Background

7.1 As discussed in the IGT's Self Assessment Review, tax practitioners have an important and significant role to play in Australia's self assessment system.339 Tax practitioners assist taxpayers in managing their tax affairs and have a role in 'ensuring that their clients understand their rights and obligations'.340

7.2 According to the OECD's 2008 Study into the role of tax intermediaries, there is a tripartite relationship between taxpayers, advisors and revenue authorities.341 By engaging advisors and involving them in the compliance process, taxpayer compliance will be enhanced, potentially at a lower cost to the ATO. Each party has a unique set of experiences and a different perspective on issues:

A strategy of positive engagement with tax advisors offers potentially significant benefits to all parties in the tax system. In particular, it can add to revenue bodies' understanding of tax advisors and the role they play in the tax system, as well as improved risk and compliance strategies and better-focussed information requests and dialogue with taxpayers, resulting in reduced compliance costs for all.342

7.3 The ATO has acknowledged the crucial role that tax practitioners play, expressing it in the following manner:

... tax agents (and other intermediaries) are a critical and crucial leverage point as a key intermediary in the tax and superannuation system. There are around 53,000 registered tax practitioners (of which around 23,000 are observed to act on behalf of taxpayers with income tax lodgment obligations) representing over 15 million taxpayers. In a given year, tax agents are responsible for the lodgment of over 90 per cent of business tax returns and over 70 per cent of individual income tax returns.343

7.4 Considering tax practitioners' important role in optimising voluntary compliance of taxpayers, the ATO seeks to encourage desired behaviours and support of the profession. Such support is largely reflected in the ATO's Tax Practitioner Action Plan 2011-15.344 Therefore, the ATO's monitoring of tax practitioners is important in promoting compliance.

7.5 Tax practitioners are also taxpayers themselves. They may be sole traders or part of a small, medium or large business. As taxpayers, they continue to have their own obligations to correctly register, lodge, correctly report their relevant tax information and pay tax liabilities on time. However, unlike other taxpayers, breaches of these obligations may affect their eligibility to practice. Principle 2 of the Code of Professional Conduct requires that tax practitioners 'must comply with the taxation laws in the conduct of your personal affairs'.345 This Code is contained in the Tax Agent Services Act 2009 (TASA).

7.6 Whilst the ATO does not administer the TASA, where ATO compliance activities indicate that persons may be breaching the TASA, (for example, by providing unregistered tax agent services), the matter may be referred to the Tax Practitioners Board (TPB) for action.346

7.7 The TPB is the independent regulator of the TASA including the Code. Whilst independent of the ATO in its decision making and administration of the TASA, the TPB is supported by the ATO and constitutes an ATO program of work under the Government's Portfolio Budget Statements framework.347

7.8 Tax practitioners may also be members of professional associations. These associations have their own standards and requirements for membership. These typically include being a 'fit and proper person', having relevant qualifications, experience and mandating continuing professional development. Any breaches may be subject to disciplinary action or even expulsion.

ATO approaches to tax practitioner risk identification

7.9 During the IGT's Self Assessment Review, the ATO advised that there were three broad approaches to risk identification relating to tax practitioners:

Firstly, there is the question of management of risk, using a Risk Differentiation Framework ('RDF') which considers a variety of factors, including association with particular intermediaries like tax practitioners and/or advisors.

Secondly, there is the assessment of risks for tax intermediaries who may be subject to the promoter penalty laws, where we need to identify whom we focus our intention [sic] upon and how we engage with them in order to manage risks of contravention of the promoter penalty laws. We have consulted extensively with industry and the professions on these issues .

Thirdly, there is the assessment of risks for tax practitioners who serve as an interface with their clients and the ATO, where we need to identify whom we focus our intention [sic] upon and how we engage with them in order to manage risks relating to taxpayer compliance with the four pillars of compliance obligations, being registration, lodgment, correct returns and debt.348

7.10 The first approach mentioned above is considered in Chapter 3 of this report whilst the other two approaches are dealt with below.

Promoter penalty regime

7.11 The ATO has advised that, where the ATO has concerns that a particular tax advisor is promoting contestable schemes, the matter would be referred to the ATO's Aggressive Tax Planning (ATP) business line for further action under the promoter penalty regime.

