Funding windfall fuels IR’s audit activity and reveals confusion on rules

This article was current at the time of publication.

Miscommunication between accountants and their clients, and possible internal system shortcomings, seem to be factors in many issues identified by Inland Revenue (IR) in its recent compliance update for agents.

“Most of these issues seem to be about the quality of information agents are seeking from their clients,” notes Richard Ashby, Tax Services Partner at Gilligan Sheppard.

Fuelled by funding boosts in the last two Budgets, IR opened 5,545 audits from July 2024 to March 2025, up 48 per cent from the same period a year earlier.

Discrepancies from audit interventions rose by 161 per cent to $881 million, while discrepancies from all compliance interventions rose by 60 per cent to $1.2 billion.

Taxpayers confused and hiding it

Only 10 per cent of audits found fraud issues which, Ashby says, reinforces the point that it is more about system problems or not fully understanding a client’s profile, than evidence of bad behaviour within the taxpayer community.

It might also relate to how agents are framing questions to their clients, such as those included in their annual engagement checklist.

“If you ask, for example, ‘are there any risks around the income attribution rules?’ – a client may not understand the question and just say ‘no’. Staff need to be adequately trained on these risk areas IR is picking up on,” Ashby says.

Shareholder salary mismatches

Technical issues comprise 36 per cent of all activity. These include shareholder salary mismatches, imputation credit accounts, mismatched limited partnerships, trust distributions to minors and diverted personal services income.

Ashby says he is surprised at the first two.

“These are easy fish to catch for the IR’s matching systems.”

He says his firm would normally do both the company’s and the shareholders’ tax returns, but this is not always the case.

“If you don’t act for either the company or a particular shareholder, you need to communicate with the other accountant who does act for either – although naturally, you need to have an awareness that your client is a shareholder in the company in the first place, which goes back to fully understanding your client’s profile.”

It is a similar situation with imputation credit accounts.

“It seems unusual that a company would attach imputation credits to dividends if it doesn’t have them in the imputation account at the time the dividend is declared – or at least have a reasonable expectation that the requisite taxes to generate sufficient credits will be paid before 31 March.”

Ashby notes that things can change but there must be processes in the accountant’s internal systems to identify the change and any subsequent potential shortfalls.

Discrepancies in returns for limited partners of a limited partnership was not unexpected however, particularly when non-resident investors were involved.

“A limited partnership is tax transparent, which means the income of the entity is attributed each year to the limited partner, with that person then directly liable to pay any taxes on their share of the income.”

Ashby sees it as a potential communication issue.

“Has the limited partner’s accountant asked the right questions of their client, and again, is there sufficient awareness about the investment?”

He concurs that the taxpayer also has responsibilities.

“If you know you’ve got an investment in a limited partnership, surely you know you’re going to have to declare something on your tax return. If your accountant has not mentioned anything, then it’s probably a good signal that they don’t know about the investment.”

Trust distribution misunderstood

IR’s findings reveal that rules relating to trust distributions to minors also appear not to be well understood.

“In the old days, these distributions were usually done to take advantage of the marginal tax rate. However, the rules changed many years ago. I would suggest it is another example of the accountant not fully understanding their client’s profile – or their beneficiary status – or issues surrounding the quality of their database,” notes Ashby.

Income from personal services

Issues with diverted personal services income also appear tricky for taxpayers. 

The attribution rule for income from personal services states that if more than 80 per cent of company income is earned by one person from one source in any tax year, the company’s income is attributed to the individual and they are taxed accordingly.

An example of contravention of that rule might be a sole trader setting up a company to mitigate the 39 per cent tax rate after landing a contract that constitutes 90 per cent of their income.  

“It’s possibly the tax issue for which there’s the most uncertainty and the most misunderstanding for the taxpaying community,” Ashby concludes.