Chapter 1 Introduction
Self assessment
1.1
The dominant feature of the tax environment today is the principle of
self assessment. The Australian Taxation Office (ATO) has outlined how self
assessment works in practice:
Under the self-assessment system, the claims a taxpayer makes
in their tax return are accepted by the Tax Office, usually without adjustment,
and an assessment notice is issued. Even though we may initially accept the tax
return, the return may still be subject to further review.
To ensure the integrity of the tax system, the law provides
the Tax Office with a period where it may review a return (and make sure all
income has been included) and may increase or decrease the amount of tax
payable. We may amend an assessment up to four years (or two years for shorter
period of review taxpayers) after tax became due and payable under the
assessment. Where anti-avoidance provisions apply, the period is extended to
six years. Where the avoidance is due to fraud or evasion, there is no time
limit on amending the assessment.[1]
1.2
Self assessment largely determines the way that taxpayers and the ATO
interact. Self assessment has also largely determined the issues that have come
before the committee during the inquiry. In particular, claims of unfair costs
imposed on taxpayers by self-assessment emerged as a theme in three ways:
n the level of
complexity of the tax system and resulting uncertainty for taxpayers
n the costs of ensuring
adequate compliance with tax obligations
n the consequences for mistaking
tax obligations because of a regime of interest charges and penalties.
1.3
In order to put these issues in context, this section outlines why self
assessment is the current philosophy underlining tax administration in Australia.
The Australian National Audit Office’s 1984 efficiency audit
1.4
The precursor to this Committee, the Joint Committee on Public Accounts (JCPA),
has explained how the tax system used to work prior to the introduction of self
assessment:
…a taxpayer would lodge a return containing information from
which the ATO assessors would prepare a statement (an assessment) of the
taxpayer’s taxable income and tax payable. A ‘notice of assessment’ would then
be issued and the amount payable would become a debt due in accordance with the
statutory period for paying taxation debts.
A taxpayer had the right
to object to the assessor’s calculations of the debt due and the ATO was then
required to review the taxpayer’s case. By the early part of the 1980s this
review procedure was placing considerable strain on the ATO’s resources. [Much
of [the] growth [in taxpayer objections] was attributable, in the ATO’s view
to, ‘taxpayers attempting to delay or avoid payment of tax by involvement in “scheme”
activities’.[2]] In 1983-84 the
number of objections against assessment numbered in excess of 236,000…
Moreover, with
approximately 10 million income tax returns to assess annually and with
quotas applying to assessors, it had been calculated that, on average, an
individual taxpayer’s return would have received an optimum of one minute of
scrutiny by the ATO assessors. Using the historical number of staff available
for performing the assessment function, the same type of calculation suggested
business returns would have been considered, on average, for four minutes…[3]
1.5
One of the problems with the previous system was how incentives operated
for different parties. For example, taxpayers did not have a disincentive to
dispute the ATO’s assessments.
1.6
As the Inspector-General of Taxation noted, the ATO’s processes at this
time were unsustainable.[4] In 1984, the Australian
National Audit Office (ANAO) finalised a report on four efficiency audits (now
referred to as performance audits) of tax administration. In its foreword, the
report stated:
…a major contribution to resolving many of the problems faced
by the Office might be made not by the provision of further staff but by the
more productive and effective use of those already engaged. It appears that
such an outcome could be achieved.
Each of the three major audits has demonstrated a need for the
ATO to take a fresh look at current practices that have outlived their
usefulness, no matter how effective and essential they may once have been…
But it is in connection with income tax assessing that the
most fundamental questions arise. The latest annual report of the Commissioner
disclosed that over 2,000 officers work as income tax assessors throughout Australia. It is observed that every effort has been made by the ATO to restrict the
assessing function to the barest of essentials…
However, the audit findings have raised some serious doubts
about the purpose and effectiveness of the assessing processes.
Audit has suggested that careful consideration be given by
the ATO to the introduction of computer processing of income returns with a
view to producing assessments, initially without assessor intervention. With
appropriate analytical techniques, those income tax returns to which particular
attention should be paid could be identified or rejected. It would then seem
possible to subject only those returns most open to query of objection to the
detailed physical examinations that the assessors now make of all returns.[5]
1.7
In other words, the ANAO was advocating a change from equality of
process for each taxpayer to a system of risk management. The attention a
taxpayer received from the ATO would be in proportion to the risk they
represented to the revenue.