7.12 The promoter penalty regime took effect from 6 April 2006 when Division 290 was inserted into Schedule 1 of the Taxation Administration Act 1953. The regime seeks to deter:

  • the promotion of tax avoidance and evasion schemes ('tax exploitation schemes'); and
  • the implementation of schemes that have been promoted on the basis of conformity with a product ruling, in a way that is materially different to that described in the product ruling.349

7.13 The Explanatory Memorandum to the Bill which enacted the regime outlines the reasons for the penalties:

3.3 Currently, there are no civil or administrative penalties for the promotion of these schemes, with the result that promoters can obtain substantial profits while investors may be subject to penalties under the TAA 1953. This represents a significant asymmetry in risk exposure.

3.4 Furthermore, the Commissioner of Taxation (Commissioner) cannot currently take legal action to stop the promotion of tax schemes. It is possible to warn investors about the risk that tax benefits will not be available, but educational initiatives have limited 'real time' impact. In contrast, the 'real time' remedies of injunctions and voluntary undertakings in this Bill can stop the promotion of schemes before investors participate.350

7.14 In relation to the alleged promoter, the regime allows the Commissioner, to:

  • ask the Federal Court to apply civil penalties;
  • ask the Federal Court to issue an injunction preventing promotion of the scheme;
  • accept voluntary undertakings; and
  • where the Commissioner considers that the terms of the voluntary undertaking have been breached, to ask the Federal Court to make orders directing compliance with the undertaking or other appropriate orders.

7.15 The ATO has issued public guidance on how it manages the risk of non-compliance with the promoter penalty regime in April 2008 through the publication of PS LA 2008/8 Application of the promoter penalty laws (Division 290 of Schedule 1 to the Taxation Administration Act 1953) to schemes involving product rulings.

7.16 Furthermore, the publication Good governance and the promoter penalty laws (Good Governance), first published April 2011, outlines the areas that currently concern the ATO and highlights the importance of a taxpayer exercising good governance to reduce the risk of non-compliance. A second edition was published in December 2012. This publication also uses a form of 'risk bow-tie':

Figure 18: Risk bow-tie for promoter penalty laws

Graphic explaining the risk 'bow-tie' for promoter penalty laws.

View image enlarged

Source: ATO, Good governance and promoter penalty laws 2012, page 15.

7.17 The risk bow-tie highlights that the risk event to be prevented is the contravention of the promoter penalty laws. This can be contrasted with the usual application of the risk bow-tie to the tax laws, where the risk events relate to registration, lodgment, reporting and payment.

7.18 Importantly, the definition of the risk event focuses the ATO's attention on the risk hypothesis that it is seeking to test when undertaking compliance activity under the promoter penalty regime.

7.19 The ATO has also indicated that it uses a risk differentiation framework with respect to managing the risk of non-compliance with the promoter penalty laws:

Figure 19: RDF for intermediaries — promoter penalty laws

Diagram showing the risk differentiation framework for managing the risk of non-compliance with the promoter penalty laws.

Source: ATO, Good governance and the promoter penalty laws 2012, page 4.

7.20 According to the Good Governance publication, the ATO takes the following approach with respect to advising intermediaries of their risk rating:

  • Higher risk intermediaries:

We notify such entities of their preliminary risk rating when we start a review or investigation of their conduct and their final risk rating at the completion of their case.351

  • Key intermediaries:

We notify such entities that they are key intermediaries as part of our regular engagement processes, unless our interactions indicate that they have moved to another category.352

  • Medium risk intermediaries:

We notify such entities of their preliminary risk rating when we start a review or investigation of their conduct and their final risk rating at the completion of their case.353

  • Lower risk intermediaries:

This category contains the vast majority of tax intermediaries so we do not ordinarily advise such entities of their risk rating, unless our monitoring indicates that they have moved to another category.354

7.21 The ATO also provides some detail of its compliance activities in this area in its Annual Report:

We reviewed the conduct of 529 entities that were potentially involved in arrangements contravening the promoter penalty legislation, resulting in liabilities of $29.3 million being raised.

In relation to those entities which had a higher likelihood of contravening the promoter penalty laws, we undertook a mixture of promoter penalty action and audits of their personal tax affairs. We also initiated six proceedings in the Federal Court involving potential contraventions and executed a number of voluntary undertakings where less significant risks were demonstrated.

