1.1 On 20 November 2003, the then Minister for Revenue and Assistant Treasurer, Senator Helen Coonan, requested that the Inspector-General of Taxation review the Australian Taxation Office's (ATO or Tax Office) systems for remitting the General Interest Charge (GIC).
1.2 The request was made pursuant to paragraph 8(3)(a) of the Inspector-General of Taxation Act 2003.
1.3 The Minister asked that the review focus on disputed tax involving groups of taxpayers, with particular consideration to the situation of participants in Employee Benefit Arrangements.
1.4 The Government's concurrent review of the self assessment system and related discussion paper1 has implications for the matter raised by the Minister. However, the matter was also one which was raised as a significant issue during the consultations which the Inspector-General undertook with stakeholder groups to determine a forward work program.
1.5 During these consultations, tax practitioners, taxpayer groups and industry representatives expressed substantial concerns at the ATO's approach to remitting GIC. They were particularly concerned that its approach, especially in the area of Mass Marketed Tax Effective Investments, is inconsistent with its practice elsewhere, such as in relation to Employee Benefit Arrangements. These consultations also indicated that that there is a view among accounting and tax practitioner bodies that the ATO is reluctant to use its power to remit the GIC.
1.6 The Minister's request was accepted as a priority for the work program of the Inspector-General.
1.7 The circumstances which led to the creation of the disputed tax liabilities and associated interest charges under review have resulted in strong feelings of dissatisfaction amongst many participants in widely marketed tax planning arrangements that may also have a commercial orientation. Nevertheless, the opportunity to finalise an unanticipated and unwanted dispute with the ATO can be tolerable to many taxpayers when compared to the ongoing cost and uncertainty of litigation.
1.8 Equally, it can be good administrative practice for the ATO to minimise its own costs and reduce community angst by seeking to finalise old disputes where no significant principle of law is involved. The ATO states that it has implemented measures to reduce the likelihood of reoccurrence of similar situations, such as by introducing the Product Ruling system, Taxpayer Alerts and a more active market intelligence function.
1.9 Early resolution of disputes with groups of taxpayers has significant benefits. The longer the ATO and groups of taxpayers take to finalise outstanding disputes, the higher is the risk of deep seated attitudes on both sides of the dispute developing.
1.10 The Inspector-General has not reviewed the actual efficacy of the disputed arrangements or the ATO processes for achieving finalisation. However, in situations extending over many years, the issue of the amount of interest charged on underpaid tax can be a significant inhibitor to finalisation of a dispute.
1.11 As mentioned above, the efficacy of Employee Benefit Arrangements and other matters of dispute with the ATO have not been a consideration of this review. Such considerations are matters for the courts, and there is now available the benefit of judicial deliberation in a number of cases. The key issue for the review is the consistency of approach by the ATO in its application of its interest remission powers. However, part of the complexity of this review lies in the history and circumstances of the disputed arrangements.
1.12 For example, Employee Benefit Arrangements could be a quite legitimate human resource strategy to reward and retain key employees in a tax effective way. Such an arrangement may have attracted favourable opinion from the legal and accounting profession and from the ATO (and in this case, further complicated by the alleged corrupt actions of a former senior ATO official). With the benefit of such favourable advice, less scrupulous or knowledgeable parties may then market such arrangements to a wider audience. At the other extreme, examples of arrangements involving small husband and wife businesses, operating as a company, setting up separate trust arrangements to hold untaxed profits to pay the 'employee' husband and wife business proprietors' retention and performance bonuses at some future time, which would be determined by themselves in their company director capacity, were provided in the review. In some situations, even the formal paperwork to create the trust entities is not formalised. Many situations fall between these extremes.
1.13 However, a key element of the overall situation is the reliance placed by taxpayers, particularly small businesses, on the advice and guidance of their professional advisers, particularly when it is backed up by opinions provided by credible legal and accounting professionals or the ATO (even if third hand or only of a general nature). The knowledge to identify the tax planning options, and the knowledge to even create and administer the required company and trust entities, is generally well beyond the competence of the normal small business or salary and wage taxpayer.
