10.1 This chapter considers the issues and concerns raised by stakeholders about aspects of the ATO's approach to interest and penalties in the context of this IGT review. It makes recommendation to improve the level of transparency and engagement and promote greater certainty in determination and application of penalties.
10.2 In a practical sense it is difficult to de-couple penalties and interest issues, as these are often paired in a discussion context. The IGT has for the purpose of clarity sought to deal with these as discrete issues where it is more appropriate for the purposes of the report.
10.3 Penalty and interest concerns mainly arise in the context of a disputed taxpayer position, although concerns may also arise in voluntary disclosure situations.
10.4 The main stakeholder issues of concern were directed at both the level of, and process for, determining penalties and interest levied by the ATO against taxpayers. For penalties and interest to be considered, there is usually a dispute of some kind on foot that will require some form of negotiated or formal resolution.
Submissions and consultation
10.5 Taxpayers submitted that the tax system is now incredibly complex both in an everyday sense and for more significant transactions resulting in very high overall compliance costs. In the event that there is ultimately a dispute between the ATO and taxpayers in interpreting through this complexity, both parties naturally look to understand each other's view of a particular matter and assess the relative strengths and weaknesses of their positions against that of the other party.
10.6 It is not an uncommon experience to find that the ATO and taxpayer may have a differing technical view or interpretation on how the law operates with respect to the same matter. It may also be that prima facie both views have considerable merit. This difference of opinion may ultimately escalate to the point of formal dispute. The outcomes of formal dispute resolution by way of litigation also gives rise to polarised win or lose outcomes — a risk on outcome that may not suit either party for various reasons. Decided cases in the Large Business & International (LB&I) taxpayer segment also provide some context in relation to formal outcomes risk for both taxpayers and the ATO.
10.7 A number of stakeholders expressed the view that the penalties and interest regime in its current design or application does not adequately take account of these difficulties that are experienced by taxpayers due to the complexity of the overall self-assessment regime which taxpayers must navigate within. Taxpayers expressed a desire to have greater flexibility and latitude in situations where they have adopted a reasonable position that may be disputed at a later time. Stakeholders also raised various specific concerns about the application of penalty mitigations such as reasonably arguable positions (RAP), amongst others.
10.8 The level of both penalties and interest was suggested by stakeholders to be too high in many instances, particularly where taxpayers were contemplating a settlement, making it difficult for them to avoid formal resolution processes as any other accommodation made no commercial sense for them.
10.9 Stakeholders also expressed a view that penalties and interest were often used as a negotiation device by the ATO. While a level of engagement that seeks to ensure penalties are carefully considered was supported, the particular concern raised by some taxpayers was that they believed the process was used in a more punitive or coercive manner.
10.10 A few stakeholders felt that where the ATO took an approach of asking the taxpayer to make a submission on penalties and interest, the process was one that was vague and uncertain as to both conduct and outcome. After a period these taxpayers complained that a raw determination would simply issue without any explanation of the ATO's reasons, reinforcing a lack of due process.
10.11 A specific concern raised by a number of stakeholders in relation to due process was taxpayer penalty reductions. A view expressed by some taxpayers was that the ATO had unduly restrictive or unreasonable approaches in relation to voluntary disclosures in determining penalty reductions. These taxpayers considered that they had provided information in good faith believing that they had done so on a voluntary basis and that it was not reflected appropriately in determinations provided. In certain instances this acknowledgement may have been provided by the ATO at a later time after taxpayer agitation, but typically only as part of a negotiated position in settlement.
Penalties and interest — ATO administration
10.12 The ATO's approach to penalties and interest is outlined in broad terms on its website.1
10.13 The ATO document has links to a range of administrative documents that provided guidance and direction to staff on the application and mitigation or reduction of penalty and interest amounts levied on taxpayers in various circumstances.
10.14 The ATO has expressed certain views to the IGT in relation to the application of penalties and interest set out in the LB&I context.
