Background

4.1 As stated earlier, recent compliance approaches of revenue authorities, such as pre-assessment and expanded lodgement disclosures, suggest that the pendulum has swung from a pure self assessment system towards a hybrid system that is closer to full assessment, without any of the previous benefits available from the former regime. In the light of this, it seems logical that our current penalty and interest regime be revisited.

4.2 The purpose of penalties is to encourage certain behaviours and discourage others.238

4.3 Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) provides for the following administrative penalties, among others, where an entity makes a statement to the Commissioner:

  • that is false or misleading in a material particular which results from a failure to take reasonable care (the reasonable care penalty);239 and
  • which treats an income tax law240 as applying to a matter in a particular way that, when having regard to the relevant authorities, is not reasonably arguable and there is a shortfall amount that exceeds the applicable threshold (the RAP penalty).241

4.4 The reasonable care penalty encourages taxpayers to take reasonable steps to ensure that they self assess in accordance with the law.

4.5 Where larger tax amounts are at issue, the RAP penalty encourages taxpayers to have regard to relevant authorities (that is, legislation, extrinsic materials and judicial decisions) and take a reasonable view of authorities to ensure that the position is about as likely as not to be correct (or more so).

Sustainable penalty decisions

4.6 Submissions raised a number of issues in relation to the application of penalties. The main issue was that taxpayers considered the ATO used penalties as a bargaining chip during negotiations, as evidenced by the high numbers and amounts of penalties that have not been sustained on internal and external reviews. As an example, some submissions pointed to cases in which the ATO maintained RAP penalties even though the Federal Court, at first instance, had ruled in the taxpayer’s favour, and only remitted them just before appeals were to be heard before the Full Federal Court.242

4.7 These claims have also been made at the ATO’s consultative forums. In response, the ATO undertook a review of the 49 large business cases for the last three years (2007–08 to 2009–10) in which additional primary tax was levied. The results and penalty considerations for these cases are summarised in the tables below.

ATO review of large business cases with penalties for 2007–08 to 2009–10

Results for LB&I audits completed for FY 2007/08 to 2009/10 YTD
2007/08 2008/09 2009/10 Total for 3 years
Number of audits completed 33 44 16 93
Audits NFAd 17 16 11 44
Number of audits with additional tax raised (audits with penalties raised) 16 (9) 28 (19) 5 (3) 49 (31)
48% 66% 31% 54%
Total results $1,285 $1,207 $140 $2,632
Total Penalties $237 $226 $72 $535
18% 19% 52% 20%
Penalty consideration for the LB&I cases where additional taxes were raised
2007/08 2008/09 2009/10

Number of audits with additional tax raised (cases with no penalties imposed)

16 (7) 28 (9) 5 (2)
WHT matter (a) 2 1
Settled cases (b) 5 (2) 6 (1)
Reasonable arguable position considered 6 (1) 7 (3)
No reasonable care with RAP considered 1
Reckless 2
Reasonable care 2 (2) 3 (3) 1 (1)
Outside of s 284-75(2)(d) Threshold (c) 1 (1)
Scheme penalties - RAP considered 2 1
Scheme penalties - RAP not held 1 1
Voluntary disclosures 2 (2) 1 (1) 1 (1)
No RAP held by TPR 1 2
TOTALS 16 28 5

Source: ATO

Notes:

(a) RAPs only apply to Income Tax so Withholding Tax cases have been excluded.

(b) Penalty decisions would be agreed as part of the Settlement Agreement.

(c) The shortfall amount must be more than the greater of $10,000 or 1 per cent of the income tax on the basis of the taxpayer's return.

(d) Total results and Total penalty amounts are in $millions.

4.8 In relation to these tables, the ATO reports:

Of these 49 cases, 31 (63.2 per cent) had penalty [sic] remitted, including 18 (36.7 per cent) where penalties were remitted in full. The reasons for penalty remission is set out in the above table (see figures in brackets for penalties remitted in full). Importantly, for the 31 cases where penalties were remitted, 14 (45 per cent) required consideration of whether or not the taxpayer had a RAP. (The other 17 cases that did not require RAP consideration includes cases that were settled and those involving adjustments such as withholding tax etc.)

