3.1 Stakeholders representing the large business market segment raised concerns regarding aspects of the ATO's risk differentiation framework (RDF) as it applied to them. The RDF provides a means to categorise taxpayers according to the relative risk they pose to the revenue as perceived by the ATO. These risk categorisations influence the ATO's compliance approach toward them and taxpayers are made aware of their categorisation. The concerns raised may be summarised into four broad themes:
- transparency, including individual ATO officers having disproportionate influence on qualitative inputs into the process;
- relevance and accuracy of the inputs into the process;
- lack of differentiation among the categorisations and the manner in which the ATO notifies the taxpayers or their boards; and
- the proportionality of subsequent ATO compliance activity.
3.2 In order to provide context for this chapter, some background about the ATO's Large Business and International (LB&I) governance and the RDF is included here. The stakeholder specific issues and concerns are addressed thereafter.
3.3 The nature of the risk assessment framework in the ATO's large business market segment has been the subject of continuing evolution. It is instructive to consider certain key developments and describe the current processes as in operation more recently to provide a background to the IGT's observations and recommendations in addressing stakeholder concerns.
3.4 During the 1980's, the ATO did not have an organisational structure comprised of business and service lines as is currently the case. Concerned about the coverage of the large business market, the ATO initiated the large case program in 1988 which was effectively an audit program of the largest 100 businesses.124
3.5 A subsequent ATO review of the program was commissioned. It recommended that the ATO segment the taxpayer population into different markets, to ensure the large business market segment is covered using a variety of ATO compliance products.125
3.6 In 1993, it was foreshadowed for this market segment that:
... as a further illustration of risk management techniques, that the large corporate group, to be expanded in coverage from 100 to 600, itself warrants internal segmentation, leading to the companies being placed across a spectrum of perceived revenue risk. This will lead, at one extreme, to a continuous ATO audit presence for a small number of low complying corporations and at the other to much shorter attention to those where the risk is seen to be lower.126
3.7 The ATO moved away from functional departments, such as assessment, collection and appeals. Instead, business lines were created in 1994 to match the taxpayer market segments.127 One of these was to become eventually known as LB&I.
3.8 During the 1990's the ATO intensified its scrutiny of large business taxpayers, including increasing use of formal information gathering powers. This also led to increased taxpayer challenges for the ATO to access information, such as that protected by legal professional privilege.
3.9 In 2000, the ATO published 'Cooperative Compliance128', which outlined the relationship the ATO was seeking to establish with large business taxpayers. It indicated that large businesses needed to be involved in the ATO's risk assessment process, to reduce the likelihood of misinterpretations or misunderstandings. The booklet also provided a list of risk categories that the ATO considered relevant, enabling taxpayers to self-assess and self-manage their own risk.129
3.10 In 2004, the Commissioner wrote letters to the boards of 1500 publicly listed companies, elevating the importance of tax risk management to the board level.130 The letter included some questions the board should consider putting to their tax advisors with a view to identifying and managing tax risks.131
3.11 In 2006, the ATO issued the first Large Business and Tax Compliance (LBTC) booklet. This publication described the ATO's approach to compliance in the large business market, including the relationship it was seeking with this market. The LBTC booklet also highlighted the ATO's expectations with respect to the taxpayer's corporate governance and tax risk management.
3.12 In 2010, the ATO issued a revised edition of the LBTC booklet. This edition introduced the concept of the RDF. The ATO continues to develop and refine their risk assessment approach in response to stakeholder consultation and changing circumstances in the business environment and within the ATO itself.
3.13 Part of the RDF strategy was not only categorising taxpayers according to perceived risk, but also informing taxpayers about their categorisation through notification letters. These letters, for income tax, were sent to key taxpayers and lower risk taxpayers in mid-2010 through to mid-2011. From November 2011 to March 2012 a new ATO campaign saw notification letters issued with a separate risk categorisation for income tax and indirect taxes.
3.14 The most recent ATO letters were sent to taxpayers in November 2012.
3.15 Relevantly, the IGT's LB&I Review was publicly released in 2011. That review covered some aspects of the RDF as it was being deployed within LB&I during the course of that review. The IGT made certain recommendations limited to the communication of the RDF risk categorisation132 and the differentiation of compliance approaches according to risk.133 The IGT also foreshadowed the need to conduct a more comprehensive review of the LB&I risk identification process.134
3.16 The IGT's Self Assessment Review, publicly released in February 2013, also made some observations and recommendations with respect to the RDF, particularly with respect to the inputs and criteria used by the ATO.135 That review also foreshadowed a more fulsome review of the RDF.136
3.17 As stated in Chapter 1, the RDF was subject to an internal ATO audit during the course of the review. The final report of that audit was made available to the IGT during the review.
The Risk Differentiation Framework (RDF)
3.18 The main ATO publication outlining the use of the RDF in the large business market segment is the LBTC booklet. The most recent edition was published in December 2012. The ATO also published a fact sheet in 2011, The Risk Differentiation Framework. During the conduct of the review, the ATO published a new version of the LB&I compliance manual, the Large business active compliance manual — income tax (LBAC manual), some of which contains guidance to staff about the application of the RDF. The LBAC manual and its publication also addresses a range of recommendations from the IGT's LB&I Review.137
3.19 The intent behind the ATO's RDF is expressed in these terms:
… we use the risk-differentiation framework (RDF) to form a view of your relative tax risk and determine the intensity of our response in a coherent and considered way.
… The RDF provides a strategic approach for directing our resources more efficiently and effectively. It provides for greater differentiation of our risk management approaches based on our considered view of taxpayers' compliance history and status.138
3.20 According to the ATO's LBTC booklet, the RDF:
… is based on the premise that our risk management approach to tax compliance should take account of our perception of both the:
* estimated likelihood of you having a tax position that we disagree with or having through error or omission misreported your tax obligations (as evidenced by your behaviour, approach to business activities, governance, and compliance with tax laws)
* consequences (dollars, relative influence, impact on community confidence) of that potential non-compliance.139
3.21 The ATO's large business RDF is shown diagrammatically in Figure 9, as extracted from the LBTC booklet:
Figure 9: Large business RDF 'quadrants'
Source: ATO, Large business and tax compliance 2012, page 25.
3.22 As a result of considering the taxpayer's perceived likelihood of non-compliance and the consequence of such non-compliance, the taxpayer is categorised by the ATO into one of four categories or 'quadrants'. These are listed below(refer also to Appendix 8 — RDF chart from Large business and Tax Compliance 2010 booklet) with both the quadrant identifiers and the numbers of taxpayers in each category for 2013:140
- higher risk taxpayers (Q1) — 6;
- key taxpayers (Q2) — 86;
- medium risk taxpayers (Q3) — about 300; and
- lower risk taxpayer (Q4) — about 750.
3.23 The RDF is also a relative risk rating system. The ATO uses the tool to assist in understanding a taxpayer's perceived risk relative to others in the population. A taxpayer is unlikely to have the same knowledge as the ATO about other taxpayers' perceived risk. Therefore:
… you may have a different perception of your tax risk. It is likely that there will always be some large businesses that we perceive have a relatively higher risk compared to other large businesses, and understandably these will face more intense scrutiny by us.141
Consequence factors in the LBTC booklet
3.24 The ATO's perception of taxpayer 'consequence' of non-compliance under the RDF is generally determined by the taxpayer's turnover. It is not the only factor considered. The ATO also examines other aspects such as the taxpayer's:
- market share;
- ability to affect the tax compliance of competitors in the industry;
- annual turnover;
- taxes paid;
- amounts reported on activity statements; and
- amounts reported for excise obligations including wine equalisation tax and fuel tax credits.142
3.25 As a result, a taxpayer is broad banded into a higher consequence or a lower consequence classification. A higher consequence taxpayer can either be a key taxpayer (Q2) or a higher risk taxpayer (Q1), depending on their likelihood of non-compliance. A lower consequence taxpayer can either be a lower risk taxpayer (Q4) or a medium risk taxpayer (Q3), depending on their likelihood of non-compliance. These broad banded consequence categories can be extrapolated from Figure 9 above.
3.26 The taxpayer's position on the RDF in relation to consequence does not influence the ATO perception of taxpayer compliance behaviours, with key taxpayers and lower risk taxpayers being equally regarded by the ATO as being 'relatively more likely to fulfil their responsibilities and likely to have a positive attitude to compliance'.143
Likelihood factors in the LBTC booklet
3.27 The ATO relies on certain evidence to help determine the 'likelihood of non-compliance'. These are reproduced below from the LBTC booklet:144
- your compliance history, including:
- the level of disclosure and engagement around significant transactions you undertake;
- the history of adjustments from previous compliance activity;
- the fullness of disclosure and cooperation demonstrated in response to any enquiries; and
- your lodgment and debt history;
- the level of transparency demonstrated by you in keeping us informed about proposed significant transactions or potentially contentious issues;
- whether or not you may have adopted a potentially contentious tax position;
- your effective tax rate;
- an organisational structure that facilitates transactions through secrecy and low-tax jurisdictions, with no commercial basis other than to reduce tax paid in Australia;
- the quality of your tax risk management and governance processes;
- the capability of your staff, systems and processes that produce your tax records;
- information collected from industry associations, domestic and foreign regulatory bodies, and our own internal intelligence areas;
- your business performance over time compared to your tax outcomes and that of your industry peers; and
- the output of various risk filters, generally for risks identified in the compliance program.
3.28 Some of the above indicators, such as effective tax rates, are factual in nature whilst a number of the others seem to require the ATO to form an opinion on the taxpayer's level of transparency, disclosure and engagement.
3.29 The ATO makes references to 'engagement'145 and 'transparency'146 in several public speeches. The ATO describes taxpayer 'engagement' as the extent to which the taxpayer is willing to disclose information about their tax risks. This disclosure may be initiated by the taxpayer or in response to an ATO information request. Transparency is linked directly to notification of 'significant transactions' or 'potentially contentious issues'. The Deputy Commissioner of the LB&I business line made the following observation in relation to transparency:
The RDF rating is primarily [sic] indicates transparency — how open is the company in revealing its tax risks to the Commissioner for review?147
3.30 The ATO's perception of a taxpayer's likelihood of non-compliance is described as one of 'informed professional judgment' based on assessing all of the above factors. The ATO also undertakes a moderation process 'to ensure the RDF categorisation process is consistent and supported by the evidence'.148
Likelihood factors in the risk categorisation template
3.31 The main input into the risk categorisation process for higher consequence taxpayers is the 'higher consequence taxpayer risk categorisation template' ('the template'). The template is completed by ATO compliance teams and sent to a moderation panel for consideration. The template considers both likelihood and consequence factors. Stakeholders' concerns were largely focused on the likelihood factors and not the consequence factors. This is not surprising as the consequence factors (set out in paragraph 3.24 above) are objectively verifiable with one exception. As a result this report does not focus on the consequence factors.
3.32 Whilst not mentioned in the LBTC booklet, this moderation process applies only to higher consequence taxpayers. Lower consequence taxpayers are subject to a different process and not the moderation panel, both of which are considered later in the report.
3.33 With respect to the likelihood factors, the template has several sections. These factors at a high level relate to:
- tax performance, comprising effective tax rate and comparisons with industry;
- organisational structure;
- specific tax risks;
- tax risk management and governance, comprising strategic and operational aspects as well as the taxpayer's adherence to its processes;
- compliance history, comprising voluntary compliance and willing participation; and
- real-time compliance, comprising voluntary compliance and willing participation.
3.34 For each of these areas, LB&I compliance teams are asked to comment on the perceived risks and to refer to evidence (such as reports or minutes) to support it. They are also asked to analyse what contribution that particular risk area makes to the overall risk assessment.
3.35 The final section of the template is for the compliance team to recommend that the taxpayer be rated as either a higher risk taxpayer, key taxpayer or medium risk taxpayer. The recommendation is made to the moderation panel, which may accept or vary the risk categorisation.
3.36 The template is accompanied by guidance material, which includes example text to assist compliance teams in completing each section. The guidance material asks the compliance team to consider a series of questions pertinent to the risk.
3.37 The following section of the report considers each of the 'likelihood' factors as listed above and considered in the template in turn.
Tax performance and effective tax rate
3.38 The template asks the compliance team to consider a variety of financial ratios relating to the effective tax rate of the taxpayer. An examination of a sample of completed templates indicates that compliance teams consider:
- whether the ATO understands the reason for the difference between the ATO measured effective tax rate and the statutory rate where the former is less than the latter;
- whether a reconciliation item warrants investigation or verification where the difference is due to items in reconciliation (such as receiving non-assessable non-exempt income); and
- whether the industry allows for a meaningful comparison as amongst competitors within that industry, as they may have a very different mix of business models, activities and assets.
3.39 This section of the template considers other financial ratios beyond that of tax payable to operating profit. For example, the section also considers tax payable to gross income ratios.
3.40 In the organisational structure section of the template, compliance teams are advised to:
Comment on the size and complexity of business structures and operations. As these are inherent risks usually associated with higher consequence taxpayers, these risks may be mitigated to a lower risk level if the taxpayer provides explanation to the satisfaction of the ATO.149
3.41 Compliance teams are also asked to consider whether they believe any complexity or interposition of entities can be justified.
3.42 This section of the template considers specific tax risk areas, as listed below:
- capital gains tax (CGT) and losses;
- withholding tax;
- taxation of financial arrangements;
- private equity;
- transfer pricing;
- research and development concessions;
- thin capitalisation;
- tax havens; and
- other issues.
3.43 For each tax risk area, compliance teams are provided with potential risk hypotheses about possible non-compliance that may lead to incorrect reporting in the income tax return. Additional guidance comes in the form of questions for the team to consider, which point to possible facts indicating the presence of a risk of non-compliance.
3.44 For example, for the Consolidation tax risk section:
Has there been a change in the consolidated group?
Taxpayers may obtain inappropriate deductions and/ or CGT outcomes where they have used incorrect amounts in the Consolidation entry and exit calculations. The application of the complex consolidation cost-setting rules upon entry and exit can result in incorrect or unintended uplifts in the tax cost of assets. This may occur due to taxpayer error or contrivance.150
3.45 It should be noted, however, that not all tax risks are accompanied by both risk hypothesis statements and information gathering questions.151
Tax risk management and governance
3.46 The template requires compliance teams to consider the taxpayer's tax risk management and governance in a separate section. This includes the ability and propensity to manage tax risks at both the strategic level (such as the company board) and operational level (such as staff and the in-house tax functions). Compliance teams must consider whether the organisational structure supports the board being made aware of tax risks, including ATO compliance activities. At the operational level, compliance teams are to consider the level of resourcing of the tax function, how staff are remunerated, and the adequacy of record keeping and control systems.
3.47 Tax risk management and governance is also discussed in the LBTC booklet, with a chapter focussing on the ATO's expectations with respect to sound tax risk management and governance arrangements.152 The ATO's access to documents relating to tax risk management is discussed in a specific section later in this chapter.
3.48 The compliance history section of the template has two parts, 'voluntary compliance' and 'willing participation'.
3.49 The voluntary compliance part has compliance teams considering the taxpayer's historical compliance with their registration, reporting, lodgment and payment obligations. It also considers the outcomes of any previous compliance activities, such as client risk reviews and audits and whether adjustments were sustained in either. The part also considers the taxpayer's use of external advisors:
- How much does the taxpayer rely on external advisors?
