Code of Practice Revenue Audits

Introduction

A revised Code of Practice is being introduced for Revenue Audits. This article provides an overview of the provisions in the new Code and highlights some of the differences between the revised Code and the Code which has been in operation for the last number of years.

Before finalising the revised Code, a wide consultative process was carried out with members of staff and representatives of the accountancy and tax practitioner professions. The revised Code is Revenue’s considered response to the issues raised. We are confident, that like its predecessor, the revised Code will lead to further benefits for both Revenue and practitioners alike and contribute significantly to an improved culture of tax compliance.

Major Changes in the Revised Code

The key changes in the revised Code are outlined in this article. They are as follows:

• The scope of the Code
• Mitigation of Penalties
• Qualifying Disclosures
• Self Correction of Returns
• VAT “No Loss of Revenue”
• CGT Valuations
• Commencement

Scope of Code of Practice

The original Code covered Income Tax (including inter alia PAYE/PRSI and RCT), Corporation Tax, Capital Gains Tax and VAT. The scope of the Code is being extended to cover audits of Capital Acquisitions Tax and Stamp Duties. This reflects the major restructuring taking place within Revenue and an objective within Revenue that all audits will operate under one general code. (Modifications apply in respect of some individual taxes and duties). The Code will be extended, in due course, to cover audits of Customs and Excise.

Mitigation of Penalties

One of the major changes in the revised Code concerns the Revenue approach to the mitigation of penalties. In the original Code, penalties were mitigated based on Co-operation, Voluntary Disclosure, and Scale and Gravity. A “one size fits all” approach resulted and, in general, the only factors, which influenced the mitigation of penalties, were factors which took place after the default had occurred. The new code addresses this issue by introducing a level of mitigation based on the category of the default which gave rise to the penalty.

The other major change in the Code is to stipulate that, to avail of the substantial levels of mitigation, which arises from the making of a disclosure, such a disclosure must be made in writing and be signed.

Adjustments which do not attract penalties

Innocent Error

The revised Code specifically recognises that not every type of an adjustment, which arises during the course of a Revenue audit, will result in a penalty. Fraud or negligence must be present before a penalty can arise.

Technical Adjustments

These are adjustments that arise from differences in the interpretation or application of legislation. The revised Code sets out the conditions to be met for a technical adjustment not to attract a penalty. The auditor must be satisfied that:

• Due care has been taken by the taxpayer, and
• The treatment concerned was based on an interpretation of the law which could reasonably have been considered as likely as not to be correct.

The treatment of the position taken by a taxpayer in relation to a particular item depends on a number of factors such as:

• Whether an expression of doubt was made under the provisions of the Taxes Consolidation Act 1997 or the VAT Act 1972
• The complexity of the relevant legislation
• The amount of legal precedent available
• The guidance available including Revenue Statements of Practice and Tax Briefing
• The tax implications of the decision taken. A taxpayer who takes a position on a matter which has significant tax consequences, is expected to take due care.

Mitigation Table

The new table for the mitigation of penalties in the revised Code is set out across. The mitigation of a penalty will depend on the following factors:

• The category of tax default within which the offence falls
• The level of co-operation received
• Whether the taxpayer has made a qualifying disclosure.

Category of Tax Default	Tax-geared Penalty	Net Penalty after mitigation where there is:
		Co-operation only	Co-operation and a Prompted Qualifying Disclosure	Co-operation and an Unprompted Qualifying Disclosure
Deliberate Default	100%	75%	50%	10%
Gross Carelessness	40%	30%	20%	5%
Insufficient Care	20%	15%	10%	3%

Fixed Penalties

The Tax Acts include many provisions where fixed penalties (normally relatively small) can be applied. The tax-geared penalty collected under the provisions of the revised Code is deemed to include any fixed penalty due.

De Minimis Exclusion

Penalties will be mitigated to nil where relatively minor shortfalls in the Insufficient Care category occur. If, as a result of an audit, the total tax shortfall in respect of which penalties are computed does not exceed €3,000 and the shortfall is exclusively within the Insufficient Care category, no penalty will be applied.