Of the 14 cases involving RAP consideration there were only 3 (21 per cent) cases where the taxpayer was not considered to have a RAP …

[I]ncluded within the 49 cases where additional tax was raised, four cases were voluntary disclosures which were made during the course of the audit. Importantly, for all of these cases where VDs [Voluntary Disclosures] were made the Commissioner’s Discretion was exercised and penalties were remitted in full.243

4.9 The ATO’s internal quality assurance processes (the Integrated Quality Framework or IQF) also selects certain cases for review. In relation to large businesses, over the period 1 August 2009 to 17 June 2010, 284 cases were reviewed. Of these cases 82 had penalty decisions that were reviewed. Only 4 of these 82 cases were found to fall below the ATO’s expected standards, on the basis of procedural and recording matters.244

4.10 However, following the IGT raising the issue of sustainability of penalty decisions in 2009,245 the ATO internally reviewed penalty decision making and found that only 87 per cent of all audit cases met the ATO’s standards for correctness during the period 1 April 2009 to 31 March 2010.246

4.11 In 2011, to assist it identify the underlying reasons for unsustainable penalty decisions (among other things), the ATO reviewed the 393 penalty decisions that did not meet the ATO’s standards for correctness and appropriateness during the 1 July 2009 to 30 June 2010 period.247 Of ‘open’ cases reviewed by the IQF, or cases that were not yet finalised and therefore could be corrected before finalisation, just under 9 per cent (53 cases) failed to meet both standards. For ‘closed’ or finalised cases, just under 14 per cent (340 cases) failed to meet both standards. The review concluded that the three main reasons for failure to meet the standards were, in descending order:

  • technical errors;
  • recording/evidentiary deficiencies; and
  • poor or incorrect notification/communication.

4.12 The ATO also observed that there were frequently some degree of overlap between technical errors and recording/evidentiary errors. Improved training was identified as a means to address these results.

4.13 The issue of unsustainable penalty decisions is not new. For example, the Joint Committee of Public Accounts recommended, in as early as 1993, that if the ATO retained the power to impose administrative culpability penalties, then it be determined in all instances by legally qualified ATO officers who are independent of the divisions conducting audits.248

4.14 The IGT has also reviewed this particular issue in a number of prior reviews and concluded that significant numbers of unsustainable penalty decisions arise because of a lack of ATO compliance officer discipline in dealing with evidentiary matters for the rate of penalty sought to be imposed.249 As a result, the IGT recommended in the Review into aspects of the Tax Office’s settlement of active compliance activities that the ATO improve the evidentiary basis for penalty decisions, among other things (recommendation 16).

4.15 More recently, the IGT recommended in the Review into the ATO's small and medium enterprise audit and risk review policies, procedures and practices that SME officers improve the evidentiary basis for compliance decisions (including penalties) by using the Facts and Evidence Worksheet to develop technical positions (recommendation 3.4). The IGT will review the ATO’s implementation of these recommendations in the course of his follow-up to these reviews.

4.16 It should also be noted that the ATO’s systems do not currently provide for reports in relation to the numbers of cases in which RAP and reasonable care penalties were imposed, or overturned, or their quantum. Management monitoring of these figures would assist in identifying opportunities to improve consistency and technical discipline in applying these culpability penalties. Information should be published to improve transparency on this issue.

Recommendation 4.1

To improve the transparency of ATO penalty decisions, the ATO should:

  1. improve its internal reporting to determine the numbers of cases, and their quantum, in which reasonably arguable position and/or reasonable care penalties were applied and remitted; and
  2. publish these figures.

ATO response:

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.

Evidence of reasonable care

4.17 Stakeholders also raised concerns that where taxpayers are required to provide documentation to prove that they took reasonable care (such as evidence of research or advice sought), some of this documentation would require the disclosure of material that would be inconsistent with the maintenance of legal professional privilege (LPP), client legal privilege and the accountants’ concession.

4.18 In these circumstances, maintaining their rights would expose them to adverse consequences, such the potential application of reasonable care penalties and a higher risk rating (as discussed above), bringing increased ongoing compliance costs with it.

4.19 As a general principle, the way in which reasonable care penalties are levied should not disadvantage taxpayers who choose to exercise their rights to maintain confidentiality.

4.20 Submissions argue that the ATO should, therefore, accept evidence of tax advice sought, rather than the advice itself. For example, this could take the form of a declaration by the taxpayer’s legal advisor that advice was sought and provided in relation to a matter.