- What kind of issues do they seek advice on and how risky are they?
- Does the use of external advice go towards the taxpayers risk appetite?153
3.50 The role of taxation advisors is discussed in a specific section later in this chapter.
3.51 The 'willing participation' part of this section, has itself several sub-sections to consider, being:
- objection and litigation history;
- rulings history;
- previous interaction with the ATO;
- interactions and relationships with other BSLs; and
- utilisation of ATO services.
3.52 Included in the Rulings History sub-section is the question: 'Does the taxpayer apply for rulings on contentious tax issues?'
3.53 Included in the 'Previous interaction with the ATO' sub-section is the question: 'Does the taxpayer make self-disclosures?'
Real time compliance
3.54 The LBTC booklet describes the ATO's transition to a 'real-time' compliance approach towards certain large business taxpayers and its emphasis on ACAs and PCRs for higher consequence taxpayers. A separate fact sheet published after the booklet, Real-time compliance engagement approach for higher consequence taxpayers in the large market, indicates that all higher consequence taxpayers who do not have an ACA will be the subject of a PCR.
3.55 The real time compliance section of the template begins with this guidance:
With the move to real-time compliance and PCR's, there is an increasing focus on voluntary compliance and willing participation. This section is for the compliance teams to discuss how willing the taxpayer is to moving towards a real-time compliance approach.154
3.56 The 'voluntary compliance' section then asks compliance teams to consider the taxpayer's responsiveness to ATO information requests, and whether their behaviour is in line with the Taxpayer Assurance Plan (TAP). The TAP is discussed in a separate section later in this chapter.
3.57 The 'willing participation' section then considers the taxpayers' proactive disclosures and explanations, such as applying for tax rulings for material issues, or disclosing major transactions or potentially controversial tax positions. Some of the important questions posed in this section include:
Requests for material rulings
- Does the taxpayer apply for material rulings with the ATO?
- Do they follow the advice provided in the ruling?
Communication and disclosure of transactions (please note: ATO expect a higher degree of communication and disclosure from ACA vs. PCR taxpayers, and this should be reflected in your evaluation/analysis).
- Does the taxpayer provide regular communication/disclosure of major issues and transactions?
- Do they provide a business approach and an explanation as to why the transaction happened?
- What has the taxpayer done to mitigate tax risks?
- Does the taxpayer possess and provide the team with documentation on transactions?
- Does the taxpayer engage with the team in real-time?
- Does the taxpayer show a willingness to raise potential controversial tax positions with the ATO and work with the ATO to resolve them?
- Does the taxpayer seek clarification with regard to the application of new legislation and measures?155
3.58 It should be noted that both the 'compliance history' and 'real time compliance' sections have identically titled sub-sections called 'voluntary compliance' and 'willing participation'. An ATO internal audit of the RDF made similar observations and concluded that such an overlap be resolved to minimise the potential for facts or evidence to be given undue weight in the risk categorisation process.156
Tax risk management and governance — ATO access to board documents
3.59 In 2004, the Commissioner sent letters to the boards of 1500 large business taxpayers, drawing their attention to the increased importance the ATO was placing on companies having adequate tax risk management and corporate governance. The letters included 10 questions that boards should ask of their tax management team.
3.60 Stemming from the likely activity this would generate, the ATO issued Practice Statement PS LA 2004/14 Access to 'corporate board documents on tax compliance risk', to recognise in part:
... that those responsible for managing a company's tax compliance risks need to be able to undertake broad ranging and candid communications. Those persons would include the company's employees, its external advisors and its directors undertaking governance of tax compliance issues.157
3.61 As a result, the ATO made an undertaking in this practice statement that:
Access to corporate board documents on tax compliance risk will not be sought by the Tax Office during a compliance risk review or an audit of a corporate taxpayer except in exceptional circumstances and the access will need to be approved by an appropriate
Senior Executive Service officer, as described in the Tax Office's Guidelines to Accessing Professional Accounting Advisors' Papers (the Accountants' Guidelines).158
… During a compliance risk review or audit the Tax Office will, in the first instance, ordinarily seek information from documents prepared in connection with the conception, implementation and formal recording of a transaction or arrangement, and which explain the setting, context and purpose of the transaction or arrangement.159
3.62 It should be noted, however, that the class of documents described in this practice statement as falling under this administrative concession are only those documents that are:
- created by advisors (being suitably qualified in-house or independent advisors);
- created for the sole purpose of providing advice or opinion to the board of directors (including properly constituted sub-committees) on tax compliance risks and their likelihood and impact; and
- that address tax risks associated with major transactions and arrangements and/or tax risks arising from corporate systems and processes.160
3.63 In the LBTC booklet, the ATO's expectations about tax risk management and corporate governance go beyond the creation of documentation as described above. The ATO is also concerned about the policies and structures that support robust internal reporting and decision-making. The practice statement notes that ATO officers will at first instance seek documentation with respect to transactions. Nevertheless, it is open for the ATO to seek documents related to the policies and structures in place that support the taxpayer's tax risk management and governance, in contrast to the corporate board documents on tax compliance risk, which is the product of these policies and structures.
3.64 The practice statement also mentions:
This Practice Statement does not restrict access to corporate board documents on tax risk to the extent that a taxpayer decides to make these documents available to the Tax Office. It is recognised that some corporate taxpayers are willing to make such documents available to assist in prompt and effective assessments of tax compliance risk by the Tax Office when risk reviews or audits are being undertaken. However, no adverse inference is to be drawn merely because a taxpayer does not make such documents available in accordance with this practice statement.161
ATO governance and moderation panel
3.65 In LB&I, the main group responsible for risk management is the LB&I Risk and Intelligence Committee (RIC). The RIC is accountable to the LB&I Executive and reports its outcomes to it.162
3.66 Accountable to the RIC is the Case Selection Sub-Committee (CSSC). The CSSC:
... reviews the risk recommendations to support risk review compliance activity of LB&I lower consequence taxpayers. The casework that is identified will relate to the operational risks that have been already been identified and assured by the Risk and Intelligence Committee.
3.67 The CSSC is also responsible for the RDF categorisations of lower consequence taxpayers. The CSSC uses the concerns raised in the case selection process to assist in determining whether a lower consequence taxpayer is a lower risk taxpayer or a medium risk taxpayer.163
3.68 The RDF categorisation process for higher consequence taxpayers is performed by the Large Market Income Tax RDF Moderation Panel ('moderation panel'). The moderation panel reports to the LB&I Operations Committee, the LB&I Executive, and the Large Market Committee. The moderation panel is chaired by the Assistant Commissioner, LB&I Risk Intelligence & Systems Support.164
3.69 The moderation panel's purpose is to:
… manage the arrangements for categorising large businesses (economic groups and single entities) in the large market, for income tax purposes.
… (the Panel) provides a level of independence and assurance that we have consistency in risk categorisations across large businesses, and that categorisations are supported by appropriate evidence.165
3.70 For lower consequence taxpayers, the panel reviews and endorses the process by which lower consequence taxpayers are categorised as either lower risk or medium risk taxpayers, but does not undertake the categorisations itself.166 As indicated above, this is done through the CSSC.
3.71 For higher consequence taxpayers, the moderation panel is responsible for settling on risk categorisation recommendations via two-thirds agreement, before referring them to the LB&I Executive for final approval.167 The main input into this process is the higher consequence taxpayer risk categorisation template (the template discussed above). The template requires an overall recommendation by the team to categorise the higher consequence taxpayer as either a key taxpayer or a higher risk taxpayer.
3.72 The moderation panel is convened annually, with sessions lasting approximately one day (but may be spread out over several days) during the June/July period.168
3.73 The moderation panel's charter makes reference to a broader range of higher consequence taxpayer categories, being higher risk taxpayers, key taxpayers with significant concerns, key taxpayers with little concerns, and key taxpayers with no concerns. The ATO notes that:
For large businesses considered to be of perceived higher risk or key taxpayers with concerns, the moderation panel will examine the data and analysis to ensure consistency, objectivity and transparency. Panel discussions for these businesses, and others where warranted, will generally involve compliance teams or other relevant stakeholders.
Where the moderation is of Key Taxpayers with little, or no concerns, the Panel may endorse the categorisation without further input from compliance teams or other stakeholders.169
3.74 Whilst not explicit in the moderation panel's charter, the panel is also responsible for making recommendations about the content and tone of the notification letter that is eventually sent to the taxpayer's Chief Executive Officer (CEO).170 The drafting of this notification letter is described in greater detail in a later section.
ATO risk filters, risk managers and risk owners
3.75 The ATO uses a range of 'risk filters' to identify or exclude potential risks. The ATO large business market segment is no exception. All LB&I taxpayer returns and related data are passed through these risk filters to detect patterns or anomalies which may indicate a risk of non-compliance. The approach in the large business market segment uses a range of quantitative data to do so.
3.76 Risk filter information may assist in directing the ATO's enquiries of the taxpayer in various ways. For higher consequence taxpayers, the main risk input is the template, which largely considers qualitative factors described above.
3.77 For lower consequence taxpayers, risk managers make recommendations for case selection. These recommendations are based on risk filter output and other intelligence or research. The section below considers risk filters and the section thereafter the risk manager and risk owner roles.
3.78 The ATO uses 'risk filters' to scan income tax return and related schedule information for all 1400 economic groups and entities in the income tax large business market. The filters are used to:
... detect financial patterns that may indicate potential non-compliant positions, for example, abnormally low tax payments compared to industry peers or high-risk transactions or arrangements that have not been disclosed.171
3.79 The risk filters are quantitative computer based assessments, and is the 'first cut' of the risk assessment process on data drawn from large business income tax returns. A description of such a filter is shown in Figure 10 below. Each risk filter contains the risk area, the risk description (being a basic form of risk hypothesis), and the risk filter description — which describes the tax return or other data that the filter is relying upon.
Figure 10: Sample ATO risk filter description
3.80 These 'Large market income tax risk filters' have been published on the internet in implementing Recommendation 3.5 of the IGT's Self Assessment Review.173 A list of the published ATO risk filters has been included in Appendix 9. Importantly, the ATO website from which Figure 10 is drawn also notes:
We use a number of qualitative and quantitative risk filters to detect areas where there may be differences in views between us and the taxpayer, for example:
- differences in treatment of capital gains and profit shifting
- where the law is new and we want to ensure that it is being complied with, such as taxation of financial arrangements (TOFA).174
3.81 The risk filters may be used to detect specific instances of potential non-compliance, which may indicate a need for verification activities. Alternatively, it may be used to select taxpayers who may be affected by a new law, so as to assist the ATO to understand how the law is being applied in that industry for assurance purposes.
3.82 The ATO has also advised the IGT during the review that in relation to risk filters:
We are now ensuring that we record more details about the purpose of reviews which are undertaken so that we can better measure our results. For example some reviews are undertaken to provide assurance around the implementation of legislative change. In these instances we may not expect to proceed to audit but that does not mean the filters were ineffective. By understanding our reasons for identifying a group using particular filters we will be better able to measure the effectiveness of these.175
Risk managers and risk owners
3.83 The actual risk areas of the ATO's LB&I business line are designated to 'risk owners' (being senior executive officers) and 'risk managers' (operational officers). Risk managers develop and implement strategies to mitigate their risks. The strategies outline how the risk will be deterred, and how it will be dealt with at an operational and tactical level.176
3.84 Risk managers consult with technical experts and officers from the ATO's Risk Intelligence and Systems Support (RI&SS) team to develop risk filters to assist in detecting risks.177
3.85 Whilst any officer in LB&I can recommend a taxpayer to be subjected to a risk review, risk managers are responsible for considering the risk filter output and regularly making recommendations for case selection.
3.86 Where a taxpayer has not been brought to the attention of the risk manager (or anyone else in LB&I) via the risk filters, the taxpayer may nevertheless be the subject of a risk recommendation due to qualitative information, such as media coverage of a large transaction or intelligence from other sources.178 All recommendations are considered by the CSSC, and must be signed-off by the LB&I Executive before commencement of a risk review.179
3.87 In the absence of qualitative information and risk filter output, it is possible for a segment of the lower consequence taxpayer population to have little contact with the ATO. Minutes from the December 2012 CSSC workshop indicate that possibly 500 lower risk taxpayers had not had any ATO contact for three years. As a result, it was indicated that the ATO (the Compliance Assurance & Governance and RI&SS teams) were examining a more robust profiling and risk assessment process for lower consequence taxpayers.180 The minutes also indicate that:
The statistics above show a funnelling effect where initially a large number of risk recommendations were not considered due to low materiality or low risk rating in the output. The numbers that are then considered are whittled down via analysis and cross-referencing to previous cases until only a small number of the original population is left for new recommendations.
It appears that the risk filters, and/or the process, is only identifying a small number of new taxpayers for potential risk reviews.181
3.88 As a result, the ATO's CSSC has identified a number of opportunities for improvement to the risk filter process.
3.89 The minutes also indicate that risk managers expressed a desire to work more closely with the LB&I Operations teams (compliance teams that undertake risk reviews etc) to assist them in identifying risks in taxpayer information and 'asking the right questions' of the taxpayer. By working more closely with them, risk managers may assist in improving the capability of the compliance teams.182
Taxpayer notification of RDF categorisation
3.90 Once a taxpayer's risk categorisation has been determined by the moderation panel, the ATO begins a process to author and issue the RDF notification letter. The letter advises taxpayers of their categorisation:
In 2011-12, for the first time we informed most large business in a single letter about our view of their relative risk of non-compliance for GST, income tax and excise.183
3.91 For higher risk and key taxpayers, the letters are sent to the CEO, while letters for lower risk and medium risk taxpayers are sent to the public officer.184 Senior executive ATO officers also meet with their tax managers to explain the ATO's views and discuss any concerns.185
3.92 Senior ATO management advised during this review that it expects compliance teams and officers to discuss the potential contents of the letter with the tax manager during the letter development process so that tax managers should not be surprised by the contents of the letter when it is issued.186
3.93 The RDF notification letters are the subject of a forty-step production process with several ATO staff involved.187 The process seeks to ensure adequate review of the compliance teams and moderation panel output and relevant Second Commissioner oversight and approval is obtained. This improved process was in response to Recommendation 4.1 of the IGT's LB&I Review.
3.94 The ATO's moderation panel documents indicate that the key taxpayer segment is further subdivided into: 'key with no concerns, key with some concerns, key with significant concerns'.188 This subdivision is not apparent in the LBTC booklet discussion about the RDF quadrants, nor in the RDF fact sheet.189 However, the recent ATO publication Real-time compliance engagement approach for higher consequence taxpayers in the large market shows key taxpayers and higher risk taxpayers displayed as a spectrum, rather than two halves.190
3.95 This is consistent with the Second Commissioner's speech in 2011 regarding the categorisations and letters:
An important thing to keep in mind is that while in the large market we have kept it pretty simple with just four risk categorisations, what plays out in reality is a spectrum of behaviours and concerns. We use the RDF to gives [sic] us a consistent suggested initial stance — an initial set of guidelines — but it is not a set of tramlines.191
3.96 For higher consequence taxpayers, the RDF notification letters only describe whether a taxpayer has been categorised as a key taxpayer or a higher risk taxpayer. The letter does not use sub-categories. Rather, moderation panel documents suggest that sub-categories are used to assist in developing the tone and content of the RDF notification letter. For example, where the ATO has some concerns about a key taxpayer, it will outline those concerns in the letter.