For this exclusion to apply, all of the tax defaults which attract a penalty and which arise during the course of the audit must be in the Insufficient Care category. If a tax default arises in any of the other two categories, the exclusion does not apply.

For example, an audit is carried out and there are tax shortfalls in a number of categories of default totalling €10,000, of which €3,000 falls within the Insufficient Care category. In this case, the penalty will be computed by reference to the total shortfall of €10,000.

Publication

The Finance Act 2002 contains changes to the publication provisions. Any settlement where the penalty element in the settlement does not exceed 15% of the amount of the tax included in the settlement will not in future be published. This effectively means that publication of the name of the taxpayer will not apply to any tax shortfall in the category of Insufficient Care, provided full co-operation is received from the taxpayer during the course of the audit.

Categories of Tax Default

There are three categories of tax default, by which penalties are mitigated in the revised Code. They are as follows:

• Insufficient Care
• Gross Carelessness
• Deliberate Default.

The following paragraphs outline how the new mitigation scheme will operate in practice.

Insufficient Care

At the core of the revised Code is an emphasis on the obligation on taxpayers to take the appropriate amount of care to ensure that correct returns for tax purposes have been made. The table shows that the taxpayer who takes insufficient care in making a declaration or return is liable to pay a penalty.

To fall within the category of Insufficient Care, the test to be applied is whether the taxpayer has taken the care that a reasonable person should take to meet his/her tax obligations.

For example, a taxpayer whose only explanation for omitting an amount of income from a tax return was that he/she forgot, would not, in the absence of any other relevant factors be accepted as having taken reasonable care.

The following are among the factors that are taken into account in determining whether a penalty in the category of Insufficient Care is to be applied.

• The internal controls in place
• The efforts the taxpayer had taken to resolve the issue
• The size and nature of the business
• The standard of record keeping in the business
• The size of the tax at risk - the greater the tax at risk, the greater the care required
• The frequency of the errors made. A case that has frequent errors will be looked at in a different light than a case with an isolated small error.

This list is not exhaustive and does not replace the need to make a decision on the facts of each case.

The penalties applicable to a tax shortfall in the category of Insufficient Care are outlined in the table above. The shortfall penalty is initially mitigated to 20%. This can be mitigated further to a penalty of 15% if the taxpayer co-operates during the course of the audit. Greater mitigation is available if the taxpayer makes either a prompted or unprompted qualifying disclosure.

Gross Carelessness

A taxpayer does not have to act dishonestly to find that he/she has acted with gross carelessness. Rather it is sufficient that the taxpayer’s behaviour displayed a high degree of carelessness and indifference to the consequences.

A taxpayer would be seen to behave with gross carelessness if:

• He or she acted in such a way which created a risk of a tax shortfall occurring
• The risk would have been foreseen by a reasonable person as being substantial, having regard to the likelihood of the consequences occurring, and the extent of those consequences (e.g., the size of the tax shortfall)
• When the taxpayer acted, he or she was either indifferent to the possibility of such a risk, or recognised that such a risk was involved and still ignored it.

Indicators consistent with gross carelessness on the part of the taxpayer would include the following, to the extent that they lead to significant tax shortfalls:

• Estimation of accounts items
• Neglecting to categorise expenditure into allowable and disallowable categories for tax purposes
• Neglecting to take advice on an issue of interpretation when either a tax advisor or Revenue should have been approached for guidance.

Gross Carelessness is distinguished from the higher category of default, i.e. Deliberate Default by the absence of indicators in the facts and circumstances of the case that are consistent with intent on the part of the taxpayer to disregard his/her tax obligations.

Gross Carelessness is distinguished from Insufficient Care primarily by reference to the size of the tax shortfall relative to the correct tax liability concerned.

For general guidance the revised Code provides that if a tax shortfall arises from lack of due care on behalf of the taxpayer and the shortfall for the particular tax type exceeds 15% of the tax finally due for that tax type, then a penalty in the category of gross carelessness applies.

The 15% guidance is used only for distinguishing defaults in the category of Insufficient Care from those in the category of Gross Carelessness. It has absolutely no relevance whatsoever in determining whether a default in the category of Deliberate Default has taken place.

