Overview of current administrative penalty regime

3.1 Administrative penalties in Australian Federal law are broadly understood as being sanctions imposed by the regulator, or by the regulator's enforcement of legislation, without intervention by a court or tribunal.5

3.2 The current uniform administrative penalty regime commenced on 1 July 2000 to streamline the penalties framework and to support compliance under the new tax system.6

3.3 This was in response to a number of problems with the previous penalties framework including the duplication of penalty provisions in the different taxation laws, the disparity between the various penalty provisions and the previous penalties framework not being designed to deal with the obligations introduced by the new tax system.7

3.4 The uniform administrative penalty regime was intended to overcome these problems by:

  • grouping together existing penalty provisions that had a substantially similar operative effect
  • imposing the same administrative penalty for breaches of similar tax obligations, and
  • applying the new administrative penalty regime uniformly to all taxation laws, including those recently introduced as part of the new tax system.8

3.5 The new administrative penalty regime was also designed to be easily understood by taxpayers and easily administered by the Commissioner.9 It had the purpose of improving equity by ensuring that a common penalty applies where a taxpayer fails to satisfy the same type of obligation under different tax laws.

Nature of penalties and interest applied

Penalties

3.6 Penalties seek to punish undesirable behaviour and thereby to promote desired behaviour. Penalties represent an escalation in sanction by the Tax Office and are an indication that less interventionist measures, such as help and education, have failed to produce compliance. The form and level of penalty applied will depend on its purpose as well as the type of wrongdoer and the nature of the wrongdoing.10

3.7 The Tax Office has adopted a compliance model which is intended to encourage voluntary compliance by taxpayers through education. Where voluntary compliance is not obtained, there is an escalation of sanctions, including penalties.

3.8 The purpose of penalties in such circumstances is two-fold — firstly, to impose a punishment where there is non-compliance so as to deter the person sanctioned from repeating the contravention, and secondly, as a general deterrent, to deter others from engaging in the prohibited behaviour.

3.9 In the active compliance environment, the most common penalties will be those that apply where a taxpayer understates their liability and therefore pays less tax than they ought. These are known as tax shortfall penalties.11

3.10 Tax shortfall penalties may apply if a taxpayer has a tax shortfall arising from any of the following:

  • making a false and misleading statement, for example, omitting income or over-claiming deductions
  • applying an income tax law in a way that is not reasonably arguable (but only if the tax shortfall amount exceeds the greater of $10,000 or 1 per cent of the income tax payable by the taxpayer)
  • disregarding a private ruling,12 or
  • entering into a tax avoidance scheme or having a transfer pricing adjustment.

3.11 The penalty regime sets out a base penalty amount depending on the culpability of the taxpayer. This is determined by examining the reasons for the tax shortfall and takes into account factors such as whether the taxpayer has intentionally disregarded the law, been reckless, failed to take reasonable care or taken a position that is not reasonably arguable.

3.12 This base penalty amount can then be increased or reduced according to whether the taxpayer has prevented or obstructed the Tax Office in investigating the shortfall, has previously been penalised for a shortfall, or has made a voluntary disclosure of the shortfall.

3.13 A taxpayer cannot be penalised for a shortfall caused by relying on Tax Office advice or a general administrative practice.

3.14 The Commissioner also has the discretion to remit all or part of an administrative penalty. A taxpayer may apply for remission, or the Tax Office may remit the penalty on its own initiative. The Tax Office must provide a taxpayer with written notice of a decision not to remit the penalty, or to remit only part of a penalty.

3.15 A decision not to remit a penalty, or to remit only part of a penalty, is reviewable in accordance with Part IVC of the Taxation Administration Act 1953 provided the penalty not remitted exceeds two penalty units.13

Interest

3.16 A general interest charge (GIC) is imposed on any tax or penalty that remains unpaid after the time it becomes due and payable. The interest charge is separate from the penalty imposed, representing compensation to the revenue for the delay in payment of tax.

3.17 Where an active compliance activity leads to a tax adjustment creating a liability to pay, then the interest charge will be imposed from the day on which tax became due and payable under the original assessment.

