3.1 GST audits for the purposes of this review have been defined as activities by the Tax Office which are directed to ensuring compliance with the GST law and which involve direct contact with the taxpayer.
3.2 These activities play an important role in providing confidence to the community that all businesses liable to pay the GST are paying their fair share. Our tax system involves taxpayers making a self assessment of their GST liability. Without a GST audit program there is a risk that taxpayers may self-assess their GST liability inaccurately, thereby receiving a competitive advantage over those businesses which do self-assess accurately.
Tax Office performance indicators for GST audits
3.3 There are a number of performance indicators used by the Tax Office to assess the results of its GST audits. These include: the amounts of GST audit adjustments, 'strike rates' (that is, the percentage of audit cases which achieved a result over the number of audit cases completed), the cycle time of audits, technical quality review, Tax Office adherence to practice statements, external surveys and Tax Office adherence to the standards of the Taxpayers' Charter.
3.4 The two main performance standards used by the Tax Office to assess its audits results are the amounts of GST audit adjustments and 'strike rates'. However, fieldwork conducted by the Inspector-General's staff for the purposes of this review has shown that both these indicators are flawed for the reasons set out below.
GST audit adjustments
Permanent and timing tax adjustments
3.5 Tax audits may yield tax adjustments that are either of a permanent or timing nature. Permanent tax adjustments are adjustments where the taxpayer has underpaid their tax or over claimed a refund entitlement and the underpayment or over claim will not be reversed in a subsequent time period. Timing adjustments are tax adjustments where payments or claims have been made in the wrong tax period. They may therefore be made in one period but reversed in a subsequent time period. Both these types of adjustments occur in GST audits.
3.6 Unlike most other kinds of tax audits, GST audits also yield tax adjustments which do not result in a net amount of additional tax being payable to the revenue. These are called 'revenue-neutral adjustments'. These revenue-neutral adjustments arise because of the nature of a GST.
3.7 A GST is levied at each stage of the supply chain of a good or service. However, if the purchaser of a supply is registered for GST purposes they can usually, with few exceptions, claim the full amount of any GST charged by the supplier as a refund (called an input tax credit or ITC) from the Tax Office. This amount is not fully refundable where the purchaser is a consumer or where the purchaser is a business which is not registered for GST. It is also not fully refundable where a purchaser is registered for GST, but the purchase is of a certain kind (such as a purchase which relates to financial supplies or supplies of residential property).
3.8 This means that, if GST is not charged on a supply made by one business to another, and this underpayment is discovered as a result of a Tax Office audit, the non-payment may not result in the payment of a net amount of additional tax to the revenue. This is because while the Tax Office may collect the underpaid GST from the supplier it may at the same time (or shortly thereafter) be required to credit this amount to the purchaser. The Tax Office calls these types of revenue-neutral adjustments 'wash transactions'.
3.9 Other types of revenue-neutral adjustments which arise from the nature of a GST include:
- where the adjustment arises from a transaction where GST was paid in the correct time period but by the wrong entity in a group (wrong entity cases); and
- where the adjustment arises from a transaction between two GST registered entities where GST was charged by one party and fully claimed as a refund by the other party but where no GST was in fact payable or claimable on the relevant transaction (no GST payable cases).
Examples of permanent and timing GST adjustments
3.10 An example of a GST audit adjustment which is of a permanent nature is where an audit adjustment relates to a supplier's failure to charge GST on a supply made to a purchaser who is a consumer. This type of tax adjustment is known by the Tax Office as a 'sticky tax' adjustment for GST purposes because, unlike the GST revenue-neutral adjustments discussed above, this type of adjustment is not offset by any refund that is payable by the Tax Office to the purchaser. The adjustment therefore 'sticks' to the purchaser and adds in real terms to the revenue's bottom line.
3.11 An example of a GST adjustment which is of a timing nature is where GST is reported and paid in a GST tax return3 period that is later than the period when the GST should have been reported and paid. In this case, as with all GST timing adjustments, the adjustment does not lead to a net increase in the amount of tax payable to the revenue overall, although interest may be charged for the period during which the tax was not paid.
3.12 Another example of a timing adjustment is where a GST credit has been claimed in a tax period but this is earlier than the period when the credit should have been claimed. This situation can arise because a purchaser may not have the correct documentation to support their claim for a GST credit. For a GST credit to be available on a purchase, the purchaser must have a document which is in the form of a tax invoice (including a recipient created tax invoice). Furthermore, if the relevant document is a recipient created tax invoice, that invoice must be supported by a written agreement that has been entered into by the purchaser and supplier under which the supplier agrees that the purchaser may issue these types of invoices. Timing adjustments arising from the absence of full and proper documentation to support a GST refund claim are referred to in this report as adjustments involving documentation issues
GST 'active compliance activities' results
3.13 GST audit adjustments are published in the Tax Office's Annual Report, which is made available to the community. They are also reported in performance reports the Tax Office must provide to the States and Territories to whom GST collections are eventually paid. These reports to the States and Territories are not made public.
