7.1 The third focus for the terms of reference asks the Inspector-General to examine the impact of the Tax Office's small business debt collection policies and practices on aspects of that collection. One of those aspects specified in the terms of reference is the impact of the Tax Office's approach to payment arrangements. Submissions voiced a number of views on this aspect of the Tax Office's small business debt collection practices. This chapter outlines those views.
7.2 Generally, where a small business is unable to meet its debts when due and payable, a creditor to that small business may recover amounts owed by exercising legal rights, including initiating bankruptcy or winding-up proceedings. However, a creditor may choose to enter into an arrangement with the debtor small business whereby the debt is repaid over a period of time by instalments (a payment arrangement).
7.3 Where the Commissioner accepts a payment arrangement and the taxpayer meets that arrangement, the Commissioner will generally not exercise his power under subsection 255-5(2) of Schedule 1 to the Taxation Administration Act 1953 to sue and recover the outstanding debt.
7.4 As at 30 June 2004, of the approximately 960,000 small businesses debt cases with the Tax Office,54 only approximately 89,000 were in payment arrangements and about 105,000 were defaulted arrangements (cases that had failed to honour arrangements fully). Of the total small business sector collectable tax debt of approximately $6.69 billion, only $1.25 billion of this amount was covered by a payment arrangement and $1.1 billion related to defaulted arrangements. Table 7.1 below further breaks up these numbers.55
|Payment arrangement||Defaulted arrangement|
|Collectable debt cases||Total for all segments||1,451||134,159||1,305||157,719|
|Micro-business segment (<$2 million annual turnover)||Total micro||935||84,460||1,050||102,994|
|Micro debt level 4||223||6,356||242||6,887|
|Micro debt level 5||213||3,118||154||2,358|
|Micro debt level 6||219||1,208||75||481|
|SME segment ($2 million-$10 million annual turnover)||Total SME*||279||4,793||84||1,846|
|SME debt level 4||27||713||12||313|
|SME debt level 5||53||746||22||313|
|SME debt level 6||163||691||56||263|
* Total SME figures are calculated as 85 per cent of $2 million to $100 million entities.
Source: Tax Office
7.5 With the exception of insolvency practitioners and some tax practitioners, all private sector parties consulted state that the Tax Office was generally flexible in its payment arrangement terms. Notwithstanding that comment the following views were expressed:
- the Tax Office does not appropriately consider how the terms of a payment arrangement will affect the underlying viability of a debtor business;
- the Tax Office does not appropriately consider how a payment arrangement will affect the underlying viability of the debtor's creditors and competitors;
- the Tax Office does not appear to consider a business's compliance history and therefore treats taxpayers inequitably;
- the Tax Office is inflexible in the period of time within which a tax debt is to be repaid; and
- the Tax Office is inflexible with its methods of repayment.
Considering the underlying viability of a business
7.6 Representatives for small businesses state that the Tax Office's flexible terms and conditions generally allow small businesses to trade out of debt.
7.7 However, insolvency practitioners comment that many small businesses trade out of debt despite, not because of, the Tax Office's flexible terms and conditions for payment arrangements. They argue that entering a payment arrangement without determining a business's viability can, and does, result in loss-making businesses continuing to trade at a loss. They argue that, with the exception of those businesses who merely forgot to make a payment, a debt with the Tax Office should sound warning bells for all creditors. This is because it is most likely that the Tax Office will be the last creditor to be paid, therefore signalling potential insolvency because of an insufficient cash flow to meet liabilities when they fall due.
7.8 Insolvency practitioners observe that without a business taking quick action to make itself more profitable, the business will likely default in repayments and incur increasing debt to the point of an unsustainable amount, leading to insolvency.
7.9 Insolvency practitioners also comment that the Tax Office's flexible approach to payment arrangements is based on accepting a business proprietor's assertions of viability without seeking corroborating information. They are of the view that, where the proprietor's perception of viability is unfounded, the Tax Office reinforces that perception by accepting the proprietor's assertions. They state that, without some event to force a proprietor of a loss-making business to seek insolvency advice, the proprietor will miss opportunities to make the changes needed to their business to turn it into a profit-making enterprise. In their experience, these proprietors seek advice far too late as debts have accumulated to unmanageable levels.