3.18 The Commissioner of Taxation may remit all or part of the GIC where:

  • the delay in payment was not caused directly or indirectly by an act or omission of the person and the person has taken reasonable action to correct the situation
  • the delay in payment was caused directly or indirectly by an act or omission of the person, the person has taken reasonable action to correct the situation, and it would be fair and reasonable to remit all or part of the charge, or
  • there are special circumstances making it fair and reasonable to remit all or part of the GIC or it is otherwise appropriate to do so.

3.19 The Tax Office's GIC remission guidelines are set out in Chapter 93 of the Tax Office's Receivables Policy. Following the Inspector-General's review into the remission of the GIC for groups of taxpayers in dispute with the Tax Office, the Tax Office announced that it would be publishing clearer guidelines on the remission of GIC, in particular where the GIC relates to the pre-amended assessment period.

Meaning of 'active compliance activities'

3.20 A key component of the Tax Office's corporate capability is active compliance. The Tax Office has developed a broad range of compliance products to be used by active compliance staff. The Tax Office defines a compliance product as a process used to deliver a compliance strategy to a client or group of clients.

3.21 Compliance products are sorted according to different compliance strategies that the Tax Office could adopt as part of its active compliance activities such as Investigate/Prosecute, Audit/Enforcement and Review. Each type of response, or 'product', is targeted for a particular revenue type and population of taxpayer.

3.22 For example, the Tax Office states that audit and enforcement products are primarily used where it is reasonable to believe there is a risk of non-compliance. This risk is addressed by the use of audit products that involve the examination of records to establish the correct liability and enforce compliance. The audit and enforcement product set also includes products, other than audit, to ensure administrative compliance with obligations such as registration, lodgment, payment, regulatory responsibilities and withholding liabilities.

3.23 In contrast, the Tax Office states that review products are designed to maintain the integrity of the tax system by helping taxpayers to comply and ensure that taxpayers remain 'on track' with compliance. These review products seek to encourage voluntary disclosures, and concessional penalty treatment may apply for amended assessments arising from such disclosures.

3.24 Each compliance product set is further sorted into more specific Tax Office active compliance activities, depending on the type of activity. For example, a review product would include desk review activities, computer review activities and field review activities.

3.25 As at September 2004, the Tax Office had 91 review products, 79 audit enforcement products and 10 investigate/prosecute products.

Extent of penalties and interest applied

3.26 For the 2002-03 income year the Commissioner of Taxation reported that the Tax Office raised a total of approximately $6.138 billion as a result of its active compliance programme, composed of $4.387 billion in tax and $1.75 billion in penalties and interest.14

3.27 For the 2003-04 income year the Commissioner of Taxation reported that the Tax Office raised a total of approximately $6.368 billion as a result of its active compliance programme, composed of $4.902 billion in tax and $1.466 billion in penalties and interest.15

3.28 The active compliance results are examined below from various perspectives including market segment, business line and revenue product.

3.29 The penalties information presented below represents all Tax Office penalties imposed and would include tax shortfall penalties along with other general penalties that relate to indirect tax, withholding tax and PAYG and which deal with acts or omissions such as failure to lodge.

By market segment

3.30 The Tax Office breaks up the taxpaying community into six market segments, which are based upon the nature of the taxpayer and the taxpayer's annual turnover. The market segments are individuals, micro-businesses, small to medium enterprises, large businesses, non-profit organisations and government organisations.16

3.31 Table 3.1 shows active compliance results by market segment for the 2002-03 and 2003-04 income years.

Table 3.1: Penalties and interest applied by market segment
Market segment Tax ($m) Penalties ($m)
including interest
For 2003-04 income year ($m)
02-03 03-04 02-03 03-04 Penalties Average rate
of penalty (%)
GIC
Individuals 222 285 33 53 46.7 16.39 5.6
Micro-business 1,138 1,589 115 269 214.2 13.48 54.5
Small to medium 785 782 135 120 89.7 11.47 31.4
Large business 2,133 2,134 1,467 1,008 354.9 16.63 653.2
Government and non-profit 110 112 1 16 13.7 12.23 2.0
Total 4,388 4,902 1,751 1,466 719.2 14.67 746.7

Source: Tax Office.

By business line

3.32 The Tax Office is structured into a number of business areas (known as 'business lines'), which, together with a number of specialist areas, are responsible for the delivery of the Tax Office's compliance programme.

