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7.44 Tax practitioners should also be consulted in relation to the entire RDF process as applied to them and, in particular, how the ATO should proceed once higher risk agents have been identified and whom the ATO intends to investigate further. One important consideration is that the tax practitioners should have a right of review and be afforded due process before the ATO risk rating is finalised.
7.45 It is important that the ATO does not approach the tax practitioners on the assumption that they are doing something wrong with respect to their clients who are perceived to be higher risk taxpayers. For example, there are various reasons why a practitioner may appear to have a large proportion of clients who are outside the small business benchmarks.
7.46 The ATO has advised that it does not disclose the risk rating of agents to their clients. This is crucial to the continued survival of the tax agent business and processes should be in place so that such confidentiality is always honoured. Where a taxpayer’s tax liabilities have been adjusted as a result of the tax practitioner not taking reasonable care, the ATO should refer the matter to the TPB.
Ibid pp 31 and 33. See table 7 (actual vs planned strike rate) and table 8 (actual vs planned average
RECOMMENDATION 7.1 The IGT recommends that, in consultation with tax practitioners, the ATO develop and publish a complete guide on the operation of RDF for tax practitioners. Matters to be covered
by the guide include:
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CHAPTER 8 — TEMPLATE FOR FUTURE DESIGN
8.1 Thus far, this report has covered specific issues in relation to the ATO’s risk assessment approaches for particular market segments. This chapter draws together key themes in the earlier chapters. The reason for doing so is to draw out general design elements that assist with future risk assessment architecture in the tax administration environment.
8.2 The key themes adopted based on stakeholder feedback and reflected in the
earlier chapters were:
• effective use of inputs;
• transparency and communication; and
• proportionality of the compliance approach.
8.3 Good governance is a cornerstone of effective tax administration. The revenue authority must have confidence that its risk assessment approaches are being carried out as intended.
8.4 All risk assessment approaches should ensure that stakeholders and officers are aware of their roles and responsibilities. This may come in the form of job descriptions or duty statements. Key committees or decision-making bodies should have their authority and remit clearly articulated. Internal reporting structures need to be in place to ensure problems and issues are escalated to the appropriate committee or decision-maker for timely action. This may come in the form of charter documents.
8.5 Decision-making bodies need to ensure that they are following agreed, articulated processes and that decisions are made on a timely basis. Decisions should be appropriately documented with supporting evidence and reasoning.
8.6 Risk assessment approaches should also have a clear line of sight from the highest level, that is the Enterprise Risk Management Framework. The ATO has, at the strategic level, identified 22 key enterprise risk areas. Any risk assessment approach, or risk management campaign, should be able to indicate to which key enterprise risk area it relates. This may be evidenced by risk assessment and risk treatment documents on the Enterprise Risk Manager.
8.7 Documentation at the business line level may be required to indicate how the enterprise risk will be addressed at the strategic or tactical level.
8.8 Furthermore, risk assessment and risk treatment measures should have an evaluation strategy, which indicates how the ATO will measure the effectiveness of,
and improve, the risk assessment or risk treatment method. A continuous improvement outlook should also be a hallmark of the entire process.
EFFECTIVE USE OF INPUTS
8.9 A system is only as good as the inputs that go into it. Relevant and effective inputs are vital for risk identification and capture. It facilitates the direction of limited resources to areas that most warrant it.
8.10 It is important to clearly articulate the risk hypothesis to ensure risk inputs are relevant to the risk being identified. In the LBTC booklet, the risk event, for example, is the taxpayer having a tax position with which the ATO disagrees or the taxpayer through error or omission has misreported their obligations.369
8.11 In this case, there are two types of risk events and it is important to ensure that the ATO does not attribute one risk factor against the wrong risk event. For example, a taxpayer may undertake transactions in an uncertain area of the law. To infer that this indicates a higher likelihood of ‘non-compliance’ (that is error or omission) is not appropriate. It is important that risks be more specifically identified and the expected remediation or action required more carefully targeted.
8.12 This report recognises that the ATO uses a combination of quantitative and qualitative inputs. Quantitative data has the benefit of being perceived as objective fact.
Furthermore, quantitative data lends itself well to analysis by computerised methods rather than manual analysis. This means a great deal of analysis can be performed at a high volume at relatively low cost to the ATO.
8.13 The application of quantitative approaches in certain situations need little qualitative inputs where there is objective, verifiable and direct evidence of non-compliance, such as those used in data-matching of interest income disclosures in income tax assessments.
8.14 In the absence of quantitative inputs, the IGT recognises the need to employ qualitative inputs. The small business benchmarks provide a good example of where both these types of input need to be used to arrive at an appropriate outcome.
8.15 The benchmarks are derived from taxpayer income tax returns and activity statements from statistically valid populations of similar businesses. Whether a particular taxpayer’s cost of sales to turnover ratio is different to the benchmark range is also objectively verifiable. However, a departure from the benchmark hypothesises an increased risk of underreported income. Therefore, as set out in the IGT’s Review into the ATO’s Use of Benchmarking to Target the Cash Economy (Benchmarking Review), ATO officers also need to examine qualitative inputs, including a better understanding of the taxpayer’s business and the consideration of other qualitative risk factors, such as the nature of the business, cash controls and its business mix and record keeping management.