1.8
In 1986-87, the Australian Government introduced a requirement for
taxpayers to self-assess their tax liability. Full self assessment for
companies and superannuation funds was required as of 1989-90.[6]
1.9
In line with the new approach, tax returns were simplified. Instead of
showing the ATO how the taxpayer arrived at the final result, they now contain
only a few important entries and some questions that help the ATO assess risk.[7]
In order to make the new system more robust, the Government introduced an
interest charge on unpaid tax to apply for the period between the ATO’s initial
assessment and any amended assessment.[8]
1.10
Recognising that many taxpayers would not necessarily have a good grasp
of tax law, the Government also introduced a system whereby taxpayers could
request the ATO’s opinion about certain aspects of their tax liability.[9]
1.11
The impact of these mechanisms on taxpayers and their effectiveness were
key issues during the inquiry.
The committee’s 1993 review of self assessment
1.12
In November 1991, the JCPA began a comprehensive inquiry into the
administration of tax in Australia. In November 1993, the Chair of the Committee,
Mr Les Scott MP, presented An Assessment of Tax: A Report on an Inquiry
into the Australian Tax Office in the House of Representatives.[10]
1.13
An Assessment of Tax began by acknowledging that the operations
of the ATO regularly received parliamentary scrutiny.[11]
However, the JCPA inquiry:
…was the first major public examination of the manner in
which taxation laws are administered in Australia since the passing of the Income
Tax Assessment Act 1936.[12]
1.14
An Assessment of Tax was also the first major examination of the
self assessment system. The Government accepted 115 of the 148 recommendations
in the report. These included:
n the introduction of a
Taxpayers’ Charter
n making public rulings
more comprehensive and accessible
n making private
rulings more accessible to the public
n the establishment of
a Taxation Ombudsman
n the introduction of a
test case program to fund taxpayers’ legal costs where the legislation is
unclear.[13]
Should self assessment continue?
1.15
A number of submissions noted that self assessment allows the ATO to be
more efficient in collecting tax. Resources saved on the initial assessments
can be directed to audits. However, self assessment has imposed extra costs on
taxpayers. They must effectively know the tax system as well as the ATO to
ensure their returns are as accurate as possible to avoid the interest charges
applied for making an error. Taxpayers faced much less risk before 1986-87.[14]
1.16
In some respects, the requirements imposed on taxpayers are higher than
those placed on the ATO because taxpayers must accurately self assess shortly
after the end of the financial year. Generally, the ATO has between two and
four years after a tax return is lodged before it needs to satisfy itself that
the return is correct.[15] This mismatch has
resulted in 97% of businesses and 74% of individuals using tax agents.[16]
1.17
The complexity of the tax laws has compounded these issues. Self
assessment requires taxpayers to correctly understand the law and many of these
complexity costs have been borne by taxpayers.[17] In its submission, the
Taxation Institute of Australia stated:
…there remains a perception in the community that the onus
for getting it right, even where the law is unclear, still lies unfairly on the
least resourced member of the ATO/taxpayer relationship - the taxpayer. In
light of the complexity that underlies our income tax laws, this burden remains
and the Taxation Institute is of the view that this burden should be shared
more equally.[18]
1.18
These factors led some groups to propose to the committee that the
current self assessment system be wound back to a form of modified
pre-assessment, or administrative assessment. The submissions did not explain
how this might work in practice, but their general wish that the ATO play a
greater initial role in tax assessment was clear.[19]
For example, CPA Australia argued:
We acknowledge that the ATO has been working very hard in
recent years to try to make things easier for taxpayers and agents. However,
these efforts appear to be really made within the constraints of the current
system, some of which have been designed by them, rather than stepping well
back to look at the underlying system.