3.33 The delivery lines include Large Business and International (LB&I), Small Business (SB), Personal Tax (PTax), Excise, Goods and Services Tax (GST) and Superannuation (SPR). The specialist areas include Serious Non-Compliance (SNC), Operations and Aggressive Tax Planning (ATP).

3.34 Table 3.2 shows active compliance results, by business line, for the 2003-04 income year.

Table 3.2: Penalties and interest applied by business line
Business Line Tax ($m) Proportion
of total tax (%)
Penalties ($m) Proportion
of penalty (%)
Average rate
of penalty (%)
Excise Revenue 11.7 0.2 4.7 0.7 40.2
Excise Transfer 330.3 6.7 0.049 0 0.0
GST 1,302.7 26.6 74.8 10.4 5.7
LBI 1,543 31.5 349.3 48.6 22.6
LBI ATP 59.1 1.2 21.1 2.9 35.6
Operations 669.9 13.7 3.1 0.4 0.5
PTax 171.6 3.5 6.4 0.9 3.7
PTax ATP 38.8 0.8 7.5 1.0 19.2
SB 199.1 4.1 24.8 3.5 12.5
SB ATP 274.1 5.6 184.6 25.7 67.3
SNC 90 1.8 30.8 4.3 34.3
SPR Revenue 36.1 0.7 0.53 0.1 1.5
SPR Transfer 176 3.6 11.4 1.6 6.5
Total 4,902.4 100.0 719.2 100.0 14.7

Source: Tax Office.

By revenue type

3.35 Table 3.3 shows active compliance results, by revenue type, for the 2003-04 income year.

Table 3.3: Penalties and interest applied by revenue type
Revenue type Finalised cases
with liability impact
Tax ($m) Penalties ($m) Average rate
of penalty (%)
Interest ($m)
Excise 9,126 348 4.8 1.38 0
GST 32,023 1,139 64.2 5.64 1.2
Income tax 480,173 2,717 626.4 23.05 709.7
PAYG withholding 27,755 509 11.7 2.3 5.1
Superannuation 1,665 11 0.063 0.57 0.17
Superannuation Guarantee 13,943 176 11.4 6.48 30.7
Luxury car tax/sales tax 68 2 0.58 29 0
Total 564,753 4,902 719.2 14.67 746.7

Source: Tax Office.

Previous reviews

3.36 The administration of the penalty and/or interest regimes, and their underlying policy, have previously been examined by the Australian National Audit Office (ANAO) and recently by the Treasury as part of its Review of Aspects of Income Tax Self Assessment (ROSA).

Australian National Audit Office

3.37 On 16 February 2000 the ANAO tabled its report titled Administration of Tax Penalties, Auditor-General Report No. 31, 1999-2000 ('the ANAO report'). This report examined the Tax Office's administration of penalties with a particular emphasis on its corporate governance framework and issues relating to the consistency, effectiveness and accountability in the administration of the then current penalty regime.

3.38 The audit found that there was scope for improvement in the Tax Office's administration of that penalty regime.17 It concluded that, although penalties are an important enforcement strategy featured in the ATO Compliance Model, the Tax Office lacked appropriate control structures to oversight the accountability, consistency and effectiveness of its penalty administration.

3.39 The ANAO made a number of key findings as part of its review. These key findings are listed in Appendix 4.

3.40 Flowing from those key findings, the ANAO made five recommendations, all of which were agreed to by the Tax Office. The recommendations were as follows:

  1. The Tax Office includes penalties administration within its corporate governance framework in order to provide assurance to the Commissioner that it is operating consistently and effectively. This could include
    1. establishing organisation-wide quality assurance of the Tax Office penalty administration to assist in promoting better practice and provide assurance that it is operating consistently, and
    2. using statistical and demographic data to monitor the effectiveness of penalties in addressing and improving compliance.
  2. The Tax Office technical training material on penalties includes reference to, and discussion of, the impact of the Taxpayer Charter and the Compliance Model. This would include guidance on the application of penalties to the different scenarios outlined in the Compliance Model.
  3. The Tax Office investigate the cost effectiveness of providing on-line, decision support tools to staff to assist with consistent and efficient application of penalties.
  4. The Tax Office considers options for providing information in plain English to better inform taxpayers about the Tax Office penalties regime.
  5. The Tax Office study the relative effectiveness of penalties on taxpayer behaviour to assist in determining whether penalties have been effective. This would assist the Tax Office in improving taxpayer compliance and in refining the Compliance Model.