1.14 It is an unfortunate feature of the system that the instigators and marketers of inappropriate tax planning arrangements may not carry any risk should the ATO and courts respond adversely — the taxpayer participant usually bears the financial consequence even though the promoter fees may be substantial and the set-up and dismantling transaction costs significant. It is noted that, on 13 July 2004, the West Australian Supreme Court sentenced 3 advisers to a mass marketed arrangement involving fraud to jail terms of 5 years each for conspiring to defraud the Commonwealth. It is also noted that the Government has flagged the introduction of legislation proposing penalties for tax avoidance promoters in appropriate circumstances.2
1.15 In an environment with the identified range of circumstances leading to large groups of taxpayers having disputes over their tax affairs, the large challenge facing the ATO is maintaining overall integrity and equity in the tax system while having regard to the individual circumstances of taxpayers.
1.16 Where there are situations of disputes involving large numbers of taxpayers with varying circumstances, thus creating significant administrative workloads inhibiting individual consideration, the onus must be to err on the side of empathy with affected taxpayers if the overall circumstance warrants (rather than focus predominantly on the actual tax planning event).
1.17 Egregious game players should suffer appropriate penalty but not to the detriment of those who have allowed the benefits of a marketed plan and natural reliance on advisers to influence their normal judgment and behaviour.
1.18 There are risks associated with generalised treatments where sheer numbers prevent the normally expected individual attention associated with individual disputes. These risks need to be weighed against the broader negative reaction and ongoing compliance attitudes that can arise when the tax consequences are out of kilter with expectations of fair treatment.
1.19 While individual participants in many of the disputes under consideration had the potential to achieve attractive tax savings, the end outcome is that many are victims of circumstances which have carried social, emotional, business and financial costs going well beyond the amount of tax involved. It is noted that the ATO acknowledged and responded to this exceptional situation in respect of Mass Marketed Tax Effective Investment arrangements.
1.20 In undertaking this review, care has been taken to avoid standing in the shoes of the Commissioner in respect of making individual judgements on specific cases. That responsibility clearly rests with the Commissioner, and various review rights are available to aggrieved taxpayers. The focus of the review has been on the broader systemic approach and conduct of the ATO. The Inspector-General cannot direct the Commissioner (other than to supply documents or information in respect of a review).
Terms of reference for the review
1.21 The terms of reference for the review were as follows.
1.22 The review will investigate the administration of GIC remission in cases of tax disputes where settlement offers involving groups of taxpayers have been made. It will especially consider the following:
- the Commissioner of Taxation's policy for remitting GIC for disputes involving groups of taxpayers;
- the distinguishing features of each group of taxpayers who are in dispute with the ATO;
- the manner in which any remission policy is applied to such groups of taxpayers in dispute with the ATO;
- the manner in which any GIC remission policy is applied to taxpayers involved in arrangements which the ATO has classified as Employee Benefit Arrangements. These arrangements are: employee benefit trust arrangements, employee share or incentive plans, offshore superannuation schemes and controlling interest superannuation arrangements; and
- the degree to which the policy applied to taxpayers involved in Employee Benefit Arrangements is appropriate and consistent with that applied to other groups of taxpayers in dispute with the ATO.
How the review was conducted
1.23 The announcement of the review was reported both in the press3 and in specialist accounting and legal publications. The review was also announced on the Inspector-General's website at www.igt.gov.au on 8 January 2004.
1.24 Written submissions on the review were taken from members of the public generally and a number of particular people and organisations. In addition, members of the review team, together with the Inspector-General (in a number of cases), met or consulted with representatives of a number of bodies relevant to the review, including the Commonwealth Ombudsman and Australian National Audit Office.
1.25 The Commissioner of Taxation was asked to provide information and documents relevant to the review. Visits were made to the Moonee Ponds and Northbridge offices of the ATO by staff of the Inspector-General to examine relevant files and interview relevant ATO officers. The Inspector-General and his staff also met with the Commissioner of Taxation to discuss aspects of the review.
1.26 The Commissioner of Taxation was also given an opportunity to make submissions to the Inspector-General in relation to the report. The Commissioner's letter in response has been attached to the report as Appendix 1. Specific responses to the key and subsidiary findings have been included in the report and the appendices to the report.
Other recent inquiries
1.27 Significantly, this review coincided with the Review of Aspects of Income Tax Self Assessment, conducted by the Australian Government Department of the Treasury. As indicated above, a discussion paper in relation to this review was released in March 2004.
1.28 The recent report on the ATO's Management of Aggressive Tax Planning by the Australian National Audit Office is also relevant.4
Summary of key findings
Key Finding 1
1.29 The legislative provisions authorising interest remission for the pre-amended assessment period provide the Commissioner with a broad power to remit the interest charge.
1.30 However, the Commissioner has adopted a narrow approach regarding the circumstances in which the interest remission power will be exercised.