The 15% guidance is to be applied separately to each tax type and period in respect of which a return is due to be made by the taxpayer. Tax for this purpose includes Income Tax, Corporation Tax, Capital Gains Tax, VAT, Relevant Contracts Tax, Employers’ PAYE/PRSI and levies, Capital Acquisitions Tax and Stamp Duties.

Audits can give rise to tax shortfalls in one or more of the default categories.

For example, a comprehensive audit is carried out for the year 2000/2001. The adjustments that arise as a result of the audit are outlined in the following table.

	Tax Shortfall	Final Liability
Income Tax	6,000	20,000
VAT	6,000	40,000
PAYE/PRSI	7,000	30,000

Assuming these defaults do not fall within the Deliberate Default category, the category of tax default appropriate to each element of the settlement is as follows:

• Income Tax- as the shortfall exceeds 15% of the final liability for the taxhead the appropriate category of default, is gross carelessness
• VAT - as the shortfall does not exceed 15% of the final liability for the taxhead, the appropriate category of default is insufficient care.
• PAYE/PRSI - as the shortfall exceeds 15% of the final liability for the taxhead the appropriate category of default, is gross carelessness.

The penalties applicable to a tax shortfall in the category of Gross Carelessness are outlined in the table above. The shortfall penalty is initially mitigated to 40%. This can be mitigated further to a penalty of 30% if the taxpayer co-operates during the course of the audit. Greater mitigation is available if the taxpayer makes either a prompted or unprompted qualifying disclosure.

Deliberate Default

This is the most serious category of tax default and involves a deliberate attempt to deprive Revenue of taxes that are lawfully due. This may include a taxpayer failing to return all the income of a business or obtaining refunds knowing that he or she is not legally entitled to them.

It arises where:

• The facts and circumstances of the case are consistent with intent to default, or
• The taxpayer’s actions or omissions were likely to result in a tax default and those actions or omissions cannot be explained solely by carelessness.

Examples of indicators consistent with deliberate default would include:

• Omissions from Tax Returns
• Failure to keep proper books and records as required by tax law to enable the taxpayer’s correct tax liability to be determined
• Repeated omissions of transactions or a large single omission of a transaction in the books of the taxpayer
• Providing incomplete, false or misleading documents or information
• Claiming a refund of tax when not lawfully entitled to that refund
• Failure to operate fiduciary taxes
• Concealment of bank accounts or other assets.

This list is not exhaustive.

An example of deliberate default discovered during an audit is where sales were significantly understated over a number of years and the proceeds were lodged to a bank account not previously disclosed to Revenue.

The facts of this case indicate intent on the part of the taxpayer to deprive Revenue of taxes which are lawfully due. The appropriate category of tax default in this case is Deliberate Default.

The penalties applicable to a tax shortfall in the category of Deliberate Default are outlined in the table over. The initial shortfall penalty is 100%. This can be mitigated to a penalty of 75% if the taxpayer co-operates during the course of the audit. Greater mitigation is available if the taxpayer makes either a prompted or unprompted qualifying disclosure.

Co-Operation

As can be seen from the mitigation table over, there is a substantial degree of mitigation available to a taxpayer who co-operates throughout the course of the audit. In order to avail of this mitigation the Code sets out the following conditions:

• All books, records and linking papers must be made available for the auditor at the commencement of the audit
• All requests for information and explanations must be responded to promptly and fully
• All correspondence must be answered promptly and fully
• The audit settlement liability must be paid promptly.

Examples of a lack of co-operation include:

• Refusing reasonable access to the business premises
• Refusing reasonable access to the business records
• Failing to provide the auditor with information known to the taxpayer which could be used in determining whether a tax underpayment arises
• Delays by the taxpayer or agent during the course of an audit where there was no reasonable excuse for those delays.

Qualifying Disclosure

In the previous Code, there was no requirement that disclosures made must be in writing.

The revised Code introduces a new concept called a “qualifying disclosure”. There are three main benefits which will arise if a qualifying disclosure is made. These are:

• Greater mitigation of penalties in line with the table already discussed
• Non Publication of the settlement
• Revenue’s assurance as regards non-prosecution - See below.