3.14 The Tax Office does not use the term 'GST audits' for the purposes of these reports. Instead, in both sets of reports, the Tax Office refers to the results of its GST 'active compliance activities'. The Tax Office defines these activities as those which it conducts which are aimed at deterring, detecting and addressing non-compliance with the GST law.
3.15 The term includes a number of activities that are not commonly thought of as audits It includes, for example, unprompted voluntary disclosures and amounts shown on returns which are lodged late after the Tax Office has followed up an overdue return.
3.16 During the review the Tax Office advised that in 2006/07 it raised over $1.436 billion in tax and $124 million in penalties and interest from all GST active compliance activities.4
3.17 These amounts came from the following market segments:
|Market||Tax liabilities raised
|Penalties and interest
|Small to medium eneterprise (SME)||440||46|
|Not for profit organisation (NFP)||50||-|
3.18 This table shows that $311 million (or 22 per cent of all GST adjustments) was raised from GST active compliance activities involving large businesses, that is those with a turnover of more than $100 million.
3.19 Although these active compliance adjustments are one of the performance measures used by the Tax Office to assess the effectiveness of its GST audits for large taxpayers, this review has found that the Tax Office does not analyse these GST active compliance results for the purposes of ascertaining a number of key data items that are relevant to fully assessing the effectiveness of its GST audit activities.
3.20 Firstly, these adjustments only reflect GST liabilities raised in the year. They are not adjusted from year to year to show the amounts of GST liabilities that are actually collected. The Tax Office has provided to the Inspector-General figures which indicate that liabilities raised from GST compliance activities on large taxpayers over the last two financial years have been between 5 and 6 per cent more than actual collections, but the reasons for and components of this difference are not reported in either the Annual Report (or the reports to the States and Territories).
3.21 Secondly, the Tax Office does not analyse the amounts of penalties and/or interest actually levied, remitted or collected in GST audit cases for large taxpayers to determine matters such as the nature of the taxpayer involved, the type of issue involved, the amount of penalty or interest involved and the nature of the penalty.
3.22 Thirdly, until this review commenced, the Tax Office only segmented adjustments according to a description of the underlying issue that was involved and the dollar values raised. It also segmented total audit adjustments according to whether the result involved permanent (sticky) tax or a wash or timing adjustment. It did not analyse them to any further extent.
3.23 Significantly, GST audit adjustments were not analysed according to whether or not the result came from an unprompted voluntary disclosure by the relevant taxpayer.
3.24 This meant that the Tax Office was unable to identify the extent to which any adjustments which arose from Tax Office initiated (that is, non–voluntary) audit activities were :
- adjustments which amounted to a contribution to the revenue (that is, 'sticky' tax adjustments);
- adjustments which arose from a request for lodgement of a late return;
- adjustments which arose from a documentation issue; or
- adjustments which arose from revenue–neutral transactions such as those involving:
- wash transactions;
- wrong entity transactions; or
- a no GST payable transaction.
3.25 During the review the Tax Office started to analyse the extent to which its GST audit adjustments arose from unprompted voluntary disclosures. This analysis indicated that for the large market for the 2006/07 year around $130 million of GST audit adjustments (that is, around 42 per cent of its reported adjustments for this market) arose from unprompted voluntary disclosures. The Tax Office also advised during the review that this $130 million of unprompted voluntary disclosures were attributable to the following types of adjustments:
- sticky tax adjustments: $75 million;
- wash adjustments: $37 million;
- timing adjustments: $18 million.
3.26 The Tax Office was unable during the course of this review to indicate any further break up of the nature of its GST audit results and in particular was unable to advise on what proportion of the $181 million of Tax Office initiated (that is, non-voluntary) GST audit adjustments were attributable to matters such as sticky tax adjustments, requests for lodgement of a late return, a documentation issue or revenue–neutral transactions.
3.27 The Inspector-General's fieldwork confirmed that there was a significant percentage of unprompted voluntary disclosure adjustments included in the ATO's reported GST audit adjustments figures. This fieldwork also indicated that, in a significant number of cases in prior years, a voluntary disclosure gave rise to an automatic audit of the item that was disclosed.
