A.3b.1 This appendix sets out the Tax Office's detailed responses to Chapter 3 of the review and contains the Inspector-General's comments on the Tax Office responses.

Tax Office detailed reply to Chapter 3

Key Finding 3.1

Only a small proportion of active compliance activities and objections lead to litigation.

Tax Office response

A.3b.2 Agreed

A.3b.3 It is important to put into perspective the number of cases that result in appeals.

A.3b.4 The table below provides an overview of compliance activities through to litigation:

Work Type Financial Year
ended 30 June 2004
Financial Year
ended 30 June 2005
Total
over two years
Compliance activities 1,167,786 1,197,891 2,365,677
Liability adjustments 558,182 679,938 1,238,120
Objections 16,872 15,884 32,756
Private Rulings objections 155 218 373
Appeals and disputes 2,034 1166 3,200
Aggressive tax planning 1551 646 2,197
Non aggressive tax planning 483 520 1003
Total 2,034 1166 3,200

A.3b.5 Based on Tax Office figures, the number of appeals generated from compliance adjustments is less than 0.3 per cent. Fewer than 10 per cent of objections result in an appeal; 3 per cent of objection decisions in non aggressive tax planning cases proceed to appeal.

Cases resolved prior to hearing

A.3b.6 These figures suggest that we mainly get our position right before litigation commences. The small number of cases that get to litigation however are reviewed through the litigation process and in many cases, the dispute can be resolved by the taxpayer conceding, the Commissioner conceding or both sides finding room to negotiate an agreed settlement. The Inspector-General takes the view that 'it is appropriate for the Tax Office to settle litigated disputes, in suitable cases and that the high percentage of settled cases suggests that the majority of Part IVC appeal cases are appropriately concluded by the Tax Office.'

A.3b.7 The report nonetheless suggests that a significant percentage of the tax cases which reach the litigation stage could have been resolved at an earlier stage. The Inspector-General has illustrated that a large number of tax matters are resolved prior to hearing in the Administrative Appeals Tribunal.

Inspector-General's comments on Tax Office response

A.3b.8 After commenting that a significant percentage of the tax cases which reach the litigation stage could have been resolved at an earlier stage the Inspector-General noted that this could be due to number of reasons. It could be due to information relevant to the dispute not being sought by the Tax Office earlier in the dispute resolution process (at the audit and objection stages) so as to allow the dispute to be properly considered, or a taxpayer not providing the Tax Office with requested information until the dispute proceeds to litigation. It could also be due to the wrong technical issues being raised by taxpayers' advisers or the Tax Office. The Inspector-General has not sought to examine in greater detail these observations. However they suggest that the earlier stages of the tax dispute process may not be wholly effective in the timely resolution of disputes and warrant further review.

Tax Office response

A.3b.9 Table 3.3 of the report is replicated with an average column included.

Jurisdiction 97/98 98/99 99/00 00/01 01/02 02/03 03/04 04/05 Average
% % % % % % % % %
All applications 77 76 77 74 74 74 81 78 76.4
Taxation Division 84 85 87 88 81 96 97 83 87.6
Small Taxation Claims Tribunal 80 78 66 68 78 73 85 75 75.4

A.3b.10 The rounded-up figure of 88 per cent used by the Inspector-General to illustrate AAT cases finalised without a hearing, includes the massive volume of mass marketed schemes and employee benefit arrangements. It also includes cases where the taxpayer has withdrawn. The table also provides eight years of percentages of cases in the STCT, averaging 75 per cent of cases which did not proceed to hearing. As the STCT only deals with small amounts, its figures are less affected by scheme cases than the cases in the AAT.

Inspector-General's comments on Tax Office response

A.3b.11 The Inspector-General examined the average percentage of applications for review of tax decisions in the AAT that were finalised without a hearing over an eight year period, from 1997/98 to 2004/05. This helped ensure a more accurate picture of the resolution of taxation review cases rather than just over a two year period. The Inspector-General has acknowledged that the average percentage is influenced by the large number of mass marketed tax arrangement cases finalised in 2002/03 and 2003/04. If these two years are excluded, the average percentage of applications for review of tax decisions finalised without a hearing falls to 85 per cent.