1.31 This has meant that, particularly where interest has accrued over a period of up to four or six years, the pre-amended assessment interest charge without remission may have a far broader and punitive-like effect. The interest remission guidelines must be flexible and responsive to remove inappropriate punitive-like consequences where out of the ordinary circumstances exist.
Key Finding 2
1.32 Prior to 1992, the Commissioner had an established policy that the remission power for interest, or its equivalent, for the pre-amended assessment period would only be exercised in exceptional circumstances.
1.33 With the 1992 legislative amendments to the penalty and interest provisions, including the introduction of the interest 'uplift' factor, the Commissioner did not revise his previous policy regarding the circumstances in which the interest remission power would be exercised.
1.34 As such, there was no detailed policy framework for the remission of the pre-amended assessment interest for the years of income from 1992/93 up to and including 1999/2000.
1.35 For the years of income 2000/01 and onwards, the ATO's Receivables Policy does not provide sufficient guidance to the public on how the interest remission power is to be exercised for the pre-amended assessment period.
1.36 For this reason, tax administration would benefit if the Commissioner published a separate policy document which provides clear guidelines on his policy, covering the current and prior years, for remission of the interest charge.
1.37 The policy should include the different considerations relevant to determining whether remission of the interest charge is warranted for either or both the pre-amended and post-amended assessment periods.
Key Finding 3
1.38 Although disputes involving different groups of taxpayers may have distinguishing features including the nature, complexity and sophistication of the arrangements, at the taxpayer level there are more common features between the individuals forming part of each group than points of differentiation. These include a broad array of investors, targeted marketing techniques, prior ATO advice/advance opinions/rulings and ATO time delays.
1.39 Against this background, an examination of all the circumstances of the taxpayers involved in these arrangements may indicate that it is more appropriate for a similar interest remission outcome to arise for taxpayers who share similar individual circumstances regardless of the particular arrangement involved.
Key Finding 4
1.40 Administrative procedures regarding the remission of the interest charge for groups of taxpayers require that an appropriate balance is achieved between considerations of administrative efficiency in dealing with groups of taxpayers and examining the conduct and circumstances of a taxpayer in accordance with the Taxpayers' Charter.
1.41 To date, the approach of the Commissioner suggests more focus has been on considerations of administrative efficiency as opposed to an examination of a taxpayer's individual conduct and circumstances. In particular, considerations of the type and nature of the arrangement and the extent to which members of a group share certain further characteristics have overshadowed consideration of the conduct and circumstances for each individual.
Key Finding 5
1.42 There are a variety of factors that the ATO has considered relevant in the statutory reduction and remission of penalties. These factors may also be relevant in considering the remission of the interest charge for groups of taxpayers in dispute with the ATO.
Key Finding 6
1.43 For certain investors in Mass Marketed Tax Effective Investments (MMTEIs) the ATO set up a formal process, which also involved separate ATO internal review procedures, for the remission of interest and other elements contained in the standardised settlement arrangements. A similar process has not been established for participants in Employee Benefit Arrangements (EBAs).
1.44 The actual formal structure of this process for certain MMTEI investors, and its accompanying review procedures, were well documented within the ATO and transparent to taxpayers.
1.45 Currently, taxpayers who are seeking a review of the level of interest charged by the ATO can only do so by making an application for judicial review in accordance with the terms of the Administrative Decisions (Judicial Review) Act 1977. This is a costly and lengthy process.
1.46 Tax administration would therefore be improved if an internal review process of a structure similar to that adopted for MMTEI investors was adopted for EBA taxpayers. Such a process would be a quicker, less expensive and more transparent review mechanism for the remission of interest than that which currently exists for such taxpayers.
1.47 However, any such review process would need to operate according to the overriding principle that all individual circumstances relating to particular taxpayers are taken into account during the operation of this process.
1.48 In particular, considerations of the extent to which taxpayers who are subject to this review process are members of a particular group, or share certain other characteristics of other taxpayers who are subject to the same process, should not override consideration of the conduct and circumstances of each individual.
Key Finding 7
1.49 Taxpayers who are members of groups of taxpayers in dispute with the ATO over arrangements frequently share a range of common features. Some of these features were identified by the ATO and used to determine the final settlement offer that was made to the majority of MMTEI investors. In the ATO's view, these common features suggested the existence of exceptional circumstances which justified applying an interest remission policy which led to the interest charge being reduced to nil.
