reduce interest payable on those home loan accounts.
 Exposure Draft – Questions we’ve been asked. PUB00319 (Deadline for comment 31 January 2018). Of note are the 7 examples addressed in this Exposure Draft that provide some guidance of the IRD’s interpretation of what is a material difference, albeit simplistic in nature.
 Typically, the period that a binding ruling is in force is 4 years.
 Refer also to coverage (next) on IRD’s PUB00318, which states that the IRD is able to change its mind in relation to the application of the general anti-avoidance provisions on a continuing transaction, but cannot disturb a pre-existing binding ruling for the period that such ruling applies.
 BNZ Investments Limited & Ors v Commissioner of Inland Revenue, and, Westpac Banking Corporation v Commissioner of Inland Revenue, both decided in the High Court in 2009.
 Exposure Draft – Questions we’ve been asked. PUB00318 (Deadline for comment 20 December 2018).
 Making Tax Simpler – Proposals for Modernising the Tax Administration Act – A Government Discussion Document. December 2016