10.15 The ATO appreciates that penalties and interest are understandably an area of concern and that they wish to ensure these are applied in a consistent and transparent manner across all taxpayers. This has implications for all taxpayers and not just the LB&I market segment.
10.16 The consideration of penalties typically does not arise until later in the process of dispute. The ATO believes that it is usually of assistance from both parties' perspectives for the taxpayer to provide a submission in relation to the process at that time, although it will give consideration to submission at an earlier time should taxpayers wish. The ATO considers that a separate penalties submission provides an opportunity for the taxpayer to raise issues that may not have been the subject of ATO focus or otherwise appreciated.
10.17 It is generally understood by the ATO and Large Market taxpayers that the issue of dealing with penalties does not warrant consideration if no primary tax liability is in dispute. However, there is an exception with the recent passing of the Taxation Laws Amendment (2010 Measures No 1) 2010 Act. Under Schedule 6 of this Act penalties may be imposed without a shortfall amount existing. The IGT has had a range of concerns raised by various stakeholders recently about these provisions and how the ATO might apply them in practice. The IGT understands that the ATO is considering its position in this regard.
10.18 The issue of penalties and interest centres on the resolution of a genuine dispute between the taxpayer and ATO. In this report the focus is solely directed toward ATO LB&I risk review and audit processes and it is difficult to make broad ranging recommendations for penalty and interest matters solely in relation to the LB&I segment (as classified by the ATO).
10.19 The potential application of any recommendation is likely to have much broader relevance across the entire taxpayer population. For this reason, the IGT considers that the issue of penalties and interest and their application (including mitigation or reductions) by the ATO is more appropriately addressed in a separate dedicated review.
10.20 In addition, the IGT has reviewed the application of penalties and interest in a compliance context previously. The report, entitled Review into the Tax Office's Administration of Penalties and Interest Arising from Active Compliance Activities, was publicly released on 28 September 20052. The nature and specific issues raised by stakeholders in the context of this report, appear to have important differences to those investigated previously and deserve dedicated attention at a later date.
10.21 There are, however, more general comments in relation to observations made during the conduct of this particular review that can be made.
10.22 It will not always be the case that both the taxpayer and ATO agree on the appropriate application or levying of penalties. A brief review of reported cases on this issue shows that there may at times be considerable variation from the original Commissioner's determination to that of the tribunal or court decisions. On the other hand, there are also cases in the tribunal or courts that reaffirm the Commissioner's original determination.
10.23 There are, however, some important areas that need to be considered in ensuring there is appropriate confidence in the system with respect to penalty and interest matters.
10.24 The four areas that the IGT considers give cause for reflection are:
- effective ATO communication with taxpayers;
- consistency in the ATO's assessment of taxpayer behaviour;
- penalty administration approaches including reasonably arguable position (RAP) and voluntary disclosure; and
- the application of due process.
10.25 The IGT has observed situations where the ATO's communication with taxpayers around penalty and interest matters could be improved. A particular area of concern for taxpayers was the communication between the time the original amended assessments were issued and the internal ATO determination of the penalty and interest were issued. While there were examples of effective engagement in this area, there were other situations where communication could have been more effective in terms of timeliness and in explanation of the analysis and calculation methodology.
10.26 The issue of greater consistency in the ATO's assessment of taxpayer behaviour in a penalties and interest context is a challenging area. The IGT has not had the opportunity to investigate this matter in detail, but preliminary indications are that this is a continuing area of taxpayer and adviser concern.
10.27 The application of a level playing field approach is critical to the prompt resolution of disputed matters by settlement or alternative dispute resolution approaches. From an efficiency perspective, it is necessary to engender trust and confidence in the process such that one party does not get a better outcome over another in relation to the same or a very similar matter, by simply taking a different approach.
10.28 The issue of reasonably arguable position or RAP also presents challenges. The ATO has advised the IGT that it has conducted an internal review in the area of RAP for the LB&I market segment. The IGT has not had the opportunity to review these findings but some are set out below for completeness.
