Conduct of review
1.1 This is the Inspector-General of Taxation's (IGT) report of his review into the Australian Taxation Office's (ATO) compliance approaches to small and medium enterprises with annual turnovers between $100 million and $250 million (larger SMEs or S4 taxpayers) and high wealth individuals (HWIs). The report is produced pursuant to section 10 of the Inspector-General of Taxation Act 2003 (IGT Act 2003).
1.2 This review was commenced pursuant to subsection 8(1) of the IGT Act 2003 and in response to submissions from concerned taxpayers and their representatives. The concerns generally related to taxpayers not receiving fair and equitable treatment and being unduly burdened with unnecessary compliance costs stemming from the wide scope of ATO information gathering requests, delays, lack of commercial awareness and technical knowledge, as well as conduct of ATO staff. The underlying issue seemed to be a lack of staff capability in this market segment.
1.3 Particular concerns were raised with the implications of certain ATO announcements made from late 2008. These announcements explained that as a result of additional funding from the Government, the ATO would:
- expand its compliance activities to risk assess over a four-year period all larger SMEs, and follow this work up with more reviews and audits; and
- increase its monitoring, reviews and audits of HWIs.1
1.4 Stakeholders commented that the ATO's recent compliance focus on the larger SME and HWI market segments was understandable. However, they considered the increased focus entailed a significant execution risk because the ATO had a general capability shortfall in this sector. They considered that the additional ATO compliance focus would significantly increase unnecessary costs and workloads for both taxpayers and the ATO, unless some improvements were realised.
1.5 Terms of reference were announced on 7 April 2010 for this review. Appendix 1 reproduces a copy of the terms of reference and submission guidelines for this review.
1.6 The IGT received over 30 submissions from taxpayers and their representatives. The IGT also met with interested taxpayers, their representatives and selected industry and tax practitioner bodies to understand their experiences.
1.7 A number of submissions expressed concerns with the ATO's approach to individuals with net wealth of between $5 million to $30 million (Wealthy Australian taxpayers or WAs). During initial inquiries, it became apparent that the ATO's work in the WA market segment was integral to the underlying issues examined in this review. The IGT therefore incorporated consideration of the ATO's WA activities insofar as they were relevant to considering the underlying issues of concern that initiated this review.
1.8 Work on this review was largely put on hold between April and December 2010 whilst the IGT diverted its limited resources to conduct a review into the ATO's Change Program at the direction of the then Minister. The review into the ATO's Change Program commenced immediately after the Minister's direction, dated 19 April 2010, due to the urgency of the matters requiring review and the public interest in those matters. Work on this review, that is, the ATO's compliance approaches into larger SMEs and HWIs, recommenced in early 2011 after the Change Program review had been completed.
1.9 During the review, the ATO advised the IGT that the area responsible for dealing with larger SMEs and HWIs — the SME business line — was moving towards reviewing economic groups (the 'private wealth' approach), focusing on building staff capability and collective support and setting key aspirational targets on qualitative and procedural measures. Significant work is underway.
1.10 If implemented effectively over the appropriate time frame, the results of these ATO initiatives should go some way towards reducing external stakeholders' current concerns. However, the work the ATO is undertaking in this regard may need some fine tuning as it progresses. In responding to stakeholder concerns, the IGT also considers that there is scope for further improvement in a number of important areas as set out in the chapters that follow.
1.11 To assist with the IGT's consideration of issues, the IGT established a working group comprising key tax practitioners and representatives: John Brazzale, Pitcher Partners; Lance Cunningham, PKF; David Drummond, KPMG; Keith James, Hall and Wilcox; Ken Schurgott, Schurgott Noolan Pty Ltd; Glenn Williams, Ernst & Young; and senior ATO officials.
1.12 The IGT greatly appreciates the generosity of the members of this working group in freely giving their time and expertise. Their involvement has greatly enhanced the outcomes of this review.
