Background

3.1 As part of Australia’s self assessment system, the ATO has a duty to collect tax in accordance with a correct assessment.123 The ATO is not a party to the underlying transactions and arrangements that give rise to taxpayers’ tax liabilities and, in this sense, operates in an environment of information asymmetry.

3.2 However, it is not considered to be an efficient use of Government resources for the ATO to gather all information in relation to each taxpayer and check every single tax return. This was the key reason in moving away from the former full assessment system.124 Further, the Courts have recognised that the revenue authority has a duty of good management, which results in circumstances where not all the tax known to be due will be collected.125 Additionally, section 44 of the Financial Management and Accountability Act 1997 (FMA Act 1997) requires the Commissioner to manage the affairs of the ATO in a way that promotes the efficient, effective, economical and ethical use of resources for which he is responsible. This means that the ATO is not required to pursue every dollar of revenue properly payable where the costs in doing so would be prohibitive.

3.3 In this respect, the ATO takes a risk based approach to compliance actions.126 This requires the ATO to gather relevant information and make a decision on what administrative treatment it will afford each taxpayer.

3.4 As such, the ATO is aligning itself with broader international trends in compliance assurance, particularly those aimed at:

  • securing taxpayer commitments to increase cooperation and transparency as part of its tax compliance framework and embed effective tax compliance frameworks within taxpayer’s broader risk management systems;127 and
  • adopting compliance risk management strategies that involve risk-orientation and differentiated responses, complemented by shifting compliance activities upstream to address risks earlier in the sequence of events potentially leading to compliance failures.128

3.5 On a broad level, the ATO currently uses a number of programs and models to assist in selecting taxpayers for compliance verification.

3.6 The Compliance Program outlines the differing foci for ATO compliance activities. It is updated and published on an annual basis.

3.7 The ATO’s Risk Differentiation Framework (RDF) sorts taxpayers according to the comparative likelihood and consequence (‘higher’ and ‘lower’) of their non-compliance with the tax laws on the basis of information provided to the ATO.129 Although the RDF is currently employed in the large business market it is intended to be rolled out next to small and medium sized enterprises (SMEs) and high wealth individuals (HWIs).

3.8 The ATO also refines its approach depending on the particular market segment it is examining. For example:

  • in relation to individuals lodging income tax returns, the ATO uses its computer systems to assess the risk of inaccurate claims before any refunds are issued (the tax refund integrity program);
  • in relation to small businesses, the ATO uses its cash economy model and industry benchmarks to identify cases for risk assessment and compliance verification;
  • the larger SME market and HWIs are more closely scrutinised using a private wealth approach that seeks to identify the controlling mind of organisations and their links between different tax entities as a means to better identify tax risks; and
  • in relation to large businesses, the ATO seeks to understand not only the tax risks but the entity’s tax risk governance framework and processes (which themselves form part of the ATO’s risk assessment).

3.9 Compliance assurance can involve a graduated level of intensity from initial risk assessment through to full audit. Typically, it can involve increased information gathering post-assessment. However, recently, the ATO has increased its collection of detailed information before an assessment is lodged (pre-assessment disclosures) as well as increasing requirements for additional disclosures at the time of lodgement (expanded lodgement disclosures).

3.10 For individuals, this can take the form of the ATO delaying the issue of refunds pending the verification of certain claims and provision of information, such as through its tax refund integrity program.

3.11 For ‘higher consequence’ taxpayers (those liable to pay more tax as compared to the general taxpaying population, such as the largest businesses or larger SMEs and HWIs) this can take the form of annual compliance arrangements (ACAs), pre-lodgement compliance reviews (PCRs), international dealing schedules (IDSs) and, in some circumstances, it could also include requests for private rulings.

3.12 Pre-assessment disclosures and expanded lodgement disclosures impose additional compliance costs on taxpayers, such as additional time spent by staff and advisors in compiling and reporting extra information. At the same time, there is no corresponding reduction in the level of uncertainty, such as shorter period of review, faced by taxpayers subject to these disclosure requirements:

For the taxpayer tax risk can arise because the taxpayer expects a particular tax result, but for any number of reasons, may end up with a different tax outcome. One of the ways in which that risk can be reduced to zero is where the ATO loses the ability to enforce a different tax outcome. If a point is reached when the ATO cannot change the tax payable in respect of particular year of income, then there is no tax risk associated with that year of income.130

3.13 A range of stakeholders contended in submissions that this movement in the pendulum represents a move backward towards full assessment by way of increased information gathering at or before the time of assessment without any of the previous benefits available from the former full assessment regime. It also raises the issue of whether ATO practices may be improved in order to reduce compliance costs and deliver greater certainty to taxpayers, without significantly impacting on the ATO’s ability to collect the correct amount.

3.14 Key themes arising from these submissions were as follows:

  • Information gathering;
  • The ATO’s risk differentiation framework;
  • The role of the private sector adviser;
  • Taxpayer uncertainty and periods of review; and
  • Aspects of specific ATO activities.

3.15 Each of these themes is discussed in the sections that follow.

Information gathering

Issues arising from submissions

3.16 The private sector has publicly commented on the ATO’s increasing appetite for information for a number of years. However, recent changes to tax administration, both for individuals as well as businesses, have prompted a number of fundamental questions. For example, what amount of information is appropriate to collect in a self assessment environment? Should refunds of overpaid tax be delayed pending the outcome of risk identification processes, or should compliance verification occur after the amounts are refunded? If both, then where should that balance lie? Given that taxpayers operate in a self assessment environment, is it appropriate that information on sensitive tax risks be requested before taxpayers have had an opportunity to assess their affairs themselves? If a risk based approach is desirable, then what type of information should be requested to identify the potential likelihood of a risk? Should this include evidence of all material facts of each issue and evidence of sufficient taxpayer tax-risk governance processes? Should information gathering be aligned with the taxpayers’ natural business systems, or should new ones be created to satisfy ATO information requests?

3.17 In addition to the ATO’s recent desire for more information at, or prior to, the time of lodgement, the IGT noted in its large business report131 that there are also external factors which affect the amount of information the ATO might require from taxpayers. For instance, the Federal Court’s Practice Note TAX 1132 sets out arrangements for the management of tax cases that are litigated in the Federal Court. As a consequence of this practice note, the ATO advises that it now seeks to collect more information at earlier stages to ensure that it is ‘litigation-ready’ at the objection stage.

3.18 Overall, many business stakeholders noted that there is often not a clear limit to the amount of information the ATO requires from a particular taxpayer in relation to pre-assessment or expanded lodgement disclosures. Furthermore, through discussions with the ATO it has been established that there is no official policy on what is a satisfactory amount of information.

3.19 Senior ATO officers confirm that, in order to determine risks for compliance assurance purposes, their objective is to obtain enough information not only to understand the transaction or arrangements but also to understand the taxpayer and be assured that they are treating their tax risks appropriately.133

3.20 The ATO explains that for larger business taxpayers it needs an understanding of the taxpayer’s governance systems. Where the ATO was unsure about a taxpayer’s systems, it tests the information the taxpayer provided. Where these systems have been assured, the ATO would need to test whether the taxpayer is treating tax risks appropriately. Where the ATO is assured of both the taxpayer’s systems and that they are treating risks appropriately (such as though an ACA or a PCR), there is no need for further investigation.134

3.21 In this respect, submissions raised a number of concerns with specific ATO compliance activities, such as ACAs. These are discussed further below.

3.22 Many representatives of individual income taxpayers also argued that delaying the refund of income tax refunds for extended periods of time in a self assessment system was disproportionate to the perceived risks which could have been better addressed through post-assessment assurance. These delays were said to substantially and adversely affect taxpayers and their advisers.

3.23 It is apparent from submissions and discussions with the ATO that, broadly:

  • the costs and impacts of ATO information gathering can be significant and there is no clear guiding principle that limits how much information the ATO needs before or at lodgement of tax returns;
  • ATO consultation with taxpayers on the design of information gathering activities could improve taxpayers’ experience with ATO information gathering;
  • there is opportunity to tailor disclosure requirements; and
  • there is opportunity to reduce taxpayer uncertainty by shortening periods for administrative review.

3.24 These issues are discussed below.

Costs and impacts of ATO information gathering

3.25 At a broad level the ATO needs information to assure itself of taxpayer compliance with the tax laws. However, significant costs arise from dealing with ATO information requirements. Therefore, the costs imposed should be proportionate to the risks of non-compliance. This implies a differentiated and graduated approach to ATO information gathering based on cogent and iterative risk assessments.135

3.26 The costs of tax compliance are high. However, this is neither new nor unique to Australia. There are a number of surveys indicating the costs of tax compliance. Of these studies, the ATO observes in its call for tenderers on a specific research exercise that:

[Quantitative] [s]tudies of compliance cost in general have been undertaken in Australia and overseas by academics, business, industry and professional groups and by governments. The methodologies used and focus have varied. The quality of the research has often been mixed; even many of the biggest and well resourced studies have attracted their share of criticism. … Previous research on cost of compliance may serve as a general reference only.136

3.27 Historically, the ATO has publicly reported the administrative costs of compliance activities, such as operating expenditure for active compliance activities. Internally, it has used certain administrative costs, such as the full-time equivalent staff, as a proxy for costs in delivering certain compliance strategies. In some cases the ATO has also surveyed relevant taxpayers to understand their perceptions.

3.28 For changes to taxation laws, the ATO has developed a methodology to calculate the compliance costs resulting from new legislation. In summary, the ATO uses a structured qualitative assessment to explain who is impacted, how they are impacted and the magnitude of the impact. Relevant ATO and Treasury officers review these assessments and produce many of the parameters used in the quantification of compliance costs. In this respect, the quantification of the impacts arising from new law:

are usually based on the ATO’s General Compliance Cost Model. This model employs an array of estimates for the yearly expenditure on key compliance activities separated by user type (such as individuals, micro enterprise, large enterprise, etc) and the type of tax (excise, GST, etc).

The key data points on which the model is based are:

  1. Current time spent in compliance activity
  2. Current monetary costs associated with compliance activity
  3. Indications of the magnitude of variation following a proposed change

To calculate the compliance cost, the model multiplies the data on time currently expended for compliance activity by the expected proportional increase/decrease. The numerical proportion employed in the model is categorically defined by an ATO analyst having assessed the variation to be low, medium or significant magnitude. By multiplying the time-based estimate produced by the average adult hourly wage, the model determines the dollar value of the marginal change in time spent on a compliance activity.

Direct monetary costs resulting from compliance are also incorporated, such as the hiring of services (such as financial advisors) and required purchases (such as IT packages).

These estimates are produced in terms of the initial variation and the ongoing impact. While most legislative changes will result in an initial compliance cost (due to re-education, and adjusting procedures) the ongoing variation may either produce increased or decreased obligations.137

3.29 In March 2011, the ATO invited market research suppliers to submit proposals for conducting research into compliance costs, including the provision for updating the ATO’s model.138 The ATO advises that a commercial market research firm won the tender.139

3.30 It is important for government to be aware of whether disclosures will increase compliance costs and intensify the costs and impacts of uncertainty inherent in the system. Where there is awareness of the costs, policy makers are better equipped to make balanced decisions such that the overall benefit to the system is the greatest that can be achieved at the lowest overall cost to the economy.

3.31 Notwithstanding their work on estimating the potential compliance costs for new law, pre-assessment and expanded lodgement disclosure obligations extend beyond information traditionally collected in the tax returns and may not directly relate to legislative change. As a basis, all agree that those with the greatest unmitigated tax risk should bear a greater compliance burden than those with a lower tax risk. However, there is a need to recognise the additional costs imposed as a result of this increased compliance burden and a need to cogently justify that imposition on the basis of a likely increase in risk. At present, it is noted that some independent surveys rate the ATO amongst those agencies imposing the greatest compliance costs on business taxpayers.140

3.32 To this end, the IGT observes that there would be benefit in an independent government body such as the Productivity Commission undertaking a study to measure tax related compliance costs and their impact on the administrator, the taxpayer, tax practitioners and the Australian economy as a whole. Such study would also advance understanding of the broader effects of such action and provide a cogent base from which to obtain a balanced assessment of the efficacy of the broad taxation system in this regard.

