6.1 Stakeholders have raised a number of concerns with aspects of the ATO's practices and approaches in correspondence audits, including:
- some auditors' evidentiary basis and reasoning for culpability penalties, especially in relation to penalties for intentional disregard of the taxation law; and
- practices and approaches that unnecessarily increased taxpayers' and tax agents' compliance costs.
6.2 These issues are discussed below.
6.3 In relation to the evidentiary basis and reasoning supporting penalty decisions, submissions singled out for particular comment the 75 per cent penalty for intentional disregard of the taxation law.129
6.4 The main concern centred on some auditors' reliance on the lack of adequate record keeping as evidence of the misstatement penalty. As summarised by one submission, the ATO officer's approach appeared to be:
- the taxpayer has put $X in their tax return
- under a correspondence audit, the taxpayer cannot substantiate $X
- the ATO applies benchmark and substitutes turnover with $Y
- since $Y does not equal $X, $X must therefore be false and misleading
- because everyone knows the law requires you to keep records for everything, there is an intentional disregard of it.
6.5 In an examination of a small number of relevant ATO case files, the IGT observed a similar approach. For example, in one correspondence audit case in March 2011, an ATO auditor wrote in a Siebel case note: '[The tax agent] queried the 75 per cent penalty and wordings of the letter. I advised [the tax agent] that where client liability is worked out by the tax office, a minimum penalty of 75 per cent applies.'
6.6 The reasons for decision in the final audit letter for this case indicated that an intentional disregard for the law penalty was justified since intentional disregard was evidenced by:
- The taxpayer not providing a satisfactory variance explanation.
- The difference between the reported income figure and the benchmarked figure 'is significant'.
- The records were not of an adequate standard.
- A reasonable person knows about record keeping.
- It can be inferred, therefore, that failure to keep records was systemic and not accidental.
6.7 The IGT is of the view that the factors above considered by the auditor have limited connection with the behaviour of the taxpayer at the time the shortfall occurred. The IGT also examined four other penalty decisions (covering lack of reasonable care, recklessness and intentional disregard). Each of these decisions listed factors which did not relate to the behaviour of the taxpayer at the time the shortfall occurred (among other factors which did relate).
6.8 With respect to making a finding of intentional disregard it is important to note ATO binding advice on the matter such as paragraphs 109-116 of Miscellaneous Tax Ruling MT 2008/1. Importantly:
113. Dishonesty is a requisite feature of behaviour that shows an intentional disregard for the operation of the law. This is another significant difference between this type of behaviour and behaviour that shows a want of reasonable care or recklessness where dishonesty is not an element.
114. Evidence of intention must be found through direct evidence or by inference from all the surrounding circumstances, including the conduct of the entity.
6.9 By way of contrast, the ATO's staff instructions on the 50 per cent penalty for recklessness states:
106. A finding of dishonesty is not necessary to a finding of recklessness. It is sufficient that the person's behaviour objectively displayed a high degree of carelessness and indifference to the consequences.
Company YZ which carries on a small business, was subject to a record keeping audit. At the end of the audit the tax officer advised the company about the areas where the records were inadequate and what was required to remedy the situation. The company was advised that it was unlikely that the correct amount of taxable income would be returned if the suggested improvements to their record keeping practices were not implemented in full. Rather than following the advice the entity made minor changes to their record keeping system which did not improve the adequacy of their records.
Two years later the entity was subject to an income tax audit. A shortfall amount was detected which was caused by inadequate record keeping. The facts indicate that the shortfall amount was caused by the entity's recklessness.130
6.10 The Explanatory Memorandum to the Taxation Laws Amendment (Self-Assessment) Act 1992, which inserted section 226J in the ITAA 1936, being the predecessor to the current intentional disregard penalty, says:
Where a taxpayer excludes from its assessable income an amount knowing it to be assessable, or claims a deduction, rebate, credit or offset knowing that it is not allowable, the taxpayer will be liable to a penalty of 75% of a tax shortfall or franking tax shortfall so caused.
6.11 In the context of correspondence audits where the ATO determines that the business's records are inadequate, the IGT is of the view that it would be inappropriate to simply impose an intentional disregard penalty purely on the basis of poor record keeping. This is because, in these circumstances, the false or misleading statement is directly due to inadequate record keeping, rather than a taxpayer taking an explicit position on the assessability of an amount that is contrary to law.
6.12 The IGT considers that there is an important distinction between a taxpayer's knowledge about record keeping obligations (which results in inadequate record keeping) and a taxpayer's knowledge about whether a given amount is assessable (which results in a shortfall).
