«A report to the Assistant Treasurer Inspector-General of Taxation October 2013 Review into aspects of the Australian Taxation Office’s use of ...»
8.36 Strike rate analysis is limited in that it only considers selected cases (the ‘positives’) and which of these were ‘true positives’ (strike rate = TP/[TP+FP]). It does not consider false negatives (FN).
8.37 Determining the true cause of low strike rates, therefore, relies on an understanding of the underlying level of non-compliance in a given population. One method for determining this is the use of random audits.
8.38 According to the ATO’s research in compliance effectiveness, randomised controlled trials are one of the most accurate ways of determining whether a particular compliance intervention was the cause of changes in taxpayer behaviour.
8.39 Similarly, auditing a random sample of taxpayers in a given population, such as a representative sample of the 900,000 benchmarked small businesses, may indicate the underlying level of non-compliance. If the underlying level of non-compliance is Manish Gupta and Vishnuprasad Nagadevara, ‘Audit selection strategy for improving tax compliance – application of data mining techniques’ in Ashok Agarwal and Venkata Ramana (eds), Foundations of Egovernment (2007) p. 378.
under say, 24 per cent, then it can be said that using the benchmarks alone to select taxpayers for audits is ‘better than random’.373
8.40 Until such sampling is undertaken, however, it cannot be said with certainty that the use of benchmarks alone is indeed better than random selection. Furthermore, random sampling may indicate a higher level of underlying non-compliance. For example, if a random representative sample of the benchmarked population revealed a non-compliance rate of over 24 per cent, it could be said that the benchmarking method was ineffective at targeting likely non-compliant taxpayers. In such a case, the sampling may reveal other correlations or relationships that can be used as a risk inputs besides benchmarks.
8.41 One of the main reasons why the ATO does not conduct random audits is the cost they impose on compliant taxpayers and the opportunity cost to the ATO in conducting a random audit instead of a risk-based audit which is likely to yield more tax revenue.
8.42 Compliance costs imposed on compliant taxpayers through random audits may be mitigated by the ATO reimbursing taxpayers for the additional compliance costs incurred if any. In the case of random audits, the taxpayer is not being audited because they represent a direct risk necessarily, but they are rather contributing to make the ATO’s risk assessment method more effective. That is, when they are compliant they are bearing some cost for the benefit of the greater taxpayer population in better identifying non-compliance more broadly.
8.43 Such an approach is not without precedent in Australia. The ATO’s test case litigation program is an example of the ATO protecting individual taxpayers from the cost of litigation which is likely to benefit a broader range of other taxpayers through
achieving greater certainty of the law:
Under the test case litigation program, the ATO provides financial assistance to taxpayers whose litigation is likely to be important to the administration of Australia’s revenue and superannuation systems. The aim of the program is to develop legal precedent — that is, legal decisions that provide guiding principles on how specific provisions we administer should be applied more broadly.374
8.44 The IGT’s Review into the ATO’s Use of Early and Alternative Dispute Resolution also considers the concept of ‘public benefit’ in greater detail.375
8.45 Whilst reimbursing compliant taxpayers for the additional costs associated with random audits would increase costs for the ATO, it would enhance the system leading to greater overall public benefit. Consistent with the above test case litigation sentiment, the aim of a random audit program is not to raise revenue, but to provide information and intelligence to optimise the ATO’s risk assessment outcomes and increase integrity.
Australian Taxation Office, Test case litigation program (10 May 2013) http://www.ato.gov.au.
Inspector-General of Taxation, Review into the Australian Taxation Office’s Use of Early and Alternative Dispute Resolution (2012) rec 4.2.
8.46 Random audits are also known to have other benefits, such as assisting in the calculation of the so-called ‘tax-gap’, and also potentially as a deterrent effect for certain taxpayers. Several OECD countries have conducted random audits, often with the objective of validating risk assessment models, and measuring compliance levels.376
8.47 With respect to the opportunity costs represented by the ATO expending resources on random audits instead of risk-based audits, one should bear in mind the opportunity cost the ATO currently incurs in audits which result in ‘no further action’ under its current risk–based approach, without the insight provided by random audit data.
TRANSPARENCY AND COMMUNICATIONTransparency
8.48 The IGT is of the view that key reasons for transparency or providing information about the risk assessment process are to engender community confidence and improve taxpayer behaviour and practices.
8.49 Transparency of the ATO’s risk assessment framework enhances community confidence that the ATO chooses taxpayers for audits on an objective and coherent basis. A lack of transparency may increase taxpayer perceptions that audit selection decisions are arbitrary or subject to individual officer discretion.
8.50 The publication of details such as risk factors or risk filters facilitates objective verification of the basis for decisions. The publication of the small business benchmarks is a good example of this transparency, where benchmark ranges are published on the ATO’s website. Where taxpayers are selected for compliance activity due to variances from the benchmarks, the taxpayer can refer to the website to verify this basis.
8.51 Other examples of transparent approaches include the publication of the Large Business and Tax Compliance (LBTC) booklet and Tax compliance for small-to-medium enterprises and wealthy individuals (Tax Compliance) booklet. Although the ATO does not give the same specific detail as in the case of the small business benchmarks, the publications do show, to some extent, how the ATO applies their risk differentiation framework, as well as what taxpayers can expect from the ATO by way of compliance activities and ATO officer conduct.
8.52 In considering what level of transparency to afford a certain risk assessment process, the ATO needs to balance the need for community confidence in a robust risk-based system and the risk of taxpayer manipulation.
