3.1 Stakeholders have raised concerns regarding experiences or perceptions that significant amounts of penalties raised in the ATO's compliance activities are reduced or reversed ('unsustained') on internal or external review inferring that such penalties should never have been imposed.
3.2 Stakeholders consider that challenging such decisions can be costly and impose personal and emotional pressures. For example, in the case of micro businesses, the penalties may be so large that the company may become insolvent if the penalty amount and the associated tax shortfall are required to be paid. Furthermore, they can damage taxpayers' reputation and livelihoods, such as the requirement for a company director to be a fit and proper person.
Amount of unsustained penalties
3.3 An accurate picture of the level of unsustained penalties cannot be accurately obtained from the ATO reporting systems at present. The main reason is that penalties raised in each case are not tracked such that it is unclear how and when these penalties are treated in any subsequent reviews such as on objection or settlement. Furthermore, the ATO reported information on penalties are aggregates determined at a particular point in time, and as disputes can sometimes take years to resolve, there are possibilities for significant distortions.
3.4 Notwithstanding the above shortcomings, Table 3 below contains an estimate of the amount of unsustained penalties by collating the data recorded during the different types of review activities. This table also uses data from the last three financial years to minimise distortions that may be caused by extended periods of time elapsing between the date at which penalties were raised in compliance activities and the date at which those penalties may be reduced in review activities.
|Financial year||Total of penalties raised
|Total of penalties reduced
Source: Australian Taxation Office.
3.5 Table 3 above shows that on average over the last three financial years approximately 35 per cent (approximately $3.47 billion) of total penalties raised were unsustained. It should be noted that this percentage may be higher as the data in this table does not include those penalties reduced in approximately 15,000 small business and individual objection cases.
3.6 There may be a number of reasons for the above unsustained penalties such as the automatic reduction of those penalties which are calculated as a percentage of primary tax shortfalls when such primary tax is reduced.
3.7 The extent to which penalty amounts are automatically reduced can be identified by calculating the difference between the percentage of primary tax and penalties that were reduced in review activities. The smaller the difference between the percentages of the two, the more likely that penalties were reduced as an automatic consequence of reduced primary tax amounts.
3.8 The data for the last three years in Table 4 below shows that there was a difference of 9 percentage points between the proportion of primary tax and penalties that were reduced.
|Financial year||Total primary tax raised and reviewed (in $)||Total primary tax reduced (in $)||% of reviewed primary tax that was reduced||Total of penalties raised and reviewed ($m)||Total penalties reduced (in $)||% of reviewed penalties that were reduced||Percentage point difference|
Source: Australian Taxation Office.
3.9 The data in Table 4 above can also be disaggregated by the type of review activity. This disaggregated data is reproduced in Appendix 13 and shows that for the last three financial years:
- 40% of total penalties involved in objections were reduced whilst only 25% of primary tax was reduced, a 15 percentage point difference;
- 82% of total penalties involved in settlements were reduced whilst only 35% of primary tax was reduced, a 47 percentage point difference; and
- 45% of total penalties involved in litigation were reduced whilst only 64% of primary tax was reduced, a 19 percentage point difference.
3.10 The extent to which penalties are reduced as a result of reversed penalty decisions can be identified by examining the outcomes of review activities. However, the ATO's internal reporting on these outcomes is limited and it is unclear whether the outcomes reported relate to either disputes with the primary tax or penalties raised where cases involve both amounts.
3.11 The data available on the outcome of review activities in which the taxpayer only disputed the penalty decision is limited to objection decisions during the 1 July 2012 to 31 March 2013 period. This data is set out in Table 5 below and indicates that almost half (47%) of such objections are either allowed in full (21%) or allowed in part (26%) and that over one-third (40%) were disallowed:
|Outcome||Total cases||% of total|
|Allowed in full||85||21%|
|Allowed in part||104||26%|
|Commissioner's discretion exercised||3||1%|
|Commissioner's discretion part exercised||2||0%|
|Withdrawn - settled||2||0%|
|Withdrawn - taxpayer||18||4%|
Source: Australian Taxation Office.
3.12 Developing a robust understanding of the extent and reasons for unsustained penalty decisions would allow the ATO to identify and better address the cause. By allowing unsustained decisions to persist, taxpayers will be deterred from voluntary compliance and perceptions of fairness may be eroded. Reporting on the number of penalty cases and the penalty amounts at various stages of a case's life cycle can also be used to measure the ATO's performance in maintaining sustained penalty decisions.
