The Inspector-General of Taxation's (IGT) review into aspects of the Australian Taxation Office's (ATO) use of compliance risk assessment tools was prompted by concerns raised about their effectiveness by taxpayers, tax practitioners and their representative bodies. It had also been identified as a review topic during the course of previous reviews.
Stakeholders have acknowledged that it is appropriate for the ATO to adopt a risk-based approach in its compliance strategy. In fact, most comparable revenue authorities take such an approach to make the best use of their resources in protecting government revenue.
There are many risk assessment tools within the ATO's enterprise risk management framework. These tools are used to gauge risks posed by taxpayers in each market segment. The IGT has observed that, ultimately, the effectiveness of these risk assessment tools could only be reliably evaluated if evidence-based metrics, such as random audits, were used. Such metrics could also be used to refine the associated risk assessment tools.
In the absence of evaluation metrics, the IGT has drawn on the examination of the ATO's main risk assessment tools in this review as well as those investigated in previous IGT reviews, to create guidelines for developing effective risk assessment tools. These IGT recommended guidelines address key stakeholder concerns, such as the governance, inputs and transparency of the ATO's risk assessment processes as well as related communication with taxpayers and the proportionality of resulting ATO compliance action to detected risks. Furthermore, these guidelines emphasise the importance of effective project management to minimise adverse impacts on taxpayers whilst making best use of ATO resources.
The appropriate implementation of the IGT recommended guidelines should result in extensive and enduring improvements to the ATO's risk assessment processes. In addition to these guidelines, specific recommendations have also been made to enhance aspects of those risk assessment tools with which taxpayers have raised the most concerns.
In a recent review1, the IGT examined the ATO's small business benchmarks, one of its main risk assessment tools in the micro and small business market segments, and made recommendations aimed at increasing the robustness and transparency of inputs and methodology used amongst other things.
The IGT has also, more recently, reviewed the key risk assessment tools used by the ATO in the individual market segment.2 These tools benefit from large amounts of relatively low-cost third-party information available to the ATO. Indeed, an estimated 1.4 million individuals with simple tax affairs may not need to lodge tax returns in the near future.3 The IGT's recommendations for improvement in this regard will be made available upon the public release of the reports of these reviews.
In other market segments, the ATO does not have access to the same level or quality of third-party information. The quality of information at the ATO's disposal and the cost of gathering more information to gain sufficient confidence (information confidence and cost) have a major impact on the way the risk assessment tools are used and the compliance activities that follow.
The ATO's main risk model, which is examined closely in this review, is the risk differentiation framework (RDF). It is used in a number of market segments including small to medium enterprises (SMEs) and large business and international (LB&I) as well as tax practitioners.
The IGT has recommended that the RDF be refined to reflect recent administrative developments and related taxpayer compliance patterns. A number of opportunities have been identified to reduce overall taxpayer compliance costs and improve ATO-taxpayer interactions by distinguishing between those risk factors that can be addressed by taxpayers (behavioural risks), those factors that cannot (inherent risks) and information confidence and cost.
The most mature application of the RDF is in the LB&I market segment. Stakeholders in this segment had raised concerns with the ATO's use of judgement-based inputs, communication of taxpayers' risk categorisations and the costs of resulting compliance activities. In this respect, the IGT has made a number of recommendations including:
- ATO risk assessment processes, related communication and subsequent compliance action should reflect the differing levels and mixes of inherent and behavioural risks as well as information confidence and cost;
- 'willing participation' and 'transparency' should be objectively considered in terms of information confidence and cost alongside, but separate from, the RDF;
- discrete transactions or presence of a number of contestable positions should not of themselves be determinative of a taxpayer's overall risk rating; and
- greater detail should be provided to taxpayers about how particular risks are assessed and there should be an open dialogue between the ATO and taxpayers before risk ratings are finalised.
Stakeholders in the SME market segment expressed uncertainty with the RDF given the infancy of its application to this market segment. Drawing on the issues that have arisen with the RDF's application to the LB&I market segment, the IGT has recommended that the ATO bolster its process of refining the risk inputs used and make more information publicly available about these inputs, amongst other things.
In relation to the application of the RDF to tax practitioners, the IGT had already raised a number of issues in his Review into Improving the Self Assessment System. In this review, the IGT has called for the ATO to consult with tax practitioners with a view to developing a guide on the operation of the RDF for them.
Overall, the IGT has made 16 recommendations to the ATO. The ATO has agreed with all of the recommendations.
1 Review into the ATO's use of benchmarking to target the cash economy, publicly released in October 2012.
2 Review into the ATO's compliance approach to individual taxpayers - income tax refund integrity program; and Review into the ATO's compliance approach to individual taxpayers - use of data matching.
3 Neil Olesen, 'Reinventing the ATO - ready, willing and underway', (Speech to CPA Congress, 17 October 2013)