Recommendation 3.1

The Government should consider commissioning an appropriate independent body, such as the Productivity Commission, to publicly report on the cost of taxation related compliance, including taxpayers’ costs and the overall cost to the economy.

ATO response:

Matter for Government.

Consultation to improve the ATO’s information needs

3.33 The potential to reduce the level of compliance costs indicates a need for greater consultation on the information needs of the ATO and whether those needs are proportionate to the relevant risks.

3.34 A consistent message in submissions to this review was that had the ATO consulted more effectively with the community in the design of its recent information requirements, it could have obtained the information in a manner that imposed less of a compliance burden on taxpayers. 141

3.35 The broader issue of consulting taxpayers and advisers to determine more effective and efficient means of information gathering has been raised at peak consultative forums, such as the ATO Large Business Advisory Group’s (LBAG) discussion on PCRs, and identified in other IGT reviews, such as the Review into the ATO's small and medium enterprise audit and risk review policies, procedures and practices.142 Furthermore, during the course of this IGT review’s working group meetings a number of ideas for improved information gathering were seen as worthy of further consideration by the ATO.

3.36 The ATO advises that it is aiming to improve its consultation on information gathering and that it is currently consulting with taxpayer groups through the National Tax Liaison Group (NTLG).

3.37 In discussions with senior ATO staff, it was noted that the ATO does consult the community when it decides to initiate a change, however, there is no programmed consultation in relation to the appropriateness of existing disclosures:

Process of company tax return consultation

The company tax return undergoes a comprehensive annual review. Not every change to the tax return and instructional material is subject to an external consultative process. However, any significant/material changes are co-designed with external stakeholders. Changes to the return form and instructional material is often the end product of a legislative change. The law design is led by Treasury and the administrative design is the responsibility of the ATO. It is usual for both processes to involve external consultations. We also keep in close contact and liaison with the external software developers through every tax time cycle as part of the software developers consultative forum (held bi-monthly) and electronic lodgment service (ELS) forum (held annually).

Examples of recent company tax return changes involving external consultations are:

Taxation Of Financial Arrangements (TOFA) …

Company tax return – Calculation statement …

International Dealings Schedule (IDS) …

Reportable tax positions.143

3.38 The ATO has noted that some disclosures formerly required at the time of lodgement are now obsolete and schedules should be revised accordingly. This was a result of recent ATO research in which the 1350 tax return related labels were examined. The ATO determined that some of the labels were not used and therefore should be deleted (these labels, however, not have not been deleted as yet due to capacity constraints with the ATO’s Tax Time change process). At the time of finalising the report the ATO advised that:

The ATO intends to delete these labels from the returns and schedules for the 2012-13 year onward. This is expected to see:

  • The removal of approximately 30 labels from the company, partnership and trusts annual income tax returns
  • The removal of about half of the labels currently on the capital gains tax schedule
  • The deletion of the capital allowances schedule
  • The deletion of the personal services income schedule
  • Consequential changes to the individual, superannuation fund and self managed superannuation fund returns to mirror the changes to the business returns.144

3.39 The ATO also determined that most labels were used with many being used for risk and monitoring purposes. The ATO is now considering whether these labels could be improved to make them more usable and to reduce compliance costs.145 The ATO has been involved in community consultations as part of this project.

3.40 The ATO has also advised that it is considering a project to ‘differentiate’ returns depending on its feasibility.146 The ATO’s concern is that it may only achieve small and piecemeal changes to the returns in very small and staged increments. These limitations are largely due to the ATO’s capacity to support the underlying technological system changes required.147

3.41 The ATO has also acknowledged that there is room for it to improve its approach to pre-assessment and expanded lodgement disclosures in order to decrease the compliance costs faced by taxpayers.

3.42 Where the ATO has consulted with taxpayers and their representatives regarding the content of pre-assessment and expanded lodgement disclosures and tax returns, it has been able to obtain a better picture of the costs associated with particular requirements and therefore tailor its approaches by balancing the costs to the taxpayer against the ATO’s needs in administering tax laws.

3.43 In the IGT’s view, the ATO should ensure that it consults with the community on its current and future information gathering requirements to ensure that these requirements are imposed in a manner that minimises the compliance burden on taxpayers and is proportionate to their tax risk.

3.44 Annual consultation with taxpayer representatives should take place regarding the form and content of pre-assessment and tax returns including expanded lodgement disclosures, albeit that the opportunity to give effect to any information technology changes may be limited in the short term.

Recommendation 3.2

  1. The ATO should consult with taxpayers, tax practitioners and/or their representative bodies every five years on information it seeks in company returns (as well as associated pre-assessment and expanded lodgement disclosure, such as annual compliance arrangements, pre-lodgement compliance reviews, the international dealing schedule and the reportable tax position schedules). This is in addition to its current practice of consulting on new information as the need for them arises pursuant to a change in the law.
  2. The ATO consultation with tax taxpayers, tax practitioners and/or their representative bodies on individual tax returns should include discussion on the information being sought through expanded lodgement disclosures as well as the tax return itself.

ATO response:

Agree.

We will develop and implement procedures to periodically consult with relevant consultative forums and the community to review the information required on company and individual income tax returns and associated schedules as well as the information requested as part of pre-lodgment compliance reviews and annual compliance arrangements.

Lowering compliance costs — tailoring businesses’ electronic lodgement

3.45 In the longer term, the ATO sees that there is potential to make collection of information easier and more tailored by using electronic channels to collect information which is already produced by taxpayers’ own systems.

3.46 With advances in electronic communications, there may not be a need in the future for at least business taxpayers to lodge returns. Rather the ATO would merely collect an electronic copy of the business taxpayer’s accounts and tax calculations, as well as some assurance of accuracy.

3.47 In the long term, the ATO should aim to align its information needs, as practicably as possible, to taxpayers’ natural business and accounting systems, with the eventual aim that tax returns will not need to be lodged.

Recommendation 3.3

With the aim of reducing compliance costs, the ATO should better align its tax information collection with natural business systems, such as electronic company financial systems.

ATO response:

Matter for Treasury.

This is the intent of Standard Business Reporting which is current government policy and the responsibility of the Treasury.

The ATO, as a participating agency, is committed to supporting the business outcomes of SBR and has agreed to contribute to the ongoing development of the SBR taxonomy as a whole-of-government asset.

Lowering compliance costs — individual tax return lodgements

3.48 Individuals’ tax returns comprise a substantial number of all tax returns lodged. The ATO advises that, for the purposes of specific research it conducted relating to the measurement of compliance costs, these individuals can be categorised as:

  • Non-business individuals (general) – people who lodge income tax returns with no business income (about 9 million taxpayers).
  • Non-business individuals (complex) – generally people who lodge income tax returns with no business income but with material property and investment activity (about 5 million taxpayers).
  • Business entities – either operating as a taxpayer or as a key third party (that is employers) [such as] Micro business – generally any entity (sole trader, partnership, trust, company) with business income up to $2 million in total business income (about 2 million entities).148

3.49 In the Australian system, employees have tax deducted from their salary and wages at source. This in an effective means to help these individuals to ‘save’ for a tax liability at the time of income tax return lodgement. The ATO assists employers and others by producing pro-rated schedules and a means by which these amounts can be remitted to the ATO and held pending assessment.

3.50 Although a substantial portion of individual taxpayers with simple affairs may have sufficient tax instalments deducted at source to fulfil their tax liabilities, a proportion are eligible to claim substantial deductions or offsets (such as work related expenses or rebates) as a result of a number of redistributive policy objectives effected through the tax system. This introduces increased compliance costs in terms of ensuring compliance with the tax laws and seeking advice.

3.51 The ATO is seeking to make it easier for individuals to lodge returns by adopting the Scandinavian model of pre-populating income tax returns.149 In this respect, the ATO pre-fills individual tax returns with information sourced from third parties.

3.52 There is a compliance cost imposed on those third parties providing this data. While these costs should also be included for overall measurement in testing the effectiveness of the system, in many instances they serve the interests of the providers’ clients who are also taxpayers.

3.53 The ATO advises that there was a 25 per cent increase in the take up of pre-filling for the 2010 financial year (9.4 million individuals) and a 15 per cent increase in the 2010–11 financial year (10.9 million individuals). Interestingly, for the 2010–11 financial year, the greatest use of pre-filling has been by tax agents by downloading information for 8.4 million individuals from the tax agents’ portal.150

3.54 The ATO has recently advised the IGT that it considers that, at present, it has expanded the provision of the pre-filling service as far as it can without significantly imposing additional costs on third party information providers or legislative removal of concessions delivered through the income tax system:

The ATO considers that there is currently limited opportunity to expand its pre-filling service without legislative change to facilitate the sourcing of additional data. Any change to the reporting obligations would ideally:

  • require comprehensive reporting obligations for all major income and deduction items,
  • require the more timely provision of information, and
  • improve the accuracy of the information provided.

Costs to third party providers will need to be weighed against the anticipated benefits.151

3.55 In the IGT’s view, future technological improvements may further lower compliance costs for taxpayers and third party providers. However, the ultimate success in expanding the provision of pre-filling depends, to a large extent, on the degree to which social policy objectives are delivered through the tax system. In this respect, the Government has acted to increase the tax free thresholds, which may exclude a number of individuals from the requirement to lodge income tax returns. Standard deduction allowances have also been explored. There are also other approaches aimed at decreasing individuals’ compliance costs which could be explored further, such as improving technological platforms.

3.56 As such, the ATO has moved to align individual tax return preparation and lodgement with changes in use of technology. E-tax is a valuable innovation in this respect. However, there is potential for the technology to be better utilised to improve the usability by individuals without a direct knowledge of tax law. As technology develops further, there may be potential for the ATO to develop an interview style product that prepares the return from answers to simple questions. Although current technology may not robustly support such a measure, this could be an aspiration that the ATO works towards under its long term information technology plan.

3.57 There is also the potential for future mobile telephone-based payment applications to become integrated with accounting software and lodgement systems. Recently, commercial mobile phone applications have been accepted to make certain payments electronically. With future advances in technology this may allow for the applications to determine the transactions’ tax implications and record those transactions in an acceptable format which allows them to be used to pre-populate the relevant tax notice/return for electronic lodgement.

3.58 Although technological advances may bring these innovations closer the IGT considers that the ATO could explore options for further simplification in the interim.

Recommendation 3.4

The ATO should explore options for further reduction of compliance costs related to individuals’ tax return lodgement obligations, such as:

  1. the earlier provision of third party information (without increase in their compliance costs); and
  2. improved technological platforms.

ATO response:

3.4(a) Matter for Government.

The ATO believes that there are limited opportunities to further expand this area without legislative change.

3.4(b) Agree.

Our future direction is to move to more web-based applications. The speed of our movement will be impacted by technological capability and cost.

In the longer term our aspiration is to move to device agnostic approaches which will enable taxpayers, regardless of the platform they use, to interact with us in a similar way.

Information gathering in relation to general anti-avoidance

3.59 Submissions raised concerns with the costs imposed by ATO information gathering in relation to the general anti-avoidance provisions.

3.60 Part IVA of the ITAA 1936 (the income tax general anti-avoidance provisions) requires the existence of a ‘dominant purpose’. Defining a ‘purpose’ is inherently difficult to establish on an objective basis without imposing substantial compliance costs incurred as a result of calling for and examining a significant range and volume of documents and other forms of evidence.

3.61 Stakeholders, however, questioned the utility of some of the types of information requested and whether the costs imposed in retrieving that information were proportionate to the risks, particularly in circumstances in which tax avoidance purposes were absent. Stakeholders also commented there was often a lack of ATO understanding about what records are kept and what information is available about the decision making process — for example, documents about commercial decisions made 30 years ago. Such information is often not documented and is difficult to compile. This issue was also considered in the IGT’s Report into the Australian Taxation Office’s large business risk review and audit policies, procedures and practices.152

3.62 Recent judicial decisions on the ‘tax benefit’ element of Part IVA also appear to have compounded ATO information gathering by prompting the ATO to examine in greater detail multiple counterfactuals (schemes which might have eventuated but did not).

3.63 It should be noted that the Government has recently announced an intention to amend the general anti-avoidance provisions.153 Therefore, further assessment of the administrative impacts on information gathering would best be made some time after the ATO has implemented the relevant administrative arrangements.