We engaged with industry, advisory firms and financial institutions about their involvement in financial products and contentious tax planning arrangements. We also undertook governance visits with 27 key intermediaries to examine how they manage their promoter penalty risks. These engagement activities resulted in:

  • improvements in their governance processes
  • an increase in the numbers of applications for product rulings
  • immediate changes to features in products
  • withdrawal of some products from the market and some entities ceasing trading entirely
  • negotiation with product issuers to pay tax-related liabilities of affected investors by way of third-party settlement deeds.355

IGT observations

7.22 The IGT has received limited stakeholder representation with respect to the administration of the promoter penalty regime. This may be due in part to a much reduced level of scheme activity or ATO activity.

7.23 The ATO's RDF approach for tax intermediaries in relation to the promoter penalty laws has been public since 2009.356 The ATO's action in this area has been cautious with only one court case initially decided against the ATO but subsequently decided in favour of the ATO upon appeal.357 The ATO also notes that several voluntary undertakings have been provided.358

7.24 The ATO takes a differentiated approach to communicating risk categorisations to tax advisors depending on their categorisation. As such, those advisors categorised as lower-risk or medium-risk would not necessarily receive a risk categorisation on a regular basis.

7.25 The IGT understands that this approach may generate a degree of uncertainty for these intermediaries. Such uncertainty about the ATO's view of their risk level is partly ameliorated by the publication of the risk factors in the Good Governance publication. This allows the intermediary to self-assess their risk to a certain degree. Importantly, this is a specific legislative regime where the ATO is empowered to take action that has a high bar and is publicly transparent.

Tax Practitioner RDF

7.26 In its Compliance Program 2012-13, the ATO has indicated that it is using 'a differentiated approach':

Our focus is on enhancing the ability of tax practitioners to promote proper participation in the tax and superannuation systems, and to create a level playing field for tax practitioners by dealing with those who don't meet the high standards of the profession.

We recognise that the great majority of tax practitioners do a good job of ensuring that their clients properly participate in the tax and superannuation systems.

At the same time, a small minority of tax practitioners struggle, lacking the expertise or resources to meet the business needs of their client base. Others lack the commitment to ensure the full participation and compliance of their clients in the tax and superannuation systems.

Our risk profiling indicates that across a range of different risks, around 90 per cent of tax practitioners have a high proportion of clients that are mostly compliant. Through our initial consultative processes with key tax practitioners we have seen best practices that support clients in getting it 'right from the start'. On the other hand, 8-10 per cent of tax practitioners have higher proportions of clients who are struggling to meet their obligations, and a further 1 per cent have a significant proportion of clients that are at risk of non-compliance across multiple areas of their tax and superannuation obligations.359

7.27 The ATO is seeking to differentiate their approach to tax practitioners, according to the perceived 'riskiness' of their clients. The ATO is of the view that it can influence a larger number of higher risk taxpayers by interacting with a smaller number of tax agents. For example, in 2011-12, the ATO visited about 800 tax practitioners whose clients 'had a high risk of under reporting cash income'.360

7.28 The ATO has also framed this approach as an adoption of the RDF. This approach currently considers the risk of specific types of taxpayer non-compliance. These areas are:

  • income tax lodgment performance (non-lodgment and late-lodgment);
  • income tax return integrity issues;
  • work-related expenses behaviour;
  • under reporting of income in cash-based industries; and
  • client debt profiles.

7.29 After the above analysis, the ATO has identified 1-2 per cent of tax agents as being higher risk tax agents. These agents account for 6-10 per cent of represented taxpayers. The figure below highlights this division (a larger version is reproduced in Appendix 11). The ATO's Compliance in focus 2013-14 document states that it plans to engage with 100 tax practices in 2013-14 using the risk differentiation approach.361

Figure 20: ATO RDF for Tax Practitioners

Chart showing the risk differentiation framework for tax practitioners.

View image enlarged

Source: ATO, supplied to IGT October 2013.