8.16 The ATO should ensure that qualitative information is considered in an objective and non-arbitrary manner. Adopting appropriate governance arrangements should assist in this regard. In the Large Business and International (LB&I) business line, the adoption of the risk template, which lists specific risk factors to consider, and the moderation panel, which subjects the risk factors to peer review and collective decision making, are helpful measures in ensuring the integrity of the use of qualitative inputs. The LB&I approach is designed to ensure that evidence is tested consistently across the risk population.
8.17 The ATO should also ensure that there are processes in place to refine the accuracy of their risk inputs. In the IGT’s Benchmarking Review, the ATO agreed to examine the results of the completed audits to identify any other risk factors which may assist in better targeting likely non-compliant taxpayers.
8.18 In the SME business line, risk managers have responsibility for the regular review of the risk rules under their ownership. This business line has also agreed to previous ANAO recommendations to review their risk rules.
8.19 In LB&I, it is noted that the risk filters are currently generating many false positives that are subsequently filtered out by risk managers. This represents an opportunity to review the risk filters with a view to ensuring they are generating more useful output and reducing the need for risk managers to do this filtering.
8.20 Risk managers play an important role in all business lines. They identify potential risks, develop rules to detect those risks, and develop risk treatment strategies. The ATO should ensure that risk managers have an adequate understanding of the business and economic environment pertaining to the risk over which they have responsibility. This ensures that risk managers can identify potential risks in a timely manner.
8.21 The ATO should also ensure that risk managers are adequately supported in their role. This includes ensuring they have the adequate skills to identify and analyse risk as well as develop guidance for active compliance officers on the indicators and evidence of non-compliance to test the risk hypothesis.
8.22 Risk managers should also be able to articulate what evidence active compliance officers can rely upon to confirm compliance and close the review or audit as soon as practicable. Risk managers should also have regular contact with compliance officers as an additional source of risk intelligence.
8.23 The ATO’s Compliance Effectiveness Methodology provides guidance to ATO officers who are developing risk treatment strategies. One aspect of this guidance is that processes should be in place to gather evidence to indicate whether the ATO’s intervention was effective in changing compliance behaviour.
8.24 From a risk assessment perspective, the IGT is of the view that the ATO should also consider how to measure the effectiveness of their risk assessment approaches in detecting non-compliance and not just the effectiveness of the compliance activities themselves.
8.25 One such way of evaluating the accuracy of risk assessment methods is through the examination of strike rates and audit yields. Both of these measures provide useful information in more accurately determining the probability and consequence aspects of a risk rating for a population.
Strike rates and audit yields
8.26 Strikes rates are essentially the ratio of cases where there is a positive adjustment in tax payable (that is a ‘strike’) as a proportion of all cases conducted. The remainder of cases are often referred to as ‘nil outcome’ cases.
8.27 For a given audit selection method, a pool of ‘positive’ cases is generated.
Where the subsequent compliance activity results in a strike, the case is considered a ‘true positive’ if the result is not reversed on objection, review or appeal. The taxpayer is non-compliant in this case and the risk method accurately detected it.
8.28 As mentioned earlier, where the audit case results in a nil outcome, the case can be said to be a ‘false positive’. The taxpayer is actually compliant, but the risk method inaccurately has detected the taxpayer as being non-compliant.
8.29 In limited situations, a nil outcome may be underlying non-compliance due to certain factors.370 Importantly, the tax administration is not assessing risk of over-compliance, being situations where taxpayers have under claimed deductions or not availed themselves of full entitlements.
8.30 It is also important that likely compliant or lower risk taxpayers are spared from unnecessary compliance costs. As such, risk assessment methods should also be accurately identifying likely compliant taxpayers. For example, in the Compliance
Program 2012–13, the ATO said of their small business benchmark approach:
We have developed benchmarks for over 900,000 small businesses in over 100 industries.
The program was promoted by extensive communication and consultation with tax practitioners, industry associations and taxpayers in those industries.
8.31 The above highlights that the benchmarks are used as much as a tool to identify likely compliance as it is to identify potential non-compliance. However, such likely compliance is an assumption, as the ATO cannot be certain that those businesses within the benchmarks are actually compliant unless they are audited.
8.32 In the case above, the benchmark approach has identified a pool of 800,000 cases as ‘negatives’. Whether these cases are truly compliant (‘true negatives’) or truly non-compliant (‘false negatives’) would require some degree of verification. That is, the ATO may need to audit some of these taxpayers to verify if they are indeed ‘likely to be competing on a level playing field with their peers’.
Australian Taxation Office, Strike rate – An analysis of Indirect Tax audits, April 2012, slide 19.
8.33 The evaluation of the accuracy of risk assessment tools can be better
understood by adding the potential true negatives and false negatives:
8.34 It may be apparent from the above table, that the ability for a risk assessment tool to accurately detect non-compliance is reliant on the underlying level of compliance or non-compliance in the risk population. That is, the combination of false negatives and true positives (FN + TP) represents all the non-compliant taxpayers for a given risk population.
8.35 If the population has a low proportion of non-compliance, it is inevitable that any risk assessment tool will have a low strike rate. Therefore, when assessing the accuracy of a risk assessment tool based on strike rate alone, one needs to be aware that
a reduced strike rate may be due to a combination of either:
• overall reductions in the level of non-compliance in the risk population (that is reductions in FN and TP); or
• the risk assessment tool is becoming less accurate at detecting non-compliance (that is reductions in TP only, but not FN).