4.21 Subsection 284-75(6) of Schedule 1 to the TAA 1953 provides that, in certain circumstances, a taxpayer will not be liable for a reasonable care penalty if the taxpayer engaged a registered tax agent or BAS agent. This provision is part of the recently enacted tax practitioner safe harbour provisions. To be eligible for this exception from liability, amongst others, the taxpayer bears the evidentiary burden to prove that they gave the agent all relevant information and the agent made the statement.250 The agent must also not make a statement which amounts to an intentional disregard for the law or recklessness.251

4.22 Relevantly, subsections 30–10(9) and (10) of the Tax Agent Services Act 2009 (TASA 2009) also require registered tax agents and BAS agents to take reasonable care:

(9) You must take reasonable care in ascertaining a client’s state of affairs, to the extent that ascertaining the state of those affairs is relevant to a statement you are making or a thing you are doing on behalf of the client.

(10) You must take reasonable care to ensure that *taxation laws are applied correctly to the circumstances in relation to which you are providing advice to a client.

4.23 The Tax Practitioners Board provides practical principles which can be applied:

128. Taking reasonable care will in many cases require that a tax agent or BAS agent ask questions based on their professional knowledge and experience in seeking information. Where there are grounds to doubt the information provided by a client, the tax agent or BAS agent must take positive steps and make reasonable enquiries to satisfy themselves as to the completeness and/or accuracy of that information.

129. Where a statement provided by a client seems plausible and is consistent with previously established statements and the agent has no basis on which to doubt the client’s reliability or the veracity of the information supplied, the tax agent or BAS agent may discharge their responsibility by accepting the statement provided by the client without further checking.

130. However, if the information supplied by a client seems implausible or inconsistent with a previous pattern of claim or statement, further enquiries would be required.

131. Again, whilst there is no requirement to audit, examine or review books and records or other source documents supplied by a client, a tax agent or BAS agent does not discharge their responsibility in such a case by simply accepting what they have been told.

132. Where information has been provided by a suitable, independent, third party expert and there is no prior experience to the contrary, it may be reasonable for a tax agent or BAS agent to rely on that information without further checking or enquiries.

... 134. This principle [subsection 30-10(10) of the TASA 2009] does not require agents to determine the correct application of the law; rather it requires agents to take reasonable care to ensure the correct interpretation and application of the law in the circumstances.

… 137. Where a tax agent or BAS agent is uncertain about how a taxation law applies to a particular set of circumstances, taking reasonable care may include seeking clarification from relevant authorities and sources such as:

  • legislation and related extrinsic material (for example, explanatory memoranda);
  • relevant case law;
  • rulings and determinations issued by the Commissioner on the topic;
  • the Commissioner’s instructions in documents such as income tax returns, BAS returns, fact sheets and practice statements;
  • information published or provided by a recognised professional association or other regulatory agency; or
  • information or relevant commentaries published by other experts, registered agents or specialists.

138. In consulting relevant authorities and sources, the tax agent or BAS agent may choose to seek assistance from another appropriately qualified person who has the ability and resources to provide advice on taxation laws.252

4.24 Difficulties arise, however, in proving that taxpayers have taken reasonable care. For example, a lack of reasonable care may be indicated where the taxpayer seeks advice on the wrong question, misapplies the advice given or does not provide information which, if provided, would have changed the tax practitioner’s advice. In such circumstances, taxpayers may be effectively forced to waive rights of confidentiality in relation to the advice to refute the application of reasonable care penalties.

4.25 The IGT considers that more could be done to clarify this area of the law in a manner that preserves taxpayers’ rights to confidential communications. There is scope for the ATO to publish binding advice that reasonable care has been met where certain circumstances exist, such as the taxpayer having consulted a registered tax agent in relation to the issue.

Recommendation 4.2

The Government should consider whether taxpayers should be presumed to have taken reasonable care where they have consulted a registered tax agent or a lawyer with regards to the issue in question and provided all the information that would be reasonably required by the adviser to provide advice on the issue.

ATO response:

Matter for Government.

RAP penalty threshold

4.26 Submissions argued that the threshold for considering a RAP penalty was too low and effectively imposed disproportionate compliance costs in relation to the risk sought to be addressed.

4.27 In this respect, a taxpayer will not be liable to a RAP penalty where:

You have a *shortfall amount, all or part of which resulted from you or your agent treating an *income tax law as applying to a matter or identical matters in a particular way that was not *reasonably arguable, and that amount is more than the greater of $10,000 or 1 per cent of the income tax payable by you for the income year, worked out on the basis of your *income tax return.253

4.28 This has the effect of ensuring that those taxpayers with smaller shortfalls, or shortfalls which are not a significant proportion of their total taxable income, do not need to consider whether they are exposed to a RAP penalty. Instead, they need only be concerned with whether they have taken reasonable care.

