The Inspector-General of Taxation's (IGT) review into the Australian Taxation Office's (ATO) use of benchmarking to target the cash economy was prompted by concerns raised by small businesses, tax practitioners and their representative bodies. In particular, concerns were raised in relation to various aspects of the ATO's approach in developing and using its benchmarks of small business financial performance ('the benchmarks') to address underreported income.
Overall, the review found that stakeholders were supportive of the use of benchmarks as a risk identification tool. They were, however, concerned with the benchmarks themselves in addition to the way the ATO was using them for compliance activities. In particular, concerns were expressed that the benchmarks did not account for business differences in an industry or for geographic differences. Furthermore, stakeholders were concerned about the data integrity of the inputs the ATO was using to develop their benchmarks. The IGT found that many of these concerns related to the transparency of the process and could be addressed by publishing the data inputs and methodology the ATO uses to develop the benchmarks as well as seeking and publishing independent third party assurance on the methodology. The IGT has also made recommendations to enhance the data integrity of the ATO's inputs.
Whilst stakeholders considered benchmarks to be a useful way for the ATO to exclude large numbers of likely compliant taxpayers from compliance activities, they were also of the view that being significantly outside the benchmarks was, in and of itself, not enough reason to commence audits. It was considered that the ATO should take into account additional factors to determine whether the risk warranted an audit. The review found that of over 7600 benchmarking audits, the ATO made adjustments in only 24 per cent of cases. The IGT believes that, whilst this is better than randomly auditing taxpayers in the cash economy population, the current approach can be improved to better exclude compliant taxpayers from audit selection.
The IGT observes that the ATO can analyse the completed audit case data to determine whether other factors can be considered as useful predictors of taxpayer compliance or non-compliance. The IGT has recommended that the ATO should use such research to refine its audit selection process, thereby ensuring that it focusses its resources on a higher proportion of non-compliant taxpayers and reducing compliance costs for compliant taxpayers.
The IGT also noted there was some confusion during ATO audits about the types of evidence the ATO would take into account in determining whether taxpayers had omitted income. The IGT found that the ATO could address this confusion by clarifying in its staff instructions and communication with taxpayers the evidence it is seeking during audits. This should also realign taxpayers' expectations with that of the ATO and improve the evidentiary basis for ATO audit decisions. In particular, the IGT has recommended that the ATO publish information regarding how the ATO takes into account taxpayer records during an audit and the evidence which a taxpayer may adduce should the taxpayer's records not meet the ATO's requirements.
The review also found that the evidentiary basis of penalty decisions resulting from benchmarking compliance activities could be improved. The review's findings are broadly consistent with past IGT reviews regarding the penalty decision making capability of ATO staff. The IGT considers that the administration of penalties, as a topic, is ripening for an IGT review in its own right. It has been a persistent stakeholder concern across all market segments in past IGT reviews.
The IGT also made a number of recommendations aimed at improving staff capability, reducing taxpayer compliance costs during the conduct of audits and improving small business record keeping into the future.
Overall, the IGT has made eleven recommendations to the ATO. The ATO has partially agreed with two and has agreed with the remainder.