6.13 The ATO has also identified, in various quality assurance reports (Integrated Quality Framework or IQF reports) from April 2010 to February 2012, the incorrect application of penalties as an area for improvement in audit practice.131 In particular, the ATO reports indicated that:
- auditors were not correctly applying the appropriate penalty, both where the behaviours justified a higher penalty than the one actually applied, and where the behaviours justified a lesser penalty that the one actually applied; and
- auditors were not clearly linking the observed behaviours with their findings of either lack of reasonable care, recklessness, or intentional disregard for the law.
6.14 The use of 'standard penalty text', whilst possibly improving consistency, also presents another issue, as highlighted in another penalties training package:132
Intentional disregard template developed for benchmarking project used for 50% penalties decisions. Templates preventing people from critical thinking.
6.15 The same package also highlights issues with respect to capacity and capability:
Team leaders or penalty decision approvers under a lot of pressure and don't devote sufficient time to reviewing and approving penalties.
Officers undertaking non face to face enquiries tend to diminish their penalties facts and evidence gathering skills.
6.16 The issue of staff capability with respect to penalties is not new, nor is it confined to the ATO's cash economy or correspondence audits.
6.17 As early as 1993, the Joint Committee of Public Accounts (as it was then known) raised concerns about ATO auditors raising culpability penalties (such as intentional disregard):
Based on the need to maintain taxpayer compliance, administrative penalties need to be set in such a manner as to effectively deter wilful behaviour but not penalise inadvertent error. Culpability, as the word implies, has a technical legal meaning and the Committee considers ATO auditors should not have the power to impose culpability penalties. While the Committee has concluded it would be preferable if culpability penalties were abolished, it recognises this was not a position that administrators would necessarily agree on. In the absence of a move to abolish culpability penalties the Committee concludes that it is essential that an officer with legal qualifications from outside the Audit Group of the ATO consider and determine culpability penalties.133
6.18 In response, the ATO rejected the recommendation to have culpability penalties be determined only by legally qualified officers:
This recommendation is not supported. These decisions are not highly technical nor do they require special skills — what is required is a practical application of the law to the facts. A range of rulings and guidelines is available for this purpose, and the ATO does not regard this as the sole domain of legally qualified officers.134
6.19 In 2000, the Australian National Audit Office (ANAO) tabled its report Administration of Tax Penalties.135 It found, amongst other things, that 'ATO staff training in relation to penalties could be enhanced by including the linkages between the Taxpayers' Charter, the Compliance Model and the imposition and remission of penalties. Also, training materials could be improved by providing analyses of the different gradations of non-compliant behaviour and the appropriate enforcement strategies to be applied. The ATO has advised of its intention to develop its training accordingly'.
6.20 As a result of the ANAO report, the ATO began implementing some recommendations and also commenced an internal review into the administration of penalties.
6.21 In 2005, the IGT's Review into the Tax Office's Administration of Penalties and Interest Arising from Active Compliance Activities noted that since the ATO had not yet completed its internal review, 'the Inspector-General will defer more substantive consideration of this topic until after the Tax Office's implementation of recommendations from its internal review and this report'. The IGT in its December 2007 follow up review (chapter 5) did acknowledge the ATO had enhanced the penalty decision making capability of its staff through that the creation and delivery of penalty training packages, the establishment of dedicated penalty teams, the review of penalty decisions as part of the quality assurance process (as evidenced by the IQF reports quoted above) and the use of technical officers in the penalty decision making process.
that it may be prudent for the ATO's external scrutineers (the ANAO, Inspector-General of Taxation and the Ombudsman) to conduct additional work on the ATO's penalty and debt practices to ensure that the ATO's performance continues to improve over time. For example, the Inspector-General's review of GST audits for large taxpayers found issues with the ATO's decisions on shortfall penalties. These included a significant number of cases where the ATO:
- concluded that a taxpayer was reckless, despite the matter being arguable at law;
- applied the penalty at the full rate, despite prior disclosure by the taxpayer; and
- applied a different penalty rule to large and small taxpayers.
The Committee believes penalty and debt decisions warrant continued external scrutiny.
6.23 In 2009, the IGT also recommended in the Review into aspects of the Tax Office's settlement of active compliance activities that the ATO improve the evidentiary basis for penalty decisions, among other things (recommendation 16).
6.24 More recently, the IGT recommended in the Review into the ATO's small and medium enterprise audit and risk review policies, procedures and practices that SME officers improve the evidentiary basis for compliance decisions (including penalties) by using the Facts and Evidence worksheet to develop technical positions (recommendation 3.4). The IGT also made a number of recommendations to improve staff technical capability and support, such as improving ATO officers' understanding of commercial and business issues and strengthening staff training (including the involvement of external experts).