4.29 The standard of proof to establish RAP is more onerous than the standard for reasonable care. Also, due to the technical nature of what the test requires, greater compliance costs will be incurred — such as the costs of engaging professional tax services and dealing with the ATO in relation to these penalties. These costs are regressive. Therefore, for smaller potential shortfalls, smaller taxpayers would incur disproportionate compliance costs in seeking professional advice on tax positions.

4.30 By lifting the threshold, to say $100,000, many small business and individual taxpayers would only have to ensure they meet the reasonable care standard, rather than incurring significant additional costs.

Recommendation 4.3

The Government should consider whether the current threshold for RAP penalties should be increased to more appropriately balance the mischief for which they were intended to address against the compliance costs to small businesses and individuals.

ATO response:

Matter for Government.

Onus of proof for disproving the RAP penalty

4.31 Submissions observed unnecessary and substantial compliance costs arising from the onus of disproving the applicability of RAP penalties, particularly in relation unsustainable penalty decisions.

4.32 As discussed above, the IGT has reviewed the basis for penalty decision making in a number of reviews and made a number of recommendations directed at improving the quality of penalty decision making.

4.33 According to ATO’s expectations of how its officers should approach RAP penalty decisions, an ATO officer should make their judgment based on an assessment of the taxpayer’s application of the law to the facts and whether it is as likely as not to be correct.

4.34 Under subdivision 284-B of Schedule 1 to the TAA 1953, there are four main steps in determining liability of penalties:

Step 1 - Determine whether a penalty for false or misleading statement is imposed by law

Step 2 - Assess the amount of the penalty

Step 3 - Determine whether the penalty should be remitted in full or in part

Step 4 - Notify the entity of the liability to pay the penalty.254

4.35 Importantly, in relation to the RAP penalty provided by subsection 284-75(2), step 1 requires the Commissioner to establish a negative proposition — that is, that the statement made by the taxpayer was not reasonably arguable. Among other things, subsection 284-15(1) defines a matter as reasonably arguable if:

it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.

4.36 Subsection 284-15(3) of Schedule 1 to the TAA 1953 provides that the relevant authorities include:

  1. a taxation law;
  2. material for the purposes of subsection 15AB(1) of the Acts Interpretation Act 1901;
  3. a decision of a court (whether or not an Australian court), the AAT or a Board of Review;
  4. a public ruling.

4.37 Justice Hill in the Walstern case255 outlined the applicable principles to subsection 284-75(2) of Schedule 1 to the TAA 1953, to include:

5. It is not necessary that the decision maker form the view that the taxpayer's argument in an objective sense is more likely to be right than wrong. That this is so follows from the fact that tax has already been short paid, that is to say the premise against which the question is raised for decision is that the taxpayer's argument has already been found to be wrong. Nor can it be necessary that the decision maker form the view that it is just as likely that the taxpayer's argument is correct as the argument which the decision maker considers to be the correct argument for the decision maker has already formed the view that the taxpayer's argument is wrong. The standard is not as high as that. The word ‘about’ indicates the need for balancing the two arguments, with the consequence that there must be room for it to be argued which of the two positions is correct so that on balance the taxpayer's argument can objectively be said to be one that while wrong could be argued on rational grounds to be right. …

7. Subject to what has been said the view advanced by the taxpayer must be one where objectively it would be concluded that having regard to the material included within the definition of ‘authority’ a reasoned argument can be made which argument when contrasted with the argument which is accepted as correct is about as likely as not correct. That is to say the two arguments, namely, that which is advanced by the taxpayer and that which reflects the correct view will be finely balanced. The case must thus be one where reasonable minds could differ as to which view, that of the taxpayer or that ultimately adopted by the Commissioner was correct. There must, in other words, be room for a real and rational difference of opinion between the two views such that while the taxpayer's view is ultimately seen to be wrong it is nevertheless ‘about’ as likely to be correct as the correct view. A question of judgment is involved.

4.38 Submissions claimed that, notwithstanding this judicial guidance, in practice and as a short-cut method, ATO officers compare the taxpayer’s arguments to the ATO’s own view of how the law applied to the facts. This leads to impressions that the ATO has difficulty accepting any position adopted by the taxpayer, which is different to the ATO’s view, could be reasonably arguable. They argue that the test for RAP does not require the taxpayer’s view to be the better view, only that there be room for a real and rational difference of opinion between the two views such that while the taxpayer's view is ultimately seen to be wrong it is nevertheless ‘about’ as likely to be correct as the one that ultimately proves to be the correct view.

