2.1 Over 838,000 small business taxpaying entities (about one-third of all small business taxpaying entities1) owed the Tax Office nearly $6.7 billion of tax as at 30 June 2004. None of this outstanding tax was in dispute. Most of the outstanding tax resulted from the lodgment of income tax returns and Business Activity Statements, with a significant component being tax withheld from employee wages and salaries.
2.2 Although nearly 788,000 small business taxpaying entities each owed less than $25,000 (505,000 of these taxpayers owed less than $2,500) as at 30 June 2004, the Tax Office has advised that some 50,812 taxpayers each owed more than $25,000. This group owed the Tax Office a total of $4.002 billion.
2.3 Media reports have suggested that the Tax Office is unnecessarily harsh with, or too quick to take legal action against, small business tax debtors. Notwithstanding isolated cases, there is no evidence to suggest that this approach is taken on a systemic basis. There is a broadly held view that the Tax Office is lenient in its debt collection approach towards small businesses and offers small businesses adequate opportunity to trade out of debt. The Tax Office describes its broad approach as one of seeking to encourage businesses to remain 'engaged in the system'. Only a small percentage of all collectable tax debt cases end in Tax Office-initiated bankruptcy or liquidation (about 0.6 per cent).
2.4 Despite this lenient approach, there is significant private sector disquiet concerning the Tax Office's understanding of the small business environment, characteristics, motivations and the effect that these factors have on small business tax debtors' compliance with tax payment obligations. These concerns are outlined in the document, Review into the Tax Office's Small Business Debt Collection Practices — Summary of submissions and evidence. Some of the issues would benefit from changes to Tax Office approaches, others would benefit from better information and communication by the Tax Office.
2.5 A key theme raised by small businesses and their advisers during the review related to the Tax Office's inability, on a broad systemic basis, to distinguish between the different general categories of tax payment compliance attitudes: those businesses wanting to meet tax payment obligations but unable to do so without short-term assistance; and those businesses either incapable of meeting tax payment obligations or in serial default. This inability has broad effects, potentially disadvantaging both compliant small business competitors and other creditors.
2.6 The business community highlighted a competitive disadvantage where the same payment leniency shown to normally compliant businesses, facing 'manageable' cash flow problems, was also shown to serial defaulters and those incapable of meeting their tax payment obligations. More small business debt cases are in default of their repayment arrangements than those not in default. Non-compliant businesses have reduced operating costs where tax debts continue to remain unpaid and are therefore believed to be able to undercut compliant businesses' prices.
2.7 Difficulty in meeting tax payment obligations can also forewarn a small business of potential non-viability and signals wider problems for all creditors. Continued trading by small businesses on Tax Office-supplied credit can significantly disadvantage creditors — usually other small businesses — by their increased exposure to loss.
2.8 The Inspector-General acknowledges that the Tax Office's relatively lenient approach may create a competitive disadvantage to self-funding small businesses or businesses that borrow funds on the open market to meet their tax payment obligations. Small businesses with established tax debts are effectively using the Tax Office as a source of funding for their business, on either a short-term or a long term basis, to enable them to continue to trade. However, it is noted that the imposition of the general interest charge on outstanding tax debts, when subsequently paid, minimises the competitive advantage arising in these situations.
2.9 The Tax Office's debt collection policy is directed towards identifying and applying the most appropriate debt collection response to each particular case, having regard to individual circumstances. However, there are many obstacles in applying this policy in practice to all tax debtors. Obstacles include large numbers of debt cases, Tax Office resource allocations, unsophisticated risk identification techniques and varying quality and reliability of small business financial information. The Tax Office also has a policy of minimising the costs of tax compliance.
2.10 Notwithstanding these obstacles, and while acknowledging that the majority of small businesses do have an effective understanding of their cash flows, there are measures that can further assist small business to avoid or resolve tax debt:
- measures that encourage small businesses to make provision for future tax liabilities;
- measures that encourage small business tax debtors to critically examine their ongoing viability at a very early stage of tax payment difficulties; and
- measures that identify wilfully non-compliant small businesses at an early stage and escalate those cases for prompt and appropriate responses.
2.11 Since the announcement of this review, the Tax Office commenced a 'small business debt initiative'. This effectively offers an amnesty from legal recovery action to about 500,000 eligible small business cases with debts under $25,000 on the condition that they enter an arrangement to repay their tax debt by direct debit within specified time frames. The initiative is aimed at reducing case numbers and debt holdings, and it signals firmer action against those businesses not complying with their tax payment obligations. It is estimated that full implementation of the initiative will take over 18 months.
2.12 The Inspector-General supports the concept of the initiative as a positive encouragement to small businesses to finalise outstanding debts. It provides some certainty to taxpayers and has received endorsement from tax advisers and their professional associations.
2.13 The Commissioner of Taxation has signalled 'firm' action against those eligible businesses that do not accept the offer. Current indications are that the initial high take up rate by small business debtors may not be maintained. In the Inspector-General's view, the effectiveness of the Commissioner's signals in encouraging payment of outstanding tax will not be as a result of the severity of the threatened action but as a result of the certainty of action being taken.
2.14 The Inspector-General notes that there is little complaint about the Tax Office collection approach from businesses in respect of their own tax debts, particularly for debts under $100,000. Provided such businesses enter into meaningful dialogue with Tax Office debt collection staff and meet their commitments as promised, or seek revision to previous extensions of time to pay, they will be allowed to trade out of their cash flow problems.
2.15 However, during the course of the review the Inspector-General has been reminded of the apparent commercial advantage which those organisations with significant outstanding tax are receiving compared with competitors in similar businesses. These compliant businesses may be either containing market growth or further investment in their business because of their commitment to meet their tax obligations as and when they fall due.
The Inspector-General recommends that the Tax Office addresses issues of competitive disadvantage by distinguishing collection approaches between:
- those small business tax debtors that want to comply with their payment obligations but need short-term assistance to do so; and
- those small business tax debtors that are either incapable of meeting tax payment obligations within a relatively short time frame or are in serial default.
We agree with the principle embedded in this recommendation – it is consistent with our directions for revenue administration generally. Consistent with this we are currently exploring the use of improved analytical tools to better distinguish our treatment of debt cases.
At the same time, as recognised in your report care needs to be exercised in making such judgements. Exactly how current practices would change will need to be carefully considered. The practicality of managing very large volumes of debt cases cannot be ignored in these considerations. This is notwithstanding the decision taken recently to deploy an additional 550 staff to debt collection.
The Tax Office will consult with stakeholders in pursuing this issue.
The Inspector-General recommends that the Tax Office works with the small business sector, and their representatives, to develop new administrative approaches to actively assist small businesses to better manage cash flows, if necessary, to meet tax liabilities as and when they fall due.
We agree with this recommendation. It too reflects current directions as evidenced by the taxi industry initiative referred to in your report and the education program we now run to support taxpayers identified as new to business.
1 While there are an estimated 1.2 million small businesses, each business may consist of more than one small business taxpaying entity.