3.13 The IGT understands that the level of unsustained penalty decisions cannot be precisely determined by the ATO. The assured figures provided in the Commissioner of Taxation's Annual Reports only set out those raised in audit and not those that are reversed on review. Also, the figures that the ATO internally compiles in relation to review activities, such as, objections, settlement and appeals, are not complete due to systems limitations, inconsistency of information collection and the infancy of recent improvements.
3.14 The preliminary estimates that may be derived from the available information indicate that between 26 per cent and 46 per cent of the total penalties raised are later reduced on internal or external review. Importantly, approximately 15,000 of the ATO's SBIT business line objection cases are not reflected in these reversal figures, indicating that the rate of reduction may be higher.
3.15 Although a number of reasons may explain these amounts of reductions, including the quality of the data that is collected by the ATO, these figures strongly suggest a significant proportion of initial penalty decisions are not sustained at the objection stage or at settlement.
3.16 In the absence of more specific data being collected and reported by the ATO, taxpayers may be justified in their perception that a significant proportion of penalties are being imposed at a high rate initially to coerce them to submit to the ATO view in return for a reduction of penalties on a subsequent review. Without greater transparency and improved information capture, these claims or perceptions will persist.
Penalties raised in market segments
3.17 The ATO's internal reports show that over the 2010–11 and 2011–12 financial years, approximately 3.8 million active compliance activities raised a total of $17.9 billion in primary tax and $2.7 billion in penalties. Table 6 below disaggregates these penalty amounts by taxpayer market segment:
|Not for profit||4,843,527||15,587,766||20,431,293||1%|
Source: Australian Taxation Office.229
3.18 The micro market segment constituted the largest proportion of total penalties raised, accounting for just over half of total penalties raised over these two years. The remaining penalties raised can be attributed in similar proportions to the individuals, large and SME market segments.
3.19 The fact that the quantum of the penalties raised is so much greater in the micro business market segment than in the large business market segment may be attributed to the latter being better equipped to comply with their obligations. Alternatively, it could also be argued that micro businesses are often not in a position or are reluctant to challenge ATO decisions.
3.20 Table 7 disaggregates the total penalties raised by type of tax obligation, or 'revenue product', such as income tax, Pay-As-You-Go withholding (PAYG(W)) and Superannuation (SPR) Guarantee, for the 2010–11 and 2011–12 financial years. As expected, income tax accounts are by far the largest amounts of penalties raised and together with GST comprise approximately 91 per cent of total penalties raised.
|Revenue Product||2010-11||2011-12||Total penalties raised||% of total|
|Luxury Car Tax/ Sales Tax||135,726||7,255,546||7,391,272||0%|
Source: Australian Taxation Office.230
3.21 Each ATO business line has its own compliance focus, such as the type of taxpayer or type of tax obligation. Table 8 below disaggregates the total amount of penalties raised by ATO business line:
|BSL||2010–11||2011–12||Total penalties raised||% of total|
Source: Australian Taxation Office.231
3.22 As Table 8 above shows, the LBI, SME, ITX and TPALS business lines generally raise the greater amounts of penalties. This may be due to the fact that the LBI and SME business lines deal with taxpayers with larger turnovers, the ITX business line deals with the indirect taxes of all Australian businesses and the TPALS business line deals with lodgement obligations amongst others.
3.23 The MEI business line, which generally focuses on compliance income tax obligations, also raises a significant amount of tax liabilities. However, compared to the amount of penalty raised in the micro enterprise market segment, this amount is relatively small. The difference in penalty amounts raised may indicate that penalties raised in the micro enterprise market segment are for penalties relating to statements and lodgement obligations.
3.24 The total penalties raised can also, to a limited extent, be disaggregated by penalty type. It should be noted, however, that this data could only be provided for the period 1 July 2011 to 30 April 2012, which is approximately 50 per cent of total penalties raised in the 2011–12 financial year. Furthermore, this data is not broken up by taxpayer market segment. Table 9 below sets out this data:
|Penalty type||Number||Amount ($)||% of total amount|
|Failure to lodge||138,407||79,213,200||11%|
|Failure to take reasonable care||42,896||170,609,160||23%|
|Intentional disregard of a taxation law||886||129,630,143||17%|
|Shortfall penalty – other||137||18,828,833||3%|
|No reasonably arguable position||235||68,135,939||9%|
|Failure to provide a document||2,790||107,451,050||14%|
Source: Australian Taxation Office.232
3.25 Table 9 above shows that the greatest proportion of penalties raised were those relating to taxpayer statements, namely for failure to take reasonable care, recklessness, intentional disregard of a taxation law and no reasonably arguable position. The table also shows the penalty most frequently imposed was that for failing to lodge on time.