4.39 Once a RAP penalty is applied, it is incumbent upon the taxpayer to prove the basis for any remission of penalty or that the application of the penalty is incorrect. As a consequence of this, the potential cost the ATO bears for levying a penalty incorrectly is low, whereas the cost that the taxpayer bears is higher. Furthermore, this diverts the resources of taxpayers and the ATO away from focusing on the substantive issue.

4.40 The IGT observes that if the onus placed on the ATO to explain why the taxpayer’s view is not real and rational, there would automatically be a greater level of accountability for ATO decisions regarding RAP penalties. A similar approach to placing the onus on the revenue authority is being employed in the UK in relation to the general anti-avoidance rules that are being considered there.256

4.41 Placing the burden of proof on the ATO would also reduce taxpayer perceptions that these penalties are not justified and may be being used as leverage. It would ensure that the ATO carefully evaluated a taxpayer’s position before claiming that it is not reasonably arguable.

Recommendation 4.4

In relation to the penalty for no reasonably arguable position, the Government should consider amending the law to place the onus on the ATO to provide reasons for why it considers the taxpayer’s view could not be argued on rational grounds to be about as likely as not, or more likely, to be correct.

ATO response:

Matter for Government.

Relationship between reasonable care and RAP penalties

4.42 During the review, stakeholders raised concerns that there was currently a lack of clarity around the interaction between the reasonable care and RAP penalty tests. For example, in the NTLG Minutes of its March 2011 meeting, professional bodies referred the ATO to the recent Administrative Appeal Tribunal decisions in Shin257 and Traviati,258 in which it was observed that a RAP is a higher standard of care than reasonable care.

4.43 The ATO, however, considers the reasonable care and RAP penalty tests as independent of each other:

39. Unlike the reasonably arguable position test which focuses solely on the merits of the position taken, the reasonable care test has regard to the efforts taken by an entity or their agent to comply with their tax obligations. There is no personal circumstances part of the reasonably arguable position test as it applies a purely objective standard involving an analysis of the law and application of the law to the relevant facts.

40. In this sense the reasonably arguable position test imposes a higher standard than that required to demonstrate reasonable care. Because of these differences an entity may not have a reasonably arguable position in relation to a matter despite having satisfied the reasonable care test.

41. Although demonstrating a reasonably arguable position involves the application of a purely objective test, an entity will usually reach their position (at the time of making the statement) as a result of researching and considering the relevant authorities. In these circumstances, the efforts made by the entity to arrive at the correct taxation treatment will also demonstrate that reasonable care has been shown.259

4.44 In June 2012, the ATO’s view prevailed in the appeal to the AAT decision in Traviati. In the appeal Middleton J found that, as a matter of statutory construction, reasonable care and reasonably arguable position are independent standards:

Put another way, ss 226G, 226H and 226J [of the ITAA 1936, that is, the predecessors to the current penalties for lack of reasonable care, recklessness and intentional disregard of the law] all examined the means (or process) that the taxpayer had utilised in complying with the Act. Section 226K [the predecessor to the current penalty for no reasonably arguable position] only examined whether, as an end, the taxpayer had a reasonably arguable position.260

4.45 In the Second Reading speech to the legislation enacting the reasonable care and reasonably arguable position penalties, the then Minister assisting the Treasurer set out the following policy aims:

Reasonable Care and Reasonably Arguable Position

The whole idea of the new understatement penalties is to ensure that people do not get penalised when they have made an honest and genuine attempt to correctly determine their taxable income. The Bill replaces the existing system where penalty is automatically attracted at the rate of 200 per cent and remitted at the discretion of the Commissioner. In so doing, it reduces the risk of penalties for taxpayers, provided taxpayers adhere to the standards of reasonable care and, where appropriate, reasonably arguable position.

The reasonable care standard requires a taxpayer to exercise the care that an ordinary person would be likely to have exercised in the circumstances of the taxpayer. Reasonable care requires taxpayers to make a reasonable attempt to comply with their tax obligations. The effort required is commensurate with all the taxpayer's circumstances, including the taxpayer's knowledge, education and skill.

The Government has opted to favour equity in this area by choosing a standard which has regard to the taxpayer's circumstances. However, following experience in the United States, the Government considers it appropriate that a more rigorous standard apply where the item at issue is very large, for example, generally more than $10,000 in tax. Where the interpretation of the law for such large items is in issue, we expect taxpayers to exercise more care; that is, the taxpayer must have a reasonably arguable position on the matter.