7.10 Insolvency practitioners and accountants acting for larger businesses within the small business sector suggested that, where a business has a large debt and has defaulted in a payment arrangement with the Tax Office, it should be required by the Tax Office to seek independent third party advice on their viability. They state that the business proprietor should also provide the Tax Office with a summary of their financial situation within 30 days or else legal action for recovery will be commenced.
7.11 The Tax Office argues that it is neither in the business of assessing a small business's viability nor does it have the resources to encourage all non-compliant businesses to seek advice. It also argues that forcing businesses to seek advice on viability would significantly increase compliance costs for businesses—upwards from $5,000 per assessment—that otherwise would not need to obtain that advice. In any event, such advice would be highly qualified—depending on the records available at the time and confidence in future earnings—and because of these qualifications, unsafe to rely upon. Some tax practitioners, in particular those acting for smaller businesses, also question the worth of obtaining this advice and have indicated that it may not provide the Tax Office with the assurances it would require regarding a business's viability.
7.12 Further, the Tax Office states that, out of the 1.6 million debt cases56 it finalised in the 2002-03 income year and the 84,000 cases that were in payment arrangements, the Tax Office only initiated bankruptcy or wind-up proceedings in 771 cases, with 273 bankruptcies and 478 wind-ups.
7.13 Insolvency practitioners argue that this view highlights the Tax Office's 'one-size-fits-all' approach to collecting debts from a diverse group as the Australian taxpaying community. They argue that for the larger level debts of $25,000 and above, steps could be taken to encourage those proprietors to assess their business's viability dispassionately. Less than 5 per cent of the collectable debt cases fall in this category and the approach would be consistent with the priority given by the Tax Office to higher debt level cases.
7.14 Further, they question whether there are more small businesses in default of their payment arrangement than those who keep their arrangements.
Underlying viability of creditors and competitors
7.15 Insolvency practitioners comment that other creditors of a debtor business may perceive that a business continues to be viable because the Tax Office agrees to payment arrangements. This results in continued trade resulting in creditors extending further credit and further exposing themselves to greater loss.
7.16 They state that this perception is based on the assumption that the Tax Office will generally act like any other creditor and not allow a business to continue to trade if significant debt obligations are not met. This assumption may also be reinforced by the media perception that the Tax Office 'comes down hard' on defaulting businesses.
7.17 Tax and insolvency practitioners comment that at creditors' meetings other creditors are amazed at the age and amount of the debt that a debtor has with the Tax Office. They comment that the Tax Office is the largest creditor in Australia and arguably the most experienced.
7.18 Some argue that the Tax Office offers generous payment arrangements that have the effect of enabling unviable businesses to avoid insolvency proceedings initiated by other creditors. They suggest that this also has the effect of reinforcing the small business proprietor's perception of the ongoing viability of the business. Also, they indicate that in some instances the Tax Office's generous payment arrangements may also frustrate the efforts of the Australian Securities and Investments Commission (ASIC) in bringing an action against directors of companies that may be trading while insolvent. No suggestion is made that the Tax Office is implicated in avoiding insolvency proceedings, only that the business is not telling the Tax Office of the state of its debts with other creditors when negotiating a payment arrangement.
7.19 The effects of insolvency are discussed in Chapter 8.
7.20 Tax and insolvency practitioners, lawyers and representatives for small businesses comment that regardless of a debtor's previous compliance history, the Tax Office would offer the same flexible terms and conditions for payment arrangements. They saw this approach as having an unintended effect of treating non-compliant small businesses more favourably than compliant small businesses and therefore directly affecting a compliant business's viability.
