Chapter 4 - Evidence exclusion rule
Summary of suggested changes
This chapter suggests the following amendments to the evidence exclusion rule:
- that it applies only to the “issues” and “propositions of law” elements of the relevant party’s SOP;
- that when one party is required to produce a SOP both parties are required to do so. The evidence exclusion rule will then attach to these SOPs; and
- that there be no formal evidence exclusion rule in place for disputes if the taxpayer and the Commissioner agree to opt out of the disputes process under section 89N(1)(c)(viii).
It also suggests that the Taxation Review Authority Regulations be updated to refer to the District Court Rules 2009.
4.1 The evidence exclusion rule (EER), contained in section 138G, applies following the issue of a disclosure notice  and limits the Commissioner and the taxpayer to the facts, evidence, issues and propositions of law that are disclosed in their respective SOPs.
4.2 By largely limiting the parties to the material in their SOP, the EER serves as the central pillar to the “all cards on the table” approach advocated by the Richardson Committee. In the words of the NZICA-NZ Law Society submission, its purpose is to “encourage open and full communication”.
4.3 The EER aims to ensure that the SOP contains all of the best arguments for each party and therefore eliminates the possibility of “trial by ambush”. It also helps to make sure that all relevant information is brought forward at the SOP stage (at the latest) to increase the possibility that the Commissioner’s assessment will be correct.
Current problems with the EER
4.4 The main problem with the EER stems from what is sometimes described as the “kitchen sink” approach to preparing a SOP, whereby all facts, evidence, issues and propositions are included. There are two possible motivations for this:
- to avoid the risk of the matter being prevented from being raised in a hearing authority; and 
- to provide all relevant information that the parties consider will be persuasive or helpful to the Adjudication Unit (which, as an independent function of Inland Revenue, will not have previously been exposed to the issues being disputed).
4.5 The result of this all-inclusive approach is lengthy documentation and, if the dispute does reach a hearing authority, potential duplication between the preparation of the SOP, court documents and discovery process.  This can increase reluctance to proceed with a legitimate dispute.
4.6 The NZICA-NZ Law Society submission suggests that the scope of the EER be relaxed, so that the parties are limited to the “propositions of law” set out in their respective SOPs, rather than also being limited to the facts and evidence. The submission argues that this will provide the necessary certainty on the legal issues at stake, while going some way towards preventing the “kitchen sink approach” to SOP preparation.
4.7 The current legislation also arguably provides the potential in taxpayer-initiated disputes for the EER to apply to the taxpayer only. This possibility comes about because section 89N(2) provides that the Commissioner can issue an amended assessment after the taxpayer’s SOP has been considered; there is no requirement for the Commissioner to also produce a SOP. The counter-argument is that the Commissioner is effectively required to issue a SOP because, without doing so, section 138G would prevent any arguments being able to be raised in a hearing authority. The matter requires clarification.
Role of disputes documents
4.8 In considering whether the EER should be amended, the respective roles of the NOPA and the SOP should be taken into account.
The role of a NOPA
4.9 The NOPA is the first step towards the identification of the issues in a dispute. The purpose of the NOPA is to ensure that the party receiving the notice is aware of the arguments on which the other party is relying. It is intended to foster open and frank discussion early in the resolution process and advance the “all cards on the table” objective. 
4.10 Irrespective of whether it is issued by the Commissioner or the taxpayer, a NOPA must identify the proposed adjustment, provide a concise statement of the key facts and the law (in sufficient detail to inform the other party of the grounds for the proposed adjustments) and state how the law applies to the facts. A taxpayer’s NOPA must also provide copies of significantly relevant documents. 
4.11 The NOPA is not intended to be an investigative tool (for Commissioner-initiated disputes), as ideally the investigation of the taxpayer’s affairs would have been concluded by this point and any proposed adjustments should already have facts and evidence to support them. If further information is considered necessary, but is not forthcoming, the Commissioner will be able to exercise the powers under sections 16 and 17 to gather it. In this respect, the NOPA is a document that reflects the outcome of a concluded investigation.
The role of the SOP
4.12 The SOP forms the basis upon which the issues will be argued if the case proceeds to court. It is generally the last card on the table before the challenge procedures, and its main role is to inform the other party of the legal and factual arguments that the party is relying on so that any “trial by ambush” is effectively eliminated from future litigation.
4.13 The SOP must, with sufficient detail to inform the other party, give an outline of the facts, evidence, issues and propositions of law relied upon.  A well-drafted SOP provides the other party with an adequate base from which to draft either a reply SOP or a notice of claim in the hearing authority. A SOP that contains at least an outline of all relevant information is also important for the effective operation of the Adjudication Unit.