1.13 The working group met several times to discuss the potential solutions to the systemic issues identified in this review. It should be noted, however, that the views and recommendations expressed in this report are not necessarily those of individual members of the working group. The views and recommendations were finalised by the IGT after much deliberation, and based on input received and discussions with private sector representatives and the ATO.
1.14 The IGT also worked progressively with ATO senior management to distil the scope for improvement and to agree on specific actions. The IGT also discussed these matters with interested external stakeholders and working group members.
1.15 In accordance with section 25 of the IGT Act 2003, the Commissioner of Taxation was provided with an opportunity to make submissions on any implied or actual criticisms contained in this report.
What are SME, HWI and WA taxpayers?
1.16 SMEs range from very simple businesses with high turnovers to businesses with complex structures involving multiple entities and complex tax issues. Included in this range are those businesses with turnover between $100 million and $250 million (that is, S4 taxpayers).
1.17 Since 2008, the ATO has classified SMEs as those entities having between a $2 million and $250 million turnover. The ATO estimates that there are around 175,000 such entities. HWIs also feature in this market segment, with the ATO estimating more than 2660 such individuals who, with associates, effectively control more than $30 million in net wealth each.2
1.18 The SME market segment pays approximately 15 per cent of the total tax that the ATO collects and a further 12 per cent is withheld by SMEs on behalf of their employees. More than 28 per cent of employees in Australia work for SMEs.3
1.19 Recently, the ATO has also focussed its efforts on WAs. The ATO estimates that there are more than 82,000 WAs, who between them control in excess of 400,000 entities.4
Key differences between the larger SME and large business market segments
1.20 There are a number of key differences between S4 taxpayers (particularly entities that are part of a closely held private group (CHPG)) and large businesses.
1.21 Large businesses tend to be public companies. This means that:
- more information about the company, its operations and finances are publicly available, whereas more than half of larger SMEs are part of CHPGs meaning that there is less publicly available information compared to that of public companies;
- its internal structure and governance processes are more transparent, whereas CHPGs tend not to have the same level of transparency and may use some form of trusts to conduct business (issues of trusts being complex and numerous);
- executive control and access to the business' wealth is more removed, whereas as executive control of a CHPG's finances may have more of an emotional attachment; and
- there may be a greater resourced in-house tax function, whereas larger SMEs may have less resources and therefore seek tax advice as and when thought needed.
The ATO's compliance approach to SMEs, HWIs and WAs
1.22 In 2010-11, the ATO had a total operating expenditure of $3.1 billion and employed 22,667 staff (not including the pool of around 2500 casual employees that the ATO can call on during times of peak workloads).5 The ATO allocates a substantial proportion of this budget to its activities aimed at assuring compliance with the tax laws (the compliance program).
1.23 The ATO's compliance program is delivered by a number of different business units whose focus is determined by the type of taxpayer, revenue product or risk assigned to it.
The SME business line
1.24 For 2010-11, the SME business line was responsible for compliance activities in relation to the following areas:
- SMEs (broken up into four market segments — the most relevant segment for this review is the S4 market segment);
- WAs (in conjunction with the ATO's Micro Enterprises and Individuals (MEI) business line);
- non-profit organisations;
- government entities; and
- the fringe benefits tax product.
1.25 On an annual basis, the SME business line develops compliance strategies in relation to its areas of responsibility and in accordance with a range of expectations set by ATO corporate plans, compliance program plans and commitments to government.
1.26 There are 15 senior ATO officers tasked with providing strategic leadership to the SME business line. These strategies are outlined in the ATO's Compliance Program, which is published each year. The SME Executive tracks delivery of these strategies on a monthly basis. Contributions to the ATO's compliance sub-plan are reported periodically to the Compliance sub-plan's committees.
1.27 The 2010-11 budget for the SME business line was $153.6 million for a total full-time equivalent (FTE) staff of 1492.5 in number.