The conditions attaching to a disclosure for non-publication purposes are contained in Section 1086 (4) TCA 1997 and do not include the stipulation that the disclosure be in writing. The term Qualifying Disclosure has been introduced to draw a distinction between the conditions attaching to non-publication and those attaching to the other benefits. The main difference is that a qualifying disclosure must be made in writing while a disclosure for non-publication purposes need not be made in writing.

An unprompted qualifying disclosure is a disclosure made before the taxpayer is notified of an audit or contacted by the Revenue regarding an enquiry into his/her tax affairs.

A prompted qualifying disclosure is a disclosure made after a taxpayer is notified that an audit is to be conducted, but before an examination of the books and records or other documentation has begun.

The mitigation table sets out the mitigation benefits available for both types of qualifying disclosure. The level of mitigation available for an unprompted qualifying disclosure is substantially greater than that which applies to a prompted qualifying disclosure. This reflects the importance that Revenue places on such disclosures and the benefits which are available to taxpayers who regularly review their tax compliance position.

Procedures for preparing Qualifying Disclosures

The following conditions must be satisfied for a disclosure to be a qualifying disclosure for the purpose of mitigation of penalties:

• The disclosure must be made in writing and signed by or on behalf of the taxpayer
• The disclosure must
  • In the case of all disclosures, state the amount of all previously undeclared liabilities to tax, interest and penalties for all taxheads and all periods, which were liabilities undisclosed by reason of deliberate default, and
  • In the case of a prompted disclosure state the amount of all previously undeclared liabilities to tax, interest and penalties, for any reason other than deliberate default, for all taxheads and all periods within the scope of the audit and all related liabilities for taxheads or periods not within the scope of the initial audit.
• The disclosure must be accompanied by a payment in settlement of the total liability.

Qualifying Disclosure - Exclusions

A disclosure will not be a qualifying disclosure if any of the following circumstances apply:

• The disclosure is incomplete by reference to the conditions set out above
• Before a disclosure of a tax default was made by the taxpayer, Revenue had made an enquiry or begun an investigation relating to the tax defaults and had contacted the taxpayer, or a person connected with the taxpayer, in that regard
• Matters the tax consequences of which are included in the disclosure have become known, or are likely to become known to Revenue through its own investigations of a class of cases, such as Ansbacher cases, or through investigations conducted by other agencies of a class of cases
• Matters the tax consequences of which are included in the disclosure, come within the scope of an inquiry wholly or partly carried on in the public domain
• The taxpayer has been linked, or is about to be linked, publicly with matters the tax consequences of which are included in the disclosure.

Time to prepare Qualifying Disclosure

It is obviously important that a qualifying disclosure is comprehensive and fulfils the conditions as set out above. Revenue recognise that a substantial amount of work may be necessary to prepare such a disclosure. Therefore, Revenue will allow a period of time, not exceeding 60 days, to prepare such a disclosure. To avail of this timeframe, Revenue will need to be informed of the taxpayer’s intention to make a qualifying disclosure.

To avail of the 60-day period in the case of an unprompted qualifying disclosure, the taxpayer must notify the Audit District of the intention to make a disclosure before:

• A notification of audit is received, or
• The taxpayer is contacted by Revenue regarding an enquiry into his/her tax affairs.

In the case of a prompted qualifying disclosure the Audit District must be notified of the intention to make the disclosure:

• Within 14 days of the notification of an audit, or
• Within 14 days of a desk or verification contact being made.

During the 60-day period the taxpayer/agent can contact the Audit District to discuss the appropriate tax default category, if any, for the tax shortfall, or any other matter.

The period of 60 days will begin on the day notification was given to Revenue of the intention to make a disclosure. The taxpayer will be informed in writing of this time period.

As already mentioned, the qualifying disclosure arrangements do not affect the entitlement of the taxpayer, who has been notified of an audit to make a disclosure, for the purpose of avoiding publication, at any time before an examination of the books and records or other documentation begins.