The ATO’s risk differentiation framework

3.64 The amount and type of information required by the ATO may depend on the ATO’s determination of a taxpayer’s risk of non-compliance and the potential consequences of such non-compliance. In this respect, the ATO uses its Risk Differentiation Framework (RDF) to determine these risks and consequences, and the ATO’s administrative treatment of those risks.

3.65 Currently, in the large business market segment, those taxpayers of higher consequence and having lower likelihood of non-compliance — ‘key taxpayers’ — are encouraged by the ATO to enter into ACAs. Whereas, those taxpayers of higher consequence and having higher likelihood of non-compliance — ‘higher risk taxpayers’ — that have not entered into ACAs may be required to participate in PCRs, consisting of questionnaires and meetings with the ATO on a routine basis.

3.66 Those taxpayers of lower consequence — low risk taxpayers — are not subject to such additional disclosure obligations and may expect to receive an ATO letter indicating that the ATO does not intend to audit the taxpayer for a particular tax year.154

3.67 As a result, these lower risk taxpayers may be exposed to a lower level of scrutiny by the ATO. However, stakeholders have suggested that the RDF has increased the low risk taxpayers’ compliance costs by reason of increased tax corporate governance, such as increased board involvement, increased external legal advice and costs associated with contemporaneous documentation of transactions and positions taken.

RDF process perceived to lack accountability or sufficient transparency in relation to higher consequence taxpayers

3.68 During the review some submissions claimed that the ATO is not accountable or sufficiently transparent in relation to the factors used in formulating risk ratings. They perceived there to be a lack of accountability and natural justice in the process because taxpayers can be rated as ‘higher risk’ with little or no practical avenue for contesting that view. They state that these ratings will inevitably become generally known in the market place, with the potential to result in a negative reputational impact on the tax director, the company’s tax advisers, the company’s management and its board.

3.69 In this respect, the IGT recommended in his recent review, Review into the Australian Taxation Office’s large business risk review and audit policies, procedures and practices, that the ATO provide taxpayers with the opportunity to discuss the basis for the risk rating (recommendation 4.1). This should include the ATO disclosing all facts relied upon in the risk rating and providing the taxpayer with an opportunity to discuss the rating and for the ATO to review any taxpayer reply to the information provided.

3.70 Additionally, the IGT also recommended in that review that the ATO improve its communication about RDF categories. As a result, the ATO has undertaken to consult with the LBAG to enhance the RDF risk categorisation process. Part of this communication will import a degree of accountability and transparency by affording taxpayers an opportunity to understand the basis for ATO risk ratings:

Later this year, the Commissioner plans to write to the Chief Executive Officer of all large businesses to advise them of the ATO’s view of their risk category including an explanation of the concerns that led to that view. At the same time, the ATO will meet with taxpayers in the higher risk and key taxpayer categories to outline the reasons for the ATO’s view of their RDF risk category. This conversation also provides an opportunity to clarify the ATO’s concerns and what is required to address those concerns.

For medium risk taxpayers, this opportunity for discussion necessarily happens a little later because of the numbers involved. Generally the ATO will meet with the taxpayer at the time of commencing a compliance activity (usually a risk review), although it is an option for the taxpayer to contact the ATO at any time to discuss their RDF risk category.

We will listen to any feedback that taxpayers may wish to provide and will work closely with taxpayers to clearly articulate the reasoning behind our risk categorisation. As this is a matter of informed judgment, it is reasonable for the ATO and taxpayers to hold different views, but the ATO is striving for an open and frank relationship that may, over time, lead to us sharing a common view of compliance risk.

If it can be shown that the ATO’s view is based on incorrect or erroneous information we undertake to correct our records and reconsider the categorisation if it is a material matter. Alternatively, taxpayers may provide further information to the ATO that will be taken into consideration when we undertake the next cycle of risk categorisation.155

3.71 The ATO’s implementation of these recommendations will be examined as part of the enhanced ATO processes for ensuring that agreed IGT recommendations are more quickly and appropriately implemented.156

Evidence used to establish lack of transparency or engagement

3.72 In addition to the procedural fairness afforded to taxpayers in determining risk ratings, submissions also raised concerns with the evidence used for some of the RDF’s inputs, such as ‘transparency’, ‘engagement’ and the tax manager’s competence.

3.73 In this respect, the ATO’s perception of a taxpayer’s transparency, engagement and accountability can have a material impact on taxpayers.157 Importantly, ‘higher risk’ taxpayers have been advised that the ATO’s concerns warrant a ‘more intense ongoing compliance stance such as continuous review’ until the ATO sees ‘strong income tax governance, engagement on potential contentious issues and a more open and transparent relationship’.158

3.74 While submissions generally agreed that the ATO should allocate resources in accordance with risk, they considered that these inputs were overly subjective judgements that were based on irrelevant evidence and lacked appropriate accountability.

3.75 Submissions referred the IGT to instances where they considered risks were inaccurately determined because of the subjective judgements made by ATO officers. As a result, this exposed taxpayers to unnecessary and disproportionate compliance costs.

3.76 A particular example of the subjective nature of qualitative tests was said to be the ATO’s approach to information protected by law or administrative concession. In this respect, the Commissioner has made a commitment on page 30 of the ATO's Large Business and Tax Compliance booklet that:

You can expect that we will ... respect your right to Legal Professional Privilege or the Accountant's Concession. This will not adversely impact our view of your cooperation.159

3.77 However, submissions observed that, in their experience, the ATO perceives non-provision of this information as evidence that the taxpayer is being uncooperative, resulting in an increased risk profile and an atmosphere of distrust.

3.78 Relevantly, a submission gave an example where taxpayers provide summary reports to their Board on the strength of their legal position (including tax) and there was ATO pressure to disclose these reports. This approach was not consistent with the ATO’s Practice Statement, PSLA 2004/14, which states that such documents will only be requested under exceptional circumstances:

Circumstances that may be taken to be exceptional and necessitate access to corporate board documents on tax compliance risk would include cases where:

  • the taxpayer has not cooperated with the Tax Office to furnish full and complete information in a timely manner
  • information important to the risk review or audit, including evidence as to purpose for entering into or carrying out a transaction or arrangement, cannot be sufficiently established from the taxpayer's source documents and other enquiries, or
  • the taxpayer has a history of serious non-compliance, for example involving fraud or evasion or persistent avoidance of their tax obligations, or is under investigation in that regard.160

3.79 The submission stated that the ATO has told them that other taxpayers provide this information and therefore those that do not are not transparent. Submissions state that the ATO’s approach in this regard is simplistic and that it may be company policy not to share such communications at all (i.e. not limited to tax communications). It also raised the issue of whether legal professional privilege would be waived.

3.80 In a similar vein, one submission noted that the ATO sees a failure to obtain a private ruling as an indicator of risky behaviour and potential non-compliance. However, there may be a number of legitimate reasons why a compliant taxpayer would not seek a private ruling on an area of uncertainty — many of which, taxpayers consider, are of the ATO’s own creation. That is to say that the taxpayers and their advisers considered that the law was reasonably clear in many instances where the ATO may suggest otherwise. Also, submissions see rulings as importing practical difficulties, being revenue biased, slow and having an unfavourable history where the ATO has some anxiety (see Chapter 2). It was noted that the current system was designed for taxpayers to make their own assessment of their tax positions and only to seek ATO advice, such as a private ruling, where the items were uncertain.

3.81 During the review the ATO advised that it would put in place measures aimed at ensuring the consistent application of risk filters and that, as a part of these measures, ATO perceptions of ‘unwilling participation’ will not, of itself, result in a higher risk categorisation.161

3.82 In the IGT’s view, certain putative indicia such as the degree of engagement and transparency that a taxpayer exhibits may be considered to be subjective measures. Given the significant potential adverse consequences arising from the risk ratings, the ATO should take action to ensure that such ratings are based on cogent criteria and independently verifiable evidence.

Recommendation 3.5

To improve community confidence that ATO risk ratings are based on cogent and independently verifiable criteria, the ATO should, to the extent possible, make publicly available more details on the risk filters and criteria it uses in its risk differentiation framework.

ATO response:

Agree in principle.

We will review the material that we already publish about our approach at a market or segment level to see if there is any additional material that is able to be published.

The Risk Differentiation Framework and the ATO’s risk engine

3.83 Related to the RDF, is the ATO’s risk engine. This system generally provides inputs into the RDF by examining taxpayer-reported information, data from other agencies, the ATO’s own intelligence and publicly available information against risk filters to identify potential compliance risks.

3.84 A number of submissions raised concerns with aspects of the risk engine and the use of RDF more broadly. These issues may be considered for review in their own right in the IGT’s future forward work program.

Role of the private sector adviser in a self assessment system

3.85 According to the OECD’s 2008 Study into the role of tax intermediaries, there is a tripartite relationship between taxpayers, advisers and revenue authorities.162 By engaging advisors and involving them in the compliance process, taxpayer compliance will be enhanced, potentially at a lower cost to the ATO. Each party has a unique set of experiences and a different perspective on issues:

A strategy of positive engagement with tax advisers offers potentially significant benefits to all parties in the tax system. In particular, it can add to revenue bodies’ understanding of tax advisers and the role they play in the tax system, as well as improved risk and compliance strategies and better-focussed information requests and dialogue with taxpayers, resulting in reduced compliance costs for all.163

3.86 There is sometimes a tension between the role advisors play in supporting the system and the work they carry out on behalf of specific taxpayers. However, the demands of clients will typically drive the services that advisors provide.164 In this respect, the OECD paper commented that:

The importance of the role tax advisers play in a tax system can be tested by answering a simple question: would compliance with tax laws improve if tax advisers did not exist? The Study Team found no country where the answer to that question is yes. Across the whole range of taxpayers, taxes and circumstances, the vast majority of tax advisers help their clients to avoid errors and deter them from engaging in unlawful or overly-aggressive activities.165

3.87 In Australia’s self assessment system, professional tax advisers such as tax agents and lawyers play a significant role:

In 1980 [under the full assessment system], 20 per cent of personal taxpayers used a tax agent. By 1992 [under the self assessment system], this figure had increased to around 75 per cent and has since remained fairly consistent. Personal taxpayers feel that the system has become too complicated, and there have been too many changes for them to be able to confidently complete their own returns … Over 90 per cent of business taxpayers use a tax agent to prepare their returns, and this figure has remained consistent at least since the 1980s.166

3.88 Advisors provide services and assistance to taxpayers to mitigate tax risks, typically by providing advice based on an understanding of the tax laws and a consideration of the ATO’s interpretative views. In addition, advisers’ expertise and involvement in shaping tax laws and administrative practices contributes to the improvement of the tax system as a whole.

3.89 The ATO and tax advisors could each be able to learn from each other in negotiating the complexities of the Australian taxation system.167

3.90 The ATO has openly expressed a desire to achieve a cooperative approach or ‘partnership’ with the tax profession.168 Although others have questioned whether this relationship is working well with the tax profession.169

3.91 In this regard, the ATO has recently announced a ‘tax practitioner action plan’ which seeks to cover three themes:

Supporting tax practitioners - by identifying areas where we can improve the support we give tax practitioners: for example making our online tools more accessible, relevant, and contemporary with a view to providing an integrated online service. This also links to the ATO Service Delivery directions, including directions in relation to increased electronic interactions, matching community trends, and with the objective of reducing compliance costs.

Tax practitioner engagement - increasing the effectiveness of ATO consultation with the profession e.g. expanding relationship manager program to support the resolution of issues not able to be resolved by online tools and/or call centre assistance. Making the Professional to Professional support program more accessible; and continuing to improve consultative feedback arrangements, both ways from our forums.

Compliance effectiveness - increasing our engagement with the profession around the development and implementation of the ATO compliance program. Also better understanding the interactions between tax practitioners and their clients and the influence the tax profession has on the compliance behaviour of their clients. The latter will help us develop leverage and differentiation strategies.170

Advisor categorisation and taxpayer risk rating

3.92 The ATO advises that it has three broad approaches to risk identification relating to tax practitioners, being:

Firstly, there is the question of management of risk, using a Risk Differentiation Framework which considers a variety of factors, including association with particular intermediaries like tax practitioners and/or advisors.