1.28 As at 30 June 2010, the SME business line employed approximately 1445 staff, comprising 145 staff working in governance and support roles, 247 staff in Interpretative Assistance (IA), 953 staff in Active Compliance (AC) and 100 staff in compliance risk and intelligence.
1.29 For the 2010-11 year, the SME business line allocated a total of 832.6 FTE staff to its 2011 compliance strategies. Of this amount, the SME business line allocated:
- 127 FTE staff to S4 work (94 FTE staff allocated to the ITI funding work and
- 33 FTE staff allocated to other risk work in the S4 market segment — note that a combination of the two is what the SME business line reports as its Income Tax Investment (ITI) commitment to Government);6
- 324.4 FTE staff to HWI work; and
- 94 FTE staff to WA work.7
1.30 This FTE staff allocation represents the expected workload of 2011 active compliance activities for these strategies. It does not mean that 545.4 staff have been allocated to work exclusively on these strategies, but that just under two-thirds of the total SME active compliance workload will comprise HWI, S4 and WA work.
Key differences in type of ATO support
1.31 There are also a number of key differences in the support the ATO provides to its officers in the SME business line and the Large Business and International (LBI) business line:
- SME officers could potentially work on a CHPG, a public group as well as a friendly society. The LBI business line utilises specialisation far more and is accordingly able to gain a more intimate knowledge of a taxpayer's business environment and associated tax risks.
- The LBI and HWI areas have more established linking systems, whereas the SME business line is relying on a linking system (BMT) that may not be identifying all relevant linked-entities (discussed in chapter 4).
- Both the LBI and HWI areas have more direct time available in a Preliminary Risk Review (PRR) and have longer cycle times in a Comprehensive Risk Review (CRR).
1.32 A recently commissioned internal ATO report that reviewed aspects of the SME business line considered the potential for further SME and LBI business line interaction, amongst other things. It observed that:
There may be advantages in further exploring the ways S&ME [the SME business line] currently interact with the technical networks in LB&I [the LBI business line]. These networks attempt to share capability and provide on the job training across AC and IA areas ...
... Furthermore, there are advantages that can be gained from BSLs [the ATO's business lines] sharing approaches that leverage off functional areas. Currently, SM&E and LB&I work closely together and share opportunities to develop staff across these functional areas. Indeed, the business lines are collaborating in relation to the early engagement model, Siebel improvements and technical networks. In relation to technical networks, LB&I is starting to increase the emphasis on these networks in building capability across all functional lines. We are allocating SES [the ATO's Senior Executive Staff] sponsors to these networks and ensuring network membership includes staff from Active Compliance and Interpretative Advice areas.
It is important for S&ME (as it is for all BSL) to ensure the capability levels of staff in IA are aligned with the risks and issues being handled in AC areas in order to ensure a smooth transition from AC to Objection. As the Active Compliance program develops and the focus shifts to different or more complex issues, it is critical that the ATO use any cross business line synergies to develop the skills of staff (whether the staff are in IA or AC). There would be clear synergies and benefits for both S&ME and LB&I to explore better use of technical networks. Alignment of capabilities across IA and AC work functions has been a challenge for LB&I, and one way we try to ensure that capability levels are aligned is through the technical networks.8
1.33 Whilst the potentially larger quantum of revenue involved may justify the LBI business line's increased access to technical support (compared with the access of SME officers dealing with S4 cases), in the IGT's view, more could be done to improve the support given to SME officers.
Transforming Tax Technical Decision Making (TTTDM) Project
1.34 Since 2005, the IGT has raised concerns with the ATO's technical decision making function in a number of IGT reviews, most recently in the IGT's review into the ATO's large business risk review and audit policies, procedures and practices.9 The IGT is pleased to see that the ATO has heeded those concerns by starting a project to improve the tax technical decision making function (the Transforming Tax Technical Decision Making Project or TTTDM project). The ATO advises that this project is aiming to establish and extend early engagement mechanisms (such as those used in the priority rulings process). The current function involves the requirement to escalate class rulings to a Centre of Expertise (COE) or a Tax Counsel Network (TCN) officer whether or not there are precedential issues involved, unless it is a priority ruling (in which case these officers are engaged from the beginning of the process).