Format of Qualifying Disclosure

All qualifying disclosures should include the following:

• A statement of all sources, including capital transactions, from which the tax shortfall arose
• A statement including computations together with the disclosure of estimates used if any, of the amount of tax, duties, PRSI and levies due for each period concerned
• A statement, including computations, of the amount of the interest and penalties due for each period concerned
• A declaration from the taxpayer that the disclosure is correct and complete to the best of the taxpayer’s knowledge.

The revised Code provides that the taxpayer need not describe the portion of the payment which refers to penalties as penalties but may instead describe it as a payment on account without prejudice.

Examination of Disclosure

Revenue recognise that taxpayers are entitled to know if the qualifying disclosures made are being accepted or are going to be examined. The policy, set out in the revised Code, is as follows:

A selection of unprompted qualifying disclosures will be examined for accuracy. If such a disclosure is not selected for examination, the taxpayer is informed that on the information to hand Revenue do not propose to make further enquiries.

All prompted qualifying disclosures will be examined to verify the details disclosed. Additional underpayments arising from this inspection will not negate the benefits from the disclosure if such underpayments are not significant.

Assurances regarding investigation with a view to prosecutions if Qualifying Disclosures are made

Where a qualifying disclosure is made, Revenue will not initiate an investigation with a view to prosecution of the taxpayer.

A taxpayer may be investigated with a view to prosecution where:

• A disclosure of tax defaults, which is a qualifying disclosure for the purposes of mitigation of penalties, has not been made by the taxpayer, or
• A disclosure of tax defaults has been made by the taxpayer which is incomplete, or
• Before a disclosure admitting a tax default was made by the taxpayer, Revenue had made an enquiry or begun an investigation relating to the tax default and had contacted the taxpayer, or a person connected with the taxpayer, in that regard, or
• The taxpayer is one of a class of taxpayers, such as Ansbacher cases, being investigated by Revenue or other agencies, or
• The taxpayer comes within the scope of an enquiry wholly or partly carried on in public, or
• The taxpayer is linked or about to be linked, publicly with matters which may involve tax default.

Having considered such cases Revenue may decide to proceed on the basis of investigating with a view to prosecution or on the basis of seeking a monetary settlement.

Second (or subsequent) Disclosures

To encourage compliance and deter evasion the level of mitigation of penalties associated with qualifying disclosures is restricted in respect of second and subsequent disclosures which relate to defaults in the categories of Deliberate Default and Gross Carelessness.

This effectively gives a taxpayer a once only chance to avail of the full benefits attaching to a qualifying disclosure if the default is in either of these categories.

The restricted mitigation is as follows:

• The mitigation of penalties, for a second qualifying disclosure in these categories is to be restricted to 50%
• In the event of a third or further qualifying disclosure in these categories, penalties will not be mitigated
• A disclosure of tax defaults, which are tax defaults that occurred before a change of ownership (within the meaning of Paragraph 1, Schedule 9 Taxes Consolidation Act, 1997) of a company, will be disregarded in considering the application of this Section to a qualifying disclosure made after the change of ownership in so far as the tax defaults disclosed after the change of ownership occurred after that change. (This is to ensure that the new owners of a company will not lose the benefits of a first disclosure due to a disclosure already made by the previous owners)

Self-Correction

The revised Code introduces a new concept of self-correction of tax returns. Revenue wishes to encourage taxpayers to regularly review their compliance position and is introducing a timeframe within which corrections can be made to tax returns without any penalty arising. Taxpayers will be allowed to self-correct tax returns, without penalty, subject to the following conditions:

• The taxpayer must notify Revenue of the adjustment to be made
• The taxpayer must include a computation of the correct tax and statutory interest payable
• A payment in settlement must accompany the submission
• For bi-monthly remitters of VAT if the net underpayment is less than €5000, the amount of the tax can be included (without interest or notification to Revenue) as an adjustment on the next VAT return to be submitted.

The following time limits will apply in respect of self-correction:

• For Income Tax, Corporation Tax and Capital Gains Tax, the self-correction must take place within twelve months of the due date for filing the return
• For VAT the self correction must take place before the due date for filing the Income Tax or Corporation Tax return for the chargeable period within which the relevant VAT period ends
• For the PAYE/PRSI annual return, the self correction must take place within twelve months of the due date for filing the annual return
• For Relevant Contracts Tax, the self-correction must take place within twelve months of the due date of filing the annual return.