1.50 The present ATO treatment of pre- and post-amended assessment interest charges for taxpayers involved in EBAs has focussed principally on the nature of the arrangement giving rise to the particular dispute. For taxpayers involved in three kinds of EBAs full interest has been charged while for taxpayers involved in one form of EBA a reduced interest rate has been applied.
1.51 This focus on the nature of the arrangement in EBA disputes appears to have led to taxpayers involved in EBA disputes receiving interest remission outcomes which are inconsistent with those received by other groups of taxpayers. It has also led to taxpayers involved in certain types of EBAs receiving interest remission outcomes which are not consistent with those applied to taxpayers involved in other forms of EBAs.
Nature and purpose of the General Interest Charge
Imposition of interest
1.52 Interest is one of the additional amounts payable when an assessment is amended by the ATO to increase the amount of tax payable by a taxpayer. The other additional amounts that are payable in this situation are the additional tax itself (called 'primary tax' in this report) and any administrative penalty that the underpayment may attract.
1.53 Interest payable in respect of an amended assessment is automatically imposed on taxpayers, under specific legislative provisions. This interest will consist of pre-amended assessment interest (being the interest which is levied up to the time when the amended assessment is issued) and post-amended assessment interest (being the interest that is levied if the amended assessment is not paid by its due date). The ATO has always had the power to remit both these forms of interest.
Pre-amended assessment interest
1.54 Pre-amended assessment interest arises in the following circumstances. Under the self assessment system, taxpayers generally self assess their tax liability; that is, they lodge their returns on the basis of what they consider to be the correct application of the law, without the ATO actually checking the validity of the information provided by the taxpayer. The ATO only normally undertakes investigation of a taxpayer's return some time after the return has been lodged and the relevant assessment paid. If those investigations indicate that the taxpayer has incorrectly determined their tax liability the ATO will issue an amended assessment, which will require payment of the amount of the underpaid tax together with interest on that amount (termed in this report 'pre-amended assessment interest' or 'interest on underpaid tax').
1.55 While an ATO Notice of Intention to Audit may give some prior warning, the amended assessment is generally the first indication that a taxpayer will receive advising them that the ATO does not agree with their application of the law to the relevant return. The pre-amended assessment interest that is charged in this amended assessment could therefore have accrued during a period when the taxpayer remains unaware of the fact that this interest is accruing.
Post-amended assessment interest
1.56 Post-amended assessment interest or late payment interest is the interest that is levied from the date when an amended assessment is due for payment until the date it is in fact paid. In contrast to pre-amended assessment interest this interest will therefore accrue during a period when the taxpayer is aware of this interest liability.
1.57 Because taxpayers are aware of when post-amended assessment interest starts to accrue, they can take steps to minimise the amount of post-amended assessment interest. One step which they can take, provided there is a formal dispute with the ATO, is to enter into what is known as a 50-50 payment arrangement with the ATO. Under this arrangement, provided the taxpayer pays 50 per cent of the amount of tax in dispute (including any accrued interest and penalties) the ATO will permit 50 per cent of the disputed tax amount to remain in abeyance until the dispute is finally resolved. The taxpayer will be liable for only 50 per cent of the interest calculated on the 50 per cent of tax not paid (that is, the ATO will remit 50 per cent of the interest accrued).
1.58 The focus of this review is principally on the imposition and remission of pre-amended assessment interest. This is because this interest is imposed during a period when a taxpayer is generally unaware of this interest charge and is not therefore able to undertake any steps to minimise its imposition.
Development of present interest system
1.59 The basic structure of the present system for pre-amended assessment interest was first introduced in 1992. Prior to 1992, except in certain limited cases, only a penalty was payable when an amended assessment was issued. However, this pre-1992 penalty was imposed by the ATO on the basis that it consisted of a fixed amount plus a per annum charge that was essentially equivalent to what is now known as pre-amended assessment interest.
1.60 In 1992, the law was changed so that the interest and penalty elements of the penalty for underpaid tax were imposed under separate legislative provisions.
1.61 The generally accepted policy behind the new separate interest charge for pre-amended assessment interest created in 1992 was that this interest charge was designed to compensate the Revenue for the time value of money over the period in which the taxpayer had short paid their tax. This also had the effect of achieving neutrality with those taxpayers who had fully met their tax obligations. The interest was therefore not primarily meant to be used as a mechanism to penalise taxpayers but rather to compensate the Revenue for its own borrowing costs.