1.35 The TTTDM project was undertaken as a result of the recommendations from an ATO internal review called the Law Improvement Project (LIP) review. The LIP focussed on identifying the practical steps that should be implemented to improve the corporate business processes for delivering COE and TCN interpretive advice.
1.36 The ATO advises that this project is in its early stages, is expected to take a number of years to complete and is not expected to affect the SME business line in the short term.
1.37 During the review, the SME business line was involved in a pilot of the TTTDM project. This began in September 2011. The aim of the pilot is:
to ensure that specialist technical resources from areas such as CoEs and TCN are involved in and providing advice and assistance on case work early in the life of a review or audit case. This pilot will include having these specialist staff involved in taxpayer interviews and discussions where necessary.10
1.38 In the IGT's view, a number of issues arising from this review provide an opportunity for the SME business line to influence the TTTDM project to deliver needed outcomes on a practical level — for example, as indicated above, guidelines could be developed to clarify the type and level of assistance that technical officers provide to compliance officers.
Additional government funding
1.39 The ATO has received additional funding for other specific compliance initiatives involving larger SMEs, HWIs and WAs. These are discussed below.
The ATO's HWI taskforce and Government funding
1.40 In May 1996, the Government allocated additional funds of $19.2 million over two years so that the ATO could establish a HWI taskforce to expand the ATO's understanding of tax planning techniques used by HWIs and the resulting compliance risks. Prior to this taskforce, any HWIs were examined by the ATO's small business or large business areas.
1.41 At the end of its first year of operation, the HWI taskforce consisted of 99 FTE staff, identified 254 HWIs and commenced 16 audits.
1.42 The HWI taskforce was initially managed within the LBI business line. The taskforce developed a different approach to compliance that was based on understanding the entire group effectively controlled (as opposed to legally owned) by the HWI. It therefore included all entities in which the HWI had a key decision making role.
1.43 In the 2006-07 Federal Budget, the ATO received $81.6 million in additional funding to maintain tax compliance amongst HWIs and their associated entities (the HWI Policy funding). This funding covered the four-year period from 2006-07 to 2009-10. At this time, the HWI taskforce was also moved into the SME business line as there was considerable commonality in taxpayer profiles and tax risks between certain HWIs and closely held private SME groups.
1.44 The HWI taskforce's staffing numbers increased from 99 FTE staff in July 2006 to 361 in May 2010. This expansion increased the numbers of reviews and audits undertaken. In 2008-09, 936 reviews of HWIs were undertaken. As at 31 March 2010, 167 HWI audits were underway.
1.45 Liabilities raised by the HWI taskforce in 2008-09 totalled $530 million compared to just $31 million in 1997, when the HWI taskforce was first established, and $166 million in 2006 before the additional funding was made available.
The Income Tax Investment (ITI)
1.46 As part of Mid-Year Economic and Fiscal Outlook (MYEFO) 2007-08 process of October 2007, the ATO received additional funding of $446 million from the Government to expand the income tax compliance program over four years from 1 July 2008-09 — the Income Tax Investment (ITI).
1.47 As a result of this government funding, the ATO is expected to deliver an additional $3.7 billion in revenue over four years. This revenue has 'direct' and 'indirect' components. 'Direct revenue' is revenue collected through enforcement activity. 'Indirect revenue' is said to be the increase in revenue achieved as a result of the combination of initiatives including 'help and education', 'assistance and advice' as well as the broader deterrent effect of the ATO's compliance program.
1.48 Although a revenue return to government is incorporated in this funding, it is not linked to specific ATO activities.
1.49 Under the ATO's internal arrangements, the SME business line was allocated $53.1 million of this funding over a four-year period. This funding is being used to risk review all SMEs in the S4 market segment.