Tax Office response

A.3b.12 The following table reflects information provided to the Inspector-General on the outcome of all appeals (court and tribunal), including those conceded and settled over the two years from 1 July 2003 to 30 June 2005. This table is reflected in the Inspector- General's report at Table 3.5. Percentages are added below for emphasis:

Outcome Category Total
Aggressive Tax
Planning (ATP)
% Non-ATP % %
Settled 1,609 73.2 249 24.8 1,858 58.1
Partly Favourable to the Tax Office 282 12.8 44 4.3 326 10.2
Favourable to the Tax Office 132 6 184 18.3 316 10
Abandoned by Taxpayer 72 3.3 185 18.4 257 8
Conceded by Tax Office 3 0.1 84 8.3 87 2.7
Affirmed on review in favour of the Tax Office 14 0.6 55 5.5 69 2.1
Unfavourable to the Tax Office 8 0.3 39 3.9 47 1.5
Abandoned by the Tax Office 5 0.2 37 3.7 42 1.3
Other 72 3.2 126 12.6 198 6.1
Totals 2,197 1,003 3,200

A.3b.13 In the absence of publicly available figures, we also examined our database of Federal Court cases finalised in the 2004/05 year. Even though the total numbers are much smaller, the number of cases settled was consistent with the above figures — about 25 per cent of all finalised cases, with another 2 per cent conceded.

Cases conceded130

A.3b.14 The Inspector-General's report suggests that the Tax Office's performance in settling and conceding in the AAT is high, resulting in the view that unnecessary appeals are created. In fact, the total number of cases conceded at appeal amounts to 4 per cent of all appeals, based on Tax Office records. In cases other than aggressive tax planning cases, we conceded or abandoned about 12 per cent.

A.3b.15 As the report illustrates elsewhere, there are a number of cases where taxpayers do not give us all of the information until the case is in litigation. There is a risk-management decision needed in a small number of cases. We need to assess whether it is appropriate to:

  • devote resources to issuing formal demands for information and then follow up with prosecution action where taxpayers resist giving the information asked for; or
  • suggest the taxpayer needs to prove his or her case and if they resist providing information, the objection should be disallowed and can be dealt with at litigation.

A.3b.16 In some cases, taxpayers do not appeal such decisions, thus bringing the dispute to an end. As shown above 90 per cent of objection decisions are accepted by the taxpayer. In non aggressive tax planning cases 97 per cent of decisions are accepted by the taxpayer. Of those that do go to litigation, the required information is sometimes forthcoming and we concede. In other cases, the information is never brought forward and the AAT deals with the evidence it has.

A.3b.17 As can be seen, the number of cases where the Tax Office makes the wrong decision at the objections stage is very small.

Inspector-General's comments on Tax Office response

A.3b.18 The Tax Office's reference to its internal data which shows that only 4 per cent of cases are wholly conceded or withdrawn by the Tax Office overlooks those cases which the Tax Office's internal records show are settled. A more complete picture of the Tax Office's resolution of cases requires that settled cases be also considered together with the cases classified by the Tax Office as conceded or abandoned. Fieldwork conducted by staff of the Inspector-General for this review indicated that a significant percentage of cases that are recorded as settled by the Tax Office in its internal records are settled wholly in favour of the taxpayer. As discussed in the report this may be due to a number of reasons, some of which have already been listed above.

A.3b.19 The Tax Office internal data does not distinguish those cases that were finalised by consent and those that were finalised by way of hearing. Also, approximately 12.6 per cent of non-aggressive tax planning cases have been classified with an 'other' outcome. Given the broad range of outcome types already used by the Tax Office it does bring into question the accuracy of the internal Tax Office data. The Inspector-General reiterates his suggestion that the Tax Office move to a more objective classification of outcomes similar to that used by the AAT to ensure greater consistency and accuracy in its recording of the finalisation of cases.

A.3b.20 The Inspector-General has made no finding to the effect that the performance of the Tax Office in settling and conceding in the AAT is high, resulting in the view that unnecessary appeals are created. No negative inference is drawn by the Inspector-General with respect to the Tax Office's management of litigation from the AAT data, which indicates that a large proportion of applications for review are finalised without a hearing. Rather, the question that is being asked is whether this high resolution rate is an indicator that upstream processes, involving both the Tax Office and the taxpayer, are not adequately leading to the timely resolution of disputes prior to the matter going to litigation. This could be the subject of any future review by the Inspector-General into the settlement and objection processes.

A.3b.21 In fact, as noted by the Tax Office as part of its response to this chapter, the Inspector-General takes the view that 'it is appropriate for the Tax Office to settle litigated disputes, in suitable cases, and that the high percentage of settled cases suggests that the majority of Part IVC appeal cases are appropriately concluded by the Tax Office.' The Inspector-General is of the view that the ability of taxpayers and the Tax Office to resolve tax disputes in a timely and cost-effective manner without the need to proceed to litigation is of utmost importance to the proper administration of the tax system.