7.30 The ATO has also communicated aspects of the tax practitioner RDF at various tax agent consultative forums in 2012.362 The tax practitioner RDF is also briefly mentioned in the September 2012 issue of the ATO's TAXAGENT magazine.363

IGT observations

7.31 The ATO's approach to risk differentiation for tax practitioners is relatively new and their compliance approaches are currently developing. In his Self Assessment Review, the IGT expressed some reservations about the application of an RDF to tax practitioners and proceeded to recommended that:

The ATO should continue consultation with the tax profession to identify strategies to achieve a more constructive relationship. Such consultation should include discussions on whether the use of a risk differentiation system is appropriate and if so how it should be implemented.364

7.32 Once the ATO's Tax Practitioner Action Plan 2011-15 has been further bedded down, the above fundamental issue, of whether an RDF should be applied to tax practitioners, may be further explored in a potential review on the current IGT work program, namely: the Review of the ATO's Services and Support for Tax Practitioners.

7.33 The discussion that follows, therefore, focuses on improvements that can be made to the tax practitioner's RDF as it currently stands. Once fully developed, further improvements to it may be considered in the above potential review.

7.34 The IGT notes that the ATO has communicated generally among tax practitioners about the use of the RDF. The minutes to the NSW Regional Tax Practitioners Working Group (RTPWG) April forum indicate that the ATO:

… is introducing a risk differentiation framework for registered agents to assess the perceived risk posed by registered tax and business activity statement (BAS) agents. As part of this framework, the ATO will design a corporate engagement strategy, aligning resources to the perceived risk of the registered agent.

… The ATO will be developing and utilising two frameworks this year:

  • the perceived risk of the registered agent as a taxpayer
  • the perceived risk of the registered agent's practice.365

7.35 The IGT observes, that where the ATO is assessing the risk of the registered agent as a taxpayer, the risk hypothesis it is seeking to test should be clear and related to effective:

  • registration;
  • lodgment;
  • reporting; and
  • payment.

7.36 Where the ATO is assessing the risk of the registered practitioner's practice, the ATO also needs to clearly articulate the risk hypothesis. By way of example, the risk bow-tie used in the promoter penalty regime describes the risk event in the centre of the bow tie, along with measures to deter and deal with potential non-compliance.

7.37 As noted in other contexts, it may be helpful for tax practitioners, as well as ATO staff, to ensure the risk event under the tax practitioner RDF is clearly articulated, so as to focus the nature of the ATO's enquiries.

7.38 The tax practitioner RDF primarily differentiates their approach to tax practitioners based on the risk profile of their clients. This seems to be the reverse of the perception that the risk rating of taxpayers (particularly those in the large business segment) is partly influenced by the advisors they choose as explained in Chapter 3. This does seem to be circular and supports Recommendation 3.6 of this report, that is the choice of advisor should not impact on a taxpayer's risk rating.

7.39 Whilst the risk inputs, being the risk profile of the clients of the tax practitioners, may be a useful method of initial identification of higher risk practitioners, the IGT believes that care needs to be taken to ensure risk modelling is appropriately augmented by follow-up and qualitative analysis. This is because the risk assessment of clients themselves may have a degree of inaccuracy. For example, in the ATO's Compliance Program 2011-12, the ATO said:

Most businesses are within benchmark and most registered agents have clients operating within benchmark. We have identified that about 50 per cent of those businesses falling outside benchmark are represented by about 1,900 registered tax agents.

We will contact registered tax agents with a high number of clients whose results fall outside benchmarks to gain an understanding of why this is the case.366

7.40 As part of his Review into the Australian Taxation Office's Use of Benchmarking to Target the Cash Economy, the IGT made the following observation:

As correspondence audits have a strike rate of 24 per cent this may suggest that a higher variance from the benchmark does not necessarily, of itself, indicate likely underreporting of income. This is not to say that the variance from the benchmark is ineffective at targeting a proportion of underreported income. As a starting point for risk hypothesis testing, benchmarks have identified non-compliant taxpayers.

However, it is equally true that correspondence audits may be better targeted by not commencing them solely based on benchmarks.367

7.41 Unless the risk hypothesis has been adequately tested, either via a campaign of compliance activity such as the small business benchmark audits or through a form of pilot or sampling, the actual level of risk is untested. In the above example, the risk hypothesis was that significant variance from the benchmark is positively correlated with a higher probability of underreporting cash income. The IGT's analysis of the results indicated that the level of risk (both in terms of probability and consequence) was lower than that originally expected by the ATO.368

7.42 To base a risk rating of an agent upon the purported, rather than confirmed, risk level of their clients increases the chances that the risk rating of the agent is also inaccurate. It is important, therefore, that the ATO, in determining the level of risk presented by a tax agent, take into account additional qualitative analysis to better understand the preliminary position. The use of confidence levels, as described in Chapter 2, may also be helpful in this regard.