Secondly, there is the assessment of risks for tax intermediaries who may be subject to the promoter penalty laws, where we need to identify whom we focus our intention [sic] upon and how we engage with them in order to manage risks of contravention of the promoter penalty laws. We have consulted extensively with industry and the professions on these issues …

Thirdly, there is the assessment of risks for tax practitioners who serve as an interface with their clients and the ATO, where we need to identify whom we focus our intention [sic] upon and how we engage with them in order to manage risks relating to taxpayer compliance with the four pillars of compliance obligations, being registration, lodgment, correct returns and debt.171

3.93 Examples of these three different approaches above include:

  • the ATO’s use of the risk differentiation framework to rate the comparative tax risks that large business may pose, of which the qualities of their tax advisers (including their employees, such as their tax managers) may form part of the inputs into these taxpayer risk ratings;
  • the ATO’s use of the risk differentiation framework in identifying those tax advisers (or ‘intermediaries’) of most concern for the purposes of administering the promoter penalty provisions;172 and
  • the ATO’s identification of those tax practitioners with a significant number of clients whose financial performance falls outside the ATO’s small business cash economy benchmarks, amongst others.

3.94 Many submissions from tax professionals expressed concern with the ATO’s recent approach to assessing tax advisers’ risk of non-compliance and their competence. Unlike an adverse risk rating given to a taxpayer (which may result in an increased likelihood of administrative scrutiny), an adverse risk rating for advisers may result in that adviser becoming unemployable.

3.95 It seems that, in certain circumstances, the ‘aggressiveness’ of an advisor is considered significant in determining the taxpayer’s risk rating. In this respect, the ATO considers that if tax advisors are supportive of the system and engaged with the ATO, all things being equal, this would lower the ATO’s perception of the underlying risk that their clients (taxpayers) pose to the system.

3.96 Furthermore, the ATO also considers the risk appetite of employees of advisers as material in determining the risk rating for the purposes of the promoter penalty provisions:

Where a tax intermediary purchases an existing business unit from another entity, there are potential promoter penalty and controversial tax position risks that flow from the vendor to the purchaser. These include: …

  • pre-existing staff in the new business unit (especially senior leaders) may have a different attitude about acceptable conduct or risk exposure for the business that are not aligned with that of the purchaser. This culture may lead to staff not following either the spirit or the letter of the purchaser’s internal control or governance processes; and
  • pre-existing relationships with higher risk appetite external advisors unit may continue, without the application of the purchaser’s normal internal control or governance processes that would normally be used to engage such advisors.

Risks in acquiring staff from another business

Where a tax intermediary hires staff who have previously worked in another entity, there are potential risks that flow from the previous employer to the new employer. These include:

  • the impact that the previous association of the new employee with controversial tax positions may have on the risk profile of the new employer and that of their clients;
  • potentially different attitudes about what the new employee constitutes acceptable conduct or risk exposure for their employer, which are not aligned with the culture of the new employer. This is especially important where the new employee is in a leadership position, because of the influence that they have over other staff. These attitudes may lead to such staff not following either the spirit or the letter of the new employer’s internal control and governance processes …; and
  • pre-existing relationships with higher risk appetite external advisors to the previous employer may continue, without the application of the new employer’s normal internal control or governance processes used to engage such advisors.

The damage to the new employer that may arise can be significant, so [the ATO] encourage[s] entities to consider and manage these risks when they are hiring staff from other entities. Conversely, if an entity loses a higher risk appetite employee, it may lower the level of these risks.173

3.97 Stakeholders, however, have outlined situations where ATO views on advisors were not necessarily based on objective evidence. In addition, they note that where the perception is incorrect, there is no recourse but to contest this. Moreover, where the ATO’s perception is communicated to taxpayers there is a negative impact on the business of the advisor or their employability.

3.98 In the IGT’s view, tax advisers need to maintain their independence and be able to provide frank and fearless advice to their clients. While aggressive tax planning should be addressed, the ATO should use more appropriate mechanisms such as the promoter penalties legislation in this respect. Furthermore, if a risk differentiation system was to apply to tax practitioners, then the latter must have a right of review and be afforded due process before the ATO’s risk rating of them is finalised.

3.99 Tax advisers also have an important role in contributing to the system as a whole. The aim should be to develop and maintain a mutually constructive and collaborative relationship between the ATO and the tax profession. While the RDF may be a means to encourage this relationship, the execution of this approach has potentially significant impacts and may ultimately contribute to a further lack of trust between the ATO and the profession. A deterioration in trust of this nature has many undesirable effects including an increase in the level of complexity in our tax system. In such an environment, both parties seek for more detail to be spelt out in the legislation in fear of the other party exploiting any perceived uncertainties.

Recommendation 3.6

The ATO should continue consultation with the tax profession to identify strategies to achieve a more constructive relationship. Such consultation should include discussions on whether the use of a risk differentiation system is appropriate and if so how it should be implemented.

ATO response:

Agree in part.

The use of risk management approaches is fundamental to good administration and efficient use of limited resources so it is not considered an option for the ATO to consult on whether the use of a risk differentiation system is appropriate in respect of the tax profession.

To assess a tax practitioner's practice risk, we apply a risk differentiation framework (RDF) based on the risk profile of the tax practitioner's client base. We have publicly stated that we do not, and will not, release an advisor’s risk categorisation to their clients

However, we will consult with the tax profession on how we implement the framework. We will give effect to this part of the recommendation through implementation of the Tax Practitioner Action Plan. This plan sets the direction, the detail, the what, the how and the when we would like to work in collaboration with tax practitioners and their professional bodies. The plan is iterative and to this end we have consulted and will continue to consult with the National Tax Liaison Group (NTLG), ATO Tax Practitioner Forum (ATPF) and Regional Tax Practitioner Working Groups.

Taxpayer uncertainty and periods of review

3.100 Uncertainty has a number of aspects in the Australian taxation system. One aspect concerns the advice framework, which was discussed in the previous chapter. Another aspect is the period for the ATO to amend taxpayers’ tax returns.

3.101 Taxpayers are responsible for lodging their returns under the self assessment system. These returns are taken at face value by the ATO initially and subject to potential review and amendment for a period of time thereafter. The statutory time limits for ATO review of returns provide taxpayers with certainty:

In the current legislative regime in Australia the mere making of an assessment … does not give the taxpayer certainty, because the assessment can be amended. However, the passing of time and the consequent expiry of relevant amendment periods in most cases produces a certainty that enables the taxpayer to draw a line under previous years’ tax liabilities and move on, secure in the knowledge that any issues or difference of views in relation to that period or the transactions of that periods are of historical interest only.174

3.102 The standard period for the ATO to review and amend assessments (including amendments based on the general anti-avoidance provision) is four years. Individual taxpayers with simple affairs have a two-year period. There are also a number of specific provisions that allow the ATO an unlimited period for review in certain circumstances.

3.103 Amendment periods aim to balance certainty for taxpayers with the capacity for the ATO to detect non-compliance.175 The ROSA review’s discussion paper stated that ‘setting periods too short may jeopardise the capacity of the Commissioner to detect non-compliance’.176 The exception has been to provide a shorter period of review to individuals with simple affairs. This was because four years was considered too long, resulting in uncertainty and unnecessary compliance costs.177

3.104 Optimal certainty is said to be reached where the period permitted for amendment is the minimum required for the Tax Office to identify the majority of incorrect assessments and take action to correct them.178

Shortening the general amendment period for micro and small businesses

3.105 Recent improvements in technology and risk identification methodology have provided the opportunity for the ATO to better detect a range of risk considerations for investigation purposes including, for example, the underreporting of income in micro and small businesses. In this particular market segment, the ATO carries out risk identification of micro and small businesses on the basis of industry benchmarks sourced from a range of lodgement data and on the likelihood of underreporting of income.

3.106 Given these recent improvements, the IGT is of the view that shorter periods of review should be considered for micro and small businesses with relatively low annual turnover. This would reduce uncertainty and unnecessary compliance costs for business taxpayers that can least afford it. In determining the threshold annual turnover for access to the shorter period of review, consideration should be given to other small business thresholds, such as those delimiting access to small business concessions. Additionally, consideration should be given to the impact that shorter periods of review may have on the desire for revenue neutrality in the goods and services tax system.

Recommendation 3.7

The Government should consider providing a shorter period of review for micro and small business taxpayers with sufficiently low turnover.

ATO response:

Matter for Government.

Pre-assessment and expanded lodgement disclosures

3.107 In relation to the ATO’s pre-assessment and expanded lodgement activities, taxpayers make significant and detailed disclosures to the ATO (including those made by individual taxpayers soon after lodgement pending the release of their income tax refunds). This places the ATO in a position where it can assess the compliance risk of particular issues and taxpayer circumstances at an earlier point in time. In this sense, pre-assessment and expanded lodgement disclosures effectively increase the time for the ATO to detect non-compliance. However, there is no corresponding obligation on the ATO to reach a view promptly about this information or start any assurance procedures earlier.

3.108 In this regard, the ATO’s pre-assessment and expanded lodgement activities can operate to reduce taxpayer certainty.

3.109 A means to reduce the level of uncertainty arising from review periods would be to trigger the start of the periods for review from the date at which pre-assessment and expanded lodgement disclosures are made. This would encourage the ATO to start its compliance detection earlier, particularly given that substantial disclosures had already been made by the relevant taxpayers. This would also allow audits (if needed) to be carried out and concluded sooner, providing compliance assurance closer in time to the lodgement of the return. Not only would such an approach decrease periods for uncertainty, it would also decrease delays and associated costs for both the taxpayer and the ATO.

3.110 In the IGT’s view, therefore, the periods of review should commence from the date at which the relevant information in pre-assessment and expanded lodgement disclosures are made.

3.111 Further, in 2005, the IGT observed that the cause for ATO delays in more complex audits has, broadly, been a combination of a linear approach to resolving issues and lack of confidence to make strategic decisions during the activities.179 The ATO advises that, as a result, it has observed that audit staff are reluctant to damage the relationship with the taxpayer when they come across difficult issues. Therefore they ask for more information and the taxpayer challenges those requests, all contributing to delays.

3.112 In the IGT’s view, what is needed is for the ATO to communicate the cause of its concern and discuss the issue with the taxpayer so that information requests are targeted to those key pieces of evidence that will either prove or disprove a taxpayer’s compliance. This may require the use of experienced ATO case leaders. Recommendations designed to achieve that outcome have been made in recent IGT reviews.180

Recommendation 3.8

To reduce the extent of uncertainty for taxpayers, the Government should consider:

  1. starting the period for amendment from the date on which a taxpayer provides information that is the subject of disclosure before an assessment is lodged (pre-assessment disclosures) or as a result of increased requirements for additional disclosures at the time of lodgement (expanded lodgement disclosure), if that is earlier than the notified or required date of lodgement of the relevant income tax return; and
  2. where taxpayers provide pre-assessment disclosures or expanded lodgement disclosures, requiring the ATO to commence compliance detection activities within one year of receiving such disclosures.

ATO response:

Matter for Government.

Minimising requests for extensions to amendment periods

3.113 Notwithstanding the statutory time periods for ATO review, these periods may (and have) been extended in certain circumstances.

3.114 Subsections 170(4) and 170(4B) of the ITAA 1936 provide the ATO with the ability to extend the statutory periods of review; the former on application to the Federal Court, the latter through agreement with the taxpayer. This can provide the ATO with further time to resolve audits where it has not been able to do so within the standard amendment period.

3.115 The practical situation was succinctly summarised by White and Walpole:

In light of the costs of opposing an application to court under s170(4), many taxpayers simply acquiesce to an extension, both to save costs and so as to appear reasonable rather than risk an adverse inference being drawn by the Commissioner or a court should they oppose an application for extension of time. The taxpayer is also open to the risk, if it does not accede to the request for an extension, that the Commissioner will simply raise an amended assessment based on the information that the ATO has, leaving the taxpayer to bear the onus, via the objection process, of proving that the amended assessment is excessive. It is therefore assumed that taxpayers generally agree to such extension requests.181

3.116 The law also provides for unlimited periods for review in cases of fraud and evasion.182 However, ATO recording systems do not allow the ATO to easily identify whether a review period was extended by reason of fraud and evasion or whether it was extended by request. ATO records show that some 1800 taxpayers over the last two years had their assessments amended outside of the normal period of review. However, the ATO advises that in the vast number of these cases, the statutory time period was extended due to fraud and evasion. Based on a survey of some ATO officers, the ATO is aware of approximately 20 large business cases over the past two years in which taxpayers agreed to an extension of the amendment periods. It should be noted, however, that extensions of the amendment periods also occur in relation to other types of taxpayers — that is, non-large business taxpayers.