3.41 The Tax Office indicated in the ANAO report that because of the high demand on system changes during the period of tax reform, it would stagger the implementation of any changes to penalties over a period of up to two years to fit into its systems development schedule.18

3.42 While these recommendations are in relation to the Tax Office's administration of the previous penalty regime, they are equally relevant to the current uniform administrative penalty regime, which came into effect on 1 July 2000.

3.43 The Tax Office has indicated that, where possible, it has implemented the ANAO recommendations. This includes:

  • the establishment of a technical quality review process that applies to all business lines and measures the quality of penalty decisions
  • the establishment of a Penalty Policy and Practice Committee to coordinate the delivery of a sustainable integrated design capability to manage penalties
  • the publishing of Taxation Authorisation Guidelines on the assessment of penalty amounts
  • the development of a national training package titled 'An Introduction to Penalties', which provides an overview of penalty administration for all staff
  • the publishing of several practice statements in relation to penalty administration which are also available to taxpayers through the Tax Office website.

3.44 The Tax Office advises that it is also currently developing a penalty website that will act as a single electronic access point for staff and taxpayers on material relating to penalties such as relevant legislation, explanatory memorandums, rulings, practice statements and policy documents.

3.45 The Tax Office has stated that it deferred implementing recommendations 1(b), 3 and 5 of the ANAO recommendations as there were fewer instances where penalties were imposed given the concessions in relation to the application of penalties as part of the new tax system.19 The Tax Office has advised that with the penalty concessions no longer generally available it is now better placed to implement the outstanding ANAO recommendations.20

3.46 While some progress has been made by the Tax Office in implementing the ANAO recommendations, the Inspector-General notes that further work needs to be done in addressing the findings of the ANAO report and improving the Tax Office's penalty administration. In particular, there is a need to ensure that there is cross-business line consistency in the processes and procedures in respect to the administration of the penalty regime.

3.47 This is further evidenced by the Tax Office's internal review into its approach and administration of the penalty regime, which addresses similar issues to those raised by the ANAO report.

Review of Aspects of Income Tax Self Assessment

3.48 On 16 December 2004, the Government released the Report on Aspects of Income Tax Self Assessment ('the ROSA report').

3.49 The Review identified a number of changes to the current system that would reduce uncertainty and compliance costs for taxpayers while preserving the Tax Office's capacity to collect legitimate income tax liabilities.21

3.50 The Government announced that it would adopt the legislative recommendations made in the report. The Commissioner of Taxation agreed to implement the administrative recommendations outlined as soon as practicable and indicated that substantial progress had already been made on many of them.22

Penalties

3.51 The ROSA report made a number of recommendations to improve the transparency of the process of imposing penalties on taxpayers who underestimate a tax liability, and clarify the standard of care required by taxpayers. Relevant to this review, the ROSA report recommended that:

  • the Tax Office revise its rulings on reasonable care and reasonably arguable position, with a view to providing clearer guidance and further examples as to what conduct will, or will not, attract a penalty
  • the Tax Office explain more fully, for example in a ruling or Practice Statement, how it exercises the discretion to remit tax shortfall penalties, including Part IVA cases
  • where the Tax Office decides that a penalty applies and should not be remitted in full, it provide an explanation of why the penalty has been imposed (for example, why the taxpayer has not taken reasonable care or does not have a reasonably arguable position) and why the penalty should not be remitted in full
  • the Tax Office further explain in a ruling or Practice Statement what understatements of liability it regards as immaterial for tax shortfall purposes.

3.52 The Inspector-General is supportive of the recommendations and is of the view that they will also have benefits in improving consistency in the application of penalties.

