«A report to the Assistant Treasurer Inspector-General of Taxation October 2013 Review into aspects of the Australian Taxation Office’s use of ...»
8.69 Nevertheless, it is important to specifically address the issue of information confidence and cost levels separately from that of likelihood of non-compliance. This allows the ATO to directly address the specific concerns with the taxpayer. The taxpayer is in a position to determine what behaviour it wishes to adopt in full knowledge of the ATO’s corresponding response.
8.70 Furthermore, dealing directly and separately with information confidence considerations should reduce the level of concern relating to perceptions that the ATO is drawing subjective or inappropriate conclusions about taxpayer behaviours or actions. This separation is illustrated in Figure 21 below which is reproduced from Chapters 2 and 3 for convenience.
8.71 It is apparent that the method by which the ATO gathers information is influenced by a variety of factors besides risk and information confidence and cost. For example, in the large business market, ‘higher consequence taxpayers’ represent such a large compliance risk to the ATO in terms of consequence that likelihood as a risk Page | 150
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8.72 Currently, the ATO divides this group of higher consequence taxpayers between key taxpayers and higher risk taxpayers. The RDF puts these taxpayers on a ‘likelihood of non-compliance’ continuum. In reality, however, the IGT considers that the underlying factor is really whether the taxpayer’s approach to the provision of information will allow the ATO to quickly develop an informed view about the taxpayer’s risks. An inability to do so is likely to increase the ATO’s costs in obtaining information. If the taxpayer chooses a relationship option whereby it will only provide information to the ATO on the basis of the ATO’s formal access and information gathering powers, the ATO will continue to gather that information at increased cost since the consequence of not doing so would be considered too high. The PCR is the default means of obtaining this information.
8.73 Where taxpayers have ‘sound tax risk-management processes’ and indicated a ‘commitment to ongoing disclosure of tax risks380‘, they may be eligible to enter into an annual compliance arrangement (ACA) with the ATO. By providing a degree of certainty to the taxpayer, ACAs provide an incentive for taxpayers to adopt a relationship option that favours real-time informal information disclosure. Such arrangements, however, entail significant obligations and costs for the taxpayer.
Relatively few taxpayers have entered into ACAs to date largely for these reasons.
These issues are explored in the IGT’s Self Assessment Review where there are also recommendations for improvement.381
8.74 The following table illustrates a sample of ATO information gathering approaches and indicates that several factors besides risk, information cost and confidence levels influence the resulting ATO approach.
Australian Taxation Office, Annual compliance arrangements – what you need to know (7 June 2013) http://www.ato.gov.au.
IGT, above n 5, pp 92-100.
8.75 A balance needs to be struck between the requirement for information and the compliance costs that such information gathering would impose on both the ATO and
taxpayers. This balance is highlighted by the Productivity Commission:
Much of the information collection for a risk based approach occurs early in implementation. Correctly identifying and measuring risks may require regulators to
invest in additional training and guidance material to overcome knowledge gaps and other limitations, and undertake extensive consultation and analysis.
…Regulated businesses may also incur costs when regulators seek to measure risk. For instance, one dilemma a regulator can face is that good information is integral to accurately assessing the cost and benefits of alternative regulatory approaches. However, if collected from business this data requirement imposes a burden on these businesses.
The regulator must ensure this burden is not excessive, and endeavour to make more effective use of existing and other sources of information wherever possible.382
8.76 The Productivity Commission also highlights the need to view risk management from a ‘net benefit’ perspective, taking into account the costs of risk
management, both for the regulator and the regulated:
A well designed risk based approach should be used within an explicit net benefit framework. When applied in this way, a risk based approach is not just a simple guide to deployment of regulatory resources, but rather determines the optimal regulatory strategy that maximises net benefits to the community. Such an approach seeks to align the allocation of regulatory resources and the consequent compliance costs for businesses to the risks presented by the actions of businesses and the benefits of reducing these risks (box D.4). Regulatory activities involve an ‘opportunity cost’, so economic efficiency requires that resources be allocated to alleviating risks where there is the greatest net benefit to society.
For instance, while reducing a risk may yield large gross benefits, the costs of intervention may also be large — including the cost and resources involved in identifying and measuring risks and classifying businesses, whether borne by the regulator or the businesses they administer.383 … Using a net benefits framework should mitigate the potential tendency of regulators — caused, in large part, by their traditional role as purely enforcers of legal compliance — to adopt an overly ‘safe’ approach and attempt to reduce a particular risk beyond the point where the benefits of doing so outweigh the costs.384
8.77 As noted earlier in this report, taking into account ‘risk premium compliance costs’ may assist in understanding the community costs associated with a regulator’s risk management.
‘Funnelling’ and case refinement products 8.78 Case refinement products are a class of ATO activities that are undertaken often after a large case pool has been determined by a quantitative method.
Importantly, these activities are performed by ATO officers, who must undertake a degree of qualitative research and analysis and come to a judgement about whether there is sufficient risk to proceed to a more intense or formal product, such as an audit.