3.97 The ATO has advised that all higher consequence RDF notification letters should contain the details of a senior executive contact officer who is available to discuss the categorisation with the taxpayer.
Additional higher consequence requirements — taxpayer assurance plans (TAPs)
3.98 Compliance teams dealing with higher consequence taxpayers are expected to develop taxpayer assurance plans (TAPs). These plans are:
the cornerstone of how we deal with our higher consequence large business taxpayers. Taxpayer assurance plans are forward looking, map out the means to achieve longer-term goals and provide options for dealing with unforeseen challenges and opportunities.
Teams are required to have a three year taxpayer assurance plan for each higher consequence taxpayer using a whole of ATO/whole of taxpayer approach. Each plan should be endorsed by the relevant SES leader and periodically updated.192
3.99 The TAP is intended to document an understanding of the current state of the relationship between the taxpayer and the ATO, including the taxpayer's compliance, their attitude towards compliance, the intended goal of the plan, the resources to achieve that goal and the approaches required to 'turn the vision into reality'.193
3.100 As the TAP only caters for higher consequence taxpayers, it provides examples of intended outcomes for higher risk taxpayers and key taxpayers only. The examples generally focus on increasing or maintaining the taxpayer's commitment to real time disclosure of tax risks to the ATO.
3.101 The ATO's compliance teams document their understanding of the taxpayer's business using an adaptation of the ATO BISEP model explained in Chapter 2. This is essentially a taxpayer profile that documents the taxpayer's past compliance behaviour, including past interactions with the ATO. This profile section also contains a section for the 'rationale for the risk category rating'. This ensures that compliance teams outline the reasons why the taxpayer received the RDF categorisation that it did.
3.102 The profile section of the TAP also contains a section to record the compliance team's observations about the taxpayer's risk management and governance function. This is considered important because:
Reviewing a taxpayer's risk management and governance function is critical to understanding its business and behaviours. Aside from its importance in assisting teams to better understand the business, taxpayers must be able to demonstrate sound tax risk management processes and a willingness to work with us in order to be considered for an ACA (providing the taxpayer meet our other ACA criteria).194
3.103 The TAP also expects compliance teams to establish protocols with taxpayers to facilitate relationship management at both the strategic and operational levels. The protocols are designed to assist where differences of opinion or disputes arise.
3.104 The TAP also anticipates that compliance teams will develop a framework that facilitates:
... both the raising of tax risks and the development of joint assessments of risk in real time in an environment of mutual trust and respect . The framework should provide for the ATO to respond promptly to taxpayer requests for rulings, APAs and position papers on significant issues.195
3.105 The TAP is to include the manner in which the ATO-taxpayer relationship is to be managed and resourced within the ATO, with compliance teams documenting the internal resourcing and governance arrangements to implement the strategy.
3.106 The section of the TAP entitled 'what needs to be done?' provides guidance to compliance teams about their approach to information gathering and risk assessment in light of what the ATO knows about the taxpayer (captured earlier in the TAP) and their RDF risk categorisation. For example, it provides examples of kinds of 'monitoring' and information gathering approaches that do not involve taxpayer contact as well as approaches that do.196
ATO review of the risk categorisation template
3.107 In October 2012, the ATO completed a review of the template, with a business analyst seeking feedback from the main users of the template, the LB&I compliance teams. The review noted that there was a degree of overlap between the information entered in the template and that already documented in the TAP.197
3.108 Feedback also indicated that compliance teams would like to receive feedback from the RDF moderation panel about the compliance teams' work, as well as information about how the moderation panel uses the information in the template.198
3.109 The review also noted an opportunity to streamline the notification letter process by using technology to reduce the amount of manual re-working of content from the template through to the eventual letter issuance.199
3.110 The ATO advised the IGT during this review that it was undertaking a review to better integrate the TAP, the template, and PCR related documentation and to reduce overlap and manual data entry.200
3.111 A summary of the process for higher consequence taxpayers can be shown diagrammatically in Figure 11: Simplified higher consequence taxpayer risk categorisation process below:
Figure 11: Simplified higher consequence taxpayer risk categorisation process
3.112 This report now considers the specific concerns stakeholders raised in submissions. The IGT will discuss these and related materials, making observations and, where appropriate, recommendations.
Stakeholder concern — transparency of the risk categorisation process
3.113 Stakeholders raised concerns about certain aspects of the ATO's RDF as used by LB&I. Of particular concern was the underlying process that the ATO used to categorise taxpayers. The LBTC booklet notes the use of a moderation process, but no further detail is given about it.201
3.114 Stakeholders generally supported the appropriate use of qualitative inputs for the RDF process, recognising that a purely quantitative approach in this market segment will often be impractical. They were concerned, however, to ensure that there was adequate oversight of any process requiring professional judgement or use of subjective measures by ATO officers. The underlying concern was that ATO LB&I audit staff involved in risk rating taxpayers would be heavily influenced by their perceptions of interactions and their own organisational or personal behavioural biases.
3.115 Stakeholder concerns were also directed at the ATO categorisation process for higher consequence taxpayers regarding the key taxpayer or higher risk taxpayer delineation.
3.116 The process for deciding a higher consequence taxpayer's risk categorisation is based on the template as noted. This contains the compliance team's consideration of both the consequence and likelihood factors, concluding with their risk categorisation recommendation.
3.117 The ATO considers the template as:
- a preliminary judgment by the compliance team;
- providing a starting point for the moderation panel to assess the appropriateness of the recommendation; and
- setting out how that taxpayer sits in the RDF relative to other taxpayers.202
3.118 The template and recommendation are then considered by the ATO's moderation panel. The moderation panel considers all the higher consequence taxpayer templates to assist in determining relativity. The moderation panel documents their decisions, which may be a confirmation or variation of the categorisation proposed by the compliance team. This decision is then escalated to the LB&I Executive whereby the categorisation is ratified.
3.119 The ATO's Internal Audit examined a sample of completed templates and found that 'comparable evaluation and evidencing methods were used for all sampled taxpayers despite different business contexts'.203
3.120 The moderation panel is an important control measure implemented by the ATO to ensure that risk categorisations of higher consequence taxpayers are not adopted or changed by the action of a single ATO officer or compliance team. As noted in paragraph 3.67 above, similar control measures are in place for lower consequence taxpayers, whose risk categorisations must be approved by the CSSC.
3.121 The IGT also acknowledges that the use of the template is an important measure to facilitate:
- adequate record keeping regarding the evidence presented by the compliance teams to the moderation panel; and
- consistent presentation of considerations and evidence as amongst other taxpayers, assisting the moderation panel to make recommendations with respect to relative risk.
Stakeholder concern — accuracy and relevance of inputs
3.122 As noted, stakeholders generally recognise that a purely quantitative approach to assess risk in the large business market segment is impractical and accept that qualitative factors have a role to play.
3.123 Stakeholders did, however, express a number of concerns about the ATO's use of these qualitative inputs. For example, stakeholders submitted that the ATO's use of these inputs would have potential shortcomings in the following areas:
- Taxpayer risk rating disproportionately influenced by one transaction — concern that the ATO may perceive the taxpayer to be risky on the basis of one transaction.
- Non-compliance and contestable tax positions — concerns that the ATO may incorrectly infer taxpayer non-compliance in the presence of a contestable tax position.
- Taxpayer engagement, transparency and access to information — concerns with ATO emphasis on concepts such as 'taxpayer engagement' with potential negative inferences drawn from taxpayer behaviours such as:
- redacting responses to ATO information requests on the basis of commercial confidentiality;
- not applying for private rulings;
- claiming legal professional privilege (LPP); and
- taxpayers making Freedom of Information (FOI) requests.
- Effective tax rates — concern that the ATO sees low effective tax rates as a higher risk even though they may be explicable.
- Risk ratings based on past behaviour — concern that ATO perceptions of riskiness may be too reliant on past taxpayer behaviour without due acknowledgement of changes or improvements.
- The role of taxation advisors — concern that engaging a tax advisor that the ATO perceives to have a higher risk profile increases ATO perceptions of taxpayer riskiness.
- ATO considerations of taxpayer governance — concern that the ATO does not have the adequate capability to make judgements about a taxpayer's tax risk management system.
3.124 These stakeholder concerns are each addressed in turn below.
Taxpayer risk rating disproportionately influenced by one transaction
3.125 Stakeholders were concerned whether the ATO's focus on a small part of a taxpayer's business or a particular transaction may effectively drive up the risk rating of an otherwise low risk taxpayer. The result would be unnecessary increases in the compliance costs for the taxpayer by exposing them to enquiries broader than the transaction of concern.
3.126 The ATO's template allows compliance teams to make observations about a particular area of tax law where the taxpayer may have interpreted or applied it incorrectly. For this section of the template, the compliance team is asked:
What impact does the taxpayer risks analysis above have in giving the taxpayer a higher risk category rating?
Negligible, Moderate, Significant, High, Severe204
3.127 Compliance teams have an opportunity to qualify the extent to which a transaction or issue of concern should impact the taxpayer's risk categorisation.
3.128 The IGT is of the view that where the ATO has a concern about a particular taxpayer transaction or interpretation issue, ATO enquiries should be focused on that concern. Such a focus also assists in narrowing the scope for information requests and in minimising compliance costs for both the ATO and the taxpayer. Internal guidance such as TAPs should ensure that the ATO's enquiries of taxpayers are targeted accordingly.
3.129 If the above approach is not adopted, there is potential for an otherwise model taxpayer to have their risk categorisation disproportionately influenced by one particular concern. This is particularly so since the RDF as currently framed is a risk categorisation of the taxpayer itself, rather than a risk categorisation of individual transactions or positions.
3.130 Classifying an otherwise compliant taxpayer as having a higher likelihood of non-compliance because of a limited number of concerns can have significant ramifications for the ATO/taxpayer relationship. It may be interpreted as the ATO not giving due weight to the taxpayer's levels of compliance in the rest of its affairs.
3.131 There may be exceptions to the above approach such as where the ATO has concerns about a single taxpayer transaction or position and the latter is substantial compared to that taxpayer's tax base. In these circumstances, the influence of such transaction or position on the taxpayer's risk rating may be justified. Other exceptions may include situations where the ATO suspects fraud, or where the particular transaction is indicative of poor internal governance whereby the taxpayer is unable to detect or manage non-compliance.
The IGT recommends that discrete transactions or business activities of a taxpayer that cause concern for the ATO should not be determinative of the taxpayer's overall risk rating unless they are substantial compared to the taxpayer's tax base or are indicative of poor internal governance or fraud.
Non-compliance and contestable tax positions
3.132 Examples of the above concern include the ATO not acknowledging that its view is not always correct, especially in relation to adverse court decisions. Put another way, stakeholders perceive that the ATO does not distinguish between taxpayers who take a detection risk as opposed to an interpretation risk.
3.133 Taxpayers who take a detection risk have not complied with the law, and ultimately rely on the ATO not discovering any tax shortfall. These taxpayers may be less than forthcoming with information as part of their strategy. Importantly, this is not considered to be a significant risk by the ATO in this market segment.205
3.134 Taxpayers who take an interpretation risk on the other hand and rely on the merits of the interpretation of the law adopted are entitled to do so under the legal system. Provided that the taxpayer meets all of the legal obligations, this is a choice that is open to them. It has been acknowledged in various quarters that the tax laws are becoming even more complex and as a consequence there is significant room for uncertainty in application.206
3.135 Stakeholders have highlighted that by not adequately distinguishing between these types of taxpayer behaviours, and describing both as having a higher likelihood of 'non-compliance', the ATO may be undermining efforts to improve taxpayer engagement with the system or driving inappropriate ATO officer behaviours.
The ATO does make reference to 'a tax position that we disagree with' regarding non-compliance in their LBTC booklet in the following terms:
'likelihood of you having a tax position that we disagree with or having through error or omission misreported your tax obligations .. .'207 [emphasis added]
3.136 The LBTC booklet also makes reference to the ATO's concerns in this way:
The majority of large businesses are compliant, however, we still have concerns about opportunistic tax planning in a relatively small group of large businesses and we will have an intense focus on these businesses.208
3.137 In the main, however, the LBTC booklet refers to 'non-compliance' as the risk event of concern to the ATO, rather than the taxpayer taking a contestable position. For example:
Our perception of the likelihood of non-compliance is an informed professional judgment based on assessing a range of risk factors for each tax type.209
3.138 In a range of other ATO materials, including the LBTC booklet, taxpayer positions are referenced to variously as 'controversial' or 'contentious'.210
3.139 The IGT is of the view that, in the large business market segment, the key risks are generally associated with taxpayers adopting a contestable tax position. The outcome may be non-compliance where the taxpayer is incorrect. Conversely, where the ATO is incorrect, the taxpayer is compliant with the law.
3.140 As already mentioned, the taxpayer accepts some interpretation risk even if it accepts the ATO view. The reason being that such a view, if challenged by another taxpayer in court, may prove to be incorrect. Taxpayers are shielded from this interpretation risk to a certain extent. Legally binding ATO advice allows the taxpayer to receive the most advantageous treatment where such advice is ultimately found to be incorrect. The ability to receive such treatment, however, is subject to statutory time limits that is where the taxpayer is found to have overpaid, they are limited by the amendment period.211
3.141 Contestable areas are often where there may be a high degree of uncertainty about the interpretation or application of law in a particular area, or where opposing taxpayer and ATO views are yet to be tested in relation to specific or unusual facts.
3.142 The ATO has drawn upon certain academic research in support of its original Compliance Model as shown above in Figure 3 in Chapter 2. This includes the BISEP factors and the 'pyramidal' relationship between taxpayer attitudes to compliance and the ATO's methods of dealing with non-compliance.212
3.143 It has also been suggested that such a pyramidal representation may not be reflective of the large business market in light of the uncertainties of the tax law which affect them, or 'grey areas'. Taxpayers may be thought to 'play for the grey' in areas of uncertainty.213 This results in a suggested egg-shaped compliance model, rather than a pyramidal one as seen below:
Figure 12: Large taxpayers and uncertain positions
Source: Taxing democracy, Braithwaite, page 180.
3.144 As noted above, the ATO regards the majority of large businesses as compliant, with its concerns focussed on 'opportunistic tax planning' and 'contestable positions' (the grey area in Figure 12 above). Furthermore, the ATO notes:
Most, but not all, clients generally will comply with the ATO view of the law if it is known to them, or will have a reasonably arguable position that they would dispute with the ATO in an open fashion (going to the umpire) should they disagree.214
3.145 The IGT observes that it is important for the ATO to acknowledge that a contestable tax position does not necessarily result in non-compliance. This can be frequently attributed to the complexity of the applicable legislation and the associated uncertainty that can arise from its application to arrangements in this market segment.
3.146 As mentioned in Chapter 2, taxpayers as well as the ATO bear risks. The ATO or the taxpayer may be proven compliant or non-compliant as the case may be when matters are litigated. Often these matters are finely balanced and turn on specific facts.