6.25 The IGT commends the ATO for including penalty decisions in its IQF processes. Due to this process, the ATO was able to recognise a capability gap in penalty decision making and implement a training schedule to help bridge that gap. The IGT notes that in its October 2011 IQF report, the ATO had rolled out penalties training to all Cash Economy staff nationally in recognition of capability issues. Nevertheless, the IGT still has concerns about the ATO's application of shortfall penalties more generally.
6.26 As this is a recurring issue across a number of areas in the ATO over extended periods of time, in addition to the following recommendation, the IGT will consider a broader review of penalty decision making as a topic in his forward program.
The ATO should improve the robustness of correspondence audit penalty decisions by, for example, providing clearer staff guidance on the specific types of evidence which would tend to indicate the application of different penalties.
ATO response: Agree
The ATO will draw from its current Integrated Quality Framework process, improved examples of the application of different penalties as guidance for staff.
ATO auditor capability — minimising compliance and administrative costs
6.27 In submissions, taxpayers and tax agents cited positive examples of ATO auditors conduct, including:
- making genuine attempts to understand the business and carefully examine records; and
- having a good knowledge of the industry they were auditing.
6.28 Stakeholders suggested that staff who demonstrated these good skills and understanding should be encouraged to support and train other auditors, rather than newer staff having to start from scratch.
6.29 However, a number of taxpayers and tax agents also reported negative experiences with some ATO auditors. This undermined their confidence that the ATO took into account their particular circumstances in correspondence audits. These stakeholders reported that, amongst other things, the auditors:
- were poor communicators, very difficult to reach or disinterested in engaging with the taxpayer;
- appeared inexperienced (for example they did not examine the records properly, followed a script from which they would not deviate and did not necessarily understand what they were asking for from the business or they had a lack of tax knowledge);
- had difficulty understanding the basic nature of the business (for example a small discount variety store is substantially different to a large chain variety store; new businesses having different cost structures during the establishment stage or more generally; or that some businesses are not always profit driven), their practice (for example that the small business owner would pay their staff wages from cash in the till) or the industry to which the business belonged (for example having to explain the industry process to the ATO auditor); and
- did not understand or appreciate how much work was involved in meeting ATO demands for records (that is unreasonable time frames).
6.30 Furthermore, certain stakeholders reported that the ATO officers auditing them appeared to have more faith in the benchmarks than in what businesses and their agents were telling them, with some reporting that some auditors were overly aggressive and openly questioned the veracity of the agent.
6.31 Certain stakeholders also raised procedural issues, with some reporting that auditors:
- did not apply principles of natural justice, and issued amended assessments before the taxpayer had an adequate opportunity to respond; and
- leaving halfway through an audit, with the next auditor wanting to start from scratch again.
6.32 During the IGT's Review into the ATO's small and medium enterprise audit and risk review policies, procedures and practices, research138 commissioned by the ATO showed some characteristics which indicated the difference between 'expert' compliance officers and 'less experienced' compliance officers. Among the relevant characteristics, the following would appear to explain the divergent stakeholder experiences set out above:
- Investigative ability: Identifying critical information sources and asking a range of questions to uncover valuable information.
- Confidence: Expresses confidence in moving a case forward, knowing what steps to take next and consulting others. Able to maintain momentum on a case when faced with uncertainty.139
6.33 Whilst this research was commissioned for the SME business line, the IGT is of the view that it is of value to TPALS as well. In particular, less experienced officers may be less confident in terms of progressing a case or making conclusions about the taxpayer's business practices. Thus it is important that the Cash Economy Branch maintains its monthly call over practice.140 The monthly call over allows an auditor and their team leader to discuss the progress of the auditor's cases on hand, and to assist the auditor in progressing the case. The IGT commends the ATO's practice of monthly call overs to support its audit staff. The IGT also recognises that staff in the Cash Economy Branch are composed of officers with a variety of experience and tenure. Staff with experience in certain industries should be recognised and actively mentor other officers to share their knowledge about the operations of businesses in certain industries. This is particularly important in areas where a team leader has many staff.
6.34 Auditors should also have a clear understanding about the nature of the benchmarks and be in a position to explain to a taxpayer or their agent why a particular benchmark is applicable to their business. Ultimately, this requires the auditor to make appropriate enquiries to understand the business being carried on by the taxpayer and the industry to which it belongs.
6.35 The IGT notes that the ATO's cash economy stream IQF reports show that there are practice issues in relation to staff keeping proper records and documentation of compliance activities.141 Poor documentation hinders the IQF's ability to detect and address practice issues. The ATO should ensure that staff are adequately documenting the facts on which they are relying to make decisions as well as the reasons for their decisions.