3.26 The ATO currently collects some information on the penalties it raises, such as the total amounts by business line, market segment and revenue product. Whilst it is important to know the amount of penalties that the ATO is raising, it is equally important to have a greater understanding of the common drivers for penalties to assist the ATO to understand the nature of underlying taxpayer non-compliance and fine-tune its strategies towards achieving the penalty regime's purpose of encouraging voluntary compliance.
3.27 For example, over half of the penalties raised are imposed on micro enterprises. Such a high level of penalty imposition indicates a need for ATO focus to alleviate causal factors and assist these businesses to more easily comply voluntarily so that the costs and time expended on tax compliance activities may be redirected to entrepreneurial activities that assist businesses' productivity.
3.28 Accordingly, improved recording and reporting would provide useful qualitative and quantitative information that gives useful insights about taxpayer behaviour, as well as the effectiveness of penalties and the ATO's administration of the taxation laws in shaping taxpayer behaviour.
3.29 Currently, the ATO records net liabilities arising from all penalty decisions for financial reporting purposes. Its data collection is limited in relation to the number and amounts of the different types of penalties raised and remitted. It is, therefore, difficult to establish the types and amounts of penalties that are most frequently imposed and the reasons for their imposition. Furthermore, the ATO does not currently have the capability to provide corporate reports on the types of penalties imposed and remitted in compliance activities.233 More information on the ATO's collection and reporting of data is provided in Appendix 13.
3.30 The ATO has started to capture more information with the aim of identifying and understanding the major reasons for initial audit decisions being changed on objection. Due to limitations with the information that is being collected, however, little insight can be gleaned from the figures on the underlying reasons for penalty imposition and subsequent adjustments to penalty decisions. An example of a limitation is that the template, which ATO objection officers are required to answer on the Siebel Case Management system, does not capture penalty-specific information. As a result, information on the reasons for unsustained penalties can only be extracted by isolating objection cases which deal with penalties only. This process excludes valuable information about those objection cases which involve both primary tax adjustment and penalty decisions. Furthermore, it does not capture information on other review activities in which penalty decisions may be adjusted, such as on settlement and only represents a small percentage of the total number of penalty cases that are subject to review.
3.31 The IGT also observed that ATO business lines have not consistently collected information on penalties, particularly in relation to the standard of conduct exhibited by taxpayers for false and misleading statement penalties. Such information would allow the ATO to distinguish between cases where the penalty amount was reduced as an automatic result of the primary tax amount being reduced from those where the penalty decision has been reversed.
3.32 In this respect, standard data definitions and input would ensure the same information is being collected on penalties across the ATO, irrespective of the type of audit or review activity. The reasons for penalty decisions being imposed and subsequently changed are also another important piece of information that must be captured.
3.33 Tracking the various penalty decisions that are made at different stages of audit or review activity after implementing standard data definitions should provide a complete and consistent end–to–end and case–by–case reporting facility that delivers substantial insights into the underlying causes of unsustained penalty decisions and facilitates the development of effective strategies to address them.
3.34 Even within the current limitations, the ATO could also take a staged approach to improve penalty information collection. Such an approach may include the capture of:
- the type of penalties that are being raised and the frequency of their imposition;
- the areas of tax law or nature of the issues that commonly attract penalties;
- changes in taxpayer behaviour subsequent to the imposition of penalties; and
- the common characteristics of taxpayers that attract penalties, such as the size of the relevant taxpayers and the industry in which they operate.
3.35 Although such information would be limited to those areas in which the ATO conducts compliance activities, the IGT is of the view that it would usefully measure the effectiveness of the ATO's compliance processes in identifying risks and influencing taxpayer behaviours. Accordingly, this information would better inform the design of its compliance strategy and reduce administrative costs by focusing on those areas that would better foster voluntary compliance.
3.36 In the longer term, the ATO will need to ensure that further information is captured, such as that for penalties relating to taxpayer statements including taxpayer behaviours and how these were inferred from the material facts and evidence, the type of penalty imposed, the remission decision and the reasoning for the penalty and remission decisions.