8.53 The IGT acknowledges that the ATO communicates through tailored communication as well as general communication. Examples of general communications include the annual Compliance Program (now Compliance in focus) as Organisation for Economic Co-operation and Development, Forum on Tax Administration, Compliance Risk Management: Use of random audit programs (2004) para .
well as those mentioned above, that is the small business benchmarks and LBTC and Tax Compliance booklets.
8.54 Examples of tailored communications, on the other hand, are the RDF notification letter for taxpayers in the large business market segment and small business benchmark letters for those operating in the cash economy.
8.55 How the ATO communicates risk related information with taxpayers depends on the number involved and the resources required. To facilitate positive change in taxpayer behaviour, taxpayers must be provided with adequate information to
the ATO’s concerns including the risk hypothesis that generated the enquiry;
the action that the ATO expects them to take (for example review your records, improve your governance arrangements);
8.56 It should also be noted that the ATO must recognise the potential for unintended outcomes resulting from inadequately designed and tested communications. For example, in the case of the small business benchmarks, the ATO sent letters to taxpayers where it did not expect a response from a large proportion.
Despite this, many taxpayers responded where this was not required. This caused considerable concern and uncertainty as the ATO initially did not acknowledge these letters.
8.57 Before embarking on large scale communication campaigns, the ATO should ensure that it has accounted for potentially unintended behavioural responses. This may take the form of community consultation, letter testing, or using a limited pilot.
8.58 By way of example, the ATO had intended to issue letters to large numbers of lower risk SME taxpayers, advising them of their lower risk categorisation.
Importantly, the letter was intended to be advisory and no action was required from the taxpayer. Consultation with tax practitioners through the ATO Tax Practitioner Forum (ATPF) revealed that such a letter was likely to increase compliance costs, with taxpayers inclined to contact their agent to discuss the letter. As such, the ATO discontinued this initiative.
8.59 The IGT has also noted in his, Review into the ATO’s Compliance Approach to Individual Taxpayers — Income Tax Refund Integrity Program (ITRIP Review), the potential benefits in having regard to research from the Behavioural Insights Team within the UK Cabinet Office. A key to this approach is the use of randomised controlled trials to assist in developing communication approaches that best achieves the desired behavioural outcome. The ATO currently undertakes a range of testing, such as ‘user-testing’ and ‘simulation centre’ projects as prototypes to determine the likely response of taxpayers to ATO communication approaches. Randomised
controlled trials, however, are often considered to be the ‘gold standard’ in generating that evidence.377
8.60 The IGT also notes that the ATO recognises the value of randomised controlled trials as ‘the ideal evaluation methodology to infer program effectiveness’ including with respect to compliance activities.378 However, the application is not widely adopted as a standard across the ATO.
Communicating outcomes and due process
8.61 Pursuant to the legal principles of natural justice, affected taxpayers or tax practitioners must be afforded a right of review of their initial risk rating particularly where they are categorised at the higher levels which may potentially result in further compliance activity.
8.62 How such a right of review should operate and be communicated to the taxpayer with respect to the large business market is detailed in the IGT’s LB&I Review379 and is augmented in Chapter 3 of this report. In this market segment, the ATO has developed a tailored letter, regarding the taxpayer’s risk rating, which is addressed to the board or CEO rather than the tax manager. In these circumstances where the ATO is effectively issuing a regulator’s opinion, it is particularly important that the ATO ensure it has the most accurate and up-to-date information by giving the taxpayer an adequate opportunity to comment on such information before issuing the letter. Without such due diligence, this type of ATO action may impede behavioural change because of a lack of confidence in the ATO’s analysis.
8.63 It should be noted that such rights of review are also considered in Chapters 4 and 7 of this report with respect to SME taxpayers and tax practitioners.
PROPORTIONALITY OF ATO COMPLIANCE APPROACH
8.64 The IGT’s view is that the ATO’s compliance approach, and potential imposition of compliance costs, should be proportionate to the level and type of risk presented by the taxpayer as well the information confidence and cost levels. Where taxpayers pose a lower risk, less intense enquiries should be made of them. It is important, therefore, that the ATO has processes in place to measure the actual risk, as opposed to the perceived or anticipated risk, posed by the taxpayer or taxpayer population.
Inherent and behavioural risk factors
8.65 The ATO needs to also distinguish between different risk factors, such as inherent risk factors and behavioural risk factors. Such differences are explained in greater detail in Chapter 3. By distinguishing between these risk factors, the ATO is able to ensure that their compliance approach addresses the particular risk and minimises the generation of mistrust between administrator and taxpayer.
Cabinet Office Behavioural Insights Team, Applying behavioural insights to reduce fraud, error and debt (2012), p 21.
Australian Taxation Office, Literature review - Measuring compliance effectiveness (2007) p 51.
8.66 For example, where a large consolidated taxpayer has undergone a large corporate restructure, it would be appropriate for the ATO to focus its enquiries in relation to the inherent risk factors associated with consolidation and capital gains tax.
8.67 On the other hand, where the taxpayer has poor governance controls or record keeping practices, then it is appropriate for the ATO to focus their attention on improvements in those areas. Naturally, if inherent risk factors were also a concern, then these should be addressed specifically. As mentioned in Chapter 3, the separate consideration of inherent risk factors and behavioural risk factors is consistent with the practices of both the HMRC in the UK and by APRA in Australia.
Information confidence and cost
8.68 The ATO requires a certain level of taxpayer information to make informed decisions about the taxpayer’s level of risk. Where the taxpayer chooses a relationship approach that may delay this process and increase information costs, the ATO should respond in a manner that it is appropriately more formal.