Cases settled

A.3b.22 We do not dispute the fact that there has been a high level of settlement of Tax Office disputes at the litigation stage in the AAT. Rather than being a negative reflection of our performance, the high number of settlements reflects the successful approach the AAT and the Tax Office has in managing and clearing the large workload of tax schemes.

A.3b.23 The Tax Office does not believe the report adequately highlights that the high percentages reflect the high level of settlements of schemes in the AAT. In these cases, litigants have accepted our offers of settlements following our success in the courts on some key cases. For the most part, in these settlements taxpayers accept the substantive adjustments, with concessions on penalties or deductions allowed for actual funds outlaid by the taxpayer.

A.3b.24 The AAT's annual reports give some indication of the large effect that mass marketed schemes have had on case figures. In 2002/3 and 2003/04, a large number of applications relating to taxation schemes that had been lodged prior to 1 July 2003 were settled.

A.3b.25 In 2002/03, 84 per cent of all finalisations related to taxation scheme cases; in 2003-04 it was 82 per cent.

A.3b.26 From the Tax Office figures above it can be seen that:

  • cases that are settled amount to about 58 per cent of all appeals;
  • about 73 per cent of aggressive tax planning appeals are settled; and
  • about 25 per cent131 of all non-aggressive tax planning cases are settled.

A.3b.27 These figures are illustrative of the large numbers of mass marketed schemes and employee benefits trust cases that have been settled based on offers by the Commissioner of reductions in penalties and interest.

Inspector-General's comments on Tax Office response

A.3b.28 Again, no negative inference is drawn by the Inspector-General with respect to the Tax Office's management of litigation from the AAT data, which indicates that a large proportion of applications for review are finalised without a hearing.

A.3b.29 Adequate recognition has been made of the effects of the mass marketed tax arrangement cases. In fact, the potential skewing of AAT data by the mass marketed tax arrangement cases and employee benefit arrangement cases was one reason why AAT data over an eight year period was examined rather than over a two year period.

Cases set aside and varied

A.3b.30 The Inspector-General's report provides a range of facts and tables that have been extracted from the AAT's annual reports.

A.3b.31 Chart 1 of Appendix 6 provides average percentages for each of these results over the last eight years and indicates that approximately 70 per cent of applications that were finalised over these eight years without a hearing resulted in the Tax Office decision at objection being set aside or varied.

A.3b.32 Tax Office records show these cases slightly differently. According to our figures, as the above table indicates, the Commissioner concedes, abandons or settles 62 per cent of cases at the litigation stage.

A.3b.33 Again however, the number of cases resolved is distorted somewhat by the high numbers of settlements of scheme cases. Excluding these cases, the Tax Office figures suggest that the Commissioner settles, concedes, or abandons 37 per cent of non aggressive tax planning cases that get to litigation. Tax Office figures suggest that the 37 per cent is broken down to 12 per cent of cases conceded and 25 per cent settled.132

A.3b.34 In non tax jurisdictions, about 76 per cent of cases do not make it to hearing. If aggressive tax planning cases are ignored, 622 cases out of 1003 did not make it to hearing, that is about 62 per cent of non aggressive tax planning cases were resolved prior to hearing.

A.3b.35 These figures suggest that our performance in getting to the correct outcome prior to litigation is quite good. That is not to say that we can't do better and we expect that our end to end review of litigation may well lead to reduced duplication and increased efficiencies.

Inspector-General's comments on Tax Office response

A.3b.36 The Inspector-General notes that the Tax Office is relying upon internal data over a two year period rather than external data over an eight year period. The Inspector-General has acknowledged the impact that mass marketed tax arrangement and employee benefit arrangement cases have had on the overall resolution of applications for review in the AAT throughout Chapter 3. For example, in examining the number of applications for review set aside or varied by consent in the AAT, the Inspector-General noted that the average percentage is influenced by the large number of mass marketed tax arrangement cases in 2002/03 and 2003/04. The report went on to observe that if these two years are excluded, then the average percentage of applications for review of tax decisions finalised without a hearing resulting in the Tax Office decision at objection being set aside or varied falls from 70 per cent to 63 per cent. Again, no negative inference is drawn by the Inspector-General in respect of the Tax Office's management of litigation from the AAT data, which indicates that a large proportion of applications for review are finalised without a hearing. Rather, as noted by the Tax Office in its response to this chapter, the Inspector-General takes the view that 'it is appropriate for the Tax Office to settle litigated disputes, in suitable cases, and that the high percentage of settled cases suggests that the majority of Part IVC appeal cases are appropriately concluded by the Tax Office.'

