Most people react to news of an IRD audit as they would to a dentist telling them they need to have a tooth removed. While the initial dread is the same, a tooth extraction can be over in minutes, whereas an IRD audit can take years. And you don’t generally get a smiley face sticker at the end of an IRD audit.

While an IRD audit letter isn’t welcome news, it’s useful to pause to think about just why you’ve come to IRD’s attention, as that helps you come up with a coherent plan and hopefully sort out things with IRD as quickly as possible.

The reasons IRD may decide to audit a business are many and varied.

It could be an entirely random general audit, but that’s less common these days.

Sometimes it’s an anonymous tip-off that comes with very specific and credible information – think aggrieved former business partner or, even more worryingly, an ex-spouse who knows where the 2^nd set of books are and who thinks revenge is a dish best served hot and spicy all over the nether regions.

Cross-check enquiries are common, things like IRD auditing another business and validating GST invoices that business has received, IRD making sure loss or credit account balances match between entities and between tax years, and IRD making sure there has been a depreciation recovery on disposal of a property.

Increasingly IRD commences either an audit or risk review as part of an extended project. IRD has run property compliance, hospitality, and construction projects for 8 years and they are due to run till at least 2020.

So IRD decides to enquire into a business for any number of reasons. And when IRD first contacts a taxpayer, it does so either through a risk review letter or a notification of audit letter.

The distinction between a risk review letter and audit notification letter is important legally. A risk review letter means the IRD audit hasn’t formally started so a taxpayer can make a voluntary disclosure of a tax discrepancy with reduced penalties and immunity from prosecution. Receipt of an audit notification letter means a taxpayer can only make a post-notification voluntary disclosure where penalties aren’t reduced as much and there is no blanket immunity from prosecution.

Putting all the above together, the response to an IRD inquiry should take into account the reason IRD is looking into a business (if known), and the way IRD start its enquiry, ie whether it first issues a risk review or an audit notification letter.

If a business owner has had a messy dispute with a business partner, or an acrimonious separation from a spouse, and then IRD commences a very focused inquiry on particular matters, you can be pretty sure IRD has received very specific information from the former business partner or ex-spouse. If IRD has commenced its inquiry through a risk review letter, consideration should be given to making a full voluntary disclosure covering the matters IRD is focusing on. If IRD commences its inquiry through an audit notification letter, it’s a sign they are confident of their position and things like prosecution may be in play. In these circumstances obtaining expert assistance beyond that given by a business’s normal accountant should be seriously considered. A tax lawyer can achieve far better outcomes if bought in near the start of this sort of case.

Similarly, if IRD starts an enquiry with a business as part of its hospitality, construction, or property compliance projects, you can assume it’s a serious enquiry where IRD already has a very good idea that there are tax issues needing to be followed up. IRD has been running these projects since at least 2010 and so has built up substantial industry knowledge. IRD also has the powers to request huge datasets (ie bulk financial data or bulk property data) and use that information to both choose which businesses to audit, and to progress audits it initiates. So if IRD starts an enquiry with a restaurant business with an audit notification letter, and identifies the main issue as being low cash bankings compared to electronic transactions, they are basically saying it’s a potential tax evasion case. The pitfalls in this sort of case are numerous, and the consequences serious, so consideration should be given to getting expert help.

In contrast to the aggrieved spouse cases and the IRD project cases outlined above, some IRD enquiries are more routine. An IRD risk review letter identifying a depreciation recovered issue of a relatively low value would fall into this category. If the IRD position appears correct, there is a lot of merit in quickly sorting the matter out without necessarily arguing over every penny. I’ve seen otherwise routine audits on a single issue explode in scope because taxpayer’s advisors argued the toss over whether an adjustment should be $4,500 as opposed to $5,000, then IRD looks into matters more closely and ends up discovering six figure cash suppression issues.

So in summary, trying to work out why IRD is enquiring into a business and understanding the significance of how IRD commences these inquiries is important in formulating a plan on how to deal with IRD. Muddling along and hoping the IRD goes away isn’t the best strategy!