3.147 Furthermore, higher consequence taxpayers that are public companies have legal corporate governance requirements, directors' duties and obligations to shareholders. These obligations and the accompanying civil penalties mean that taxpayers already have a strong incentive to avoid unreasonable tax positions.215
3.148 It would be helpful if both ATO internal staff guidance and public guidance acknowledged the complexity and the regulatory landscape to discourage ATO officers from approaching taxpayers with a broader notion of non-compliance when contestable positions are encountered. Such an approach would foster better relationship with taxpayers.
3.149 Currently, the use of the generic term 'likelihood' which is applied as 'likelihood of non-compliance' in documents such as the LBTC booklet obscures the specific nature of the ATO's concerns and its ability to effectively communicate them to taxpayers.
3.150 In addition, the references to 'controversial' or 'contentious' should be replaced with 'contestable' which is a more appropriate reflection of the actual risk in the large business market segment context. These former terms may also be considered unhelpful or even pejorative.
The IGT recommends that the ATO revise its internal and public documentation to:
- acknowledge that, for the purpose of the RDF, the presence of a number of contestable tax positions does not of itself render a taxpayer as non-compliant; and
- replace references to 'controversial' or 'contentious' tax positions with 'contestable' tax positions.
Agree and point (b) will be adopted over time as documents are recast.
Taxpayer engagement, transparency and access to information
3.151 Concerns were raised as to what the ATO considered to be 'engagement' by taxpayers, and whether perceptions of engagement were influenced by the personal judgements of ATO officers.
3.152 Furthermore, it was contended that a lack of engagement does not necessarily translate into an increased likelihood of non-compliance, and the ATO should not draw that inference.
3.153 Stakeholders raised two main types of concerns relating to the ATO's perception of taxpayer behaviour:
- those relating to a taxpayer's level of 'proactive disclosure' to the ATO; and
- the taxpayer's responsiveness to ATO information requests.
Proactive disclosure to the ATO
3.154 In the large business context, stakeholders believed the ATO inappropriately uses factors such as whether the taxpayer asked for private rulings, and the personal auditors views of the taxpayer's 'transparency' in assessing the taxpayer's likelihood of non-compliance.
3.155 Some stakeholders highlighted that a taxpayer may decide not to apply for a private ruling for a variety of reasons and not necessarily be wanting to avoid detection. For example, with respect to time sensitive transactions, a taxpayer may not be able to seek a private ruling because it can be a lengthy process. In this respect, stakeholders may decide to rely on external advice rather than seeking the ATO's view of the issue.
3.156 Alternatively, a taxpayer may not apply for a ruling if they are of the view that the matter is not contestable.
3.157 It was also suggested that simply relying on the number of rulings sought is misleading or is open to manipulation (for example, a taxpayer seeking a large number of fairly straight forward rulings to create an impression of engagement, transparency and compliance).
3.158 In response, senior ATO management have advised that the ATO does not consider mere numbers of private ruling applications as indicative of taxpayer 'transparency'. The ATO considers that the key issue is whether the taxpayer proactively informs them of its significant transactions or perceived contestable positions.
3.159 The template used by compliance teams for risk categorisation considers aspects of proactive taxpayer disclosures in both the 'Compliance history' and 'Real-time compliance' sections of the template. Each of these sections contains a part called 'willing participation' and considers issues such as whether the taxpayer makes private ruling applications for contentious or material issues, and whether the taxpayer provides information outside of the ruling process. The specific questions addressing these factors are described in paragraphs 3.48 to 3.57 above.
Taxpayer responsiveness to ATO information requests
3.160 Stakeholders have also raised specific concerns in relation to the unwillingness of the ATO to exercise its formal information gathering powers (for example those under section 264 of the Income Tax Assessment Act 1936) or that the ATO draws negative inferences about the taxpayer where the taxpayer is unable to informally disclose certain information due to contractual, privacy or confidential obligations.
3.161 Other stakeholders raised concerns that the ATO may also draw negative inferences when taxpayers assert their right to LPP. They strongly disagreed 'with the exercise of a fundamental legal right being used as a factor in the risk assessment process.' Similar issues have also been raised with respect to use of the Accountants' Concession and FOI requests.
3.162 The ATO's TAPs for higher consequence taxpayers, though not a direct part of the risk categorisation process, considers past taxpayer behaviour including 'the nature and extent of the taxpayer's use of LPP/accountants' concession claims and the extent we have lifted/challenged the claims' is listed. This item contains the footnote:
The use of LPP or accountants' concession are legitimate avenues available to taxpayers. Concerns only arise where it appears that these processes are being used outside their intent — for example, in an attempt to frustrate our active compliance activities.216
3.163 The LBTC booklet also makes reference to the ATO's approach to taxpayer claims of LPP. Broadly, the ATO will recognise a taxpayer's right to claim LPP and expects taxpayers to provide sufficient information to enable the ATO 'properly assess the veracity of their claims'.217
Transparency as a risk factor
3.164 The ATO currently considers 'transparency' as a significant likelihood risk factor in the LBTC booklet. It is the main consideration in determining whether a taxpayer is a key taxpayer (Q2) or higher risk taxpayer (Q1) that is a 'lack of transparency' will see an otherwise key taxpayer categorised as higher risk instead.218 Furthermore, the following speech highlights the ATO's concerns with taxpayers who it considers are not being transparent and how this would result in increasing costs for both parties:
Unfortunately, it has appeared to us that some taxpayers have been engaged in 'game playing' when responding to information requests. I hasten to add that I've discussed this with many large business taxpayers and their advisors, and also with many of my compliance teams and we are talking about the approach of a minority. However, it has been our observation that game playing during our information requests has dragged out a number of reviews and audits and it must be discouraged.
Of course we prefer to work with you informally when it comes to information gathering, and it is most efficient when there is dialogue and a mutual understanding of what information is required to complete the audit in the cheapest way possible. However, we have observed that despite extensive dialogue and cooperation prior to the information request we sometimes have received information marked 'draft', or 'subject to confirmation', or culled due to the auditee's view of its relevance, or claims are made for privilege with no information given as to the basis of the claim.
In such cases we have had to explain that informal approaches are being used in the place of formal powers for efficiency reasons and it is not acceptable that the Commissioner be provided with a lesser standard of information than he would be entitled to under formal approaches [emphasis added].219
3.165 The ATO acknowledges that where a taxpayer does not proactively provide information (such as in private ruling requests or otherwise) or is generally unresponsive to ATO information requests, it does not necessarily follow that the taxpayer is likely to be non-compliant.
3.166 However, the ATO is concerned that, where the taxpayer does not proactively make full disclosures and promptly respond to ATO information requests, it would be unable to quickly gather all the facts to form a view as to whether the tax position accords with the ATO view.220 The LBTC booklet contains a relatively limited articulation of this important transparency issue. It briefly refers to information provision and transparency as factors in assessing likelihood. These factors are described as:
The level of engagement and disclosure around significant transactions you undertake.
The fullness of disclosure and cooperation demonstrated in response to any enquiries.
The level of transparency demonstrated by you in keeping us informed about proposed significant transactions or potentially contentious issues.221
3.167 There is some additional discussion in speeches by ATO officials about the importance of these factors for higher consequences taxpayers but these are relatively limited.
3.168 During this review, the ATO also indicated that, for a given large business taxpayer population, the ATO is initially uncertain as to which taxpayers are adopting contestable tax positions which may need to be scrutinised and challenged. Real-time engagement by the ATO and information disclosure by taxpayers is the primary means by which the ATO is able to assess the presence of these risks.
3.169 For those taxpayers that are 'transparent', the ATO states that it can be more confident that these taxpayers do not have contestable tax positions. For taxpayers that are not as transparent, the uncertainty remains. As the uncertainty about contestable tax positions now applies to a much smaller population, the ATO regards that the likelihood of non-compliance is now higher for these taxpayers (a statistical principle known as 'Bayes' Theorem'). The ATO dedicates resources to reduce this uncertainty with respect to those taxpayers. In summary, the ATO regards the use of transparency as a likelihood factor.222
3.170 Whether taxpayers' willingness to proactively make full disclosure or be 'transparent' continues to be a helpful risk factor needs to be examined in the light of the relatively recent use of the reportable tax positions (RTP) schedule which effectively compels higher consequence taxpayers to be transparent. The RTP schedule is explored further in the next section.
Reportable tax positions
3.171 For higher consequence taxpayers, the ATO has also mandated a particular information gathering approach called the RTP schedule.
3.172 The ATO has piloted the RTP schedule for some higher consequence taxpayers for the 2011-12 income year.223 The schedule requires the taxpayer to disclose three types of reportable tax positions:
- Category A: a position that is about as likely to be correct as incorrect or less likely to be correct than incorrect.
- Category B: a position in respect of which uncertainty about taxes payable or recoverable is recognised and/or disclosed in the taxpayer's financial statements or a related party's financial statements.
- Category C: a reportable transaction or event.224
3.173 The RTP schedule 'requires large businesses to disclose their most contestable and material tax positions'.225 Taxpayers do not need to disclose positions outlined in private ruling applications, a company tax return, an RTP early disclosure form, or is subject to an advance pricing arrangement. The ATO will then use the disclosures in the RTP schedule to:
- better understand tax risk for taxpayers, industries and the large market
- further refine our risk differentiation framework categories to enhance the risk-based choices we make to prioritise our work
- improve our dialogue with large businesses about their risk ratings and corporate governance
- help us focus our compliance activities
- identify areas of uncertainty in the tax law that may need:
- law clarification or legislative improvements
- further advice and guidance by us.226
3.174 For the 2012-13 income year, all higher consequence taxpayers will be required to complete an RTP schedule. Taxpayers who have an ACA with the ATO for that year will not be required to complete the schedule.227
Information confidence and cost
3.175 The IGT acknowledges that a taxpayer's approach toward information provision may directly affect the ATO's ability to gather facts and develop a fully informed view on a timely basis. The IGT believes, however, that invoking the 'likelihood of non-compliance' paradigm to frame these information confidence concerns can unnecessarily raise negative or even pejorative connotations. Such connotations may impede the ability for the ATO and taxpayer to cooperatively identify the contestable positions and how they can be addressed.
3.176 The IGT considers that a more refined use of the RDF would assist the ATO to identify and communicate the specific factors causing ATO concerns and select the most appropriate treatment activity. Such treatment activities would primarily consist of:
- reviewing those specific issues causing concern with an intensity commensurate with the level of ATO confidence in the information; and
- differentiating ATO activities based on the following taxpayer behavioural risk factors:
- a reduced taxpayer ability to identify contestable positions indicating a need to focus ATO activities on improving taxpayer's tax risk management and governance;
- good tax risk management governance systems but a high number of contestable positions, indicating a need to focus ATO activities on earlier engagement to quickly obtain necessary information to narrow the issues and fast-track resolution processes; or
- a low level of ATO confidence that the taxpayer provides all information needed in a form that the ATO officers understand, indicating a need to focus ATO activities at improving the quality of the communication channel.
3.177 The IGT acknowledges that, when deciding upon its compliance approach to a taxpayer, the ATO should consider both risk and information confidence and cost. Although useful as a high level pictorial representation, the two dimensional nature of the RDF (likelihood and consequence of non-compliance) means that factors such as information confidence and cost are bundled into the likelihood consideration. Other speeches from the ATO highlight this entanglement.228
3.178 The IGT believes that, although the ATO seeks to apply Bayes' Theorem to use transparency or information confidence and cost issues as a likelihood factor, it should consider them separately from likelihood risk factors listed in the LBTC booklet and risk template. This would be consistent with ATO's enterprise approach to risk and the ISO approach as set out in Chapter 2.
3.179 The disentangling of information confidence and cost from risk considerations is depicted in Figure 8 in Chapter 2 and is reproduced below for convenience:
Figure 13: Risk and information confidence and cost
3.180 Both the LBTC booklet and risk template should be updated to reflect that information confidence and cost, whilst legitimate considerations in determining the ATO compliance approach, do not necessarily indicate a higher likelihood of non-compliance or contestable tax positions.
3.181 The IGT acknowledges that at this time information confidence and costs concerns can only be effectively articulated for higher consequence taxpayers, since these taxpayers have an ongoing relationship with dedicated ATO compliance teams. However, as stated earlier, whether information confidence and cost remain a legitimate factor in determining the compliance approach for these taxpayers is in doubt given the use of the RTP schedule.
3.182 The ATO requirement that all relevant higher consequence taxpayers disclose their 'most contestable and material tax positions' through this schedule appears to run counter to the intent of the RDF to foster taxpayers proactively making disclosures through their day-to-day relationship with the ATO.
3.183 Whilst the ATO has emphasised taxpayer transparency as a key determinant for a taxpayer's RDF categorisation, the schedule represents a movement towards more formal information gathering methods. With the shift to real-time compliance reviews for higher consequence taxpayers (in the PCR229) and to mandated disclosure of contestable and material tax positions (in the RTP schedule), the relevance of taxpayer 'transparency' or 'information confidence and cost' in terms of the RDF categorisations needs to be reconsidered once the ATO has gained more experience with the use of the RTP schedule.
Willing participation as a risk theme
3.184 The ATO's use of 'willing participation' as a criterion is problematic. While the ATO may use the concept of 'willing participation' in its vision statement and other corporate materials, the IGT questions its use as a theme in an evidence-based template. The reason is that such a term would lead the ATO officer to make a judgement or form an opinion in relation to the taxpayer whereas the template is intended to be a record of facts, evidence and behaviours.
3.185 Furthermore, the use of a subjective and imprecise concept such as 'willing participation' obscures the analysis in relation to information confidence and cost which may adversely impact the ATO/taxpayer relationship. The ATO may be far more effective in influencing taxpayers' approaches to proactive disclosures and/or response to information requests if it simply communicated facts to the taxpayer relating to their action or inaction in the provision of information and how these may result in increased compliance costs on both sides. The use of Figure 13 above is intended to provide an enhanced framework for this communication.
Taxpayer requests for formal exercise of ATO powers
3.186 While the ATO has stated in the LBTC booklet that taxpayers may request the ATO to exercise its formal powers in certain circumstances, some factors support stakeholder concerns that the ATO may be unwilling to exercise its formal powers and perceives taxpayer requests for such exercise as being uncooperative. These include the lack of internal ATO guidance on this matter, especially in the template and TAP. Furthermore, a recent ATO speech appears to set the expectation that taxpayer disclosures during informal approaches should be of the same standard as that the ATO would be entitled to under formal approaches.230
3.187 Clearly there are exceptions to the expected standard as articulated in the LBTC booklet. Where the ATO insists on using an informal approach, despite taxpayer requests for the formal exercise of powers, then it should accept that taxpayers would redact information subject to contractual or confidentiality obligations as a likely result. Where this occurs, the ATO should not make negative inferences about the taxpayer's 'lack of engagement or transparency'.
3.188 The IGT is of the view that the ATO should better support its stated position in the LBTC booklet by reinforcing these types of exceptions in its internal guidance to ensure ATO officers deal appropriately with taxpayer requests for the exercise of the Commissioner's formal information gathering powers.