7.21 In support of their claims they pointed to the automated interactive voice response (IVR) phone line that accepts lower debt level payment arrangement proposals without checking a business's compliance history. They also stated that, with the exception of very high level debt cases, in their experience and notwithstanding the stage of legal proceedings, they had rarely been questioned over a business's previous compliance history when negotiating payment arrangements with tax officials.
7.22 The Tax Office refutes this claim and states that, in determining payment arrangements, the ATO receivables policy requires staff to consider a number of factors, including the debtor's compliance history such as:
the manner in which the debtor has previously met tax obligations, including payment and lodgment obligations.57
7.23 However, senior tax officials interviewed by Inspector-General staff consider it important to 'keep the taxpayer engaged' by keeping defaulting small businesses in payment arrangements. They state that they would 'err on the side of the taxpayer' in accepting reasons for delays and defaults.
7.24 Also, it is not clear what methods the Tax Office uses to distinguish those businesses with a capacity to repay without affecting their underlying viability from those who could not repay without affecting their underlying viability.
7.25 The Tax Office states that there is no method which can do so without viable businesses incurring further significant compliance costs and increasing Tax Office resources.
7.26 One insolvency practitioner recommends that the Tax Office should consider a proprietor's previous history with ASIC and the proprietor's involvement in any previous judgments.
Time limit for repayment
7.27 Representatives for small businesses and tax practitioners state that the Tax Office generally had no difficulty in agreeing to payment arrangements lasting under a 12-month period.
7.28 At the commencement of this review, submissions from the tax practitioner professional associations, insolvency practitioners and legal practitioners argued that the Tax Office was generally inflexible with the time within which a debt must be repaid where that period is more than 12 months. They were of the view that such inflexibility may unduly affect the viability of businesses that may otherwise meet all other taxation obligations and repay the debt over a longer period of time.
7.29 In any event, they comment that payment arrangements should be based upon the merits of the proposal, not an arbitrary timeframe. They recommend that businesses should be given extended time periods for repayments, such as five years.
7.30 However, since 30 June 2004, small businesses with debts under $25,000 are able to enter into payment arrangements of up to 18 months if eligible for the small business debt initiative. This initiative is discussed below.
7.31 In relation to those small businesses ineligible for the initiative, the Tax Office disputes that payment arrangements will not be accepted unless full repayment can be made in one year. It states that this public perception may be due to one of the exceptions to the rules governing the IVR phone line.58 This rule is that the payment arrangement must extinguish the tax liability within a year.
7.32 The Tax Office states that where the IVR phone line rejects a debtor's payment arrangement proposal because of a failure to satisfy either validation rules or business rules, the proposal will be transferred to an area in the Tax Office for 'human intervention' and consideration by tax officials.
7.33 Different officers have authority to enter payment arrangements on behalf of the Commissioner for different debt levels and different time periods up to unlimited amounts.
7.34 Where a proposal is referred for human intervention, it is considered by a tax official who may contact the debtor to renegotiate the proposal with a view to agreeing to an alternative arrangement that may be accepted within the officer's authorisation.
7.35 However, tax practitioners state that they continue to observe instances where longer term payment arrangements are unreasonably denied.
ATO practice of requiring repayment in 12 months
7.36 The ATO receivables policy does not expressly state that taxpayers are required to repay outstanding debts within 12 months. It requires tax officials to manage the risk of non-payment. One identified factor of this risk is 'ageing debt':
The Tax Office Debt Collection strategy is premised upon prompt payment being received as it recognises that an aging debt becomes more difficult to collect.
An aging debt normally increases in size through the accrual of additional tax for late payment/GIC and the taxpayer's financial position may deteriorate in the interim making collection of that debt more difficult than a new debt. Accordingly, any factor which is likely to cause or contribute to delay in the collection of a debt must be regarded as an inherent element of risk.59
7.37 The period at which debt becomes 'ageing debt' is not defined in the policy. However, it seems to indicate that a debt outstanding for a period of more than one year is considered a greater risk—for example:
The Commissioner expects taxpayers paying by instalments to finalise their debts in the shortest possible timeframe. However, he acknowledges there will be instances where that timeframe may extend beyond one, two or more financial years depending on factors such as the ability to pay, the size of the debt and the likely costs of alternative collection activity.60
Flexibility with instalments
7.38 Some submissions also commented that the Tax Office was inflexible with varying the instalment amounts and dates for payment. Small business saw varying amounts and dates as beneficial to coincide more tightly with a business's cash flow cycle and to minimise the risk of not making provision for the tax debt.