3.117 The ATO agrees that it is not desirable to request extensions. In its guidelines to staff the ATO states:

As the limited period nears its end we have four options. They are:

1. Make no amendment

2. Where possible, issue an assessment. It is important to note that this assessment should not be ‘tentative’ assessment (for example see Federal Commission of Taxation v Stokes) but a definitive one

3. Apply to the Federal Court for an extension of the limited period … or

4. Ask the taxpayer to consent to an extension of the limited amendment period …

Clearly the best option is to be in a position to make a proper assessment prior to the end of the limited amendment period.

All efforts should be taken to ensure that extensions of time at the taxpayers consent are not necessary. In many circumstances the taxpayer and their advisors may take the tactical position that it is not beneficial to grant an extension. For example they may anticipate that our request strengthens an argument that any assessment that we issue in response to a refusal by them to grant an extension of time is a tentative assessment and thus open to challenge (Stokes).183 [emphasis in original]

3.118 Increased rigour in these processes, such as requiring senior ATO official approval, would improve management focus on these circumstances. Such approval should use the same criteria used as if the request was made to the Federal Court, being:

… that it was not reasonably practicable or it was inappropriate for the Commissioner to complete the examination within the limited amendment period, or that period as extended, because of

(a) any action by the taxpayer; or

(b) any failure of the taxpayer to take action that would have been reasonable for the taxpayer to take.184

3.119 The issue of senior ATO officer approval was considered in relation to large businesses in the IGT’s Review into the Australian Taxation Office’s large business risk review and audit policies, procedures and practices.185 In response, the ATO agreed that the decision to seek an extension of time to amend a taxpayer’s assessment was an important one and should not be made without due consideration. In this respect, the ATO stated that it would ensure such decisions would be made by team leaders, in discussion and consultation with their senior executive officers.186 Although such processes appear appropriate in areas accustomed to dealing with well-resourced taxpayers, a higher level of rigour should be applied to other areas of the ATO.

3.120 In the IGT’s view, extensions (other than those due to fraud or evasion) should not be available where the delays resulted from a lack of ATO efficiency in dealing with complex and difficult matters. Also, public confidence in the use of this relaxation of the statutory time limits would be improved if transparency of such decisions was increased.

Recommendation 3.9

To improve the rigour and transparency of decisions to extend the statutory timeframes for review, the ATO should:

  1. require Senior Executive approval before the taxpayer is asked to agree to an extension to the timeframe; and
  2. publicly report on the cases in which extensions to the periods of review are requested and the reasons why compliance activities could not be completed within the statutory timeframes (in a manner that takes account of secrecy or privacy laws).

ATO response:

3.9(a) Agree.

In response to Recommendation 8.6 in the Inspector-General of Taxation’s Review into the ATO’s large business risk review and audit policies, procedures and practices, we advised that the decision to seek an extension of time to amend a taxpayer’s assessment should be made by our team leaders, in discussion and consultation with their senior executive officer, as appropriate. A guidance note setting out the grounds and approval processes for extending the amendment period was published on 8 June 2012.

We agree to expand the application of this guidance note to all relevant parts of the ATO and will review the process after 12 months of operation to evaluate how it has bedded down.

3.9(b) Agree in principle.

The information to support the requirements is not currently captured consistently across our compliance areas. IT systems and business processes will need to be changed to provision the requirements. In some cases these requirements are quite complex. This work will be subject to prioritisation on the Enterprise Solutions and Technology Forward Program of Work and possibly funding allocation/provision.

Unlimited periods of review

3.121 The IGT received submissions citing the persistence of a number of unlimited amendment periods, or periods of review. Moreover, many stakeholders have claimed that these unlimited periods are not consistent with the operation of a system of self assessment. They queried that ‘if it is accepted that four years for income tax assessments is ‘about right’ by both the ATO’s and taxpayers’ perspectives, then why are there still unlimited periods for certain things?’

3.122 Treasury’s ROSA report identified many instances where the ATO had unlimited time to amend assessments and recommended further work to reduce the periods for unlimited review.187 In this regard, Treasury’s Review of Unlimited Amendment Periods in the Income Tax Laws – Discussion Paper examined unlimited amendment periods and proposed to replace most of them with the standard amendment periods, fixed amendment periods, or amendment periods based on a contingent event.

3.123 As a result, Schedule 6 to the Tax Laws Amendment (2010 Measures No. 2) Act 2010 repealed over 100 uncontroversial provisions that had provided the ATO with unlimited time to amend assessments. The remaining unlimited periods were to be replaced with contingent or fixed amendment periods at a later date, subject to the Government’s legislative priorities.188

Transfer pricing

3.124 A key area in which unlimited periods of review continue to apply is in relation to transfer pricing.189

3.125 Compliance assurance of transfer pricing transactions is typically complex and requires a greater amount of time to obtain and process information. This is largely due to issues involving obtaining information and valuations. In this respect, the ATO now requires a certain amount of this work to be done by taxpayers before claims are made. The ATO, consistent with other major global revenue administrators, also offers Advance Pricing Agreements as a means to reach agreement on the method of application of the arm’s length principle to taxpayers’ international related party dealings on a prospective basis.

3.126 Timeframes may also be stretched where taxpayers have applied for a Mutual Agreement Procedure (MAP). A MAP is a process by which compensating adjustments might be agreed to between Australian and other countries’ Competent Authorities. This is aimed at minimising the extent of double taxation arising from the transfer pricing amendments. Such compensating adjustments may be agreed to many years later and will need to be reflected in amendments to the taxpayer’s original assessment.

3.127 The OECD’s Forum on Tax Administration (FTA) has recently undertaken a comprehensive examination of dealing with transfer pricing.190 As part of the FTA’s work, it conducted a survey of member countries (43 OECD and non-OECD countries) that revealed the average resolution for transfer pricing cases was 540 days. In relation to the difficulties in obtaining information the survey revealed:

  • Obtaining information across borders is a particular issue for some countries whereas others have very effective international relationships and use their double taxation treaty networks to good effect …
  • The ease of access to and the quality of relevant supporting documentation is a key practical issue for auditors.
  • The risk assessment process is central to the success of transfer pricing programmes but countries approach this in very different ways, the differences in approach being driven to some extent by the different environments in which they are operating and the particular constraints they have to work within.191

3.128 The FTA work is instructive and may provide the ATO with substantial practical improvements in reducing delays experienced in transfer pricing disputes. The IGT may examine the potential for ATO improvements in managing transfer pricing issues in the future.

3.129 Although transfer pricing claims may be complex, other developed countries have a limited (albeit extended) period of review for transfer pricing cases. Many developed countries, such as the United Kingdom (UK),192 do not provide special extended periods of review for transfer pricing issues — rather, the standard period of review applies. In other countries, the time limit is merely extended — for example, in Japan, the general period of review is five years, extended to six years in transfer pricing cases.193

3.130 In this respect, it is important to note that the Treasury has indicated in a recent consultation paper the need to reconsider the amendment periods for transfer pricing cases:

General amendment rules which allow for a two-year or four-year amendment period may not be sufficient to examine cases such as transfer pricing, due to the complexity of those transactions and the difficulty in obtaining verification information. Nevertheless, even for these cases a finite, albeit longer, amendment period may be more appropriate than an unlimited amendment period. The timeframe for a longer amendment period should be sufficient for the Commissioner to ensure compliance, but not so long as to create unwarranted risk and uncertainty for taxpayers involved. A compromise of eight years, from the time the Commissioner gives the taxpayer the notice of assessment, may be more appropriate.194

3.131 The IGT also considers that while a number of these cases can be very complex, there is a need to ensure the administrators have an incentive to resolve them at the earliest opportunity. Unduly long timeframes raise consistency and continuity issues regarding personnel engaged on these matters. Whereas shorter periods tend to focus organisational energy and imperatives toward resolution.

Recommendation 3.10

To improve the certainty in relation to the review of transfer pricing matters, the Government should consider providing the same period of review for these matters as exists for the general period of review.

ATO response:

Matter for Government.

Losses

3.132 Submissions revealed prevailing confusion on the event that triggers the statutory period of review for amending losses. They observed that taxpayers with carried forward losses may not fully utilise those losses for many years after they were first incurred. As a result they experience additional uncertainty and compliance costs. Difficulties may also arise in relation to record retention and critical corporate memory being lost. They argued that the ROSA review intended to address these issues.

3.133 Prior to the ROSA review and the enactment of the Taxation Laws Amendment (Improvements to Self Assessment) Act (No. 2) 2006, the time period for amendment was triggered when tax became due and payable. Therefore, a taxpayer with no liability, or a loss, did not have tax ‘due and payable’ and there was no ‘assessment’.195 The resulting effect was that the ATO and taxpayer would have an unlimited period to change the purported assessment because the time limits for review were not triggered. This effectively exposed taxpayers to an unlimited period of review for unutilised losses. The tax laws were amended to include ‘nil’ assessments in the definition of ‘assessment’, as a result of the ROSA report’s recommendation 3.4:

From the 2004-05 income year, the period of review for loss and nil liability cases should be equivalent to the period for the Tax Office to amend assessments creating liabilities.196

3.134 Importantly, however, the ROSA review also considered that the deductibility of a tax loss would be determined in the year that the taxpayer had income in which to offset the loss, indicating that this could be many years after the loss was incurred.197 The view was confirmed in the explanatory memorandum to the amending legislation:

2.51 The meaning of assessment does not extend to the ascertainment of the amount of a tax loss. The deductibility of a tax loss will be determined in the year that the taxpayer has income against which to offset the loss, in accordance with normal deduction principles.198

… Example 2.5

A company returns losses of $10 million in the first year, $12 million in the second year, $5 million in year 3 and $3 million in year 4. In year 5, the taxpayer returns a taxable income of $10 million after deducting $30 million for losses of previous years. During year 6, the taxpayer is audited with the result that the company’s first year return was incorrect and should have returned a taxable income of $8 million. Under the new law, the ATO would be unable to issue an assessment of a positive liability for year one. However, the year 5 assessment can be amended to disallow the $10 million deduction claimed for the loss brought forward from year one.199

3.135 Notwithstanding the fact that the law allows the ATO to review the deductibility of a carried forward loss in the year in which the taxpayer seeks to recoup them, the ATO has sought to improve its focus on assessing the deductibility of losses in the year in which they are incurred. For example, in the 2005–06 year, the ATO sought to conduct ‘real time compliance activity’ to examine the validity of losses being carried forward:

Losses

We are still concerned that some businesses are generating and claiming losses that do not reflect genuine commercial arrangements, lack economic substance, or do not reflect the intent of the various capital gains tax events.

In response to these concerns and to recommendations in the Report on aspects of income tax self assessment, we are doing more real-time compliance activity, with an increasing focus on:

  • the validity of losses being carried forward
  • the origin of losses generated, and
  • the origin of losses transferred into consolidated groups.200

3.136 The IGT considers that it is preferable, for both taxpayers and the ATO, that the amendment period for losses be the same as the general amendment period — that is, the ATO can only challenge losses within four years of the year in which those losses are incurred and it cannot challenge them thereafter even in a year in which the taxpayer seeks to recoup those losses. Such a situation is followed in a number of other jurisdictions.201 Dealing with losses at an earlier point in time not only provides certainty to both parties much earlier but also allows the investigations to occur when relevant records and corporate memory are likely to be at their best.

Recommendation 3.11

The Government should consider setting the amendment period for losses to only four years from the year in which those losses are incurred.

ATO response:

Matter for Government.

Aspects of specific ATO activities

3.137 Submissions also expressed concern with aspects of certain pre-lodgement compliance and expanded lodgement disclosures, being the income tax refund integrity program, annual compliance arrangements (ACAs), the International Dealing Schedule (IDS) and pre-lodgement compliance reviews (PCRs). These concerns are outlined below.