3.28 However only voluntary disclosures involving amounts of GST payable gave rise to such automatic audits. Cases were also encountered where a number of voluntary disclosures were made by taxpayers involving both debit and credit amounts and only the debit amounts (not refund claims) were audited. This suggests that GST auditors may be selectively choosing to audit only debit voluntary disclosures amounts so as to boost overall reported GST audit results.
3.29 The Tax Office has advised that its current procedures for voluntary disclosures by large taxpayers do not automatically give rise to audit activity. It states that now every voluntary disclosure is reviewed and risk assessed. Where the risk assessment is rated as high, and is in line with the current GST audit program, the voluntary disclosure may give rise to audit activity.
3.30 The Tax Office has also advised that it treats credit amendments referred to in a voluntary disclosure by a taxpayer as being in the nature of self amendments rather than as part of any voluntary disclosure of a tax shortfall. On this basis it contends that it is not conducting any audits of voluntary disclosures in a manner which boosts overall reported GST audit results.
3.31 The Inspector-General considers that if the Tax Office includes for reporting and other purposes the quantum of any debit adjustments arising from unprompted voluntary disclosures in GST audit statistics then it should:
- firstly, separately identify the quantum of any such debit adjustments; and
- secondly, separately identify unprompted credit adjustments to prior year GST returns that are made by taxpayers.
3.32 This would provide a more transparent picture of the nature of GST audit results made from year to year in terms of the extent to which those results arise from Tax Office initiated audit activity and the extent to which prior year adjustments initiated by taxpayers give rise to an overall contribution to the revenue.
3.33 The Tax Office's definition of what it regards as a voluntary disclosure (that is, that only debit, not credit amounts are included) also affects its rules for the application of penalties in cases involving voluntary disclosures. This penalties impact is discussed in the next chapter of this report.
3.34 Unlike some other jurisdictions (for example, Canada) the Tax Office has no formalised consolidated policy for how it will deal with unprompted voluntary disclosures by taxpayers — either in the GST area specifically or in relation to any other taxes which it administers. In Canada this formal consolidated policy is summarised in an information circular which is titled 'Voluntary Disclosures Program' which is dated October 2007 and is available on its revenue agency's website at www.cra.gc.ca.
3.35 Significant percentages of the GST tax adjustments (in dollar value terms) reviewed by staff of the Inspector-General in Perth and Adelaide involved documentation issues only. These at most would lead to a GST timing adjustment. Audit cases that were handled by the Melbourne, Sydney and Brisbane Tax Offices involved more adjustments for issues not involving documentation and/or for sticky GST. However, in Melbourne and Sydney there were not many examples of GST audits involving sticky GST as opposed to timing or wash transactions in the cases selected by staff of the Inspector-General for review.
3.36 GST tax adjustments are also escalated for review within the Tax Office purely on the basis of the size of the relevant tax adjustment. There is no regard to the nature of the adjustment such as whether it involves no additional net tax because it involves a documentation or wrong entity issue. The resources of senior management are being unnecessarily tied up in the review of such cases.
3.37 The Inspector-General has analysed the sample of GST audit cases it examined during the fieldwork phase for this review to determine the extent to which any adjustment falls into the following categories:
- Unprompted voluntary disclosures;
- Non-voluntary adjustments which involve:
- sticky tax;
- a request for lodgement of a late return;
- a documentation issue;
- a timing issue;
- revenue-neutral transactions such as those involving:
- wash transactions;
- wrong entity transactions; and
- a no GST payable transaction.
3.38 The cases examined by the Inspector-General during his fieldwork consisted of cases for each of the 2004/05 and 2005/06 years and for the 10 months ended 30 April 2007.
3.39 The results of the Inspector-General's analysis are as follows.
|Nature of adjustment||Amount
|Unprompted voluntary disclosures||765||22|
|Late lodgement cases||44||56|
|Cases involving potentially invalid tax invoices or RCTIs||34||6|
|Revenue-neutral wash transactions||35||9|
|No GST payable revenue-neutral cases||61||1|
|Wrong entity revenue-neutral cases||-||-|
|No tax adjustment cases||-||12|
|Penalty only review||-||1|
|Total dollar value of cases in Inspector-General sample||377||126|
|Total GST adjustments for 2 years||741|
|Nature of adjustment||Amount
|Unprompted voluntary disclosures||36||7|
|Late lodgement cases||2||8|
|Cases involving potentially invalid tax invoices or RCTIs||28||2|
|Revenue-neutral wash transactions||48||1|
|No GST payable revenue-neutral cases||-||-|
|Revenue-neutral wrong entity cases||16||2|
|No tax adjustment or refund cases||-||3|
|Penalty only review||-||-|
3.40 Both tables appear to confirm that:
- A significant percentage of GST audit adjustments for large taxpayers involve unprompted voluntary disclosures. These cases accounted for 22 per cent of the dollar value of all cases with an adjustment examined during this review.