3.37 Once the above information is captured, it is important that the ATO report it publicly to improve accountability in respect of the sustainability and consistency of penalty decisions and dispel any incorrect perception of leverage.
3.38 There is also some information that is already captured but not reported. For example, the ATO does not currently report penalty decisions made in position papers or those later reduced or remitted when audits are concluded. Reporting such figures appropriately would provide a better understanding of the ATO–taxpayer interaction in and around the time the position paper is discussed. Given the adverse impacts of unsustained penalties around this stage of compliance activities, the IGT considers such reporting would promote transparency and improvements in ATO-taxpayer engagement.
3.39 System improvements may also need to be implemented to provide direct search and retrieval of relevant data. In this respect, the ATO could examine information management approaches taken by other organisations in relation to the application of law involving dynamic standards and inferences based on facts and evidence.234
3.40 Importantly, the information collected and reported must be analysed to identify underlying patterns or trends in taxpayer behaviour and the areas requiring increased taxpayer attention to develop practical improvements. The strategies developed by the ATO could then be tested through a number of methods, such as randomised controlled trials, to ensure effective outcomes are achieved.
The IGT recommends that the ATO:
- systematically collect and analyse a broad range of penalty information (including the type of taxpayer behaviour observed, the relevant percentage rate of penalty and the decision itself) to identify patterns of taxpayer behaviours that drive non-compliance and develop strategies to address those patterns;
- utilise standard data definitions and input for recording and reporting on all decisions for penalties relating to taxpayer statements, including the reasons for each penalty's imposition and any subsequent adjustments;
- improve its penalty reporting systems to track changes to penalty decisions at a case level over the life of the case, namely from an initial decision through to resolution; and
- publish a broad range of statistical information and measures in respect of penalty decisions, including penalty imposition and reductions on a business line basis.
Agree in part with recommendation 3.1(a)
The ATO agrees with the objective of the recommendation that compliance strategies that address identified patterns of non-compliant behaviour will generally achieve more effective outcomes.
There is significant ongoing work in the area of information gathering and analysis of compliance behaviour and strategy including behavioural economics. An analysis of penalty information forms part of the work addressing a variety of aspects of compliance behaviour. The ATO will continue to look for further opportunities to use available penalty information but does not propose to undertake a specific program of work.
Agree in part with recommendation 3.1(b)
The ATO agrees to report the following data items relating to penalty decisions:
- case numbers and quantum for imposition of primary tax and shortfall penalties, and
- objection adjustments and aggregated settlement and litigation adjustments.
Reporting of these items is planned to progressively commence from 1 July 2014.
The ATO disagrees with the recommendation to have further standard data for subsequent adjustments due to the required system changes and impacts on productivity due to the keying of the data for a large number of simple and high volume objections cases. Similar information could be obtained using a sampling methodology.
Agree in principle with recommendation 3.1(c)
The ATO agrees with the objectives of the recommendation to track changes to penalty decisions at a case level over the life of a case. Reporting of this nature will require significant changes to information technology systems and business processes The system changes will be subject to prioritisation on the ATO Information Technology Forward Program of Work.
The ATO notes that reporting from source systems in the enterprise reporting project (progressively implemented from 1 July 2014) may be the first step in this process and the ATO will evaluate opportunities for further systems changes once the project is implemented.
Agree in part with recommendation 3.1(d)
The ATO agrees to publish the following information upon finalisation of the enterprise reporting project (see response to recommendation 3.1(b)):
- the number and value of penalties imposed for false or misleading statement and for not having a reasonably arguable position; and
- the number and value of adjustments that occur to imposed penalties as a result of objections, settlements and litigation.
The ATO does not agree to report this information on a business line basis. This is because work types and market segments managed within each of the business lines continue to change over time and may continue to do so, resulting in limited usefulness for the development of trend data and comparative analysis.
The ATO does not propose to undertake a program of work for additional reporting. The ATO notes the significant staff costs involved in keying further data in addition to the limited system deployment capacity to deliver all of the items noted in the report.
229 Above n.150, p 4.
230 Ibid, p 4.
231 Ibid, p 3.
232 Ibid, p 6.
233 Ibid; Australian Taxation Office communication to the Inspector-General of Taxation, 5 December 2013.
234 Such as the 'sentencing table' used by the Public Defenders office, the 'sentencing database' developed by the Judicial Commission of New South Wales, and the 'sentencing database' maintained by Legal Aid Queensland.