The Income Tax Investment Additional Compliance Dividend Component
1.50 In the 2008-09 Federal Budget, the Government provided the ATO with additional funding of $256.9 million over four years to enhance its compliance activities, particularly for large businesses and HWIs (the ITI Additional Compliance Dividend Component). This measure is expected to deliver an additional $1.98 billion over four years.
1.51 The SME business line was allocated $89.2 million of this funding over a four-year period.
1.52 The overall funding associated with the ITI and ITI Additional Compliance Dividend Component totals over $700 million and is expected to deliver a total of $5.7 billion in additional revenue. The funding associated with this measure was allocated across the ATO's Compliance, Law and Operations sub-plans.
Strategic Compliance Initiative
1.53 In the May 2009 Federal Budget, the Government provided the ATO with additional funding of $302 million over four years to manage taxation compliance risks related to Australia's economic recovery (the Strategic Compliance Initiative).
1.54 The SME business line was allocated $68.9 million of this funding over a four-period to identify and profile WAs. The ATO advises that this project aims to 'instil community confidence by demonstrating that 'Wealthy Australians' pay their fair share of tax'. Approximately three-fifths of the SME business line's allocated funding for this initiative will be used to fund the MEI business line's workforce assisting with this project.
1.55 The overall additional revenue this initiative is expected to deliver is $285 million.
1.56 In summary, the SME business line received the following government funding to deliver on the following initiatives.
|HWI Policy Funding||Income Tax Investment (ITI)||ITI Additional Compliance Dividend||strategic compliance Initiative (Wealthy Australians)|
|Announcement date||May 2006 Federal Budget||MYEFO October 2007||May 2008 Federal Budget||May 2009 Federal Budget|
|Period covered||2006-07 to 2009-10||2008-09 to 2011-12||2008-09 to 2011-12||2009-10 to 2012-13|
|ATO Funding received (a)||$79.5m (Budget papers $81.6m)||$487.6m (Budget papers $446m)||$277.9m (Budget papers $256.9m)||$302.1m (Budget papers same)|
|SME business line allocation of funding over 4 years||$62.1m||$53.1m||$89.2m||$68.9m (split with the MEI business line)|
|FTE staff at final year of investment||180||226||174||171 (5:3 split with the MEI business line)|
|- Direct Revenue||$770m||$350m||$510m||$285m|
|- indirect Revenue||-||$630m||-||-|
Note (a): Discrepancies exist between figures quoted in the Government's budget papers and funding received by the ATO. Budget papers reflect the Government's fiscal balance and excludes items such as superannuation, workers' compensation, revaluation adjustments and depreciation which are included in the ATO's allocated funding. Source: ATO presentation to IGT staff, 15 May 2010.
1 Australian Taxation Office, 2008-09 Compliance Program, Canberra, 2008, p. 37.
2 Australian Taxation Office, Compliance Program 2011-12, Canberra, 2011, pp. 16-17.
3 Australian Taxation Office, Compliance Program 2009-10, Canberra, 2009, p. 18.
4 Australian Taxation Office, Compliance Program 2011-12, Canberra, 2011, p. 18.
5 Commissioner of Taxation, Annual Report 2010-11, Canberra, 2011, p. 9.
6 See 'S&ME Active Compliance — performance report: year to date 24 February 2011', p. 5, reported to the SME Executive.
7 Mid-Year Review SME 2011 Internal Plan; Note also that the SME's information collection teams may also carry out specific work on HWI, WA and S4 taxpayers — these figures are not included as their work is preliminary to conducting reviews and audits and do not directly result in liabilities and collections.
8 'Review of interpretative advice as part of the SM&E pipeline', a report commissioned by and prepared for the ATO's SME Executive, June 2011, pp. 12-14, 22-23.
9 Report into the Australian Taxation Office's large business risk review and audit policies, procedures and practices, September 2011.
10 Australian Taxation Office, written communication to the IGT, 23 September 2011.