1.62 From 1992, the Government intended that the new separate penalty provisions were to be the mechanism that was to be used to punish taxpayers, where appropriate, for underpayments of tax. From 1992, the amount of any penalty was set, by statute, to vary according to certain actions of the taxpayer and the degree to which their tax claims were reasonably arguable.
1.63 The rate of pre-amended assessment interest in 1992 was the 13 week Treasury note yield plus a further 4 per cent. The additional 4 per cent uplift was described by the Government as reflecting administration costs and the fact that most taxpayers would not be able to borrow at the 13 week Treasury note rate.
1.64 From 1 July 1999, the rate of pre-amended assessment interest was increased by a further 4 per cent. No explanation was given for this further increase in the Explanatory Memorandum to the Bill which introduced this uplift. There is evidence from other material which suggests that this uplift was made to discourage taxpayers from using the tax system as an unsecured mechanism for borrowing. Another view is that this increase was part of a broad simplification package for interest generally.
1.65 From 1 July 2001, the 8 per cent uplift factor in the rate of pre-amended assessment interest was reduced to 7 per cent.
1.66 Further details on the nature of the law and policy for the imposition of pre- and post-amended assessment interest are contained in Appendix 2.
ATO conduct in issuing amended assessments with an interest charge
1.67 The ATO commenced issuing amended assessments to groups of taxpayers involved in mass marketed tax effective investments in 1998. In subsequent years, it extended this activity to other groups of taxpayers who had entered into certain other investment arrangements.
1.68 The ATO issued these amended assessments up to four or, in certain cases, six years after the date on which the relevant underpaid tax was originally due. In many cases, the size of the pre-amended assessment interest component in the amended assessments outweighed the size of any culpability penalties contained in the total amended tax bill. In practice, this meant that, although pre-amended assessment interest was not meant to be imposed as a penalty, taxpayers could receive amended tax bills where the amount of culpability penalties levied were less than the amount of accrued pre-amended assessment interest.
1.69 The ATO's actions in issuing amended assessments over such extended periods, thus creating large interest liabilities, may expose flaws in the manner in which the ATO has exercised its powers of remission for interest and penalties.
Meaning of terms 'General Interest Charge' and 'Interest'
1.70 Although the terms of reference for the review refer to the remission of GIC, the current GIC regime in its present form was only introduced for the years of income commencing after 1 July 2001.
1.71 For each of the two income years between 1 July 1999 and 30 June 2001, the GIC regime operated but with certain key features that are different to the present regime.
1.72 The majority of the disputes examined for the purpose of this review actually concern years of income between 1 July 1993 and 30 June 1999. For these years of income, the interest payable by a taxpayer in a situation where their assessment is amended by the ATO prior to 30 June 1999 is not GIC. Instead, it consists of 'tax shortfall penalty interest' (which is payable for the period prior to the amendment of the assessment) and 'late payment interest' (payable from the due date of the amended assessment if this assessment is not paid).
1.73 Under transitional rules, interest payable by taxpayers in respect of these years of income consisted of GIC to the extent that interest was payable for the period prior to the issue of the amended assessment and that period accrued after 1 July 1999. It also consisted of GIC to the extent that the interest was for the late payment of the relevant amended assessment and the period of late payment arose after 1 July 1999.
1.74 Both the ATO, in its communications to affected taxpayers, and taxpayers themselves use the terms 'general interest charge' and 'interest' to embrace any interest that is payable on disputed amounts of tax. This is regardless of the year of income involved or the period during which the relevant interest has accrued. For this reason, where the terms of reference for the review and this report refer to the 'general interest charge' or ' interest' these terms cover interest payable under the interest regime that preceded the GIC as well as the GIC itself.
1.75 The Inspector-General would like to acknowledge the co-operation and assistance of many staff, at all levels, in the ATO and Department of the Treasury. This review was also greatly assisted by the contribution of many interested organisations and people in the private sector.
1 Commonwealth Treasury, Review of Aspects of Income Tax Self Assessment, Discussion Paper, March 2004.
2 The Assistant Treasurer, Press Release C117/03 — Crackdown on Promoters of Tax Avoidance and Tax Evasion, dated 5 December 2003.
3 Inspector-General of Taxation, Media Release 'Inspector-General of Taxation Announces Terms of Reference for Review of Remission of General Interest Charge', dated 7 January 2004.
4 Australian National Audit Office, The Australian Taxation Office's Management of Aggressive Tax Planning, Audit Report No. 23 2003-4.