Productivity Commission, Regulator Engagement with Small Business – Productivity Commission Research
8.79 The use of case refinement products, with limited taxpayer contact, can
minimise compliance costs and is a useful way of treating compliance risks where:
• the level of risk is relatively low (that is historically low strike rates); or
8.80 In the micro enterprises context for example, prior to the IGT’s Benchmarking Review, the ATO conducted correspondence audits directly from cases where taxpayers were outside the benchmarks by a pre-set threshold. As a result of the IGT’s review, those ‘significantly outside the benchmark’ cases are now subject to an ‘office
8.82 Case refinement in LB&I is essentially conducted by risk managers who examine the output of the risk filters and remove those cases which are understood to be false positives. There is generally no taxpayer contact for this activity. If a case is ultimately recommended for compliance activity, such as a risk review, the recommendation must be approved by the Case selection sub-committee. This committee, however, has in the past given some consideration to the use of a formal case refinement product.387
8.83 In the SME business line, ATO officers may undertake ‘preliminary risk reviews’ (PRR) before going on to conduct a comprehensive risk review (CRR). Due to the comprehensive nature of CRRs, they can involve substantial time and cost, both for the ATO and the taxpayer. The PRR gives the ATO an opportunity to determine if sufficient risk exists to justify escalating to a CRR. Importantly, as in the case of the ATO communication to IGT, 25 February 2013.
Australian Taxation Office, Senate Estimate Briefing October 2012, page 1. Disclosed under FOI reference number 59632 on ATO FOI disclosure log.
Australian Taxation Office, Case Selection Sub-Committee Minutes 7 December 2011, page 9.
cash economy Office Review and large business Case selection process above, the SME product allows lower risk taxpayers to be identified and removed from the process.
8.84 In the Indirect Taxes (ITX) business line (responsible for GST and excise), the
ATO undertakes ‘refinement’ and ‘review’ activities:
Case refinements are internal review products, used across markets, to conduct in-house analysis and assessment of client risk. Cases are selected to determine whether further compliance action is required or if the indicative risks can be explained at the case refinement stage. No contact is made with the taxpayer at this stage.
Case reviews are used to determine the existence of a specified risk or the existence of risks generally in respect of that particular entity. Reviews are also used to collect information about specified risks across particular industries and activities to determine the existence and level of risks and the effectiveness of mitigation strategies.
Depending on the nature of the entity and the risk under review, the review process may be conducted by letter, phone or at the entity’s business premises. A review is usually less intrusive than an audit and is designed to encourage voluntary disclosure. It is designed to obtain sufficient information to demonstrate that a specified risk does not exist or has been mitigated substantially by the entity’s business processes.388
8.85 Support for the use of case refinement activities can also be found overseas.389 This approach recognises that there are limitations on relying on mathematical methods to select audit cases. There are expectations that the tax administrator undertake such additional work beyond risk models to filter out lower risk taxpayers.
8.86 The use of increasingly intense activities is often regarded as a type of ‘funnel’ as shown in the figures below relating to the SME and ITX business lines respectively.
Australian Taxation Office, Indirect tax case selection framework, page 10.
United States Treasury Inspector General for Tax Administration (TIGTA) Report 2012-30-062, The Recommended Adjustments From S Corporation Audits Are Substantial, but the Number of No-Change Audits Is a Concern, 21 June 2012, page 10.
Source: ATO, ITX Strike Rate analysis.
8.87 It should be noted that client risk reviews and comprehensive risk reviews often occur before an audit to give the ATO an opportunity to assess the risk with a high level of taxpayer interaction in order to come to a judgement about whether to proceed to an audit. However, due to their intensity, resources and length of time required as well as the extent of taxpayer contact, these are often regarded as ‘compliance products’, which may carry significant associated compliance costs and are not considered to be ‘case refinement products’.
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COMPLIANCE EFFECTIVENESSMeasuring compliance effectiveness and compliance costs
8.88 As highlighted in Chapter 5, the ATO has reported on behavioural changes in the micro business market segment in relation to the small business benchmarks. The Compliance Program 2012–13 tracked the financial performance of a set of taxpayers in certain cash economy industries. It reported ‘significant increases in the number of businesses that now report income in the same range as their industry peers when they had previously reported income tax that was well below that of other similar businesses’.390
8.89 Chapter 5 also observed that such convergence may be the result of:
• previously non-compliant taxpayers becoming compliant (positive change in taxpayer behaviour);
• non-compliant taxpayers reporting within the benchmark, but still underreporting their actual income (strategic taxpayer behaviour); and
• compliant taxpayers now over-reporting their income to stay in the benchmarks to reduce audit risk (taxpayer over-compliance).
8.90 Compliant taxpayers may decide to deliberately over pay their tax so as to reduce the chance of an audit.391 This ‘over-compliance’ may be regarded as one indicator of taxpayer perceptions of costs associated with ATO compliance activity.
The existence of an audit insurance industry is also indicative of the perceived costs of ATO audits.392 Taxpayers may decide to pay such insurance premiums to limit the risks of excessive audit costs.