The benefit of self- correction will not apply after Revenue has notified a taxpayer of an audit or contacted the taxpayer regarding an enquiry or investigation relating to his or her tax affairs.

Self- correction in accordance with this section will not result in an audit. However, an audit of the return may arise based on normal selection procedures.

Once the time limits listed above have elapsed the taxpayer will still be entitled to benefit from a qualifying disclosure.

Examples of self-correction are as follows:

• During the preparation of the accounts for the year ended 31 December 2002, the agent while conducting a reconciliation between the sales per the VAT returns and the sales per the accounts noticed that the 21% sales per the VAT returns were understated by €30,000. Because of this new provision to self-correct, the agent can notify Revenue of the adjustment that needs to be made and submit a payment for the relevant tax and statutory interest with this notification. A penalty will not be applied and the case will not be selected for a Revenue Audit because of this self-correction.
• A taxpayer discovers when preparing the November/December 2002 VAT Return that he or she has incorrectly claimed input credits amounting to €3,500 in the September/October 2002 VAT Return. The taxpayer can now self-correct this error in the November/December 2002 without having to notify Revenue and without incurring an interest charge.

VAT “No Loss of Revenue”

Revenue has reviewed its position in respect of what came to be known as “No Loss of VAT” cases. The resultant policy is set out in the revised Code.

New Procedures

The new procedures are as follows:

• Notwithstanding any previous instructions, interest and penalties are to be collected, in addition to the relevant VAT in all cases other than the “group case” specified below
• Where the taxpayer proves, to the satisfaction of the Auditor, that “no loss of VAT could be claimed, the penalty for the non operation of VAT will be mitigated to the lesser of 3% of the VAT underpaid or €60,000. It is a matter for the taxpayer to prove that this penalty mitigation should apply. This mitigation does not apply where:
  • There has been a general failure to operate VAT, or
  • There are suppressed supplies.

“Group Case”

Interest and penalties will not be pursued in respect of VAT on transactions, other than supplies to exempt or partially exempt companies:

• Which are transactions between the members of a group of companies, and
• Where “no loss of revenue” could be claimed in respect of those transactions.

The “group” is a group of companies satisfying the following conditions:

• The group is made up of companies resident or established in the State, and
• All the members of the group are under common control, where “control” means:
  • The power to hold fifty percent or more of the issued share capital or voting rights in the company, or
  • The power to appoint fifty percent or more of the Board of Directors of the company.

CGT Valuations

Revenue is introducing a separate basis for mitigating penalties in circumstances where the issue involved concerns a difference between the valuation originally submitted with the return and the valuation eventually agreed. This is a concept which already exists in Capital Acquisitions Tax and Stamp Duty. The basis is set out in the revised Code. Where reliable evidence has not been supplied in support of a taxpayer’s valuation, penalties are to be mitigated by reference to the following criteria:

Ascertain the difference between the valuation figure finally agreed and the original valuation.

• If the difference is not greater than 30% of the valuation figure finally agreed, there is no penalty
• If the difference is greater than 30% but not greater than 50% of the valuation figure finally agreed, the category of tax default for the purposes of mitigation of penalties is Insufficient Care
• If the difference is greater than 50% but not greater than 60% of the valuation figure finally agreed, the category of tax default for the purposes of mitigation of penalties is Gross Carelessness
• If the difference is greater than 60% of the valuation figure finally agreed, the category of tax default for the purposes of mitigation of penalties is Deliberate Default.

Commencement

The revised Code will come into effect from 1 September 2002 as regards audits which are notified on or after that date. As regards audits which had been notified but which have not been settled before 1 September 2002, the taxpayer may chose whether the settlement is to be made under the terms of the revised Code or the original Code.

The revised Code will come into effect as regards qualifying disclosures or self-corrections where the qualifying disclosure or self-correction is made from now on.

The revised Code will be available shortly in hardcopy from any Tax Office. It will be published on the Revenue Website on 16 August, under the heading publications. You can access the Revenue Website at www.revenue.ie.