7.39 The Tax Office states that there is no impediment to agreeing to these variations.
Methods of repayment
7.40 Submissions also suggested alternative payment methods could be made to improve small business compliance. These included:
- using a card through which small businesses could pay instalments at third party outlets, such as Australia Post;
- making payment by way of credit card; and
- as a condition of agreeing to a payment arrangement, having instalment amounts deducted from the business's bank account.
Small business initiative
7.41 At the outset of the Inspector-General's review, tax and insolvency practitioners argued for more flexible Tax Office repayment arrangements. Specifically, they argued that the Tax Office was reluctant to accept payment arrangement proposals involving a 'quarantining' of an existing tax debt. These proposals involved arrangements in circumstances where the underlying viability of small businesses was threatened if the tax debts were required to be repaid immediately. Under the terms of the proposal the Tax Office would defer recovery of the outstanding amount and remit the general interest charge (GIC) until a later time when the business had improved its trading position. This proposal was made on the condition that all other taxation liabilities were met.
7.42 On 30 June 2004, the Tax Office announced its 'small business debt assistance initiative'. In return for entering a payment arrangement, the Tax Office would reduce the GIC and allow the debtor to repay the amount over either a 6, 12 or 18 month period. Only those businesses with an annual turnover of less than $10 million and a total taxation debt of less than $25,000 are eligible. The terms of maintaining the arrangement are that, with the exception of the debt, the debtor must meet all past, current and future liabilities. Additionally, the debtor must pay the instalments by direct debit.
7.43 According to the Tax Office, this initiative will target about 500,000 small businesses and individuals that owe about $2.5 billion in collectable debt.The reduced interest rate will only apply to the period in which the small business has a payment arrangement. The Tax Office advises that it will progressively send letters of offer to identified eligible small businesses over the next 12 to 18 months. The Tax Office advises that small businesses do not need to wait to receive a letter of offer to take advantage of the offer. Small businesses may initiate contact with the Tax Office immediately.
7.44 The Tax Office states that where a small business has been sent a letter of offer and has not responded to it, the Tax Office will take action to recover the debt without further notice.
7.45 The Tax Office's initiative has received public support from small business representatives, accounting and tax practitioner bodies. However, some tax practitioners are of the view that the initiative does not offer enough incentive for small businesses to resolve their outstanding debt, that the time period is rigid, it is limited to a certain threshold, and reduction of the GIC is 'not enough of a sweetener'.
7.46 The Tax Office publicly reported that of the first 3,500 offers made, around 60 per cent or 2,100 taxpayers have entered payment arrangements. However, further information provided by the Tax Office reveals a lower response rate for later offers. As at 17 September 2004, of the 51,077 offers made in which taxpayers have had a reasonable period to accept, about 9 per cent or 4,800 taxpayers had paid in full and 12 per cent or 6,362 taxpayers had entered arrangements. If taxpayer-initiated arrangements, post-1 July 2004 debts and converted existing arrangements are also added, then 24.4 per cent or 12,496 taxpayers have entered arrangements.
54 This figure includes 114,636 cases with credit or zero balances. No reason was provided for why the Tax Office's debt report figures include cases with credit or zero balances.
55 Note there may be minor inaccuracies in these figures as totals are as at 30 June 2004 and debt level figures are as at 13 September 2004.
56 The Tax Office indicates that a debt case refers to an instance of outstanding debt. One taxpayer may have many debt cases during the year depending upon whether they resolved a debt before any additional debt is raised.
58 See Chapter 5.
60 ibid, paragraph 10.4.6.