In the circumstances, therefore, it may be appropriate for
the Government to consider a move to a modified self-assessment system for most
individual and small business taxpayers to give them greater comfort that their
returns have been assessed and relevant issues raised as appropriate before any
final assessment is issued. We note in this context, however, that the recent
move to a two year review period for individual and STS taxpayers goes some way
towards meeting this objective.[20]
1.19
In assessing the proposal for a form of administrative assessment, the
committee first noted the JCPA’s comments in An Assessment of Tax in
relation to the efficiency consequences on the ATO of a return to
administrative assessment:
…on the basis of cost efficiency alone the Committee
concluded that it was unlikely that a return to a system of ATO assessment
could be justified in terms of the consequences for revenue.[21]
1.20
The current Committee also examined the practices in other countries, in
particular within the OECD. Fourteen out of 30 OECD countries use self
assessment for personal income tax. These include Canada, Ireland, the UK and the USA.[22] So self assessment is
commonly used in other advanced economies.
1.21
Treasury, which is the primary agency for tax policy in the Government,
wished to retain self assessment. In relation to the proposal put to the
Committee, it stated:
It is unclear that such a system would provide a substantial
increase in taxpayer certainty, compared with the Private Binding Ruling
system, while having the clear potential to generate significant additional
processing and administrative costs for the Tax Office (with implications for
all taxpayers).
Unlike Private Binding Rulings, which can be obtained before
a transaction occurs, taxpayers using this proposed system would not be able to
determine the Commissioner’s view on the correct taxation treatment for a
particular transaction prior to entering into the transaction.[23]
1.22
The ATO supported self assessment, both in terms of protecting the
revenue and in how most people perceive it:
I do not have those figures but, in terms of tracking to
budget estimates, we have continually been at budget estimates or above, which
reflects our expectations of what would be claimed as deductions and what would
come in as income and it is reflected in the results. From that perspective,
the system is working as expected, albeit that there are always improvements
that can be made…
The big iceberg to my mind works well. Most people do not see
an issue.[24]
1.23
Finally, the Inspector-General of Taxation, who operates independently
of the Government, also believed that self assessment should continue:
Self assessment was introduced by the government in
consultation with tax practitioners and there is no doubt that self assessment
works well and to the benefit of the vast majority of taxpayers. It has
provided efficiency gains to taxpayers. For example, those with simple affairs
can lodge a return through their tax agent or e-Tax and have their assessment
issued within 14 days. It has certainly benefited the Tax Office, with it no
longer being required to scrutinize every tax return. There cannot be, and
should not be, any question of turning back to the era of full assessment.[25]
1.24
The Committee accepts that self assessment has led to some difficulties,
in particular where the tax law is complex and taxpayers must expend resources
to ensure their tax returns comply with the law. Just as the ATO was under
considerable pressure in the first half of the 1980s, taxpayers and tax agents
are now themselves coming under pressure to comply with the tax system.
1.25
Self assessment of itself, however, has not solely been responsible for
these concerns. The problem is that self assessment operates within an
environment of complex legislation, public and private rulings, and
administrative discretion exercised over audits, settlements, and the remission
of penalties and interest. The answer to taxpayer difficulties with
self-assessment is not to increase the use of tax agents, or to increase the
role and function of the ATO on taxpayers’ behalf, but to decrease the onus on
the taxpayer by simplifying the tax law and tax process.
1.26
The subsequent chapters of this report demonstrate that tax laws, in
particular, need to be simplified. Further, this chapter demonstrates that a
number of reforms have been implemented that bring more balance to the
ATO/taxpayer relationship. In light of these reforms and the potential to
simplify the tax legislation, the Committee does not support any changes to the
basic principle of self assessment.
Aggressive tax planning in the 1990s
Description of the investments
1.27
The major incident involving self assessment since its inception arose
during the mid-1990s in relation to mass marketed investment schemes and
employee benefit arrangements. Deductions for these investments grew from $170
million in 1993-94 to $1.4 billion in 1996-97.[26]
1.28
The average tax debt under the mass marketed investment schemes was
$42,000.[27] The ATO outlined to the
committee the characteristics of the schemes:
n based on a public
offer document (prospectus);
n were often supported
by a legal opinion;
n promoted to a mass
audience;
n were often
aggressively marketed to participants who had no control over, and very little knowledge
of, the internal workings of the arrangements; and
n may rely on common
structuring features including:
§
round robin financing;[28]
§
limited or non-recourse loans;[29] and
§
participant obligations limited to investment profits.[30]
1.29
The ATO came to the opinion that these schemes were established for the
dominant purpose of obtaining a tax benefit, and hence applied the
anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936.