The reasonably arguable position standard will, because of the $10,000 threshold, apply only to relatively few taxpayers. The crux of the standard is that taxpayers should not take positions at law which, at the time taken, are not about as arguable as an alternative position. All said and done, the standard is about analysing the law and its application to the facts. If there is a strong argument to support the taxpayer's position, that may be enough. However, the Government does not want taxpayers to take positions which are not defensible or which do not have reasonable prospects of success.261

4.46 On the basis of the current interpretation of the legislative provisions, the application of the RAP and reasonable care penalties, in tandem, can lead to anomalous outcomes in practice which appear inconsistent with the original policy aims — that is, a taxpayer can be penalised for not making a reasonable attempt to comply with the law (a lower standard) in circumstances where their position at law is as likely to be correct, if not more so (a higher standard, and without penalty). The IGT considers that the penalty provisions could be improved to protect taxpayers from these anomalous outcomes — that is, where a taxpayer has a reasonably arguable position they would be deemed to have met the reasonable care standard.

Recommendation 4.5

The Government should consider whether taxpayers should be deemed to have taken reasonable care where they have met the higher standard of a reasonably arguable position.

ATO response:

Matter for Government.

RAP penalty’s interaction with the Reportable Tax Position schedule

4.47 As a particular aspect of the penalty regime, submissions from large business expressed some confusion over the ATO’s potential approach to penalties in relation to matters disclosed in the reportable tax position (RTP) schedule.

4.48 RTPs include positions that are ‘about as likely to be correct as incorrect or less likely to be correct than incorrect’. A reasonably arguable position is also defined in the law as ‘about as likely to be correct as incorrect, or is more likely to be correct than incorrect’ (see subsection 285-15(1) of Schedule 1 to the TAA 1953).

4.49 This being so, the disclosure of a RTP may effectively amount to an admission that the taxpayer does not have a RAP and thus expose them to a RAP penalty. The ATO may overcome this perception by providing an incentive to disclose matters in RTP schedules.

Recommendation 4.6

The ATO should consider reducing penalties relating to a lack of reasonably arguable position for taxpayers who have made relevant disclosures in reportable tax position schedules.

ATO response:

Agree in principle.

The ATO continues to encourage taxpayers to engage early with us to seek clarity around uncertain tax positions before they are taken, including through requests for private rulings (for which penalty protection is available). The ATO will consider the circumstances in which a penalty reduction may be warranted where a taxpayer has made a sufficient disclosure as part of a reportable tax position schedule and has been cooperative in dealings with the ATO.

The interest charge regime (GIC and SIC)

4.50 The primary design function of interest charge regime is to compensate the Commonwealth for the time value of money (e.g. the Shortfall Interest Charge or SIC, and a proportion of the General Interest Charge or GIC).262 In circumstances where a tax debt is raised and known, interest charges may also have a secondary function, as a quasi-penalty, to discourage the use of tax debts as a source of business or private finance).263

4.51 This is reflected in the current regime where two rates of interest charge can apply to tax liabilities:

  • the GIC — determined by adding a 7 per cent uplift factor to the 90-day bank accepted bill rate (published by the Reserve Bank); and
  • the SIC — determined by adding a 3 per cent uplift factor to the 90-day bank accepted bill rate.

4.52 These interest charges can apply in three circumstances:

  • Where, the liability was self assessed correctly but not paid by the due date of the original assessment — in which case the GIC is applicable.
  • Where the liability was self assessed incorrectly and there was a shortfall in tax paid, however, once the correct liability was determined the tax was paid by the due date of the amended assessment — in which case the SIC is applicable.
  • The liability was self assessed incorrectly and there was a shortfall in tax paid, however, once the correct liability was determined the tax was not paid by the due date of the amended assessment — in which case the GIC is applicable.

Interest accruing during ATO delays

4.53 Submissions described various situations where there was ATO delay in developing its view or otherwise deciding not to pursue compliance action. In certain situations, taxpayers had disclosed information to the ATO regarding areas of significant uncertainty, however, no view was forthcoming from the ATO and no determination was provided as to whether the issue was considered ‘closed’ or not.

4.54 The key theme was that where there is an area of significant uncertainty, and where the ATO is delayed in developing its view, then there should be some concession on interest charges. In this way, the costs and impacts of uncertainty would be somewhat mitigated, despite the complexity of the circumstances and the resultant ATO delay, particularly in the light of disclosures which had already been made by taxpayers.