4.14 Concerns about possible duplication of the NOPA and SOP are, in our view, not overly problematic when looking at the disputes process as a whole. Given that the NOPA and the SOP are extremely likely to focus on the same points, some degree of duplication is inevitable (some issues may have been resolved in the intervening period).
4.15 If the NOPA is completed as outlined, the pressure for the SOP to be a heavily detailed document will be reduced. If not all of the contents of the SOP are subject to the EER, as suggested by the NZICA-NZ Law Society submission, there will be less temptation to include every available shred of information. These factors should in turn result in the SOP being the “outline” document contemplated by the TAA.
4.16 We therefore agree that the EER should be relaxed, subject to:
- the Commissioner having all relevant information available so that any assessment is as accurate as possible; and
- if a challenge does arise from that assessment, any court proceedings operating on a “no surprises” basis to the fullest extent possible.
4.17 If the EER is to be relaxed, it is questionable whether an “evidence exclusion rule” is an appropriate label for such a rule. Any new label used will need to be consistent with its role in the overall disputes process. One possibility is simply to change the label to “exclusion rule”.
4.18 The NZICA-NZ Law Society submission suggested relaxing the EER so that it was limited to the “propositions of law” contained in the SOP, allowing for new issues, facts and evidence to be adduced at the challenge stage. The submission also suggested, especially if no SOP is involved, binding the Commissioner to the “grounds of assessment”.
“Proposition of law” EER
4.19 A “proposition of law” can be regarded as the legal basis for the technical position taken by the party. It will contain references to the relevant statutory provisions, and judicial and other authorities that may assist in the interpretation of them (including, where appropriate, overseas court decisions, legislative history analysis, and reference to legal principles and cases outside of the taxation area). It may also include a statement on the application of law that has not previously been considered by the courts.
4.20 Certainty as to the propositions of law is important to the efficient operation of the disputes process. If propositions of law are not finalised during the dispute phases, legal issues may be poorly defined until the commencement of proceedings in court. Such an outcome would be directly contrary to the objectives of the Richardson Committee, which sought full and early disclosure of relevant matters.
4.21 Removing the existing strict requirements to include facts, evidence and issues in the SOP, and having the EER limited to propositions of law appears to have a number of advantages:
- It continues the current practice of both parties being aware of the legal arguments proposed by the other.
- It should provide the Adjudication Unit with all the information required to analyse the respective legal arguments.
- It should take some of the pressure away from including every fact and piece of evidence in the SOP.
- Propositions of law, as a term, is already included in the legislation and is a requirement for the contents of a SOP. Any legislative change to limit the EER in this way would therefore be minimised.
“Grounds of assessment” EER
4.22 The NZICA-NZ Law Society submission suggests that the Commissioner should be bound by his “grounds of assessment”, particularly when no SOP has been issued. A rule based on grounds of assessment has one major advantage, in that there is almost always an assessment in a substantive dispute. Because the challenge is generally to the assessment, there is no possibility of the rule not applying to the Commissioner.
4.23 However, we do not favour a “grounds of assessment” rule for the following reasons:
- The assessment is generally issued after the SOP. Therefore, there would be no finality to the SOP.
- The Commissioner’s assessment quantifies the tax liability but does not contain detailed analysis. This would necessarily change. If there is a SOP, this could be a simple cross-reference or reproduction of the SOP. However, when there is no SOP, (such as opt-out disputes), this rule would effectively still require the Commissioner to produce a document similar to a SOP with the attendant documentary detail.
- To provide parity, so that the Commissioner was not the only party bound, an additional reply would be required of the taxpayer. Placing further documentary requirements on the taxpayer would be an unnecessary additional compliance cost.
4.24 We see “issues”, in the context of the SOP as akin to “legal issues to be resolved between the parties”. This is supported in some respect by the fact that sections 89M(4) and (6) both refer to issues that the party “considers will arise”. This can be contrasted with the facts, evidence and propositions of law “on which the [party] intends to rely”. In other words, the issues arise and the remaining elements are relied upon to demonstrate a particular view. If this is the case, then “issues” is effectively the umbrella term and propositions of law, facts and evidence are put forward by the parties in an attempt to make a decision-maker resolve the issues in their favour.
4.25 On this basis, it makes sense to consider the possibility that the issues should be set, so that the parties can go about constructing their propositions of law and gathering their facts and evidence. Such an approach has many of the advantages of a “propositions of law” approach (discussed above) while recognising that propositions of law are only ever determined in the context of the wider legal issues.