The ATO’s reasons included:
n apart from
subscribing to the scheme, participants have no hands-on involvement and
therefore are not carrying on a business;
n financial
arrangements involve limited- or non-recourse loans, often based on round robin
arrangements;
n high up-front
management fees geared to create inflated tax deductions;
n participants have
little or no practical control over the scheme’s management;
n limited exposure to
risk; and
n in some cases, a
guarantee from promoters to reverse the transaction if claimed tax deductions
are not allowed.[31]
1.30
In legal terms, there is no doubt that the ATO was correct in
disallowing these deductions. The Federal Court considered six cases involving
mass marketed investment schemes and disallowed the deductions in all six. In
two of these, the taxpayer sought to appeal to the High Court, which refused
leave in both cases.[32] In its reports on these
schemes, the Senate Economics and References Committee stated:
…a large number of these schemes appeared to be designed
specifically to defraud the tax system and to use ordinary taxpayers in that
process. Not only have they left many taxpayers with large tax bills, but many
of these schemes have ceased to exist. The Committee is of the view that few
schemes represented ‘a good investment’ in the ordinary meaning of the term,
and that without the ‘tax deductibility’ factor, very few would have got off
the ground.[33]
1.31
Employee benefit arrangements were significantly different to mass
marketed schemes. Firstly, the average tax debt was higher at $156,000.[34]
These investors were more sophisticated and needed to be employers to set up
the appropriate financial structures.
1.32
There was a variety of arrangements established. The ATO described the
simplest of these, employee share or incentive plans, as follows:
n The employer entity
establishes a special purpose company.
n Shares or membership
interests are allocated to selected employees for a nominal amount in the
special purpose company.
n The employer
contributes a sum of money to the special purpose company, greatly increasing
the value of the employees’ shares or membership interests.
n The special purpose
company invests the contribution amounts on behalf of the employees, often
lending the contribution back to the employer entity or their associate…
Employee share or incentive arrangements are designed to provide
the employer with an effective incentive plan for employees. However, the only
employees who generally participate in such plans are the controllers of the
employer business.[35]
1.33
The share/incentive plan is demonstrated below.
Figure 1.1 Employee share or incentive plan
Source ATO,
sub 50.1, p 25.
1.34
The taxpayers’ arguments in these cases is that the employer’s payment
to the special purpose company is allowable as a deduction for the employer and
avoids fringe benefits tax, the superannuation guarantee charge, payroll tax
and workcover. Other advantages are that the employee’s income is not subject
to the superannuation contribution surcharge and contributions to the company
are not subject to the 15% tax on superannuation contributions.[36]
1.35
The artificial nature of the arrangement becomes clear when one examines
figure 1.1 and notes that the employer and employee were often the same people
and providing funds to themselves. The ATO disagreed with these taxpayers on a
number of issues, including:
n the employer’s
contributions may be subject to fringe benefits tax
n the contributions may
be subject to income tax for the employee
n the employer’s
contribution may not be allowable as a deduction.[37]
1.36
Apart from the special circumstances in the case of Indooroopilly
Children’s Services,[38] the ATO has won all the
cases where it has challenged employee benefit arrangements, mainly on the
grounds that the payments did not represent a deduction for the employer. As
one judge stated:
The ability of a private company employer to obtain unlimited
deductions for contributions made to a superannuation fund benefiting employees
who are directors and shareholders without either the trustee of the fund being
liable to pay tax on the amounts contributed or the employer being liable to
pay fringe benefits tax must be the holy grail for tax planners. This is what
was offered to the applicant in the present proceedings ... by a well known
firm of chartered accountants.[39]
1.37
Viewed as a revenue issue, mass marketed investment schemes and employee
benefit arrangements have been satisfactorily resolved. The ATO has initiated
court cases that have set legal precedents which confirm these investments are
subject to the usual taxes. However, what set these investments apart is that a
large number of investors felt they had been treated unfairly.
Why did investors feel unfairly treated?