4.55 In this regard, the IGT notes that where taxpayers are engaged with the ATO under an ACA, there may be an undertaking to provide concessional treatment on penalties and interest where material tax risks have been disclosed.264

4.56 Interest charges play an important role in self assessment systems. They compensate the consolidated revenue for the time-value of the taxpayer’s use of the money. They also deter taxpayers using the consolidated revenue as a source of unsecured credit.

4.57 However, it may not be appropriate to charge interest where the delay giving rise to the interest liability is beyond the control of the taxpayer. In circumstances where the ATO is responsible for delays in the compliance assurance processes (including delays in issuing amendments after the ATO has sufficient information to do so), it will be unfair to charge the taxpayer for those periods as it is beyond the taxpayer’s control.

4.58 The ATO has previously committed to remit interest to the base rate for the period that a large business audit extended beyond two years.265 Therefore, the IGT considers that capping interest to two years should persuade the ATO to complete compliance detection and verification sooner for pre-lodgement, expanded lodgement disclosures and tax returns.

Recommendation 4.7

The Government should consider providing taxpayer protection from penalties and cap SIC at two years for issues which have been the subject of pre-lodgement, expanded lodgement disclosures and tax returns.

ATO response:

Matter for Government.

Punitive levels and regressive effect on small businesses

4.59 A number of submissions claimed that the GIC and the SIC rates operate as a punitive measure. In addition, some stakeholders observed that taxpayers can borrow at different rates and suggested that it may be appropriate to differentiate rates as between different taxpayers — for example, large business may be able to access funds at interest rates well below those charged under the SIC or GIC regime, whereas small business may only be able to access funds from financial institutions at rates in excess of the SIC or GIC.

4.60 The ROSA report considered this issue:

The base rate [the 90-day bank bill rate ] feeds through movements in the overall profile of interest rates, ensuring that the GIC retains commercial relevance. The uplift factor’s role is to make the GIC rate sufficiently high to encourage the payment of tax liabilities when due, discouraging the use of tax debts as a source of business or private finance. Although the GIC is calculated by adding the uplift factor to the base rate, the uplift factor is not intended to reflect the risk premium that applies to the normal finance costs of affected taxpayers, nor to serve as a penalty for having engaged in blameworthy conduct.

… Businesses tend to carry tax deductible debt as part of their financing structure and the GIC is therefore primarily a cost of finance issue. By design, the GIC will generally impose a substantial premium over the rates at which healthy businesses would normally borrow, the extent of that premium varying according to the businesses’ credit ratings.

With individuals and very small businesses, the impacts can vary significantly. For some, the net impact of the GIC could be favourable or negligible, while others could experience a penalty effect. The fact that many businesses incur GIC, rather than borrow commercially to clear crystallised tax debts, indicates that the GIC rate is not excessive in many instances — and may even constitute a ‘soft’, application-free source of finance. However, for others, rather than providing loan benefits, shortfalls can cause a cash flow crisis, or cause larger debts than a proprietor would voluntarily have allowed to accrue.

… for many taxpayers the base rate would be below — sometimes well below — their normal borrowing rate, potentially giving them significant loan benefits from having made a shortfall. This could provide an incentive for risk-taking across a wide range of high risk sectors. It should also be noted that, because of tax deductibility, the base rate would not normally compensate the revenue fully for the time value of money.

The Review considers that, in principle, the objective of a shortfall interest charge should be to neutralise loan benefits that taxpayers might typically receive from their shortfall, so that they do not receive an advantage over those who assess correctly.266

4.61 Interest charges can also have a regressive effect on smaller businesses. These businesses may be less likely to be able to absorb the cost of an amended assessment than a larger business. This is because small businesses typically have fewer resources available and much less access to credit to address debts, including tax debts, such that any additional unanticipated cost erodes these businesses’ profitability faster than larger businesses.

4.62 Furthermore, small businesses with large tax debts are likely to suffer from reduced access to bank funding as a result of their tax debts, compounding any existing difficulties in raising funds.

4.63 One solution would be to reduce the GIC and SIC uplift factors, with the effect that the lower rates would be less onerous, particularly for small businesses.

4.64 This issue was considered by the ROSA report:

In practice, it is not feasible to fine-tune the interest charge to the circumstances of each taxpayer. Further, it is not feasible to apply differential rates to different market segments (such as individuals, very small businesses and other businesses), because the loan benefit within segments can vary widely. Similarly, because tax deductibility is only one factor affecting the impact of shortfall interest on a particular taxpayer, the Review does not recommend altering current arrangements whereby all GIC is tax deductible.