- Sticky GST tax adjustments gave rise to 32 per cent of the dollar value of all cases with an adjustment examined during this review.
- Late lodgement cases accounted for 9 per cent of the dollar value of all cases with an adjustment examined during this review.
- Cases involving documentation issues accounted for 12 per cent of the dollar value of all cases with an adjustment examined during this review.
- Revenue-neutral transactions accounted for 23 per cent of the dollar value of all audit cases with an adjustment examined during this review.
- Cases involving timing issues accounted for 2 per cent of the dollar value of all audit cases with an adjustment examined during this review.
3.41 These figures suggest that only 32 per cent of the dollar value of all GST audit adjustment cases for large taxpayers may involve a net contribution to the revenue which may not have been obtained but for the audit activity.
3.42 The Tax Office's reported GST audit results for large taxpayers do not show the above kind of break-up. They are not therefore transparent and give an overly negative view of the nature of the GST compliance in the large taxpayer market.
Tax Office's risk assessment processes for large taxpayer GST audits
3.43 The Tax Office's failure to fully analyse its actual GST audit results negatively affects the processes the Tax Office uses to determine which risks the Tax Office will seek to address through future audit activity.
3.44 This review has confirmed the results of other reviews9 which have found that the Tax Office's overall risk assessment processes for GST were under-developed. The Inspector-General found that the Tax Office has yet to develop an overall process for assessing and prioritising all GST risks in the large taxpayer segment. However, it has taken a number of steps in this direction. These steps include the establishment of a GST Risk and Strategy stream, a GST risk management subcommittee and a GST risk register. The Tax Office also acknowledges that its risk management processes are evolving as the GST business line becomes more sophisticated in its dealings with risk.
3.45 Overseas experience indicates that GST is relatively low risk for large taxpayers except for systems breakdowns. This view is supported by a survey that was done by Deloitte Touche Tohmatsu Limited in 2006 of in-house GST advisors at large corporates in Australia, which found that 50 per cent of survey respondents agreed that some large businesses had failed to keep up their internal corporate governance processes and systems for GST.10 From the fieldwork conducted by the Inspector-General for this review it appears that systems breakdowns may represent the most significant category of issues that are the subject of unprompted voluntary disclosures.
3.46 The Tax Office's approach to assessing the risks to be addressed by GST audits may also need to be better integrated with audits involving other tax issues on the same taxpayers so that for any one particular taxpayer the Tax Office's overall audit activity focuses on the tax issues that are of the greatest actual risk.
3.47 The Inspector-General notes that in a number of comparable overseas jurisdictions — notably New Zealand and Canada — there is no separate GST business line in the relevant revenue authority. In these countries, GST and income tax audit risks for any one taxpayer are assessed jointly. From discussions with tax practitioners in these countries it appears that this may have had the effect of lessening the extent of GST–specific audit activity that is conducted on large taxpayers in those countries when compared to what currently occurs in Australia.
3.48 Strike rates for particular GST audit activities are an internal measure used by the Tax Office to assess its audit activities. A strike rate is the percentage of audit cases which achieved a result over the number of audit cases completed.
3.49 The Tax Office has advised that the overall strike rate for large taxpayer GST audits calculated on this basis was 17.4 per cent for the 2006/07 year. There were 2,403 audits which were escalated to an audit as a result of a telephone query on a GST refund. These had a strike rate of 12.5 per cent. There were 496 audits which were initiated as fieldwork audits. These had a strike rate of 41.1 per cent.
3.50 However, these strike rates include cases which yield an overall net positive result to the revenue (that is, sticky tax cases) and those that do not. The rate therefore includes revenue-neutral adjustments where a corresponding credit in the same case is not recorded, adjustments which arise from unprompted voluntary disclosures and adjustments involving documentation issues only. The inclusion of these adjustments in the strike rate figure gives a misleading picture of the results of the Tax Office's GST audit program for large taxpayers.
3.51 During the review the Tax Office advised that if non sticky cases were excluded from the strike calculation the overall strike rate would be reduced. However, the Tax Office considers errors in wash transactions and other non-sticky transactions (for example, where the wrong entity accounts) as important matters requiring audit intervention and amendment for the following reasons:
- The Tax Office is obliged to correct errors in reporting GST payable.
- Its strategy is to maintain the integrity of the tax, introduced by Parliament as a multistage tax rather than a retail tax.
- The Tax Office aims for equity of treatment among all taxpayers through the supply chain including business to business transactions and business to consumer.