1.38
In the case of mass marketed investment schemes, the first reason why
many investors felt they had been treated poorly was that the schemes were
aggressively marketed and many taxpayers were not fully aware of what they were
signing up to.[40] Experience has shown
that ordinary Australians often trust marketers and promoters who use written
accounting and legal opinion, and/or testimonials, to give their schemes
credibility. That such material is often merely opinion that has not been
verified by credible authorities such as the Australian Securities and
Investments Commission or the ATO, does not occur to them. As the Senate
Committee discovered, the affected taxpayers felt let down when later on the
tax deductions were disallowed and penalties imposed. Although it was a
misguided view, such taxpayers still often blamed the authorities, as they felt
that they had been put in a position where they could be ‘conned’.
1.39
As an example of the sales techniques used, the ATO provided the
Committee with a transcript from an instructional tape for scheme promoters:
Furthermore you’ve got a $20,000 loss which you can forward
on to next year and because you’re on 48.5 cents in the dollar means you’ll get
another $9,700 in your hand next year in July or you’ve got a choice of about
$800 a month. Now here come the first close that I use.
‘Now John, what would you prefer? $800 a month or the other
$9,700 at the end of next July as a lump sum?’ And shut up. Let them make the
choice ‘cos by them making the choice they’re already going to say yes to the
deal...
…when you say the words ‘licensee’ say ‘you, now owning a
licence, are the licensee’ – refer to them as the licensee. It also helps to gives
them the impression that they've already bought because you’re starting to call
them the licensee.[41]
1.40
The next reason many investors felt they had been treated unfairly, for
both the mass marketed schemes and the employee benefit arrangements, was that
the ATO delayed its reaction to the investments.[42]
If investors were able to make the deductions in one financial year and the ATO
did not query them, then it tended to set a precedent for future years and the
investments grew in size. This also demonstrates that many individuals do not
fully understand self assessment because the ATO has the right to issue amended
assessments for some period after the initial assessment.[43]
1.41
Consistent with this lack of understanding of self assessment, many
investments were promoted using private rulings from the ATO. The basis of
private rulings is that they bind the ATO, but only in relation to that
particular taxpayer and only if the taxpayer follows the facts and processes
set out in the ruling. The ATO had issued private rulings for both the schemes
and arrangements and promoters used these for the investments, despite them
being for different investors and sometimes for different schemes.[44]
A close reading of the rulings would often indicate that their precedent value
was reduced.
Current status of the investments
1.42
Following the inquiry by the Senate Economics References Committee into
mass marketed investment schemes, the ATO made a settlement offer to ‘typical’
investors on 14 February 2002. These tended to be people who had a good tax
record, were subject to aggressive marketing and lacked full knowledge about
the schemes and the tax system. Both the ATO and the Senate Committee
distinguished between unsophisticated investors, and sophisticated investors
and promoters. The former were offered ‘gentler’ settlement terms than the
latter.
1.43
The offer to typical investors was open until 21 June 2002. The offer comprised:
n a tax deduction for
the cash outlaid under the investment
n full remission of
penalties and interest
n a two year interest
free period for repayment, provided the taxpayer entered into a suitable
payment arrangement.[45]
1.44
In other words, the settlement allowed the deductions for cash outlaid up
until the ATO raised its concerns with taxpayers. For these investments, the self
assessment system (allowing the ATO to later amend assessments) was converted
back to administrative assessment (restricting the ATO to what it detects when
it issues the initial assessment).
1.45
In June 2006, the ATO stated that 98% of scheme investors had finalised
their dispute, with 82% having paid their tax and a further 9% with payment
arrangements in place.[46]
1.46
On 5 August 2004, the Inspector-General of Taxation finalised his report
into employee benefit arrangements, Review of the Remission of the General
Interest Charge for Groups of Taxpayers in Dispute with the Tax Office. On 18 November 2004, the ATO announced settlement offers for investors involved with
employee benefit arrangements. There were five types of offer depending on the
taxpayer’s individual circumstances. Further, each offer varied, depending on
whether the taxpayer was prepared to give up their objection and appeal rights.[47]
1.47
The most generous conditions were offered if the taxpayer relied on the
ATO’s advice about the arrangement and advised the ATO of their arrangement
during the safe harbour period. If the taxpayer was prepared to give up their
objection and appeal rights, the ATO offered the following settlement:
n only one tax (either
income tax or fringe benefits tax) would be levied
n 5% penalty on the
primary tax
n interest charged at
4.72%
n a payment plan could be
agreed, with interest charged at 4.72%.[48]
1.48
The least generous offer was made for taxpayers who did not have any
advice from the ATO and did not provide information when requested by the ATO.