Taxpayer exercise of legal rights such as LPP and FOI or use of the Accountants' concession
3.189 The IGT acknowledges that the ATO must take what formal action it sees fit under the law to consider significant transactions or potentially contestable positions. In such cases, the ATO should seek the necessary information directly from the taxpayer where it is not provided voluntarily. However, the exercise by taxpayers of their legal rights such as LPP or FOI applications, should not, of themselves, lead to perceptions of non-compliance or even a 'lack of transparency or engagement'.
3.190 The ATO has set an administrative precedent with PSLA 2004/14 which ensures that in certain circumstances where the taxpayer does not provide corporate board documents on tax compliance risk, the ATO will not make an adverse inference about that non-disclosure.231 This is a useful illustration that it is open to taxpayers in the self assessment environment to determine the nature of their relationship with the ATO, including how information is provided, without necessarily invoking the risk paradigm.
3.191 Whilst such acknowledgements of taxpayer 'rights' to maintain the confidentiality of certain board documents are important, it is even more important for the ATO to make at least the same acknowledgement for legal rights such as LPP claims and FOI applications.
3.192 The LBTC booklet does makes some references to how the ATO handles taxpayer claims for LPP and the Accountants' Concession as well as tax risk board documents concession. These references, however, are in the context of compliance activities, rather than how the ATO considers past claims when considering likelihood risk factors for the purpose of the RDF.232
3.193 The IGT is of the view that the ATO should clearly articulate when the ATO will or will not consider the taxpayer exercise of legal rights and administrative concessions when assessing the taxpayer's risk categorisation.
The IGT recommends that the ATO:
- Consider 'willing participation' or 'transparency' in terms of information confidence and cost and use them alongside, but separate from, the RDF in determining the ATO compliance approach to taxpayers;
- The tool for assessing information confidence and cost should consist of objective and specific criteria such as:
- Does the taxpayer voluntarily disclose information to the ATO?
- Does the taxpayer respond to informal ATO information requests?
- If no, what were the reasons for this?
- Have you used formal information gathering powers with respect to this taxpayer?
- If so, what were the reasons for this? Did the taxpayer outline a specific concern that gave rise to a need for you to exercise such powers?
- How did the taxpayer respond to our formal information gathering requests?
- Did the taxpayer exercise their right to legal professional privilege correctly?
- If not, what was the issue of concern? How was it resolved?
- Did the taxpayer avail themselves of the accountants' or board papers concessions correctly?
- If not, what was the issue of concern? How was it resolved?
- Update its internal guidance to ATO officers to reflect its stated position in the LBTC booklet in relation to taxpayer requests for exercise of the Commissioner's formal information gathering powers; and
- State, in an appropriate publicly available document such as the LBTC booklet, its position with respect to the exercise of such taxpayer legal rights as LPP and FOI as well as use of Accountants' Concession when determining the taxpayer's risk categorisation.
The ATO considers willing participation and transparency pivotal in forming a view as to the likelihood of a risk. We agree to separately consider "information confidence and cost" for higher consequence taxpayers, those where we would be able to form an informed professional judgement on these aspects. We note that for lower consequence taxpayers we would not normally have the information necessary to answer the suggested questions due to the infrequency of interactions.
Effective tax rates
3.194 As noted in paragraph 3.38, the ATO does consider the taxpayer's effective tax rate, or 'tax performance' in the template. However, it is unclear to stakeholders what the basis is for calculating effective tax rates and the weight the ATO attributes to these rates when determining the risk categorisation.
Tax performance focuses on how well the economic performance of the taxpayer translates into tax performance.233
3.195 Tax performance is essentially indicated by tax payable, whilst indicators of economic performance are variously indicated by taxable income, net income and gross income. Where the rate is below the statutory rate, there is an emphasis on the ATO understanding the reasons for this.
3.196 A difference in the tax performance and the economic performance of a taxpayer does not automatically point to an inherent risk. The difference between the effective tax rate and the statutory rate may be due to policy design (for example, accelerated depreciation) rather than being attributable to tax planning.234
3.197 The IGT considers that effective tax rate analysis, whilst not definitive, serves as a useful signpost for ATO enquiries which may assist in identifying specific tax risks. The ATO template does not provide a particular risk hypothesis for this section but asks compliance teams to consider whether they understand the reason for any 'divergence'.
3.198 During discussions with the IGT, stakeholders expressed a desire to better understand how the ATO made its calculations and comparisons.235 The ATO acknowledged the benefit of making such additional information available to taxpayers. This could include comparisons with others in the industry and a greater degree of granularity about the types of risks that concern the ATO. This information, however, would be limited to ensure the protection of other taxpayers' privacy, and in order not to reveal any risk thresholds (to prevent manipulation).
3.199 The ATO has also undertaken some internal review work on the notification letters. For example, it was observed by some ATO staff that there would be benefit in separating the communication to the board (CEO, CFO) which should focus on relationship management, and the communication to the tax manager, which should focus on greater detail of the risks.236
The IGT recommends that the ATO share with taxpayers greater detail about how the ATO assesses particular risks, including details about how the effective tax rate is calculated.
Risk ratings based on past behaviour
3.200 Stakeholders have noted that if the ATO always took into account past compliance history, then it may negate more recent positive behaviours of taxpayers. The result may be that, despite the taxpayer significantly improving their tax risk management and governance processes, the ATO may still regard them as higher risk due to past non-compliance. Such delays in changing ATO behaviours may adversely impact on continued taxpayer improvements.
3.201 In this respect, the ATO's template has sections on both 'compliance history' and 'real time compliance'. The compliance history section gives the following guidance:
The compliance history of the taxpayer is an indicator of future compliance performance.
It is also a good indicator of how well the taxpayer engages with ATO systems and services and their approach to compliance. It may also help teams to identify gaps in ATO communication or taxpayer understanding, which then can be actively managed to improve the taxpayer/ATO relationship.
(In some cases, there may have been a change in CEO or tax manager and the taxpayer's current behaviour may not be consistent with their past behaviour. If this is the case, compliance teams can provide this input here.)237
3.202 The real time compliance section gives the following guidance:
With the move to real-time compliance and PCR's, there is an increasing focus on voluntary compliance and willing participation. This section is for the compliance teams to discuss how willing the taxpayer is to moving towards a real-time compliance approach.238
3.203 The IGT is of the view that the compliance history of a taxpayer may be relevant in assessing the likelihood of the taxpayer being non-compliant. These considerations largely focus on the taxpayer's compliance with their obligations to correctly register, report, lodge and pay. For example, where the taxpayer is regularly lodging late returns and statements, incorrectly reporting information in these returns and paying debt late, it may be indicative of poor internal controls or an under-resourced tax function that is likely to see such non-compliance continue.
3.204 This criterion is subject to a number of considerations in the large business market. For example, aspects of compliance history may be immaterial or the underlying cause of non-compliance may have been addressed. Such factors have the potential to make analyses of past compliance behaviour an unreliable indicator of future compliance particularly where taxpayers have resolved legacy issues, improved their tax governance and are seeking a better relationship with the ATO.
The role of taxation advisors
3.205 The ATO has previously indicated that it may consider the taxpayer's association with a particular intermediary when determining the taxpayer's risk categorisation. For example, at the National Tax Liaison Group (NTLG), the ATO has noted:
The ATO has signalled on a number of occasions that the use of advisors who have a history of association with controversial or contestable tax planning arrangements will be a consideration in determining the overall risk rating of taxpayers.239
3.206 Furthermore, the LBTC booklet, under the heading 'Checklist of what will attract our attention' contains the following:
History of aggressive tax planning by the corporation, group, board members, key executives or advisers.240
3.207 During the IGT's Self Assessment Review, stakeholders raised particular concerns in relation to the ATO's risk approaches to tax advisors:
Many submissions from tax professionals expressed concern with the ATO's recent approach to assessing tax advisors' risk of non-compliance and their competence. Unlike an adverse risk rating given to a taxpayer (which may result in an increased likelihood of administrative scrutiny), an adverse risk rating for advisors may result in that advisor becoming unemployable.
It seems that, in certain circumstances, the 'aggressiveness' of an advisor is considered significant in determining the taxpayer's risk rating. In this respect, the ATO considers that if tax advisors are supportive of the system and engaged with the ATO, all things being equal, this would lower the ATO's perception of the underlying risk that their clients (taxpayers) pose to the system.
... Stakeholders, however, have outlined situations where ATO views on advisors were not necessarily based on objective evidence. In addition, they note that where the perception is incorrect, there is no recourse but to contest this. Moreover, where the ATO's perception is communicated to taxpayers there is a negative impact on the business of the advisor or their employability.241
3.208 Stakeholders have argued that the ATO should be more concerned with the merits and correctness of the position being adopted. These tax positions, although potentially contestable, may ultimately prove to be correct.
3.209 It has also been suggested that any concerns about specific advisors are already dealt with in various statutory or professional standards governed by regulatory or professional boards. Further, advisors may be sued by their own clients for not fearlessly and frankly advising their clients of the optimal position to adopt under the tax laws.
3.210 The ATO's template considers certain questions in relation to the taxpayer's use of external advisors. These are described above in paragraph 3.48. However, there is little additional guidance provided as to how this information should be considered in formulating the risk categorisation.
3.211 Despite the questions in the template, during the course of this review, the ATO has advised the IGT that, with respect to higher consequence taxpayers, the ATO does not consider the taxpayer's engagement of particular tax advisors as determinative of the taxpayer's risk categorisation. Rather, it is focused on the actual transactions that the taxpayer undertakes as a result of that engagement.242
3.212 Further, if the taxpayer adopts a contestable tax position as a result of that engagement, the ATO would still rate them as a key taxpayer (rather than a higher risk taxpayer) where the taxpayer was forthcoming with material information about the transaction. The ATO's concerns about the transaction (rather than the advisor) would be reflected in the RDF letter to the taxpayer.243
3.213 The ATO has also indicated that difficulties in the relationship with the taxpayer cannot necessarily be attributed to any particular personnel within the organisation. The ATO would only include in the RDF letter examples of taxpayer behaviour that were causing concern. For example, the ATO would state the time taken for the taxpayer to respond to information requests, rather than naming any particular person or imputing any motive for the delay.244 The ATO considers that since personnel themselves are not risk factors, the ATO focuses on the taxpayer's governance and tax risk management structures.
3.214 Beyond the template and the above advice provided by the ATO, there is minimal public guidance available indicating the ATO's approach in this area.
3.215 The ATO has also advised that where it is apparent that a taxpayer had undertaken a particular contestable position as a result of a tax advisor promoting the scheme, it may investigate other clients of the tax advisor, with a view to administering the promoter penalty legislation.245 Such administration, however, is within the purview of the ATO's Aggressive Tax Planning business line rather than LB&I.
3.216 The IGT has already explored the arguments for and against applying the RDF to tax advisors or practitioners in his Self Assessment Review.
3.217 Unlike assessing tax liability, ATO risk assessments of advisors and the like are not generally considered to be 'reviewable' through any forum such as the Administrative Appeals Tribunal. As such, in the review mentioned above, the IGT asserted that if the ATO were to persist in applying the RDF to tax advisors, the latter must have a right of review.
3.218 In response to recommendations in that review, the ATO has stated that it does not disclose the tax advisor's risk categorisation to their clients. Therefore taxpayers are unaware of the risk rating of advisors and it follows their choice of advisor may therefore not reflect the taxpayers' risk appetite.
3.219 The IGT is of the view that the ATO should not use the choice of tax advisor as a factor in determining the taxpayer's risk rating. The focus should be on objective criteria to determine actual tax risks rather than using an unreliable shortcut of identifying individual advisors. This is especially so since taxpayers may use a range of different advisors for different tax matters.246
3.220 Although the ATO approach as described in paragraphs 3.211 to 3.215 above accords with this IGT view, such an approach is not reflected in current ATO guidance material.
3.221 The IGT is of the view that the ATO may reduce concerns by ensuring ATO expectations are made clear in staff guidance, such as in the template as well as public guidance, such as in the LBTC booklet regarding the role of tax advisors in the taxpayer risk assessment process. Including examples of the ATO's approach in this area will provide further clarity on the matter.
The IGT recommends that the ATO update its internal and public documentation to make it clear that use of particular tax advisors is not a factor in determining a taxpayer's risk categorisation.
We will improve existing documentation for both staff and the public about when we will follow up on tax arrangements that we view as contentious and associated with certain Advisors.
3.222 Further consideration of the ATO's risk assessment approaches in relation to tax practitioners is discussed in Chapter 7.
ATO considerations of taxpayer governance
3.223 Stakeholders have generally supported the increased ATO focus on taxpayer governance processes, acknowledging that it enhances the ATO's risk-based approach. Some concerns have been expressed, however, about the capability of ATO officers to make judgements about the adequacy of the taxpayer's tax risk management and governance processes. For example, one submission indicated that the ATO was unsure if the taxpayer had an audit committee, despite the fact that the taxpayer was a publicly listed company with pertinent information being available in its annual report and accessible via the internet.
3.224 Furthermore, stakeholders have raised concerns that how a tax manager deals with his or her own personal tax obligations has a bearing on the risk rating of the taxpayer for whom they work. The following difficulties with the current ATO approach have been highlighted:
- employees should not be compelled to disclose their personal tax affairs to their employer;
- the ATO itself is better placed to know and deal with the personal tax obligations of tax management staff; and
- the personal tax performance of tax staff has limited correlation to their ability to carry out the corporate tax function.
3.225 As noted above, the ATO's template specifically considers the 'taxpayer's tax risk management and governance process'. Furthermore, the LBTC booklet contains specific expectations regarding a taxpayer's tax risk management arrangements at both the strategic and operational levels. Under the operational level checklist, the ATO asks taxpayers to ensure:
- you obtain appropriate assurances that personal tax obligations are up-to-date for individuals in key tax management roles.247
3.226 Such a requirement, however, is not included in the ATO's template.
3.227 Senior ATO management have indicated that the ATO's interest in a taxpayer's tax risk management and governance stems from two risk hypotheses:
- a taxpayer may have inadequate tax risk management and governance and may be inadvertently adopting potentially contentious tax positions, or even obviously non-compliant ones, without being aware of it and therefore exposing themselves to possible compliance action due to poor tax risk management control systems; or
- a taxpayer may have good tax risk management and governance, but the taxpayer has knowingly adopted a contestable tax position as a result of management's willingness to accept higher levels of tax risk.248
3.228 The IGT believes that it is appropriate for the ATO to consider the tax risk management and corporate governance arrangements of the taxpayer. It is important to adopt methods which seek to minimise the overall costs of taxpayer compliance and administrator costs by focusing more on the systems and structures that govern the decision-making and operations.
3.229 The ATO has elevated the importance of a taxpayer's corporate governance in many publications, such as the LBTC booklet. Furthermore, the ATO has made 'sound tax risk-management processes' as a one of the pre-requisites for entering into an ACA.249
3.230 Large businesses are generally aware of and compliant with their regulatory responsibilities and obligations including taxation. Accordingly, they appreciate that they have to bear a baseline level of compliance costs. Unnecessary compliance costs, however, are a burden that imposes a dead weight cost on them and the economy.250 This market, along with other commercial markets, understandably seeks to minimise such costs.