The Review therefore proposes a uniform interest charge on shortfall amounts. A consequence of having a single rate is that, in practice, some taxpayers will receive a loan benefit and some taxpayers will incur a penalty effect after paying the shortfall interest charge. Once the shortfall and related interest have been notified to the taxpayer, the GIC should operate normally at the usual rate.267

4.65 The IGT considers that the view expressed in the Treasury’s report has merit and in the absence of compelling reasons otherwise makes no recommendation for change at this time.


238 See the discussion in Paul Sokolowski, ‘The Administrative Penalty Regime — A Swinging Reminder of Just Swinging?’ (Paper presented at the 25th National Convention (Tax Institute of Australia), Melbourne, 3–5 March 2010) pp 5-6.

239 See Taxation Administration Act 1953 sch 1 ss 284-75(1), (4), 284-90(1) item 3.

240 Note that these provisions also apply to the Mineral Resource Rent Tax.

241 Taxation Administration Act 1953 s 285-75(2).

242 E.g. Commissioner of Taxation v BHP Billiton Finance Limited; Commissioner of Taxation v BHP Billiton Limited [2010] FCAFC 25.

243 Australian Taxation Office, Communication to the Inspector-General of Taxation, 14 October 2011.

244 Ibid.

245 Inspector-General of Taxation, Review into Aspects of the Tax Office’s Settlement of Active Compliance Activities (2009) p 17.

246 Australian Taxation Office, ‘Penalties — Continuous Improvement Report’, Internal Document, 26 May 2011, p 7.

247 Ibid.

248 Joint Committee of Public Accounts, above n 27, p 300.

249 Inspector-General of Taxation, above n 245, p 17.

250 Taxation Administration Act 1953 sch 1 s 284–75(6)(b).

251 Ibid sch 1 s 284–75(6)(d).

252 Tax Practitioners Board, Explanatory Paper TPB 01/2010: Code of Professional Conduct (2010) pp 28-34; note that Australian Taxation Office, Penalty Relating to Statements: Meaning of Reasonable Care, Recklessness and Intentional Disregard, MT 2008/1, 11 July 2012, paras [85], [86] and [89], are similar to this material.

253 By operation of s 284-75(2) and item 4 in the table at s 284-90 (note items 5 and 6 similarly provide for trusts and partnerships) of sch 1 to the Taxation Administration Act 1953.

254 Australian Taxation Office, Administration of Shortfall Penalty for False or Misleading Statement, Practice Statement PS LA 2006/2, 25 August 2006, para [22].

255 Walstern v FC of T (2003) 54 ATR 423. Note that Justice Hill’s reasoning was based on the predecessor to sections 285-15 and 284-75(2). However, the extrinsic materials to subdivision 284-B indicate that the RAP concept has the same meaning as its predecessor.

256 HMRC, ‘A General Anti-Abuse Rule: Consultation Document’, 12 June 2012, p 21.

257 Shin and Commissioner of Taxation [2010] AATA 1012.

258 Traviati and Commissioner of Taxation [2011] AATA 478.

259 ATO, Penalty Relating to Statements: Meaning of Reasonable Care, Recklessness and Intentional Disregard, MT 2008/1, 7 March 2012; see also ATO, Shortfall Penalties: Administrative Penalty for Taking a Position That is Not Reasonably Arguable, MT 2008/2, 1 June 2011, paras [27]-[31].

260 Commissioner of Taxation v Traviati [2012] FCA 546, para [71].

261 Commonwealth, Parliamentary Debates, House of Representatives, 26 May 1992, p 2774-2779 (Mr Baldwin), second reading speech to the Taxation Laws Amendment (Self Assessment) Bill 1992.

262 The Treasury, above n 1. p 53.

263 Ibid pp 49, 52.

264 Australian Taxation Office, Annual Compliance Arrangements - What You Need to Know (13 December 2011).

265 ATO, ‘Tax Office to Complete Large Audits within Two Years’ (Media Release, NAT 2006/34, 30 August 2006); ATO, Remission of Shortfall Interest Charge and General Interest Charge for Shortfall Periods, PS LA 2006/8, 11 July 2012, paras [66]–[70].

266 The Treasury, above n 1, pp 49–53.

267 The Treasury, above n 1, pp 53–54.