If the taxpayer was prepared to give up their objection and appeal rights, the
ATO offered the following settlement:
n only one tax (either
income tax or fringe benefits tax) would be levied
n 10% penalty on the
primary tax
n full General Interest
Charge applied (approximately 12%)
n a payment plan could
be agreed, with interest charged at 6.28%.[49]
1.49
In June 2006, the ATO stated that 90% of arrangement investors had
finalised their dispute, with 88% having paid their tax and a further 2% with
payment arrangements in place.[50]
1.50
Since the problems with these investments came to light, the ATO and the
Government have implemented a number of reforms that have greatly reduced the
chances of such an incident re-occurring. These include:
n Since 1998, the ATO
has issued product rulings, a type of public ruling, that applies only to that
specific type of investment. It is now very hard for anyone to market an
investment without such a ruling.[51]
n The ATO publishes its
compliance program, making public its analysis of the risks to the tax system.
n The ATO releases
taxpayer alerts, which are early warnings about emerging, potential tax risks.
n Promoters’ conduct
after 6 April 2006 is now potentially subject to civil penalties under the Taxation
Laws Amendment (2006 Measures No 1) Act 2006.[52]
Recent reforms to tax administration
1.51
The fairness issues raised following the mass marketed investment
schemes and employee benefit arrangements led to a number of reforms. These
included:
n the establishment in
2000 of the Board of Taxation, a non-statutory advisory body which provides an
avenue for business and the community to contribute to the design and operation
of tax laws[53]
n the establishment in
2003 of the Inspector-General of Taxation, who independently reviews the ATO’s administration of tax laws[54]
n the commencement in
2006 of promoter penalties legislation, which allows the ATO to apply to the Federal Court for a civil penalty against the promoters of illegal tax
schemes[55]
n the introduction in
2007 and 2008 of exposure draft legislation for a new regulatory system for tax
agents.[56]
1.52
Although not explicit in some of the ANAO’s reports, it appears the ANAO
also responded to concerns about how the ATO treated these investments. These
audits, which this report refers to where relevant, covered:
n debt recovery (1999)
n penalties (2000)
n the rulings system
(2001)
n aggressive tax
planning (2004).
1.53
Probably the most important response to mass marketed investment schemes
and employee benefit arrangements was the review of self assessment (RoSA).
Report on aspects of income tax self assessment
1.54
On 24 November 2003, the Government commissioned Treasury to conduct RoSA. The review reported to the Government in August 2004 and made 54 recommendations.
1.55
Treasury stated that:
In December 2004 the Government announced that it would adopt
all of RoSA’s recommendations…:
n The first tranche of RoSA legislation, comprising the Tax Laws Amendment (Improvements to Self Assessment) Act
(No. 1) 2005 and Shortfall Interest Charge (Imposition)
Act 2005, received Royal Assent on 29 June 2005. Those Acts reduced the consequences of errors in assessment for taxpayers who act in
good faith, by providing for a lower rate of interest for the period before
they are notified of their error [the Shortfall Interest Charge], and by making
refinements to the penalty regime.
n The
second tranche of RoSA legislation, comprising the Tax Laws Amendment (Improvements to Self Assessment)
Act (No. 2) 2005, received Royal Assent on 19 December 2005. This Act increased taxpayer
certainty by improving the timeliness and reliability of Tax Office advice and
by reducing the time in which the majority of taxpayers’ assessments can be
altered by the Tax Office.[57]
1.56
In short, RoSA reduced taxpayer risk and transferred it to the ATO. Taxpayers are subject to lower interest in the period leading up to an amended assessment.
They are protected from interest and not just penalties when they follow ATO advice. The ATO has less time in which it can amend taxpayer assessments.
Conclusion
1.57
Many of the reforms to tax administration since 2000 outlined above have
been influenced by the investments of the 1990s. They focus on the three main
participants: the ATO, taxpayers and advisors. In particular:
n creating the office
of Inspector-General places the ATO under greater scrutiny
n RoSA has required
greater responsiveness from the ATO and represents a shift in the balance in
the relationship between taxpayers and the ATO towards taxpayers
n the proposed changes
to the regulation of tax agents and introducing promoter penalties are likely
to improve standards in tax advice and hold advisors more accountable.