7.43 In addition to improving the inputs and the risk modelling, there is a need for more transparency and communication in relation to the tax practitioner's RDF. The IGT believes that public information should be available about how the Tax Practitioner RDF operates. Such information or guidance would be in addition to the information in the Compliance Program and TAXAGENT magazine. A starting point may be the depiction of the RDF in Figure 20 above and tax practitioners should be consulted on the further development of these guidance materials.

7.44 Tax practitioners should also be consulted in relation to the entire RDF process as applied to them and, in particular, how the ATO should proceed once higher risk agents have been identified and whom the ATO intends to investigate further. One important consideration is that the tax practitioners should have a right of review and be afforded due process before the ATO risk rating is finalised.

7.45 It is important that the ATO does not approach the tax practitioners on the assumption that they are doing something wrong with respect to their clients who are perceived to be higher risk taxpayers. For example, there are various reasons why a practitioner may appear to have a large proportion of clients who are outside the small business benchmarks.

7.46 The ATO has advised that it does not disclose the risk rating of agents to their clients. This is crucial to the continued survival of the tax agent business and processes should be in place so that such confidentiality is always honoured. Where a taxpayer's tax liabilities have been adjusted as a result of the tax practitioner not taking reasonable care, the ATO should refer the matter to the TPB.

Recommendation 7.1

The IGT recommends that, in consultation with tax practitioners, the ATO develop and publish a complete guide on the operation of RDF for tax practitioners. Matters to be covered by the guide include:

  1. the risk hypothesis being tested;
  2. the inputs used;
  3. tax practitioners opportunity for review to initial risk rating (consistent with the principles of natural justice);
  4. communications between the ATO and practitioners;
  5. confidentiality of the risk rating as between the ATO and the practitioner;
  6. referral to the ATO's Aggressive Tax Planning Unit where the promoter penalty regime may apply; and
  7. referral to the Tax Practitioners Board where the Code of Professional Conduct contained in the Tax Agent Services Act 2009 may have been breached.

ATO response

Agree.


339 IGT, above n 5, pp 75-77.

340 ATO, above n 33, p 12.

341 Organisation for Economic Co-operation and Development, Study into the Role of Tax Intermediaries (2008) p 54.

342 Ibid p 44.

343 ATO communication to IGT, 25 February 2013.

344 Australian Taxation Office, Tax Practitioner Action Plan 2011-15 (7 February 2012).

345 Tax Agent Services Act 2009 s30-10(2).

346 ATO, above n 33, p 15.

347 The Tax Practitioners Board, Annual Report 2011-12 (2012) p 30.

348 ATO communication to IGT, 7 June 2012.

349 Explanatory Memorandum, House of Representatives, Tax Laws Amendment (2006 Measures No.1) Bill 2006, para [3.1].

350 Ibid para [3.3] and [3.4].

351 Australian Taxation Office, Good governance and promoter penalty laws (2012) p 6.

352 Ibid.

353 Ibid p 7.

354 Ibid.

355 ATO, above n 17, p 82.

356 Bruce Collins, 'The promoter penalty regime - How the ATO is applying it in practice', (Paper presented at the Tax Institute of Australia's Annual Tax Forum, Sydney, 17 May 2012).

357 Commissioner of Taxation v Ludekens [2013] FCA 142; Commissioner of Taxation v Ludekens [2013] FCAFC 100.

358 ATO, above n 17, p 82.

359 ATO, above n 33, p 12.

360 Ibid p 14.

361 Australian Taxation Office, Compliance in focus 2013-14 (2013) p 24.

362 Australian Taxation Office, Nth QLD RTPWG minutes, April 2012 (26 September 2012).

363 Australian Taxation Office, The TAXAGENT magazine (56th issue, 2012).

364 IGT, above n 5, rec 3.6.

365 ATO, above n 362.

366 ATO, above n 33, p 37.

367 IGT, above n 7, para [4.32].

368 Ibid pp 31 and 33. See table 7 (actual vs planned strike rate) and table 8 (actual vs planned average adjustment).