A.3b.37 Further, it should be noted that the AAT data for 'all applications' in Table 3.3 of the report would include tax applications and mass marketed tax arrangement cases. Therefore a direct comparison between that data and the Tax Office's own internal data for non aggressive tax planning cases could result in incorrect conclusions on the finalisation of tax decisions in the AAT as compared to other jurisdictions.

A.3b.38 The Inspector-General welcomes the Tax Office's comment that it is now reviewing its end-to-end process for objections and appeals to see whether further improvements can be made.

Cases at hearing

A.3b.39 Of the cases that went to hearing in the Administrative Appeals Tribunal (AAT) or the Small Taxation Claims Tribunal (STCT), the Commissioner won 69 per cent of cases in 2003/04 and 76 per cent of cases in 2004/05 (where there was a substantive tax decision).133

A.3b.40 In the Federal Court, of the cases that went to hearing, the Commissioner won 68 per cent of cases in 2003/04 and 63 per cent in 2004/05 in substantive decisions.134

Conclusions

A.3b.41 We review our cases as they progress through the litigation stages and seek opportunities to avoid further costs to both sides, where resolution can be found. This is consistent with the Tax Office being a model litigant. We note that in cases where resolution has not been possible, the Tax Office has been successful in the majority of cases heard by the courts and Tribunal.

A.3b.42 It is suggested elsewhere in the report that inadequate quality of Tax Office processes upstream of litigation, such as audit or resolving objections, may be driving unnecessary litigation. While we accept that more can be done to improve our processes, the results suggest our processes work well:

  • Of the 1.2 million compliance activities that produced a liability adjustment in the two years to 30 June 2005, there were in the same period about 758 cases where the dispute was unable to be resolved and reached a hearing;
  • Of the approximately 32,000 objections that were lodged in that same time, taxpayers accepted our decision in 90 per cent of the cases.
  • As the Inspector-General says in Key Finding 3.1 'Only a small proportion of active compliance activities and objections lead to litigation.' In those small number of cases the Commissioner:
    • conceded a small percentage;
    • settled large numbers of scheme cases;
    • settled about a quarter of non scheme cases; and
    • won the greater majority of cases that got to hearing and received a decision.

A.3b.43 The low rate of dispute and the high success rate at hearing, combined with the relatively low rate of settlement compared to other jurisdictions, suggest that the Commissioner has managed litigation well.

Inspector-General's comments on Tax Office response

A.3b.44 As noted, the AAT data for 'all applications' in Table 3.3 of the report would include tax applications and mass marketed tax arrangement cases. Therefore a direct comparison between that data and the Tax Office's own internal data for non aggressive tax planning cases could result in incorrect conclusions on the finalisation of tax decisions in the AAT as compared to other jurisdictions.

A.3b.45 Furthermore, while the Inspector-General has suggested that the possibility that inadequate quality of Tax Office processes upstream of litigation, such as audit or resolving objections, may be driving unnecessary litigation, there is no specific finding in this report to that effect. Rather, the report indicates that this may be due to a number of reasons, some of which have already been listed above. The Inspector-General has highlighted this topic as one likely to be the subject of a future review examining whether the earlier stages of the tax dispute process is wholly effective in the timely resolution of disputes.

Subsidiary recommendation 3.1

The Tax Office should publish a more complete picture of the outcomes of litigation to include information on the proportion of applications for review and appeals finalised without a hearing and the outcome.

Tax Office response

A.3b.46 Agreed


130 Tax Office figures on cases conceded are indicative only. The Inspector-General has correctly identified that there some cases which have been recorded as settled on the Tax Office database which should more correctly be categorised as conceded. Without a complete analysis of the error in recording it is difficult to be precise. However to the extent that cases conceded are higher the rate of settlements will be lower.

131 This figure may well be overstated, due to apparent errors in that some cases that were wholly conceded were recorded as settlements.

132 As mentioned earlier it is accepted that there may be compensating errors between those two figures due to some conceded cases being incorrectly recorded as settlements.

133 Source: Annual Reports.

134 Source: Annual Reports.