- Correcting errors in classification upstream (at the business to business level) helps to ensure that errors are not made downstream (at the business to consumer level).
- Acquirers have a right to ITCs that is not extinguished where the Tax Office does not adjust the supplier.
- Acquirers may have a right to an ITC without having to pay the supplier additional consideration, say where the contract does not make allowance for the imposition of GST.
3.52 The Tax Office also advised that it would continue to look at wash transactions as conformance with the law protects the integrity of the system.
3.53 The Inspector-General considers that Tax Office accounting for GST compliance results does not accurately attribute results by reason for the adjustment, lacks transparency and needs more detail.
3.54 Also, the Tax Office's identification of risks for large cases and allocation of resources towards its GST compliance work have not been appropriately matched with true outcomes from its compliance activities. There is a low strike rate in GST audits. A significant number of audits are chasing issues with no outright revenue gain. The low strike rate in GST audits would be even lower if cases that do not deliver 'sticky tax' were excluded. Combined with the low level of 'sticky tax' this suggests a substantial unnecessary cost to business from GST active compliance work for large taxpayers.
3.55 These conclusions and the other material in this chapter lead to the following key recommendations.
Key Recommendation 3.1
The Tax Office should ensure that there is greater transparency in the presentation of its GST audit results to the community by:
- identifying those GST audit adjustments which have arisen from unprompted voluntary disclosure and those that have not;
- identifying how much of reported GST audit adjustments which have not arisen from unprompted voluntary disclosures involve a net contribution to the revenue and how much of these adjustments involve revenue-neutral or other kinds of adjustments which do not; and
- identifying the quantum of credit amendments made by taxpayers to prior year GST returns which the Tax Office has not included as GST audit adjustments.
Tax Office response
Dot point 1
3.56 The Tax Office agrees with this recommendation and is in the process of implementing it. The GST Risk and Strategy and Large Active Compliance (RS & LAC) Business Plan for 2007-08 includes a commitment to plan and report separately on active compliance activities and unprompted voluntary disclosures. Work is currently under way by the Tax Office Compliance Support and Capability unit to introduce Tax Office wide reporting procedures to deal with voluntary disclosures.
Dot point 2
3.57 The Tax Office agrees with this recommendation and will work to separately report revenue neutral adjustments.
Dot point 3
3.58 The Tax Office notes this recommendation and will investigate the extent to which we can report credit amendments associated with audits.
Key Recommendation 3.2
The Tax Office should ensure that, for risk management purposes, it fully understands the nature of the GST audit results it is achieving for large taxpayer GST audits with a view to ensuring that the resources it allocates to these audits are being appropriately balanced against the risk management outcomes of these audits.
Tax Office response
3.59 The Tax Office agrees with this recommendation on the basis that we have, as part of major organisational changes made in November 2006, established an area with responsibility for identifying and managing GST risks in the large market to achieve these outcomes. Based on our most recent assessment of the risks in the large market, the Tax Office believes it has appropriately allocated audit resources to this market.
Key Recommendation 3.3
The Tax Office should provide the whole community with a consolidated statement or guide on how they can make voluntary disclosures and how they will be treated in terms of tax, penalties and GIC when they do so.
Tax Office response
3.60 The Tax Office agrees with this recommendation.
3 GST returns are called Business Activity Statements.
4 The ATO's 2006/07 Annual Report, which was published after this report was submitted to the ATO for their response, indicates that in 2006/07 $1480 million in tax and $165 million in penalties and interest was raised from GST active compliance activities. The ATO has advised the Inspector-General that all of the $41 million difference in penalties and interest and $33 million of the $44 million difference in liabilities between the Annual Report figures and those provided to the Inspector-General arise from GST active compliance activities undertaken by business lines other than the ATO's GST business line. There is also $11 million overstatement of liabilities in the Annual Report. The new figures do not materially alter the amounts for the large market for 2006/07 shown in Table 3.1.
5 A further $54 million of GST adjustments for the 2005/06 year are known to involve unprompted voluntary disclosures.
6 Note that one Brisbane case accounts for $72 million of this amount.
7 One Sydney case accounts for $9 million of this amount.
8 There is one unfinalised wash case in Sydney which according to the ATO will generate between $20 and $30 million of GST.
9 See: Deloitte, Final Report: Review of the GST Large Corporate Compliance Program and Appendix prepared for the Australian Taxation Office, 23 March 2005 (both these documents are available on the Tax Office's website at www.ato.gov.au); and also Australian National Audit Office, Administration of Goods and Services Tax Compliance in the Large Market Business Segment — Australian Taxation Office, Audit Report No. 13 2005/06, 18 October 2005.