1.58
These legislative changes will make it much harder for investments such
as mass marketed investment schemes and employee benefit arrangements to
challenge the integrity of the tax system. This means that taxpayers and their
advisors who wish to engage in aggressive tax planning will probably take a
different path in future. The next generation of challenges facing the ATO are more sophisticated, involving:
…confidentiality agreements, password protected web pages,
the use of encryption and detection software, and payments to offshore
entities, including those in tax havens.[58]
1.59
However, the prevention of aggressive tax planning in future is less
likely to depend on legislation. As the history of these investments show, the
legislative response takes a number of years. Rather, it is more likely to
depend on the ATO’s data collection, analysis, risk management, initiative and
the quality of staff. Although such preventative work is unlikely to attract
much public recognition, it is an important factor in the integrity of the tax
system.[59]
Performance of the ATO
Overview
1.60
In discussing the ATO’s performance, it is worth noting that it is
engaged in important, but difficult work. While there is a large number of
agencies that spend and distribute public funds on behalf of the Government,
the ATO is the main agency that collects these funds.
1.61
The ATO has a relationship with every Australian that earns an income
and with every business. In total, this makes 14 million relationships that it
must manage, which is probably higher than any other Australian agency,
including Centrelink. In fact, with the growth in Government assistance
provided through the ATO, it is fulfilling some of Centrelink’s role. The Uhrig
review of corporate governance of statutory authorities in 2003 noted:
It could be argued that of all statutory authorities, the ATO
has the most significant and wide-ranging relationship with the community,
involving people both as individuals and also where they may be participants in
business or non-profit organisations or as tax professionals.[60]
1.62
Although tax administration is often recognised as important work, the
idea that governments can forcibly appropriate individuals’ finances means citizens
can have concerns about their quantum of tax, others’ quantum of tax, how the
tax is collected, and the work required of taxpayers.
1.63
Overall, the Committee is satisfied that the ATO is responding to these
challenges. A number of performance statistics from the ATO’s 2006-07 Annual
Report demonstrate this conclusion:
n the ATO’s collections
exceeded the Budget forecast by 2.0%
n 82% of community
members think that the ATO is doing a good job overall
n 90% of tax agent
respondents indicate that it is easier now than in the past to deal with the
tax system
n 87% of business
respondents overall agree the Tax Office is doing a good job
n the ATO’s operating
expenditure was 2.3% below budget. [61]
1.64
An across the board comparison of performance statistics between
national tax authorities is not feasible due to their varying roles and
legislative foundations.[62] The ATO has, however, developed a positive reputation internationally. The Inspector-General of
Taxation stated in evidence:
…we are dealing with a tax office that is held up by other
tax authorities around the world as one of the leading examples of
best-practice tax authorities.[63]
Responses to reviews
1.65
The ATO advised the Committee that it has been subject to numerous
reviews, in addition to regular accountability requirements such as Senate
Estimates and performance audits by the ANAO. For example, the ATO has been
subject to 11 formal external reviews in the area of aggressive tax planning
alone since 1999.[64] Part of the Ombudsman’s
role is to specifically oversight the ATO.