3.231 Therefore, the ATO should ensure that its expectations of corporate governance and tax risk management are as closely aligned as practicable with the general corporate governance standards which are expected of corporate taxpayers. Any prescription or divergence over and above general corporate governance standards has the potential to reduce flexibility of the system251 and unduly increase compliance costs.
3.232 Furthermore, the examination of tax risk management and corporate governance requires specific skills and experience. It is important, therefore, that ATO compliance staff tasked with the examination and assessment of a taxpayer's corporate governance are adequately skilled to undertake such a task and that such an assessment is subjected to an appropriate internal assurance process.
3.233 The IGT is also of the view that it is not appropriate for the ATO to effectively impose an obligation on taxpayers to monitor their employees' personal tax affairs. Taxpayers have little control over how their employees manage their own tax affairs and the ATO is in better position to know if particular taxpayers are complying with their personal tax obligations.
The IGT recommends the ATO:
- ensure that its LB&I compliance staff are appropriately skilled to examine and assess the adequacy of a taxpayer's corporate governance and tax risk management arrangements and that such assessments are the subject of an appropriate internal assurance process; and
- remove tax manager personal tax obligations as a consideration when assessing the taxpayer's tax risk management and corporate governance.
In relation to (a), capability building is an ongoing aspect of maintaining and developing a professional workforce and we invest significantly in our learning and development programs. Our acquisition and or use of external experts also contribute to these developmental programs. Through implementation the ATO will consult with the IGT and others in relation to the specific elements of assessing tax corporate governance and tax risk management which require greater focus.
General IGT observations about inputs
3.234 Further to concerns raised by submissions in relation to the adequacy and relevance of inputs, some general observations can be made on the ATO's use of these inputs, the risk filters, risk managers and risk owners. These are each discussed in turn below.
Distinguishing between different ATO risk factors
3.235 The ATO uses a variety of risk factors in its risk categorisation process. Each of these risk factors may be indicative of specific concerns. The way in which the ATO resolves these concerns will depend on the nature of these risk factors. Better distinguishing between these factors may ensure that the ATO adopts the most suitable approach.
3.236 The IGT considers that the 'likelihood factors' in the ATO template cover three main areas:
- inherent risk factors;
- behavioural risk factors; and
- information confidence and cost.
3.237 Inherent risk factors are those economic or business factors or transactions which, by their very nature, increase the likelihood of a taxpayer adopting a position with which the ATO may disagree (a contestable position). Taxpayers are essentially unable to eliminate these risks since they are a feature of the business they are in. For example, a taxpayer may technically be able to minimise the risks associated with cross-border transactions by ceasing them altogether, but this is unrealistic.
3.238 Behavioural risk factors are those aspects of a taxpayer's behaviour, such as a taxpayer's tax risk management and governance and appetite for risk, which either serve to mitigate or exacerbate a taxpayer's inherent risk. Taxpayers are more likely to have greater discretion over these risk factors and may minimise behavioural risk factors by adopting certain behaviours or approaches. This may include actions such as increasing resourcing to its tax management function, improving tax information systems or ensuring tax risk management policies are board-approved.
3.239 Information confidence and cost factors have already been addressed in the preceding sections.
Inherent and behavioural risks
3.240 The distinction between inherent risk factors and behavioural risk factors is usefully described in Her Majesty's Revenue and Customs' (HMRC) Tax Compliance Risk Management Manual. The manual firstly considers seven factors:
Complexity — The potential risk in the size, scope and depth of business or tax interests.
Boundary — The level of complexity of international structures, financing and connected party issues.
Change — The degree and pace of change with tax implications affecting the business.
Governance — The customer's openness and co-operation with HMRC and the management accountabilities for managing tax risk.
Delivery — The customer's ability to deliver the right tax through systems, processes and skills.
Tax Strategy — the customer's involvement in tax planning which does not support genuine commercial activity.
Contribution — whether the amount of tax declared/claimed looks reasonable in the light of what we know about the customer and/or sector.252
3.241 The manual then describes the relationship between these factors:
The first three factors (Complexity, Boundary and Change) are 'inherent' factors i.e. in themselves they create risks while the second three factors (Governance, Tax Strategy and Delivery) are the behaviours through which these inherent risks might be managed. A customer may have inherent factors that potentially create major tax compliance risk, but they can still be Low Risk if they effectively manage these inherent risks through their behaviours. This is not purely theoretical. There are already a number of highly complex Large Business customers who we have identified as Low Risk.
The 'contribution' factor is a reality check before agreeing the overall risk status. In other words, if all other indicators suggest a customer is Low Risk but the customer's tax/duty contribution is lower than expected, we would want to know the reason for this before agreeing Low Risk status overall.253
3.242 The ATO's template considers similar, but not identical, risk factors to those in the HMRC manual. For example, the ATO template considers the taxpayer's organisational structure which is analogous to the 'complexity' factor in the HMRC manual. Similarly, the ATO's consideration of tax risk management and governance corresponds to some aspects of the 'governance' factor in the HMRC manual.
3.243 Unlike the HMRC manual, however, the ATO template does not explicitly make a distinction between risk factors that are 'inherent' and those that are 'behavioural'. This demonstrates that risk-based approaches can differ as between revenue authorities. As highlighted in Chapter 2, risk management continues to be an evolving discipline in this area.
3.244 The IGT believes that consideration of specific 'tax risks' and 'organisational structure' are largely 'inherent risk factors'. The IGT notes that not all inherent risk factors in the template have a risk hypothesis associated with them. It is the IGT's view that all inherent risk factors should indicate the risk hypothesis that it is purported to test. Such hypotheses may assist in guiding further specific ATO inquiries.
3.245 Identifying inherent risk factors and addressing them through risk hypotheses should assist in framing the ATO's concerns to the taxpayer. For example, where the ATO has concerns regarding inherent risk factors, such as the taxpayer undertaking transactions in a complex area of law, the nature of the dialogue between the ATO and taxpayer can focus on the technical merits of the taxpayer position and the relative 'interpretation risk' associated with each parties' positions.
3.246 'Behavioural risk factors', on the other hand are covered more by the tax risk management and governance section of the template. Where the taxpayer has good tax risk management and governance in place, there may be minimal behavioural risks but there may be inherent risks at play, for example specific transaction(s) of the taxpayer that cause concern for the ATO.
3.247 By specifically addressing the two different types of risk factors noted above, the ATO is better able to present those behavioural risks that taxpayers can address directly such as improving tax risk management and governance and the inherent risk factors which the taxpayer has little ability to change but may be able to monitor or mitigate.
3.248 Accordingly, the ATO should make a clearer distinction between inherent risk factors and behavioural risk factors in the template and other ATO guidance material. This distinction should flow through to subsequent communication to the taxpayer, thereby enabling the ATO to clearly articulate the prima facie risks and to identify potential risk mitigation strategies or information that may assist in reducing those risks.
3.249 The IGT also notes that a similar distinction is also adopted by other regulators, with the Australian Prudential Regulation Authority separately considering 'inherent risk' and 'management and control' when calculating 'net risk'.254
The IGT recommends that the ATO update its LB&I RDF categorisation template along with internal and external communications to be consistent with the following principles:
- higher consequence taxpayers will always be subject to a form of direct ATO engagement regardless of likelihood factors and the nature, extent and timing of this engagement is influenced by likelihood factors;
- likelihood factors consist of inherent and behavioural factors and should be addressed separately;
- inherent factors require the testing of particular hypotheses;
- behavioural factors require the testing of the taxpayer's tax risk management and governance processes; and
- the intensity and formality of the review depends on the taxpayer approach to provision of information as well as inherent and behavioural factors.
The ATO agrees with the proposed recommendation for the management of higher consequence taxpayers, where the behavioural and inherent factors noted by the IGT should be known to the ATO due to the nature of the relationship model we have with higher consequence taxpayers. For lower consequence taxpayers the information needed to form an informed professional judgement on many of the behavioural factors will generally not be known at the time of case selection due to the infrequency of interaction.
Risk filters, risk managers and risk owners
3.250 Whilst risk filters are applied to all large business taxpayer returns, higher consequence taxpayers also use qualitative input from the risk categorisation template. Risk assessment for lower consequence taxpayers are mainly reliant on the risk-filtering system to generate avenues of enquiry or concern which may eventuate into risk reviews for taxpayers.
3.251 In relatively recent ATO documentation considered by the IGT, it appears that the risk filters or the related processes are acknowledged to be less effective at identifying case work:
It appears that the risk filters, and/or the process, is only identifying a small number of new taxpayers for potential risk reviews.255
3.252 The ATO documents also highlight the significant effort risk managers are expending to filter out potential cases for risk review. The risk filters are producing considerable numbers of 'false positives', which require further risk manager intervention to reassess cases either on the basis of materiality, data mismatches, or risk hypotheses which have already been addressed by previous compliance activity for that taxpayer.256
3.253 The ATO documents also noted that the ability to detect some risks was limited due to the nature of the income tax return labels. It envisages improved risk detection with the introduction of the new international dealings schedule (IDS).257
3.254 Furthermore, ATO documents indicate the need for better interaction between the risk managers (who identify the risk and recommend the cases) and the compliance teams (who conduct risk reviews to confirm the existence of the risk). For example:
- compliance teams need to consult risk managers when closing a case as an early exit (that is, the compliance teams consider no risk exists before the case commences);258 and
- risk managers could better collaborate with compliance teams in the conduct of cases by helping them to 'ask the right question' of the taxpayer but are subject to resource constraints.259
3.255 The IGT considers that the false positives generated by the risk filters could be attributed to a number of factors:
- risk filters themselves do not accurately discriminate between 'compliant' and 'non-compliant' taxpayers;
- taxpayers in this market segment have increased their general level of compliance, such that any chance of selecting a 'non-compliant' taxpayer has diminished significantly; and
- taxpayers are aware of how risk filters work and ensure they correctly report in those areas subject to the risk filters.
3.256 Considering the importance of the risk filters in identifying potential risks for lower consequence taxpayers and the opportunity costs associated with risk managers regularly reassessing the output of risk filters, the ATO should consider improvements to the risk identification and management systems including the role of risk managers and their relationship with compliance teams.
3.257 Furthermore, since risk managers are responsible for developing risk filters, risk hypotheses and risk recommendations, they are an important source of information in better designing compliance activity in the lower consequence market. The ATO should ensure these risk managers are adequately skilled and supported to carry out their role. There should also be, on an ongoing basis, a mutual obligation of risk officers to engage with the compliance teams to better identify potential risks or required information access improvements.
3.258 During the course of the IGT review, the ATO commenced an 'LB&I improvement program', which amongst other things, seeks to address the above concerns to some extent. For example, efforts are being made to ensure that:
- risk managers are given meaningful feedback from the compliance teams to refine their risk identification process; and
- compliance teams 'understand the genesis of their work and apply the correct risk lens when undertaking their work'.260
The IGT recommends that the ATO continue to improve the LB&I risk identification process including:
- better identifying potential risk hypotheses through closer working relationships between risk managers and operations teams on an ongoing basis;
- capture better input data through the income tax return and its associated schedules; and
- refine or remove inappropriate risk filters.
Stakeholder concern — formal notification of risk categorisation
RDF notification letter
3.259 A significant concern arising from the large business market segment were the RDF notification letters sent by the ATO to the CEOs of higher consequence taxpayers and the due process underpinning them. It is important to note the dynamic in relation to large business taxpayers. These taxpayers often have appointed tax managers, some who work solely on tax, or as part of a broader suite of responsibilities.
3.260 Despite the ATO's stated intention that the RDF notification letter is not a 'report card on performance261', tax managers representing higher consequence taxpayers have indicated that the letter, including the tone of the letter and the manner in which it is sent, may give the appearance of a de-facto ATO report on their view of the tax manager's performance to the CEO.
3.261 Of particular concern is the fact that tax managers feel they have little involvement in checking the accuracy of the ATO's notification letter. The letter has implications for the tax managers personally as well as the taxpayer organisation as it is sent directly to the CEO. However, tax managers feel it was incumbent on the ATO to ensure that they are adequately consulted about the contents of the letter. They believe that errors and inaccuracies served to undermine the credibility of the ATO as well when the letters are poorly considered. Once the letter goes to the board, tax managers have little right of redress, despite their willingness to provide information to address concerns raised in the letters.
3.262 Furthermore, it was observed by stakeholders that although the risk rating process took into account both quantitative and qualitative information, it appears that more weight was given to, and subsequent discussions centred upon, the qualitative aspects. It was perceived that much of this qualitative information was created by the audit teams directly. The implication being that a taxpayer's attempt to challenge the qualitative information is effectively challenging the audit team. This may create conflict where either the qualitative information is not independently reviewed or is selectively ignored by audit staff.
3.263 Stakeholders also highlighted the need for the ATO to provide more information, in addition to the letter, about the reasons for specific risks or concerns. The benefits of taking such an approach are that the taxpayer may better understand the nature of the concerns in addressing these.
3.264 Certain stakeholders have also raised delays in issuing these letters, with some taxpayers indicating that they have not received them at all despite ATO senior management's intentions.
3.265 An ATO internal audit also analysed a sample of RDF notification letters to determine the average duration between the moderation panel process and the issuance of the RDF letters. The sample identified an average of 188 days, indicating that delays in issuing the letters would reduce their impact as a taxpayer engagement tool. The internal audit anticipated that such delays would improve as a result of shifting the letter notification process from a project to a business-as-usual process. It also recommended reviewing the internal letter approval process to remove non-essential steps and aligning it with 'other natural events during client engagement'.262
3.266 As a consequence of the IGT's LB&I Review263, there have been some improvements to the structure, content and manner of the delivery of the notification letter. There is, however, further room for improvement given the level of stakeholder concern raised in this current review.
3.267 The ATO's position is that the RDF notification letter provides an 'initial stance', or opinion of the taxpayer.264 A senior executive contact officer is available to discuss the categorisation. Furthermore, the ATO has advised that compliance officers should be discussing the risk factors with tax managers before the notification letter is sent to the taxpayer such that there should be 'no surprises' in the letter.265
3.268 Notwithstanding this ATO 'initial stance' approach, the IGT considers that there are a number of factors that undermine this characterisation, giving the RDF letters a sense of finality.
3.269 First, the risk categorisation process, which includes the moderation panel, indicates that significant ATO resources are used to determine the risk categorisation as well as aspects of the notification letter's potential tone and content.
3.270 Second, the ATO undertakes an internal forty-step process in drafting the RDF notification letter, indicating significant ATO resources are used to produce the letter itself. However, concerns were expressed that taxpayers are not consulted during either of these two stages of deliberation.
3.271 Third, the ATO's expectation that compliance officers discuss with tax managers the impending notification letter appears to be a general one. Accordingly, it is understandable that taxpayers and tax managers may feel surprised by its content.
3.272 Fourth, sending the letter to the board members (such as the CEO) of higher consequence taxpayers elevates the importance of the letter well beyond that of 'initial stance' and this is essentially by design:
Our advice has focused the attention of senior executives and Boards on tax matters and has heightened interest in the ATO's view of their relative tax risk. Taxpayers identified as 'higher risk' are talking to us about things they can do differently and 'key' taxpayers want to know how they can maintain their ratings.266
3.273 Fifth, tax managers have indicated that they had little opportunity to have the letter or categorisation revisited before they are sent to the CEO or the board. Some reported that the notification letter was sent to the tax manager as a courtesy, shortly before being sent to the board, and that the tax managers had insufficient opportunity to address their concerns or correct factual errors in the letter.