General interest charge

3.53 The ROSA report also made a number of recommendations for change to the design of the GIC to improve its operation in the context of self assessment. Relevant to this review, the ROSA report recommended that:

  • from the 2004-05 income year, the standard interest charge applying to income tax shortfalls (that is, the tax difference between the original and amended assessment) be lower than the GIC rate, reflecting the benchmark cost of finance for business
  • the new lower uplift factor be implemented by a separate pre-amendment shortfall interest charge, in lieu of the GIC. GIC will continue to apply to crystallised debts from the new due date
  • the Commissioner have a broad discretion to remit the new shortfall interest charge, where he considers it fair and reasonable23
  • where unremitted shortfall interest exceeds 20 per cent of the tax shortfall, the taxpayer be entitled to object to the decision not to remit. Objection decisions should be subject to review and appeal where the shortfall interest remaining after determination of the objection exceeds 20 per cent of the tax shortfall
  • when notifying taxpayers of a shortfall interest liability, the Tax Office advise taxpayers on how to seek remission
  • the Tax Office provide reasons for rejecting shortfall interest remission requests.

3.54 The Inspector-General is supportive of the recommendations and is of the view that they will also have benefits in improving consistency in the application and remission of GIC.

3.55 Submissions to the Inspector-General have raised concerns that there will still be outstanding issues with the administration of tax shortfall penalties and interest after the implementation of the recommendations of the ROSA report. These include the treatment of taxpayers prior to the legislative enactment of the ROSA report recommendations and the application of tax shortfall penalties where the tax shortfall arises due to a timing mismatch with no net detriment to the revenue. The commencement date of the revised tax shortfall interest regime is a matter for Government. On 17 March 2005 the Minister for Revenue and Assistant Treasurer introduced legislation into Parliament to give effect to the penalty and shortfall interest changes recommended by the ROSA report.

3.56 In respect to the concerns regarding the application of tax shortfall penalties arising from a timing mismatch, Practice Statement PS LA 2004/5 discusses the Tax Office's approach to timing adjustments. It addresses situations where taxpayers include an income amount in a period later than the period in which the amount should have been included, or claim a deduction or credit in a period earlier than the period in which the claim should have been made. In such cases, the penalty on the resulting shortfall amount will generally be remitted unless it is clear that the taxpayer was aware of the proper tax treatment of the particular item but sought to gain an advantage by disclosing or claiming in the incorrect period.


5 Australian Law Reform Commission, ALRC 95, Principled Regulation: Civil and Administrative Penalties in Australian Federal Regulation, at paragraph 2.64.

6 Explanatory Memorandum to A New Tax System (Tax Administration) Bill (No. 2) 2000, at paragraph 1.3.

7 ibid., at paragraphs 1.3-1.7.

8 ibid., at paragraph 1.12.

9 ibid., at paragraph 1.4.

10 Australian Law Reform Commission, op. cit., at paragraph 3.4.

11 Tax shortfall penalties are set out in Part 4-25 of Schedule 1 to the Taxation Administration Act 1953.

12 On 17 March 2005, the Tax Laws Amendment (Improvements to Self Assessment) Bill (No. 1) 2005 was introduced into Parliament to amend the administrative penalty regime in the Taxation Administration Act 1953 to repeal the penalty for failing to follow a private ruling.

13 Section 4AA of the Crimes Act 1914 sets the current value of a penalty unit at $110.

14 Commissioner of Taxation, Annual Report 2002-03, at p. 65.

15 Commissioner of Taxation, Annual Report 2003-04, at p. 62.

16 The Tax Office classifies micro-businesses as those with an annual turnover of less than $2 million. Small to medium enterprises are defined as those businesses with an annual turnover of between $2 million and $100 million. The large business segment consists of those businesses with a turnover of $100 million or more. High-wealth individuals are included as part of the large business segment.

17 Australian National Audit Office, op. cit., at p. 11.

18 ibid., at p. 28.

19 These penalty concessions are outlined in Practice Statements PS LA 2000/9 and PS LA 2002/8.

20 Practice Statement PS LA 2004/5 outlines the Tax Office's position on the remission of penalties following the transition period to the new tax system.

21 P Costello, Treasurer, Outcome of the Review of Aspects Of Income Tax Self Assessment, Press Release No. 106, Melbourne, 16 December 2004.

22 ibid.

23 The Explanatory Memorandum to the Tax Laws Amendment (Improvements to Self Assessment) Bill (No. 1) 2005 states that remission should occur where the circumstances justify the Commonwealth bearing part of the cost of delayed receipt of taxes. Such cases would usually entail delay, contributory cause or fault on the part of the Tax Office or others. Where the Commissioner is aware that these circumstances arise, he should initiate remission.