4.26 On balance, we consider that the best approach may be to have the EER apply to “issues” and “propositions of law”. We prefer this for the following reasons:
- Simply having an “issues” EER could lead to concerns around exactly how broadly “issues” is defined. A dispute may only have one over-arching issue. Although there are arguably benefits in having this issue set, it may be so broad as to effectively provide no limitation at all.
- Having a “propositions of law” EER would effectively limit the issues because a new issue would be unlikely to be introduced unless propositions of law could be raised to support it.
- Requiring the parties to clearly state what they consider to be the relevant issues, and the propositions of law that would support the resolution of those issues in their favour, would create an appropriate level of certainty – especially when coupled with the requirement to provide an outline of facts and evidence in the SOP.
4.27 We do note, however, that any amendment to the EER within the existing legislative framework would not cater for truncated disputes.
“Trial by ambush” and factual certainty
4.28 To relax the EER, both parties would need assurance that they could not be “ambushed” at a court hearing by previously undisclosed material. Correspondingly, the parties would also need to be confident that they fully understood the factual events relied upon by the other (even if there are disagreements over the relevant facts).
Trial by ambush
4.29 The risk of trial by ambush is reduced in the modern litigation environment. Lord Donaldson of Lymington MR in Mercer v Chief Constable of the Lancashire Constabulary stated: 
Over the last quarter of a century there has been a sea-change in legislation and judicial attitudes towards the conduct of litigation, taking the form of increased positive case management by the judiciary and the adoption of procedures designed (a) to identify the real issues in dispute (b) to enable each party to assess the relative strengths and weaknesses of his own and his opponent’s case at the earliest possible moment and well before any trial. Not only does this tend to make for shorter trials and save costs, even more importantly it facilitates and encourages settlements.
4.30 New Zealand commentators have expressed the view that the above passage is equally true in New Zealand. Discovery and the advent of the case management system  has encouraged an environment where the Court is no longer accepting of trial by ambush,  and the traditional adversarial approach to litigation whereby parties “keep their cards close to their chest”. 
District Courts Rules and judicial settlement conferences
4.31 Under section 16 of the Taxation Review Authorities Act 1994, the TRA has a wide discretion to determine its own proceedings.  The District Courts Rules in effect act as a guide to reduce any uncertainty about TRA proceedings. To this end, Regulation 4 of the Taxation Review Authorities Regulations 1998 states:
To the extent that they are not inconsistent with these regulations, or the provisions of the Taxation Review Authorities Act 1994, or the Tax Administration Act 1994, the District Courts Rules 1992 apply to the commencement, interlocutory steps, and conduct of proceedings in the Authority as if those proceedings were civil proceedings in the District Court.
4.32 New District Court Rules came into effect 1 November 2009. One feature of the new rules is that they provide for “settlement conferences” between the parties before a hearing.
4.33 A judicial settlement conference must be convened by a judge and held in chambers. The purpose of the conference is to give the parties to the proceedings an opportunity to negotiate a settlement of the claim or any issue.  The inclusion of the conference is another opportunity to make sure parties have the same understanding of the facts and should prevent any trial by ambush before a hearing. It is worth noting that a party can still apply for discovery if there is a serious possibility of information having been withheld or trial by ambush.
4.34 Under section 16 of the Taxation Review Authorities Act and Regulation 4, the TRA has the discretion to adopt these settlement conferences into its proceedings. However, greater certainty on the application of the rules may be desirable.
4.35 Because of the improved systems that settlement conferences introduce, and to make it easier for disputants (who will not then have to deal with the “old” rules) we suggest that the Taxation Review Authorities Regulations be amended to apply the 2009 District Court Rules and that the settlement conferences be incorporated for tax challenges. 
4.36 One question that does arise, however, is whether the documentation required by the disputes process and the new District Court Rules overlap. Our view is that this is not likely because if adequate exchanges between the parties have occurred under the disputes process, the court documents will simply become more manageable in nature.
4.37 To this end, we also suggest an amendment to Regulation 8 of the Taxation Review Authorities Regulations to relax the requirement that notices of claim have to effectively duplicate the SOPs of both parties. Provided the relevant information (NOPA, NOR and SOPs) were attached to the notice of claim, that would be sufficient. In practice, this is often what occurs and appears to cause little difficulty.
4.38 Factual certainty is essential to an efficient disputes process and, as previously noted, it is important that any relaxation of the EER does not undermine this. Whatever change is made towards relaxing the EER, there would still be a requirement that a SOP contain an outline of the facts and evidence “on which the [party] intends to rely”.  If an important fact or piece of evidence is not included in this outline and the party then seeks to rely on it, they run the risk of the hearing authority refusing to accept it.