3.274 The IGT considers that the current features of the notification process suggest that the letter is effectively a form of administrator's opinion of the taxpayer which goes beyond an 'initial stance'.
3.275 In the IGT's view, some changes to the ATO approach would engender greater mutual transparency and assist taxpayers to better understand the reasons for the ATO's concerns. A more effective consultation process would provide a better basis to identify risks and develop appropriate compliance action. Affording due process to tax managers may be better achieved by greater consultation before the issuance of the RDF notification letter, rather than after it.
3.276 Firstly, the IGT believes that the completion of the template should be a point at which the ATO compliance team develops and sends a risk report to the taxpayer. Such a risk report would be the template itself or one that effectively mirrors the contents of the template. The risk report should share the ATO concerns with respect to inherent risks, behavioural risks and information confidence and cost. The report would include the evidentiary basis for these risks including relevant risk filter output.
3.277 Second, the tax manager should be given an opportunity to correct any factual errors within the report and to discuss the ATO's concerns. During this dialogue, the ATO should explain how the risks relate to any potential ATO compliance activity. Even where there is disagreement about a particular risk issue, there should be sufficient engagement to enable the taxpayer to fully understand the ATO's opinion and the reasons and evidence for it.
3.278 Third, once the ATO and tax manager have reached a shared understanding of the evidentiary basis for the risk assessment and its implications, the risk categorisation is subject to the moderation panel process.
3.279 Fourth, the ATO may undertake an internal development process to author and send the RDF notification letter to the CEO. Such a letter would be the product of thorough taxpayer consultation, rather than a purported initial stance.
3.280 This proposed process offers the following advantages:
- tax managers are given adequate notice about the ATO's concerns and provides an opportunity to address them in real-time;
- the ATO can take into account tax managers' concerns before finalising and communicating the risk categorisation;
- it removes potential errors from the template;
- it provides early agreement on facts and narrows the scope of potential disagreement;
- improved relationships through open dialogue;
- distinguishing between ATO perceptions of inherent risk factors and behavioural risk factors of the taxpayer avoiding unnecessary perceptions of a lack of professionalism or competence of the tax manager or indeed of the ATO itself;
- it builds on the ATO's expectation that compliance teams communicate with tax managers in the lead up to the RDF categorisation process to ensure 'no surprises'; and
- it addresses timeliness concerns, since the ATO has engaged the taxpayer throughout the process, before the letter has been issued.
3.281 This consultative approach could also take into account the various communications and activities that the ATO already undertakes. For example, the letter could:
- align the ATO's specific taxpayer compliance concerns with those expressed in the ATO's Compliance in focus 2013-14 publication;
- reflect any recent activity from current or concluded PCRs or ACAs; and
- align with any protocols, frameworks or communication that were generated as part of implementing the TAP.
3.282 A transparent risk assessment system would enable the ATO to communicate its concern at an early stage and allow the taxpayer to understand the risk hypotheses more readily. Unnecessary or unduly onerous escalation by the ATO to CEOs or boards may be seen as an inefficient use of resources.
3.283 If the taxpayer and ATO together are able to address concerns collaboratively, then the IGT considers this to be a desirable outcome of the process.
3.284 The increased level of interaction between higher consequence taxpayer and the ATO is conducive to the above approach. In relation to lower consequence taxpayers, it may not be possible to strictly follow such an approach because of the less intensive level of ATO/taxpayer engagement. However, the underlying principles remain the same in both scenarios and should be observed.
The IGT recommends that the ATO improve the RDF notification letter process for higher consequence taxpayers by:
- providing tax managers with a draft risk report;
- having a dialogue with tax managers to address any factual errors and discuss the ATO's concerns;
- having the risk report subject to a moderation process after this dialogue;
- preparing the RDF notification letter by:
- taking into account previous dialogue with the tax manager;
- reflecting any recent ATO compliance activity, such as current or concluded PCRs or ACAs;
- aligning it with any protocols or frameworks generated as part of implementing the TAP; and
- including a roadmap for expected or likely ATO compliance requirements regarding specific concerns; and
- upon finalising, sending the RDF notification letter to the CEO.
The ATO's large business RDF approach continues to evolve and we continue to consult with business each year with a view to enhancing the RDF process.
Stakeholder concern — proportionality of ATO compliance approach
3.285 Stakeholders have raised concerns that, despite their lower risk categorisation, they have experienced ATO compliance activities whose intensity and frequency were more commensurate with higher risk taxpayers. Several stakeholders observed that, although they were categorised as a key taxpayer (Q2), they appeared to be treated as if they were a higher risk taxpayer (Q1).
3.286 A similar sentiment was expressed in relation to a taxpayer who had been given a medium risk (Q3) rating. Another view expressed by a professional advisor was that Q1 taxpayers appeared to receive consistent treatment, but Q2 clients appeared to receive inconsistent treatment as between themselves.
3.287 Certain professional advisors observed that, in their opinion, the ATO did indeed treat Q1 and Q2 taxpayers differently in an overall sense. However, there were situations where the level of compliance intensity appeared to be inconsistent with that suggested by the original framework. There seemed to be changes in the ATO's approach from the original model that were not communicated. Some argued that the ATO needs to explicitly sub-divide the key taxpayer quadrant (Q2) to allow for a meaningful differentiation in that segment and communicate this properly to reflect what the ATO actually do in practice.
3.288 Additional concerns include that the ATO has been moving some taxpayers from higher risk (Q1) to key taxpayer (Q2) as a means of allaying those taxpayers' concerns, but are in fact still treating some of these taxpayers as higher risk taxpayers.
3.289 The overarching concern for stakeholders appears to be that, if the taxpayer did not perceive that a lower risk rating would result in a less intense ATO activity (and hence lower overall taxpayer compliance costs), the purported incentives that the ATO were offering in relation to the taxpayer were at best illusory and at worst misleading.
3.290 The extent to which the taxpayer's risk categorisation is seen to follow the ATO's stated intentions regarding a specific compliance approach is vital in creating incentives for taxpayers and for them to make informed choices.
3.291 Stakeholders have also observed that risk reviews and audits are two distinctly different compliance activities, requiring different skill sets from ATO officers. Concerns were expressed that compliance staff often took an 'audit approach' when undertaking risk reviews. By way of example they would seek to vouch for transactions or facts, rather than taking a risk-based approach and asking the right questions. The result being that risk reviews continued longer than required and with an intensity that went beyond that of a risk-based approach, which was more akin to an audit.
3.292 Stakeholders have also perceived that the ATO does not use a 'funnelling' approach to information gathering, but rather adopts a 'gather all evidence' approach early in the risk review process, driving up compliance costs. The suggestion is that the gathering of all evidence upfront is inconsistent with a risk-based approach and is not a proportionate compliance approach.
3.293 It is useful to consider the relevant ATO material against the above stakeholder concerns.
3.294 The ATO has indicated that the LBTC booklet and the LBAC manual are the main guidance materials when determining what compliance approach to take. In particular, the LBTC booklet states:
For income tax, we support the real-time compliance approach applied to higher consequence taxpayers through the use of a pre-lodgment compliance review.267
3.295 With respect to higher consequence taxpayers, the LBAC manual states:
Because of their importance in the system the ATO manages tax risks for higher consequence taxpayers (those we have categorised as key taxpayer or higher risk) using real-time tailored approaches. We encourage key taxpayers to enter into an ACA as a way of providing real-time, practical certainty and of reducing disputes and compliance costs.
For those higher consequence taxpayers not in an ACA, the ATO uses PCRs [pre-lodgement compliance reviews] and risk filtering to detect what risks may exist and if any of these require further treatment such as encouraging a ruling or progressing to an audit.
For higher risk taxpayers, the PCR is in the form of a continuous review. We are more likely to be involved in a comprehensive audit of past years and have other intensive risk analysis approaches underway.268
3.296 With respect to lower consequence taxpayers, the LBAC manual states:
For most lower consequence taxpayers (those categorised as lower or medium risk), the ATO undertakes internal review processes, monitoring, questionnaire, risk reviews or where we are more certain a risk exists, audit activity. For taxpayers categorised as medium risk we generally undertake targeted activities to confirm (detect) and deal with identified tax compliance concerns. These activities are more likely to be reviews and audits than questionnaires.
For lower risk taxpayers we may seek to clarify any concerns that arise out of our internal review processes or monitoring through activities such as requesting targeted information about specific issues (such as via a questionnaire) and visiting the taxpayer.269
3.297 Additionally, the ATO has published a fact sheet called Real-time compliance engagement approach for higher consequence taxpayers in the large market.270 This publication and the LBAC manual indicate that all higher consequence taxpayers should expect a PCR if they are not in an ACA. This is regardless of their ATO assessed likelihood rating, that is, whether they are key taxpayers or higher risk taxpayers.
3.298 For higher consequence taxpayers, therefore, the ATO takes a compliance approach which is consistent with the taxpayer's risk profile, resulting in the 'tailoring' of the PCR product. The LBAC manual states:
a level of intensity aligned with the taxpayer's positioning within the RDF — this requires flexibility in the application of the review.
Taking a flexible or tailored approach
The PCR, because of its nature and timing, will be heavily influenced by factors not normally encountered in other risk or audit products. While the PCR framework will be in a standard format, the product is flexible and needs to be tailored for each taxpayer. This provides the case officer and the team with the ability to consider different approaches to how the PCR will be undertaken.
It is the case officer, together with their team leader or technical leader, who will be most involved in gaining an understanding of their taxpayer and their transactions. The case officer should be proactive in ensuring that the PCR product works as efficiently as possible for both the ATO and the taxpayer.271
3.299 Furthermore, the ATO has additional internal guidance material for ATO officers when conducting PCRs, the Pre-lodgment compliance review framework guide for higher consequence taxpayers.272
3.300 This guidance indicates that the PCR is to be implemented with a level of engagement and intensity commensurate with the taxpayer's level of relative risk.273
3.301 The guide's framework for intensity makes a distinction between four types of taxpayers:
- key taxpayers with an ACA (2);
- key taxpayers without an ACA and with no concerns (51);
- key taxpayers without an ACA and with concerns or with significant concerns (30); and
- higher risk taxpayers (7).274
3.302 The guide makes the following observations about these groups of taxpayers:
Higher consequence taxpayers that fall into the first two categories will generally find similarities in terms of our approach to engagement and intensity. Higher consequence taxpayers that fall into the last two categories will generally find similarities in terms of our approach to engagement and intensity.
If the compliance team's intended approach and level of intensity changes materially during the life of the PCR, the PCR framework will need to be revised and re-issued to the taxpayer.275
3.303 The guide's appendix sets out how these four groups would be approached by the ATO in terms of:
- The level of information required from the taxpayer to give assurance to the ATO about a particular risk.
- The frequency with which information is requested of the taxpayer.
- The likelihood the ATO will use its formal information gathering powers.
- The likelihood the ATO will seek details of decisions made by key decision makers or committees.
3.304 Lower consequence taxpayers are not subject to real-time, continuous monitoring. Rather, the ATO usually conducts compliance activities as and when risks emerge through the ATO's internal processes. This is usually the result of the taxpayer triggering the risk filters and subsequently being the subject of a recommendation by a risk manager for review in relation to that specific risk.
3.305 Once a risk recommendation is made the taxpayer's case is workshopped by the CSSC who decide on the pool of cases for compliance activity. These compliance activities are typically risk reviews. The process for conducting the risk review is set out in the ATO's LBAC manual.
3.306 As already mentioned, the IGT supports best practice risk management principles as a general proposition. The application of ATO resources should be proportionate to the relative risk. This is generally adopted as an enterprise wide concept in commerce as well as many public organisations.
3.307 The IGT considers that it may be difficult for taxpayers to understand whether or not particular ATO compliance action is appropriately differentiated.
3.308 The explicit use of the RDF to categorise taxpayers may have caused taxpayers, who previously had modest ATO contact, to now receive considerably more contact. The IGT is of the view that such a change of itself does not necessarily indicate that the ATO compliance approach is disproportionate to their relative risk level where those ratings opinions have been reasonably expressed and communicated to taxpayers. Indeed, it has also been suggested that it may be better to know what the ATO perceptions are so that one has the opportunity to address them.
3.309 The IGT is of the view that one of the main sources of contention in this area is the ATO's ability to reasonably and transparently determine and communicate their opinion of the taxpayer's relative risk. As described in the background, the RDF only makes a distinction between key taxpayer and higher risk taxpayers for higher consequence taxpayers. Furthermore, the RDF notification letter only provides those categorisations.
3.310 Nevertheless, as indicated in the moderation panel documents, and the PCR framework guidance documents, the ATO now sub-divides the key taxpayer quadrant into three different sections:
- no concerns;
- some concerns; and
- significant concerns.
3.311 Whilst the ATO compliance approach may on one view be proportionate to the perceived risk level, the risk levels that the ATO are relying upon to develop these approaches are not explicitly communicated to the taxpayer.
3.312 For example, some previously higher risk taxpayers that are now key taxpayers may in fact be 'key taxpayers with concerns/significant concerns'. However, the taxpayer is unaware of this more recent sub-categorisation and may explain why they may be receiving a level of scrutiny beyond their expectations.
3.313 The IGT is of the view that the ATO's use of the RDF framework should be properly reflected in their various publications and communications to taxpayers. The notification letter, by way of example, should explicitly contain the key taxpayer sub-categorisation, in addition to any content addressing particular concerns. By making the sub-categorisation explicit, taxpayers will have a better understanding of the ATO's opinion of level of relative risk and expected compliance approach.
3.314 As discussed in paragraph 3.276, there is scope to provide taxpayers with more specific information about particular risks and the relative risk as compared to other taxpayers. Such information will also assist ATO compliance teams to better understand the risk hypotheses used as a starting point for subsequent ATO compliance actions.
3.315 In this respect, the LBAC manual highlights the importance of the risk hypothesis:
By using a risk-hypothesis-based approach, the ATO can:
- focus resources where they are most needed,
- adjust for or adapt to new information received and or new risks identified, and
- decide whether there are any tax risks requiring further investigation and determine an appropriate response.
A clear risk hypothesis is very important when involving others in the compliance activity. The taxpayer and ATO experts can contribute more efficiently through an early engagement strategy where the risk hypothesis is clearly stated.
For this reason it is essential that taxpayers are informed of the risk hypothesis at the start of the case and at each point it materially evolves or is refined.276
3.316 The IGT is of the view that targeted information requests during risk reviews are one way that the ATO can tailor their compliance response to the risks posed by the taxpayer. By ensuring that information requests are targeted only to those risk hypotheses that have been raised during the internal risk processes, taxpayer as well as ATO compliance costs can be minimised.
3.317 This is consistent with the observations made in the IGT's LB&I Review, including Recommendation 8.2 of that review.277
3.318 The IGT understands that another source of concern arises from the fact that some key taxpayers have been the subject of audits. The ATO advises that these audits are in relation to prior year (or 'legacy') issues and that the RDF categorisation is relevant for the ATO's current view of the taxpayer's risk in real-time. Whilst the LBTC booklet highlights post-lodgment reviews for higher consequence taxpayers may take place to 'manage a post-lodgment legacy year as part of a transition strategy into real time278', it does not make the same statement in relation to audits. For completeness, the ATO should update the LBTC booklet to reflect this approach.