10.29 The ATO conducted a review of penalties in all large business audits that were completed between 1 July 2007 and 18 May 2010. During this period LB&I completed 93 audits, 49 of which resulted in tax shortfall adjustments. Of these 49 cases, 31 had penalties remitted including 18 where penalties were remitted in full. The ATO found that of the 31 cases where penalties were remitted, there were 14 where it was relevant to consider whether the taxpayer had a RAP. Of these cases there were only 3 where the ATO decided that the taxpayer did not have a RAP. The ATO considers that, based on this internal review, it has considered and applied RAP penalty mitigation fairly and appropriately. The experiences that some stakeholders related to the IGT suggested a different take on this outcome.
10.30 The IGT is mindful that there may be differing opinions about how the issue of RAP should be tackled in a practical and interpretive sense. It may also be that new attitudes are emerging, suggesting that the broader taxpaying community is recognising the difficulties that arise from a very complex tax system in a self-assessment environment where taxpayer responsibility for voluntary compliance is extremely difficult and costly to manage.
10.31 The application of penalties may be considered or perceived to be increasingly unfair or unreasonable where taxpayers believe they have been making genuine and reasonable efforts to comply with highly complex law. If correct this presents a growing tension for taxpayer and administrator alike, and raises potential policy considerations.
10.32 It is important to consider voluntary disclosures in this context. Voluntary action by taxpayers is a modern tax administration foundation stone. The provision of information by voluntary disclosure by taxpayers to tax administrators is vital for efficiency. Reduction of penalties for voluntary disclosures are an important feature designed to assist this outcome. The effective management of penalty remissions by tax administrators is particularly important in reinforcing voluntary taxpayer behaviours. Any conduct by tax administrators must carefully consider this as a positive incentive in support of pro-active taxpayer assistance. To do otherwise may hinder taxpayer confidence in the important area of information disclosure to, and gathering by, tax administrators.
10.33 The IGT considers that voluntary disclosure actions by taxpayers should not be unclear or otherwise amalgamated with broader issues or settlement negotiations. The understanding should be one that is commonly held as between the parties at the earliest opportunity. To do otherwise provides for an environment of uncertainty at best and at worst bad faith perceptions by both parties. Other areas of penalty remission are important, but any aspect that relates directly to voluntary taxpayer action is particularly vital both in practice and perception.
10.34 The payment of interest on amounts owed to another party demonstrates the economic concept of opportunity cost that is both well understood and accepted by large business. The two main concerns raised by stakeholders in relation to the ATO's levying of interest were:
- the actual application of the interest charge be it General Interest Charge, Shortfall Interest Charge or a funding equivalent concept. The differences in application as to which charge was applied and how it was applied presented significantly different economic outcomes; and
- the credit margin or opportunity cost between the ATO (or more correctly the Commonwealth Government) and taxpayer has increased dramatically in more recent times due to the prevailing market situation where deposits with banks are earning historical highs over Government equivalent interest rates. This may occur where a taxpayer deposits 50 per cent of a disputed tax liability amount with the ATO and it is resolved in the taxpayer's favour and ultimately refunded.
10.35 The application of due process is an issue that is often raised by stakeholders with the IGT. The IGT will consider the concerns raised in this context along with others in determining and conducting future reviews.
To improve transparency and taxpayer understanding of the ATO's interest and penalty consideration and determination processes, the ATO should improve the quality and timeliness of its communication and engagement with taxpayers.
The LBTC booklet commits our teams to ongoing dialogue and engagement with taxpayers in relation to all aspects of the risk review and audit. In response to other recommendations in this review, we have committed to update instructional materials to better reflect the LBTC commitments. This will include more specific guidance on the importance of communication around the penalty decision to support teams in improving the way they engage and communicate with taxpayers on this aspect of the case.
The ATO should enhance the voluntary disclosure process by ensuring that it clearly communicates to the taxpayer, at the time of the disclosure in question or promptly afterwards, whether it accepts that the disclosure is voluntary.