Income tax refund integrity program

3.138 The ATO’s income tax refund integrity program stops individual income tax refunds from issuing where various risk attributes are triggered. In this respect, it differs from other ATO lodgement processing compliance verification activities, such as income matching.

3.139 Where a refund is stopped under the income tax refund integrity program, the ATO issues a letter to advise of potential delays. For the last financial year this delay was of at least three months.

3.140 Many advisers to individuals commented that, notwithstanding ATO public claims that the program identified most as fraudulent claims, the advisers observed significant delays with refunds ultimately not being adjusted. In many cases these were small amounts that did not indicate a risk worthy of pre-assessment review and delay. As a result tax practitioners have incurred unproductive work in contacting the ATO to check on progress and taxpayers have suffered the effects of reduced cash flows.

3.141 In response, it has been publicly reported that:

[T]he ATO understands that the time taken to process the income tax returns held for ‘integrity checks’ has an impact [on] some tax agents. [The Deputy Commissioner] said that, while registered tax agents lodge 71 per cent of individual returns, less than half of the returns held for integrity checks were prepared by tax agents. With more than 21,000 tax agents preparing returns, [the Deputy Commissioner] said ‘this overall is a positive reflection of the quality of work done by [tax agents]’. Returns prepared by tax agents are significantly less likely to be reviewed, than self-prepared returns, the Deputy Commissioner said.

[The] Deputy Commissioner … said most affected tax agents ‘had only 1 or 2 returns held for review, however, we are concerned with a small group of tax agents who had significant numbers of held returns; half of the tax agent prepared held returns, were lodged by just 1,200 tax agents’.

Last year, [the Deputy Commissioner] said the ATO checked around 29,000 returns and found more than 20,000 refunds were incorrect or fraudulent. This year, it expects to review about 30,000 returns to remove any incorrect or fraudulent claims before refunds were issued. Since 1 July 2011, 106,000 tax returns with refund claims totalling $447m had been held. The Deputy Commissioner acknowledged this has meant that the processing of some tax returns has taken longer than anticipated and resulted in delays in receiving an expected refund. To date, [the Deputy Commissioner] said ATO reviews had resulted in amendments to 80 per cent of held returns. ‘These results support the necessity to review these types of claims’, she said.

[The Deputy Commissioner] said the ATO undertakes to contact tax agents with held returns by the end of May 2012, with more information about the returns the ATO holds. [The Deputy Commissioner] said the ATO may send a review letter, make phone contact, and/or finalise the case. Where multiple returns lodged by a tax agent have been held, [the Deputy Commissioner] said the ATO may visit or phone to address the issues collectively.202

3.142 The IGT may examine the effectiveness of this program through his forward work program. The design of the program, especially delaying the issue of refunds of small amounts pending delayed ATO compliance verification, suggests that more could be done to better engage the community on understanding the impacts of the program and its benefits.

Costs and benefits of Annual Compliance Arrangements (ACAs)

3.143 The ATO’s Annual Compliance Arrangements (ACAs) have merit, based on the United States of America’s (USA) positive’s experience with its Compliance Assurance Program (CAP) — a comparable program whereby taxpayers work collaboratively with the Internal Revenue Service (IRS) to identify and resolve potential tax issues before the tax return is filed each year.203

3.144 On this basis, applying the ACA approach to a wider range of taxpayers could be beneficial, however, improvements are required.

3.145 Some business taxpayers have asserted that in order to enter into an ACA, a large amount of additional work was often required by taxpayers in dealing with the ATO, resulting in higher costs. This higher cost can be beneficial where the taxpayer’s existing tax risk management processes are inadequate to ensure that its compliance risks are minimised or eliminated. However, the costs can be disproportionate where existing processes are adequate.

3.146 In this respect, many submissions considered that the targeting of ACAs could be improved to exclude taxpayers that already have strong governance processes, have developed a cooperative relationship with the ATO and behave in a compliant manner. Other submissions have made more general suggestions that refinements could be made to the ACA process in order to make it less resource intensive and the benefits more accessible, with a view to widening the availability of the process to other taxpayers. Still other submissions suggested that ACAs were not really necessary at all.

3.147 The ATO has provided qualitative survey results from twelve participants which indicate that ACAs do not impose a significant increase in costs. This survey was conducted in May 2011. However, no figures were provided and the methodology of the survey may not have enabled the ATO to receive unbiased information. For example, ATO audit staff managing the ACAs contacted taxpayers in ACAs to obtain their views, ATO staff views were accepted to represent the views of taxpayers not involved in ACAs and taxpayer comments were received that ACAs were more costly than audits or reviews.204

3.148 All respondents to the ATO survey did, however, comment that there were benefits in terms of improved access to ATO staff and obtaining administrative certainty earlier (even though some delays in delivery had still been experienced).

3.149 In relation to ATO surveys more generally, the IGT has observed in other reviews that the ATO has drawn certain conclusions about the comfort and direction it receives from these surveys.205 The IGT considers that this is an area that is ripening for review, given the stakeholder feedback that the IGT receives often differs from the survey results and the implications that the results have for ATO management direction.

3.150 Submissions did observe that ACAs had benefits in terms of administrative certainty in relation to uncontroversial issues. However, there was some debate over whether the ATO’s sign-off letters that say ‘no further action at this time’ provided sufficient certainty such that the ATO would not re-examine these issues at a later point in time.

3.151 Importantly, however, ACAs were perceived as not delivering certainty on a timely basis where controversial issues were concerned — for example, taxpayers did not consider it beneficial to be told to get a private ruling after protracted and involved discussions on issues over many months. In these circumstances, taxpayers may determine that the cost involved in maintaining an ACA is not justified given that certainty cannot be guaranteed in those very instances where it is most needed— that is, certainty in relation to the ATO’s treatment of controversial issues.

3.152 Submissions also argued that the low take up of ACAs suggests that many taxpayers and advisers do not consider the costs of ACAs are commensurate with the benefits. The IGT observes that many stakeholders who were reticent to engage in ACAs perceived that, although their governance processes are adequate for their own tax risk management purposes, they were unsure whether they would meet the ATO’s expectations and considered the potential costs in dealing with the ATO on this issue would reap proportionate benefits.

3.153 It should be noted that the take up of the USA’s ACA equivalent (the CAP) was also slow to start with, but has now become more popular.206 However, it is important to appreciate that the situation may have certain jurisdiction specific reasons for this more recent development.

3.154 Overall, it is clear that taxpayers and advisers strongly doubt whether the observed benefits in entering an ACA are proportionate with the costs. The IGT observes that uncertainty on the extent of information gathering and resulting costs (both in terms of a taxpayer’s direct administrative costs and their ongoing resourcing to maintain ongoing ATO expectations) underpin these concerns.

3.155 If the ATO were to more clearly quantify, at the outset, the expected costs of information gathering and more clearly demonstrate the commitment to delivery of the benefits arising from that increased level of information provided, greater taxpayer and adviser acceptance of the ACA may result.

Widening ACA availability — increased workload and impact on ATO delivery

3.156 If ACAs are improved to the extent that they are an attractive option for a greater number of taxpayers and advisers, then there may be concerns with the ATO’s ability to appropriately deal with this increase in demand.

3.157 Managing an increased workload may become an increasing concern when the ATO rolls out pre-assessment and expanded lodgement disclosure initiatives to a wider range of taxpayers.207

3.158 In summary, the concerns are that the ATO could be in a situation where it is over promising and under delivering. In this respect, the IGT considers that the ATO could benefit from examining overseas approaches, such as those of Singapore, the UK, the Netherlands and the USA.

Singapore — outsourcing assurance work

3.159 In order to address the ATO’s assurance requirements, it has been suggested that some assurance work could be outsourced to external professionals who have been accredited by the ATO. This may be similar to the process employed by the Singapore revenue authorities (the Assisted Compliance Assurance Program (ACAP)).

3.160 Under the ACAP, the Inland Revenue Authority of Singapore (IRAS) allows accredited tax practitioners (either internal or external to the taxpayer) to review the eligible taxpayer’s GST compliance practices in order to:

provide guidance for businesses to voluntarily initiate a holistic risk-based review on the effectiveness of their internal controls to enhance their GST compliance capability, including accurate GST reporting.208

3.161 Under the ACAP program, the applicant and reviewer must follow the IRAS’ methodology. Independent assurance of the taxpayer’s control framework may be performed. The final step in the ACAP process is for the IRAS to review the case and afford ACAP status to taxpayers. Depending on the rating of the adequacy and effectiveness of the applicant’s controls, transaction and reporting levels, the IRAS may afford ‘ACAP Premium’ or ‘ACAP Merit’ status.209

3.162 As a result of being accorded ACAP status taxpayers receive the following benefits:

for either 5 years [for ACAP Premium status] or three years [for ACAP Merit status]:

  1. Step-down of IRAS-GST compliance activities unless significant anomalies are noted in GST declarations;
  2. Expeditious GST refunds, if no anomalies are noted;
  3. Dedicated team to handle GST Rulings and resolve GST issues expeditiously; and
  4. Auto-renewal of the GST schemes (for example Major Exporter Scheme status), if applicable.210

3.163 In addition, the IRAS offers taxpayers incentives to engage with it under the ACAP. They agree to:

  1. Co-fund 50 per cent of the explicit fees incurred by businesses for the purpose of ACAP Review, subject to a cap of $50,000 per ACAP Applicant; and
  2. Grant an exceptional one-time waiver of penalties for past GST errors (regardless of the period to which the errors may relate) disclosed voluntarily in the course of the first ACAP undertaken by the business. This waiver applies only to past errors that occurred within the statutory time-bar period, and where fraudulent intent was absent.211

United Kingdom — improving relationships and timeliness through senior officers as key contact points and clearance processes

3.164 In the UK, around 2000 of the large business population have been allocated Customer Relationship Managers (CRMs). Each CRM services around six large business taxpayers.212 A CRM typically has 10–20 years of service in HMRC and has professional tax qualifications in at least one of the taxes.

3.165 A CRM’s primary role is to manage the relationship between the taxpayer and HMRC across all taxes and duties.213 They have the primary responsibility and accountability for resolving issues with their client taxpayers. They are either the lead direct tax or indirect tax specialist, depending on their tax technical background, and are accountable for deciding HMRC’s position unless the issue turns on a novel or contentious technical interpretation.214

3.166 The CRM could be seen as loosely equivalent to the ATO’s key client manager. However, CRMs are responsible for resolving disputes and deciding HMRC’s position. In this respect, they are able to marshal HMRC’s resources and have senior technical expertise.

3.167 Submissions comment that this customer management model is effective in reducing delays and improving the relationship between the administrator and the taxpayer.

3.168 Also in the UK, when taxpayers are considering large, high risk transactions, they are able to apply for clearance on certain issues from the revenue authority regarding HMRC’s view of the transaction. HMRC’s advice will be issued within 28 days as the norm and bind HMRC even if the view is incorrect at law, so long as all material facts were disclosed and the taxpayer reasonably relied upon the advice.215

3.169 Submissions comment that this process is much less formal than the ATO’s ACA or private binding ruling processes. They observe that a key difference between an ACA and the UK’s Tax Compliance Risk Management approach (the UK’s equivalent to the ATO’s Large business and tax compliance booklet) is the amount of disclosure required.

3.170 Overall, HMRC believes that this approach with large businesses has procured an additional £8 billion in compliance revenue in 2010–11.216 It is noteworthy that while collections have improved, the relationship between the revenue authority and taxpayers in this market segment has also improved. Questions, however, have been raised whether this relationship between HMRC and taxpayers is ‘too close’.217 Nevertheless, the UK Government has acknowledged the achievements of this program — that is, improved relationships have resulted in improved collections and reduced costs for the revenue authority and taxpayers.218

3.171 Underpinning this relationship is a legal requirement that Senior Accounting Officers (mainly Chief Financial Officers) of large companies certify that they have taken reasonable steps to ensure that appropriate tax accounting arrangements (i.e. arrangements that enable the company’s relevant liabilities to be calculated accurately in all material respects) have been established and maintained.219 This requirement was introduced to address an ‘accountability gap’ in ensuring that accounting arrangements are fit for the purpose of delivering correct and complete tax returns. The ATO considers that the Senior Accounting Officer certificate is the key feature underpinning cooperative taxpayer relationships in this context.220 It is of the view that this echoes the same commitment that taxpayers are required to undertake when entering into an ACA.