Pre-lodgment Compliance Reviews (PCR)
3.319 In terms of higher consequence taxpayers, the ATO has indicated in their Real-time compliance engagement approach for higher consequence taxpayers in the large market fact sheet that such taxpayers will all be subject to a PCR if they do not have an ACA.
3.320 As previously mentioned, it is important for taxpayers to perceive benefits in a lower risk categorisation, such as lower compliance costs, to provide an incentive to adopt behaviours desired by the ATO. The broad application of the PCR, to all higher consequence taxpayers without an ACA, seems to taxpayers to undermine such a proportionate approach. However, the ATO intends to achieve a proportionate approach through the 'tailoring' of the PCR product in accordance with the LBAC manual (publicly available), and the PCR framework guide (ATO internal document).
3.321 Whilst the PCR framework guide is indicative of the spectrum of risk, including the concept of key taxpayers with 'no concerns, some concerns and significant concerns', the framework itself appears to place key taxpayers with some concerns and key taxpayers with significant concerns in one category. This may reduce the effectiveness of the guide in facilitating tailored PCR approaches for key taxpayers.279
3.322 Previously in relation to PCRs, in the IGT's Self Assessment Review, the ATO agreed to:
... develop and implement procedures to periodically consult with relevant consultative forums and the community to review the information required on company and individual income tax returns and associated schedules as well as the information requested as part of pre-lodgment compliance reviews and annual compliance arrangements.280
3.323 The ATO also agreed, as part of the above review, to publish more information about the conduct of PCRs through additional information in an updated LBTC booklet.281 The 2012 version of the LBTC booklet contains a 'what we will do and what we expect from you' section in relation to PCRs. Furthermore, additional information about the conduct of the PCR is available in the publicly available LBAC manual.
3.324 With respect to proportionality, the LBAC manual states:
Level of intensity
The level of intensity is not a static concept and can change depending on key aspects. It is relative to the taxpayer's:
- RDF categorisation
- level of sustained cooperation
- level of transparency and willing participation.282
3.325 The IGT is of the view, however, that taxpayers may gain greater confidence in the proportionality of the tailored PCR, if the ATO, among other things, made the PCR framework guide publicly available as part of the LBAC manual or LBTC booklet as appropriate.
3.326 Furthermore, the PCR if conducted appropriately represents an opportunity for the ATO to have ongoing dialogue with higher consequence taxpayers in a manner which affords natural justice, assists taxpayers to make informed choices about their risks and ensures the ATO approach is proportionate to those choices. Such benefits may only be realised if the PCR is conducted as a consultative activity and not merely as another information gathering activity.
3.327 To illustrate this view, consider the following example. As discussed above and consistent with Recommendation 3.9 above, rather than the RDF notification letter going directly to the CEO of the taxpayer, the letter can serve as an opportunity for the ATO to share its risk perspectives with the tax manager. These include an explanation of the ATO's opinion on the taxpayer's inherent risks, behavioural risks and information confidence and cost levels and the evidentiary basis for such an opinion. This may include information about particular taxpayer risks, how they compare with others in the market and/or information from the risk filters. It may also include information sourced from the RTP schedule and IDS and the ATO's views on those disclosures.
3.328 In the above example, the tax manager can test the evidence and better understand the ATO's proposed approaches in light of those risks. Where the ATO's primary concern is about information confidence and cost, the ATO's subsequent PCR approach may focus on formal information gathering, unless the taxpayer opted for more real-time disclosure.
3.329 Alternatively, where the ATO is primarily concerned about the inherent risks, the ATO's subsequent PCR would focus on ensuring the taxpayer has adequate tax risk management arrangements in place to mitigate those inherent risks.
3.330 A letter may then be sent to the CEO setting out these approaches. The taxpayer is then in a position to make an informed choice as to how they will engage with the ATO over the coming year and select the most appropriate engagement option.
3.331 The PCR may then commence on a basis of consultation and differentiation. At the end of the PCR process, the ATO may review the year with the tax manager. Such a consultation may form the basis of the next risk template. Figure 14: Potential integrated PCR process below outlines this approach and incorporates the approach described in Recommendation 3.9.
3.332 The IGT also notes that the PCR elements suffer the same difficulties in application that the RDF does regarding notions of sustained cooperation, level of transparency and willing participation as noted earlier in the chapter.
3.333 The ATO's internal audit team found that there were opportunities for the template, TAP and PCR plans to be streamlined and to make the relationship between these documents clearer.283
Figure 14: Potential integrated PCR process
The IGT recommends that the ATO:
- make the pre-lodgment compliance review (PCR) framework guide publicly available as a part of either the large business compliance manual or large business and tax compliance (LBTC) booklet;
- disclose the risk categories more fully, including any sub-categorisations of the key taxpayer segment, in RDF notification letters and in the LBTC booklet;
- ensure that the compliance burden of PCRs are graduated according to differing levels and mixes of inherent risk, behavioural risk and information confidence and cost factors; and
- update the LBTC booklet to indicate that audits may still be applicable to manage legacy issues even where the taxpayer is a key taxpayer.
124 Pappas Carter Evans and Koop, Review of the Large Case Program: Australian Taxation Office (Boston Consulting Group, 1992).
125 Ibid p 8.
126 Peter Grabosky and John Braithwaite, Business regulation and Australia's future (Australian Institute of Criminology, 1993) p 238.
127 Leigh Edmonds, Working for all Australians: A brief history of the Australian Taxation Office 1910 - 2010 (Australian Taxation Office, 1st ed, 2010) pp 199 - 228.
128 Australian Taxation Office, Cooperative Compliance: Working with large business in the new tax system (2000).
129 Ibid p 21.
130 Australian Taxation Office, Commissioner of Taxation Annual Report 2003-04 (2004) p 139.
131 Glenn Williams and Emily Marsden, 'Tax risk and corporate governance: The ATO's growing interest in taxpayer self risk management' (Paper presented at the Corporate Tax Masterclass (Tax Institute of Australia), Sydney, 30 October 2012).
132 IGT, above n 122, recommendation 4.1.
133 Ibid recommendation 4.2.
134 Ibid para [4.19].
135 IGT, above n5, recs 3.5 and 3.6.
136 Ibid para [3.84].
137 IGT, above n 122, recommendations 4.2, 4.3, 5.1, 6.1, 6.2, 7.3 and 9.1.
138 ATO, above n 63, p 25.
140 Mark Konza, 'Our compliance approach in the large market', (Speech delivered at the Tax Institute's 28th Annual Convention, Perth, 13 March 2013).
141 ATO, above n 63, p 25.
142 Ibid p 26.
143 Ibid p 26.
144 Ibid pp 25-26.
145 Michael D'Ascenzo, 'Colours to the mast', (Speech delivered at the Corporate Tax Association Convention, Sydney, 15 June 2010).
146 Mark Konza, 'A world without audits', (Speech delivered at the Thompson Reuters Annual User Conference Sheraton on the Park, Sydney, 17 October 2011).
147 Konza, above n 108.
148 ATO, above n 63, p 25.
149 Australian Taxation Office, Higher Consequence Taxpayer Risk Categorisation Template instructions, page 12.
150 Ibid page 15.
151 CGT and Losses does not have a risk hypothesis;; TOFA has only a basic risk hypothesis; Private equity has no risk hypothesis; Transfer pricing does not have evidence gathering questions; R&D Concessions do have not evidence gathering questions; Tax havens has limited guidance.
152 ATO, above n 63, p 11.
153 ATO, above n 149, page 23.
154 Ibid page 26.
156 Australian Taxation Office, Internal Audit Communications Update 14 May 2013, page 5.
157 Australian Taxation Office, Access to 'corporate board documents on tax compliance risk', PS LA 2004/14, 1 July 2006, para .
158 Ibid para .
159 Ibid para .
160 Ibid para .
161 Ibid para .
162 Australian Taxation Office, LB&I Risk and Intelligence Committee Charter, January 2012.
163 Australian Taxation Office, LB&I Case Selection Process August 2012.
164 Australian Taxation Office, Large Market Income Tax RDF Moderation Panel Charter October 2012.
170 Australian Taxation Office, RDF Moderation Panel Minutes - 14 June 2012.
171 ATO, above n 63, p 5.
175 ATO communication to IGT, 23 November 2012.
176 ATO, above n 163.
177 ATO, above n 175.
178 ATO, above n 163.
180 Australian Taxation Office, Case Selection Sub-Committee Workshop Documents December 2012, page 7.
181 Ibid page 25.
182 Ibid pp 8-9 .
183 ATO, above n 63, p 5.
184 Konza, above n 146.
186 ATO communication to IGT, 15 February 2013.
187 Australian Taxation Office, RDF Notification Letter Process.
188 Australian Taxation Office, RDF Moderation Panel Minutes 14 June 2012.
190 Australian Taxation Office, Real-time compliance engagement approach for higher consequence taxpayers in the large market fact sheet (15 February 2013).
191 Quigley, above n 88.
192 Australian Taxation Office, Taxpayer assurance planning guide for higher consequence taxpayers July 2011.
193 Ibid page 5.
194 Ibid page 14.
195 Ibid page 16.
196 Ibid page 27.
197 Australian Taxation Office, Higher Consequence Taxpayer Risk Categorisation Revision: Revision of the 2012 Higher Consequence Taxpayer Risk categorisation template and related processes with the purpose of improving annual taxpayer categorisation. Revised 2/10/2012.
198 Ibid Requirement R14 and R4.
199 Ibid Requirement R11.
200 ATO communication to IGT, 19 April 2013.
201 ATO, above n 63, p 25.
202 Australian Taxation Office, Higher Consequence Taxpayer Risk Categorisation 2012, PowerPoint File provided to Internal Audit under Test 1.3.
203 Australian Taxation Office, Final Report - Compliance Intelligence & Risk Management Internal Audit, 13 August 2013, p 15.
204 ATO, above n 149, page 18.
205 ATO, above n 63, p 28.
206 Australia's Future Tax System (Ken Henry, chairperson), The Treasury (Cth), Final Report 2(2) (AGPS, 2009) pp 651-652 and Margaret McKerchar, 'Tax Complexity and its Impact on the Tax Compliance and Administration' (Paper presented at the IRS Research Conference, Washington, 13-14 June, 2007) pp 190-191.
207 ATO, above n 63, p 25.
208 Ibid p 5.
209 Ibid p 25.
210 ATO, above n 189; D'Ascenzo, above n 145; ATO, above n 63, p 25.
211 Australian Taxation Office, Taxpayers' charter - helping you to get things right (2010).
212 The ATO's adoption of the Compliance Model is reflected in Australian Taxation Office, Improving Tax Compliance in the Cash Economy (1998).
213 John Braithwaite, 'Large Business and the Compliance Model'. In Valerie Braithwaite (ed), Taxing Democracy: Understanding Tax Avoidance and Evasion (Ashgate Publishing Ltd, 2003) 177-202, p 179.
214 Australian Taxation Office, Large Business Advisory Group minutes 4 March 2010 (9 July 2010); For the avoidance of doubt, the reference to 'going to the umpire' should be taken as referring to going to the courts as the umpire for independent judicial interpretation of the law.
216 ATO, above n 192, page 10.
217 ATO, above n 63, pp 8 and 32.
218 Konza, above n 108.
219 Konza, above n 140.
220 Australian Taxation Office, Large business active compliance manual - income tax (9 July 2013).
221 ATO, above n 63, p 25.
222 ATO communication with IGT, 28 and 29 August 2013.
225 ATO, above n 223.
226 ATO, above n 223.
228 Konza, above n 108.
229 A more detailed discussion of PCRs is contained later in this chapter.
230 Konza, above n 140.
231 Australian Taxation Office, Access to 'corporate board documents on tax compliance risk', PS LA 2004/14, 1 July 2006, para .
232 ATO, above n 63, pp 8, 30, 32.
233 ATO, above n 149, page 10.
234 Organisation for Economic Co-operation and Development, Addressing Base Erosion and Profit Shifting (OECD Publishing, 2013) p 19.
235 Australian Taxation Office, Large Business RDF - Report to Large Market Committee 16 February 2012, page 1.
236 Australian Taxation Office, '2012 - bright ideas for innovation and 'aha' moments' 'Lightbulb moments for RDF'.
237 ATO, above n 149, page 23.
238 Ibid page 26.
240 ATO, above n 63, p 9.
241 IGT, above n 5, paras [3.94] - [3.95] and [3.97].
242 ATO meeting with IGT, 17 April 2013.
245 See Chapter 7 for more information about the promoter penalty legislation.
246 ATO, above n 239.
247 ATO, above n 63, p 13.
248 ATO email to IGT 4 June 2013.
249 Australian Taxation Office, Annual compliance arrangements - what you need to know (7 June 2013).
250 IGT, above n 122, para [3.17].
251 KPMG, Tax in the boardroom (2005).
252 HM Revenue & Customs, TCRM3310 - The Business Risk Review (BRR): Business Risk Review indicators: General (undated).
255 ATO, above n 180, p 25.
257 Australian Taxation Office, Case Selection Sub-Committee Workshop Minutes, June 2012, p 4.
258 Australian Taxation Office, Case Selection Sub-Committee Workshop Documents, 15 June 2012, p 12.
259 ATO, above n 180, p 8.
260 Australian Taxation Office, LB&I Business Improvement Program, 19 June 2013, internal document.
261 ATO, above n 63, p 25.
262 ATO Internal Audit Communications Update 14/05/2013 page 7.
263 IGT, above n 122, paras [4.35]-[4.36].
264 Quigley, above n 88.
265 ATO, above n 186.
266 Quigley, above n 88.
267 ATO, above n 63, p 29.
268 ATO, above n 220.
270 ATO, above n 190.
271 ATO, above n 268.
272 Australian Taxation Office, Pre-lodgment compliance review framework guide for higher consequence taxpayers, 13 December 2012.
273 Ibid page 4.
274 Numbers are from IGT analysis of ATO Moderation Outcomes for 2012-13. Numbers of ACA taxpayers are noted where ACAs for income are mentioned in the Moderation Panel Outcomes field.
275 ATO, above n 272, page 7.
276 ATO, above n 268.
277 ATO, above n 122, pp 87-112.
278 ATO, above n 63, p 43.
279 Australian Taxation Office, Appendix 1 to Pre-lodgment compliance review framework guide for higher consequence taxpayers, 13 December 2012, see also page 8.
280 IGT, above n 5, p 66.
281 Ibid p 102. It should also be noted that there was a PCR related Recommendation (4.7) about capping penalties and interest for taxpayers subject to these processes. The matter was noted by the Government. 'The Government needs to better understand how the ATO uses these tools to address risk and how they are used to enhance compliance levels and the effect on compliance more generally'. David Bradbury, Assistant Treasurer, 'Inspector-General of Taxation review into improving the self assessment system' (Media Release, 13 February 2013).
282 ATO, above n 268.
283 Australian Taxation Office, Internal Audit Communications Update 14 May 2013, page 6.