6.36 This is a particularly important credibility issue for the ATO as it is seeking to ensure taxpayers are themselves maintaining a high standard of record keeping. See chapters 2 and 5.
6.37 It is the IGT's view that lessons can also be taken from the way in which these audits were conducted. The ATO could identify any systemic causes of objections in benchmarking audits and adequately support audit staff to address any capability gap or correct any formal or informal procedures.
To enhance staff capability, the ATO should:
- ensure staff with knowledge or experience in certain industries and businesses are recognised, and have them mentor other less experienced auditors when they are undertaking work in relation to such industries and businesses;
- analyse the underlying causes of objections being allowed to identify common themes and address these directly with auditors and team leaders; and
- ensure that auditors are aware of their own recording and documentation requirements for all compliance activities and ensure that other practice issues arising from the IQF process are addressed.
ATO response: Agree
We will implement a process to incorporate feedback from case analysis (including objections), IQF analysis and relevant industry knowledge into broad-based capability development programs and team-specific development.
This will include making it clear that there is an expectation that more experienced officers mentor those with less experience.
Provisions of hard copy and electronic records
6.38 Tax agents raised the issue of the ATO not accepting records electronically during audits, requiring them to print out reports from accounting software and fax or mail the document to the auditor. For example, a tax agent reported that she had to send 'boxes' of records to the ATO, all of which had to be photocopied first. The client was charged $8000 by the tax agent for handling the case. Importantly, in some cases, the act of photocopying can be so time consuming that a client does not bother to make copies of the records first and simply sends the originals direct to the ATO. One representative group indicated that the use of hard copies and mailing caused lag between the delivery and receipt of records which extended the time taken for the audit to complete. It was also suggested that it would have been cheaper and faster to pay for the ATO officers travel costs and visit the premises and inspect the original documents on site. This would also have the added benefit of allowing the auditor to ask questions, as well as opportunities to observe the running of the business.
6.39 Some tax agents mentioned that cloud accounting software is becoming more prevalent with their clients. Cloud accounting platforms allow small business owners to perform their record keeping on internet based software. The client then grants limited access to the accountant to check the financials and complete tax returns based on those financials. The client may even grant limited access to a financial institution where the financial institution was to check financial health before granting loans.
6.40 It was suggested that accessing such records would significantly reduce compliance costs imposed by audits. In this respect, the IGT is aware of at least one case where the tax agent granted limited access to their online accounting system to the ATO auditor.
6.41 With respect to email communication with taxpayers, ATO staff are guided by a variety of practices statements and instructions. Corporate Management Procedures and Instructions CMPI 2006/07/09 Email security in the Australian Taxation Office is an example of such an instruction. It provides that 'IN-CONFIDENCE'142 emails may be exchanged with external parties, such as taxpayers, when:
no alternate, secure channel exists that reasonably meets the external party's and ATO needs and expectations. Alternate channels include ATO portals, phone, fax or postal services, hard copy documents, encrypted CD's and DVD's, and ... the external party has initiated the exchange of IN-CONFIDENCE emails.143
6.42 The IGT considers that, since the ATO appears to prefer channels other than email and that the taxpayer is required to initiate the exchange of email, auditors may not consistently communicate the availability of email as a possible channel of providing evidence.
To reduce compliance costs and time frames the ATO should make it easier for businesses to deliver their records electronically for inspection.
ATO response: Agree
The ATO will expand the use of the existing bulk data exchange facility to make it available for businesses and their representatives involved in cash economy audits.
129 Section 284-90 of Schedule 1 to the Taxation Administration Act 1953.
130 Law Administration Practice Statement PS LA 2006/2 Administration of shortfall penalty for false or misleading statement.
131 ATO communication to IGT, 23 February 2012 and 31 May 2012.
132 ATO communication to IGT, 23 February 2012.
133 Joint Committee of Public Accounts, Report 326 An Assessment of Tax, Canberra, November 1993, para. 12.30.
134 Government response to Report 326, paragraph 183, September 1994.
135 Administration of Tax Penalties, Auditor-General Report No. 31, 1999-2000.
136 Joint Committee of Public Accounts and Audit, Report 410: Tax Administration, Canberra, June 2008, paragraph 6.21.
137 ibid, paragraph 6.30.
138 Inside Story researched commissioned by ATO for S&ME Compliance Officer Research, July 2010.
140 ATO communication to IGT, 8 May 2012.
141 ATO communication to IGT, 23 February 2012 and 31 May 2012.
142 ATO Corporate Management Procedures and Instructions CMPI 2006/07/09 Paragraph 32 indicates that 'the majority of client information falls within the IN-CONFIDENCE category'.
143 CMPI 2006/07/09, paragraph 34.