Netherlands — horizontal monitoring

3.172 Since March 2008, the Netherlands Tax and Customs Administration (NTCA) has sought to shift its enforcement policy from a ‘control based on an absence of trust’ to ‘monitoring through trust’. The basis for this policy is that ‘the government no longer stands above the citizen, but rather the two stand side by side’. As a result the NTCA introduced horizontal monitoring as a means to establish mutual trust, understanding and transparency.221

3.173 Horizontal monitoring can involve ‘enforcement covenants’ with very large businesses. These covenants include agreements on the manner and intrusiveness of monitoring and the ways the parties work together. They are based on self-regulation by the taxpayer establishing an ‘Internal Control Framework’ to control business processes (as a result of financial governance legislation). The NTCA determines whether the tax control framework (part of the internal control framework) provides reliable tax information and, if so, requires little monitoring. The NTCA’s aim is to be less concerned with tax issues and more concerned that the business is and remains in control.222

3.174 The ATO advises the IGT that it is aware of the Dutch model but it has had little influence with the ATO because the ATO was well-advanced in the development of its ACAs at the time:

The ATO initiated the development of the ACA product based on feedback and experience with FCA [Forward Compliance Agreement] processes. Therefore, although we shared our experiences with other countries we did not consider similar ACA products from other countries in the design process.223

3.175 The IGT considers that there is some merit in reconsidering this approach at a future time. It should also be noted that the original Forward Compliance Agreement product had a very small uptake and was ultimately discontinued, albeit it provided learnings for the development of the ACA product. 224

USA — the Compliance Assurance Process (CAP)

3.176 In the 2005, the USA piloted with 17 taxpayers with $10 million or more in assets a process to conduct real-time compliance reviews. These reviews aimed to establish the correct tax treatment of tax return positions prior to these taxpayers filing their federal income tax returns.225 Based on its success, the CAP was expanded and made permanent in March 2011.226 In the 2011 financial year there were 140 taxpayers participating in CAPs.

3.177 The CAP program consists of three phases: Pre-CAP, CAP and Compliance Maintenance.

3.178 In the Pre-CAP phase taxpayers and the IRS work together to close off examinations of filed returns with a view to progressing to the CAP phase. During this phase taxpayers are expected to display the same level of transparency and cooperation that is required of taxpayers in the CAP phase, which is to make open, comprehensive, and prompt disclosures of the transactions, descriptions of steps within the transaction that have material effect on their relevant tax liabilities, and other tax return items related to the positions taken on their filed tax returns.227

3.179 In the CAP phase, and in addition to that outlined above, taxpayers are expected to disclose their proposed tax positions with regard to their disclosures. Taxpayers that resolve all material items and positions taken with regard to transactions are assured that the IRS will accept their tax returns if filed consistent with the resolutions agreed between the taxpayer and the IRS. Items and positions that cannot be resolved prior to the filing of the return, or any new material items or positions discovered on the return as filed, are resolved through traditional examination processes.228

3.180 For taxpayers that continue to meet the CAP eligibility requirements and expectations may progress to the Compliance Maintenance phase. In this phase, taxpayers must execute a memorandum of understanding and continue to make open, comprehensive, and contemporaneous disclosures of their completed business transactions, the relevant steps and their positions on items that would have material effect on their tax liabilities. In return, the IRS reduces the level of review based on the complexity and number of issues, and the taxpayer’s history of compliance, cooperation and transparency in the CAP.229

IGT observation

3.181 In relation to the ATO’s ACAs, the IGT considers overall that based on the USA’s experience, the aims of ACAs can form an important part of the ATO’s objective to improve certainty for taxpayers while allaying ATO concerns about potential tax risks. However, work remains to minimise costs. Additionally, any increase in ACA workload is likely to add to these costs through delays and therefore detract from one of the key benefits — ‘real time’ ATO response to issues.

3.182 In the light of the discussion above, the IGT considers that as a matter of priority the ATO should investigate alternative models, such as those in Singapore, to provide an improved service. Such a model need not be adopted in whole — for example, the ATO may consider that external assurers should refer limited matters to ATO for review at certain points in the process or if certain technical issues are encountered. Importantly, the involvement of the tax profession in carrying out this initiative on behalf of the ATO would best promote increased engagement with the ATO by tax practitioners and taxpayers alike.

3.183 Such an approach is equivalent to the ATO’s approach towards the type of prudential reviews undertaken by taxpayers’ representatives in relation to Wickenby matters and the overseas voluntary disclosure initiative.

Recommendation 3.12

  1. With the aim of making Annual Compliance Arrangements (ACAs) more widely available to taxpayers, the ATO should publicly communicate the expected work required to enter and maintain an ACA as well as the expected benefits.
  2. With the aim of appropriately addressing the expected increased ATO workload with respect to ACAs and to reduce timeframes and compliance costs associated with ACAs, the ATO should consider overseas models, such as those in Singapore and the United Kingdom.

ATO response:

Agree.

The ATO will publish more information about the way in which ACAs operate and the outcomes of a survey of ACA participants that was conducted last year.

We regularly monitor international developments for best practice.

We are currently scoping a jointly-administered, external prudential review process for large market taxpayers categorised as 'lower' and 'medium' risk where further assurance on certain aspects is sought. The project will identify and explore options through a collaborative and consultative approach with the community.

If the review process is considered viable, a pilot will be undertaken before commencement of the program. We will, however, reserve the right to open up assessments and review arrangements where appropriate.

Pre-lodgement compliance reviews (PCRs)

3.184 The pre-lodgement compliance review (PCR) is a real-time identification and assessment of a taxpayer’s material tax risks. It is used with taxpayers who are identified as ‘higher consequence’ under the ATO’s RDF that are also not in an ACA.

3.185 The ATO uses the PCR to provide a high-level understanding of a taxpayer’s business operations and key transactions, and contributes to identifying the taxpayer’s compliance level and risk profile.230 It is also aimed at providing the ATO with an opportunity to address in real time a number of related compliance matters during the pre-lodgement period. These include:

  • updating or undertaking a tax governance review
  • engaging with taxpayers to facilitate the disclosure of tax risks including the early disclosure component of the RTP requirements
  • applying the Taxation of Financial Arrangements compliance risk strategy, and
  • facilitating private ruling processes.231

3.186 However, a PCR will not provide taxpayers with practical certainty or ATO sign off on issues. It will, however, provide taxpayers with a ‘PCR plan (framework)’:

The PCR plan (framework) will take into account a range of factors and is tailored to each taxpayer. It is also important to emphasise that the PCR plan (framework) will specifically recognise the appropriate level of intensity required in our day-to-day engagement with the taxpayer.

Our aim is to encourage disclosure of all material risks in real time prior to the lodgment of the return. This incorporates RTP [Reportable Tax Position] considerations. Ideally, this requires the ATO and the taxpayer to work cooperatively and establish a framework that facilitates the raising of tax risks in an environment of openness and respect.232

3.187 Submissions expressed doubts about the purpose and focus of PCRs. At one extreme there are suspicions that PCRs are designed to create a more costly imposition to effectively push (or an economic incentive for) taxpayers into an ACA. At the other extreme, there are mixed messages as to whether PCRs are targeted at compliant or non-compliant taxpayers and whether they are designed to work in a cooperative relationship or in an uncooperative relationship. For example, it is said to be done on a voluntary basis for ‘higher consequence’ (Q1 and Q2) taxpayers but with an implicit threat of compulsory information gathering action (such as section 264 of the ITAA 1936).

3.188 Submissions also expressed concern that for disclosures made under PCRs, it is unclear whether they will attract penalties and interest and whether such disclosures would be closed off to further review and amendment.

3.189 In the IGT’s view, the ATO could do more to address the taxpaying community’s concerns by improving the understanding of these ATO activities. In particular, if the ATO were to more clearly quantify, at the outset, the expected costs of information gathering and clearly articulate the benefits arising from that increased level of information provided, greater taxpayer and adviser acceptance of the PCR would result. This would have a greater desirable impact on shaping taxpayer compliance attitudes and behaviours.

Recommendation 3.13

The ATO should, in consultation with the community, develop and publish comprehensive materials on pre-lodgement compliance reviews. These materials should include advice regarding:

  1. what the ATO will and will not do during these compliance activities;
  2. the manner in which those activities will be conducted; and
  3. effective escalation processes where ATO officers do not meet these expectations.

ATO response:

Agree.

Pre-lodgment compliance reviews are only used in the large market.

We consider the Large Business and Tax Compliance booklet to be the appropriate document in which to publish this material. It is currently being redrafted following extensive consultation with the Large Business Advisory Group.

Income tax return schedules

3.190 Submissions raised a number of concerns with the focus and utility of some information required in tax return schedules. The IDS was raised as a particular example in this regard.

3.191 The IDS replaces the schedule 25A (relating to international related party transactions) and thin capitalisation schedules to the income tax return form. Approximately 12,000–14,000 taxpayers currently complete the schedule 25A and/or thin capitalisation schedule.

3.192 The IDS comprises 40 questions, with 30 of those questions being replicated from the former schedules. Ten questions are new and were the subject of consultation.

3.193 In relation to the IDS, the ATO advised that:

the IDS is intended to provide better data collection on higher risk international issues, leading to enhanced risk management, intelligence, mitigation and reporting to stakeholders on overall effectiveness.

… IDS data, when subject to analysis helps refine international risks and mitigation strategies. This process allows better targeting of compliance activities and reduced costs for low risk taxpayers.233

3.194 Some submissions claim that the IDS is an example of ATO efficiencies being made at taxpayer expense.

3.195 With regard to the information requested about non-related party international dealings, the ATO considers that ‘there is a higher tax compliance risk associated with international dealings by Australian taxpayers with particular tax jurisdictions’. To help the ATO develop compliance strategies to combat these risks, the ATO is therefore ‘seeking to identify the principal specified countries where the taxpayers' activities are undertaken and the level of taxpayer’s activities in those countries’. The ATO has explained that it needs ‘appropriate data to manage the compliance risk associated with activities with specified countries and this is best collected via the IDS rather than through other post-lodgement compliance activities’.234 The ATO advises that this schedule is needed:

Because international dealings in particular countries pose a significant compliance risk, we must manage that risk by collecting the international risk data provided at this question, which is not available from AUSTRAC.235

3.196 Submissions were concerned that significant costs were imposed because the IDS asks the taxpayer to collect data they do not naturally collect from existing systems. Instead the IDS asks for unrelated party expenditure and revenue dollars (not relevant to the taxpayer’s liability) and related party derivatives. This imposed additional costs over and above managing their own affairs because taxpayers did not have systems in place to collect and collate this information. In order to comply with the request for disclosure, the information had to be either manually extracted or a new system developed. In effect, taxpayers expressed the view that they are expected to bear the compliance costs for perceived risks that do not relate to themselves.

3.197 Additionally, submissions expressed concern that the compliance burden imposed by the IDS is disproportionate to the compliance risks as the required level of disclosures are of the same intensity experienced during audits. They argue that the ATO has not achieved its stated objectives of ‘aligning, where possible, the information [taxpayers] already collected under their normal business systems’ (ATO letter to [submitter] dated 10 June 2009), and ‘to reduce and standardise compliance/reporting costs’.236

3.198 Concerns with this approach have been raised with the ATO. For example, at a teleconference hosted by the ATO on 25 October 2011, tax professionals expressed concern about the $1 million threshold for completing the IDS and, due to the compliance burden on small and medium sized enterprises (SMEs), argued that the threshold should be revised upwards. The threshold was subsequently raised to $2 million. However, representatives of SMEs have advised that this threshold is not likely to be effective in reducing unnecessary costs for this market segment.

3.199 The IDS has since been rolled out to all taxpayers for the 2011–12 income year.

3.200 In the IGT’s view, disproportionate costs are imposed on taxpayers where they are required to provide information in relation to other taxpayers’ potential risks. To help minimise the compliance costs in these circumstances, the ATO should consult with taxpayers as part of its annual consultation on the information that it seeks in tax returns and associated schedules (see recommendation 3.2).