4.39 Factual certainty could be achieved in the following ways:
- There is a natural incentive for taxpayers and the Commissioner to put their best case forward as early as possible in the dispute process because of the costs (including UOMI) of doing otherwise. If the Commissioner suspects the taxpayer has not disclosed all the relevant information, the Commissioner can rely on the information-gathering statutory powers under sections 16 and 17, or the hearing authority’s powers in relation to discovery and interrogatories, to obtain as much factual certainty as possible.
- The Commissioner will also have the ability to achieve greater factual certainty during the conference phase, particularly if there is an opt-out under section 89N(1)(c)(viii), as an agreement will be signed at the end of the conference stating that all material facts have been disclosed.
- As discussed above, the District Court Rules 2009 also provide for a settlement conference to take place between the parties. Assuming that this element of the new rules is applied to proceedings in the TRA, this conference will also afford the parties with an opportunity to ensure that all the key facts are available and issues discussed in requisite detail. The prospect of material factual information being withheld from a statement of claim, when a settlement conference is imminent, is minimal.
EER applying to both parties
4.40 We agree with the NZICA-NZ Law Society submission that, where the EER applies, it should apply to both parties. There are two possible solutions to ensuring this is achieved:
- make it clear that the Commissioner must, to continue a taxpayer-initiated dispute, issue a SOP in response to the taxpayer’s SOP; or
- provide that the Commissioner always issues the first SOP, even in taxpayer-initiated disputes.
Commissioner issues a SOP
4.41 This proposal would require an amendment to section 89N(2)(b) (concerning the process for taxpayer-initiated NOPAs) to the effect that the Commissioner cannot amend an assessment until the later of:
- the Commissioner has considered a statement of position issued by the disputant; or
- the Commissioner has issued a statement of position.
4.42 This would mean that if one party has to produce a SOP, so would the other. Each party to a dispute would then have a SOP to which the EER could apply.
Commissioner always issues the first SOP
4.43 An amendment could be made to section 89M(3). This section currently states that the Commissioner’s disclosure notice does not need to be accompanied by a SOP if the NOPA was issued by the taxpayer. If this requirement were removed, the Commissioner would always have to issue a SOP at the same time as the disclosure notice. The taxpayer would then have the usual response period to reply with their SOP.
4.44 This proposal has the advantage of aligning all disputes from the conference phase onwards. Irrespective of who initiated the dispute, the onus would always be on the Commissioner to produce a disclosure notice and SOP. In the event that the taxpayer’s SOP raised novel material or arguments not previously discussed between the parties, the Commissioner would still be able to respond to these through the addendum SOP provisions in section 89M(8). On the other hand, this approach presupposes that the Commissioner will have completed the investigation well in advance of the SOP having to be issued. For taxpayer-initiated NOPAs this is not always the case and the approach may not therefore provide an adequate basis from which the Commissioner can prepare an appropriate SOP.
4.45 We welcome submissions on the possible approaches.
EER and opt-out under section 89N(1)(c)(viii)
4.46 When the taxpayer and the Commissioner agree to opt-out of the disputes process under section 89N(1)(c)(viii), the EER (in either its current or proposed form) will not apply, as no SOP will have been issued. Therefore, in theory, nothing limits the issues, propositions of law, facts or evidence put forward by either the taxpayer or the Commissioner. The question is whether or not this should be seen as a problem for either party to such a dispute.
4.47 The natural incentive to end the dispute as soon as possible will still exist under an opt-out scenario. Also, because of the requirement set out in the opt-out guidelines that all material information has been provided by the taxpayer, the conference is likely to be an adequate disclosure tool in an opt-out case.
4.48 Factual certainty does not necessarily provide certainty as to the issues and propositions of law. However, when a conference is undertaken before an opt-out, there is less potential for disputes to reach a hearing stage without the issues and propositions of law being sufficiently well defined. This is because, if the parties have all the information relevant to the dispute (a pre-requisite of being eligible for opt-out), they should be in a position to anticipate the legal arguments of the other party with some degree of accuracy.
4.49 The following further factors appear to weigh in favour of there being no EER (or equivalent) applicable to opt-out disputes:
- If novel arguments are raised in the court documents, the other party will still have some time to consider these before filing their documents or the judicial settlement conference begins (as applicable).
- Although it is not correct to say that all disputes of $75,000 or under (a suggested criterion for an opt-out) are “simple”, we do not anticipate that the most complex of cases will be eligible for the opt-out.
10 Note the distinction between dispute documents – documents which are legislatively required under the Disputes and Challenge procedures of the TAA – eg, NOPA, NOR, SOP, disclosure notice – and court documents, which are required to be filed within the hearing authority – eg, Notice of Claim, Notice of Defence.
11 Resolving tax disputes: a legislative review. A government discussion document. July 2003 para. 2.14-2.16.