3.201 Additionally, there are significant difficulties in imposing a change in expanded lodgement disclosures halfway through the reporting period for many taxpayers without providing sufficient time to implement changes.

Reportable tax position schedules

3.202 The reportable tax position (RTP) schedule is a new initiative that is currently being piloted by the ATO.

3.203 The ATO has stated that the RTP schedule:

require[s] the disclosure of those ... material issues that a robust governance process would escalate for the attention of senior management…

A reportable tax position is a position that is any of the following:

  1. [a] material position that is about as likely to be correct as incorrect or less likely to be correct than incorrect;
  2. [a] material position in respect of which uncertainty about taxes payable or recoverable is recognised and/or disclosed in the taxpayer's or a related party's financial statements ; and
  3. [a] position in respect of a reportable transaction.237

3.204 Although submissions to this review raised a number of concerns with this initiative, the schedule has not yet been fully implemented. Furthermore, the IGT understands that consultation between the ATO, taxpayers and their representatives are advanced and focusing on implementation issues. As such, the IGT may consider the RTP schedule at a later time if stakeholder concerns arise with its operation.


123 Brown v Federal Commissioner of Taxation (1999) 42 ATR 118, 130 (Hill J).

124 Joint Committee of Public Accounts, above n 27, pp 64–65.

125 Inland Revenue Commissioners v National Federation of Self-employed & Small Businesses Ltd [1982] AC 617, 651 (Lord Scarman).

126 Australian Taxation Office, Compliance Program 2011–12 (2011) p 3.

127 For example, the UK’s approach to Senior Accounting Officers’ certificates.

128 Forum on Tax Administration, OECD, Executive Overview: Working Smarter (2012) p 3.

129 See for example, Australian Taxation Office, Large Business and Tax Compliance (2010) pp 6–7.

130 White and Walpole, above n 2, p 4.

131 Inspector-General of Taxation, Report into the Australian Taxation Office’s Large Business Risk Review and Audit Policies, Procedures and Practices (2011) p 31.

132 Federal Court of Australia, Practice Note TAX 1 (1 August 2011).

133 Australian Taxation Office, Communication to the Inspector-General of Taxation, 15 December 2011.

134 Australian Taxation Office, Communication to the Inspector-General of Taxation, 15 December 2011.

135 See for example New Zealand’s application of the Compliance Management Cycle and the initial concepts from the Treatment Dictionary in its Property Compliance Programme as outlined in Robert Russell, ‘Our Journey on Compliance – IR’s Story’ (Paper presented at the ATAX UNSW 10th International Tax Administration Conference, Sydney, 2 April 2012).

136 Australian Taxation Office, Research Brief — Measuring Compliance Costs: Enhancing the ATO’s Ability to Estimate Compliance Cost Impacts (2011).

137 Ibid.

138 Ibid.

139 Australian Taxation Office, Communication to the Inspector-General of Taxation, 6 June 2012.

140 NSW Business Chamber, Annual Red Tape Survey 2011 (2012); see also, OECD, Businesses’ Views on Red Tape: Administrative and Regulatory Burdens on Small and Medium Sized Enterprises (2001).

141 See also, Inspector-General of Taxation, above n 129, ch 7.

142 Inspector-General of Taxation, Review into the ATO's Small and Medium Enterprise Audit and Risk Review Policies, Procedures and Practices (2011).

143 Australian Taxation Office, Communication to the Inspector-General of Taxation, 28 June 2012.

144 Australian Taxation Office, Communication to the Inspector-General of Taxation, 7 August 2012.

145 Australian Taxation Office, Communication to the Inspector-General of Taxation, 3 February 2012.

146 Australian Taxation Office, Communication to the Inspector-General of Taxation, 28 June 2012.

147 Ibid.

148 Australian Taxation Office, above n 136.

149 See also Forum on Tax Administration: Taxpayer Services Subgroup, Centre for Tax Policy and Administration, OECD, Information Note - Third Party Reporting Arrangements and Pre-filled Tax Returns: The Danish and Swedish Approaches (2008).

150 Michael D’Ascenzo, ‘Mitigating risk’ (Speech delivered at the 10th International Tax Conference (ATAX), Sydney, 2 April 2012).

151 Australian Taxation Office, Communication to the Inspector-General of Taxation, 28 June 2012.

152 See Inspector-General of Taxation, above n 131, ch 7.

153 Mark Arbib, Assistant Treasurer, 'Maintaining the Effectiveness of the General Anti-Avoidance Rule', Media release, 1 March 2012.

154 Australian Taxation Office, Communication to the Inspector-General of Taxation, 12 October 2011.

155 Australian Taxation Office, above n 48, Item 3.

156 See Inspector-General of Taxation, Annual Report 2010–11 (2011) pp 13–14.

157 Australian Taxation Office, Large Business and Tax Compliance, 2011, p 8.

158 Australian Taxation Office, Communication to the Inspector-General of Taxation, 12 October 2011; see also Australian Taxation Office, above n 48, Item 3.

159 Australian Taxation Office, above n 157, p 30.

160 Australian Taxation Office, Access to 'Corporate Board Documents on Tax Compliance Risk', PS LA 2004/14, 23 December 2004, para [4].

161 Australian Taxation Office, Communication to the Inspector-General of Taxation, 9 July 2012.

162 OECD, Study into the Role of Tax Intermediaries (2008) p 54.

163 Ibid p 44.

164 Ibid p 7.

165 Ibid p 14.

166 Margaret McKerchar, ‘Tax Complexity and its Impact on the Tax Compliance and Administration’ (Paper presented at the IRS Research Conference, Washington, 13-14 June, 2007) pp 190–191.

167 See Fitzpatrick, above n 21, pp 394-400.

168 See for example, Michael D’Ascenzo, ‘A Partnership Based on Trust and Respect’ (Speech delivered at the National Institute of Accountants Board Meeting, Canberra, 8 May 2007).

169 Justin Dabner and Mark Burton, ‘Lessons for Tax Administrators in Adopting the OECD’s “Enhanced Relationship” Model - Australia’s and New Zealand’s Experiences’ (2009) 63(7) Bulletin of International Taxation 316.

170 D’Ascenzo, above n 150.

171 Australian Taxation Office, Communication to the Inspector-General of Taxation, 7 June 2012.

172 Australian Taxation Office, Communication to the Inspector-General of Taxation, 17 February 2012.

173 Australian Taxation Office, Guide for Tax Intermediaries - Good Governance and Promoter Penalty Laws (2011) p 14.

174 White and Walpole, above n 2, p 4.

175 See The Treasury, ‘Review of Unlimited Amendment Periods in the Income Tax Laws’ (Discussion paper, August 2007) p 7.

176 Ibid p 7.

177 Peter Costello, Tax Reform: Not a New Tax, a New Tax System - The Howard Government's Plan for a New Tax System (AGPS, 1998) p 147.

178 Treasury, above n 175, p 7.

179 Inspector-General of Taxation, Review into Tax Office Audit Timeframes (2005) pp 18-21.

180 See for example, Inspector-General of Taxation, above n 131, Recommendations 5.1 and 5.2; Inspector-General of Taxation, above n 142, Recommendation 3.4.

181 White and Walpole, above n 2, pp 20–21.

182 For example, Income Tax Assessment Act 1936 s 170(1).

183 Australian Taxation Office, ‘Guidelines on The Legislative Timeframes for Making Amendments and for Requesting Extensions of Time to the Limited Amendment Period’, ATO Intranet, 30 September 2011.

184 Income Tax Assessment Act 1936 s 170(7) item 1.

185 See Inspector-General of Taxation, above n 131, pp 125–126.

186 Ibid pp 137–138.

187 The Treasury, above n 1, Recommendation 3.7.

188 The Treasury, ‘Repeal of Certain Unlimited Periods for Amending Assessments — Summary of Consultation Process’.

189 Income Tax Assessment Act 1936 s 190(9B).

190 OECD, Dealing Effectively with the Challenges of Transfer Pricing (2012).

191 Ibid pp 16–17.

192 See Finance Act 1998 (UK) sch 18 para 46(1) as amended by Finance Act 2008 (UK) sch 39 para 42(2).

193 Deloitte, 2011 Global Transfer Pricing Desktop Reference, 2011, p 60.

194 The Treasury, ‘Review of Unlimited Amendment Periods in the Income Tax Laws (Consultation paper, November 2007), p 11; also referred to in The Treasury, ‘Income Tax: Cross Border Profit Allocation — Review of Transfer Pricing Rules’ (Consultation paper, 1 November 2011) p 20.

195 See FC of T v Ryan 2000 ATC 4079; note also FCT v BCD Technologies Pty Ltd [2005] FCA 708.

196 The Treasury, above n 1, Recommendation 3.4.

197 Ibid pp 32–33.

198 Explanatory Memorandum, House of Representatives, Tax Laws Amendment (Improvements to Self Assessment) Bill (No 2) 2005, p 23.

199 Ibid.

200 Australian Taxation Office, Compliance Program 2005–06 (2005) p 47.

201 For example, Sweden.

202 Terry Hayes, ‘Delayed Tax Refunds - ATO Explains’, Thomson Reuters Weekly Tax Bulletin (online) 4 May 2012.

203 Internal Revenue Service (IRS), ‘IRS Expands and Makes Permanent its Compliance Assurance Process (CAP) for Large Corporate Taxpayers’ (Media Release, IR-2011-32, 31 March 2011).

204 Australian Taxation Office, Communication to the Inspector-General of Taxation, 19 September 2011.

205 See for example, Inspector-General of Taxation, above n 131, p viii.

206 IRS, above n 203.

207 See Katie Walsh, ‘Top-Heavy ATO Units Face Staff Cuts’, Australian Financial Review (Sydney), 12 July 2012, p 11.

208 Inland Revenue Authority of Singapore, IRAS e-Tax Guide – GST: Assisted Compliance Assurance Programme (ACAP), Singapore, 5 April 2011, p 1.

209 Ibid pp 11–12.

210 Ibid p 3.

211 Ibid p 2.

212 Her Majesty’s Revenue & Customs (HMRC) and Capgemini Consulting, International Tax Benchmarking: Final report 2011, London (2011) p 76.

213 HMRC, About the Customer Relationship Management Model.

214 HMRC, Roles and Responsibilities of LBS Client Relationship Managers and Sector Leaders, 22 December 2006.

215 HMRC, Clearance Service for Businesses - How to Get Certainty on Significant Business Tax Issues.

216 David Gauke (Speech delivered at the Hundred Group, London, 28 February 2012).

217 See, See Treasury Committee, Parliament of the United Kingdom, Administration and Effectiveness of HM Revenue and Customs: Sixteenth Report of Session 2010–12 (2011).

218 UK Chancellor of the Exchequer, Communication to the Chief Executive of HMRC, 29 March 2012.

219 HMRC, Duties of Senior Accounting Officers of Qualifying Companies — Guidance (19 August 2009).

220 Australian Taxation Office, Communication to Inspector-General of Taxation, 7 February 2012.

221 Netherlands Tax and Customs Administration, Tax Control Framework – From a Focus on Risks to Being in Control: A Different Approach, TCF Working Group, March 2008.

222 Ibid.

223 Australian Taxation Office, Communication to the Inspector-General of Taxation, 23 February 2012.

224 See Michael D’Ascenzo, ‘Delivering for the Community: Making Tax and Superannuation Easier, Cheaper and More Personalised (2008) 3(2) Journal of the Australasian Tax Teachers Association 23, p 29; Quigley, above n 38.

225 IRS, Internal Revenue Manual (2011) section 4._.1.1.

226 IRS, above n 203.

227 IRS, above n 225, section 4._.1.3.

228 Ibid.

229 Ibid.

230 Australian Taxation Office, Communication to the Inspector-General of Taxation, 28 November 2011.

231 Ibid.

232 Ibid.

233 Australian Taxation Office, communication to the Inspector-General of Taxation, 14 October 2011.

234 Australian Taxation Office, Overview of the Key Changes to the International Dealings Schedule - Financial Services (5 September 2011).

235 Australian Taxation Office,International Dealings Schedule - Financial Services 2011 (14 July 2011).

236 ATO, IDS Workshop (Minutes, 2 July 2009).

237 Australian Taxation Office, Reportable Tax Positions, Introduction (22 December 2011).