1.66
Not only has the ATO been subject to these reviews and accountability
requirements, but it argues it has participated in them and responded to them
in good faith:
We are committed to an open and transparent tax
administration which works with the community in the care and management of
Australian’s tax system. We welcome feedback, collaboration and co-design where
it is constructive and assists in the implementation of practical improvements
to the law and to our administration…
We worked constructively on those [aggressive tax planning]
reviews and have adopted the thrust of the recommendations that were made. We
continue to be very responsive to the guidance provided by Parliament,
scrutineers and other stakeholders.[65]
1.67
The Ombudsman verified this claim. He stated that the ATO:
…has encouraged a culture that is open to external scrutiny
in relation to both the concerns of individuals and the broader community.[66]
1.68
By way of corroboration, the Committee examined how the ATO responded to
a number of external reviews. In relation to complaints handling, the
Commonwealth and Taxation Ombudsman completed an interim report in 1999 on how
the ATO handled complaints. The Ombudsman followed this up with an ‘own motion’
investigation in 2003, which made six recommendations, all of which the ATO
accepted.[67]
1.69
The Ombudsman advised the Committee that the ATO’s complaints system now
works well:
I am pleased to say that the ATO’s co-operative approach has
resulted in a system reflecting best practice complaint management principles
and a consistent approach across the ATO. For example, the new centralised
complaint-recording system of November 2004 included an area dedicated to
resolving systemic issues. While we will continue to monitor this area, the
ATO’s responsiveness suggests a cultural commitment to complaints resolution
within the agency…
While it may be impossible to create a perfect system, the
ATO has worked hard to provide for fair and responsive remedial mechanisms to
ameliorate any mistakes that do occur.[68]
1.70
Over the past four years, the Inspector-General of Taxation has
conducted approximately four reviews annually of the ATO. In a follow-up review
of six inquiries, the Inspector-General found that the ATO had accepted 65 out
of 73 recommendations. Further, of these 65, the ATO had either implemented or
partly implemented 62 of them.[69]
1.71
Being subject to reviews by the ANAO, Inspector-General and Ombudsman, it
is clear that the ATO is under heavy scrutiny. This evidence supports the ATO’s
claim that it responds positively to external reviews. The Ombudsman also
stated that the ATO’s willingness to improve has led to better performance:
The bulk of complaints we see now going to the ATO are
perhaps best described as ‘low level’ or ‘modest’ in nature. Few complaints
raise concerns of broader systemic or other significance to this office. We see
very few complaints that reveal issues of institutional bias or bad faith. Most
of our complaints relate to ‘simple errors’, such as concerns about delay or
ambiguity in ATO correspondence or accounting errors, or relatively
straightforward disputes about tax assessments or a taxpayer’s level of debt…[70]
Our observations over the ten years’ operation of the
Taxation Ombudsman role within the Commonwealth Ombudsman’s office is that the
ATO is increasingly committed to providing an administration of the tax system
that strives to balance fairly the needs and interests of individual taxpayers
with those of the wider community. Most importantly, the ATO has recognised
that it will not always get that balance right, and so it has established
internal processes that are responsive to the concerns of individual taxpayers…[71]
1.72
The Committee is satisfied that, over a considerable period, the ATO has
developed systems and a culture of continuous self improvement that is now
demonstrated in improved performance.
Improving accountability and communication
1.73
One of the challenges facing the ATO is gaining community trust and
confidence in the tax system. One way in which this might be achieved is
through increased open dialogue with Senators and MPs.
1.74
At the public hearing for the inquiry on 9 November 2006, the Committee suggested to the ATO that the Commissioner and his senior executives could
attend six-monthly meetings with the Committee to give the ATO an additional
opportunity to communicate with its stakeholders. The ATO could also outline
the state of tax administration and describe its current challenges.
1.75
The model for the biannual hearings with the ATO is the six-monthly
meetings between the Reserve Bank and the House Economics Committee. At the
hearing in November 2006, the ATO agreed, stating, ‘We are happy to be open and
accountable’.[72]
1.76
Another purpose of the hearings could be for the Committee to scrutinise
the ATO’s public and product rulings. On occasion, concerns have been raised
that the ATO’s public rulings operate in effect much like delegated
legislation, but are not subject to Parliamentary oversight.[73]
In An Assessment of Tax, the JCPA suggested that one solution would be
for Parliamentary committees to examine public and product rulings.[74]
The biannual meetings between the current Committee and the ATO provide this type of opportunity.
1.77
On 20 April 2007, 21 September 2007 and 30 April 2008, the Committee held the first three of these regular meetings with the Commissioner in Melbourne, Canberra and Sydney. The meetings were constructive and supplied extra
information for this report. They also laid the basis for future, regular
meetings. Chapter two of this report gives an overview of the proceedings.
Recommendation 1
|
1.78
|
The Commissioner of Taxation continue to make himself
available twice a year to attend public hearings on the administration of the
tax system with the Joint Committee on Public Accounts and Audit in order to
promote an open dialogue between the ATO and the Parliament.
|
Overview of the inquiry
Conduct of the inquiry
1.79
Under section 8 of the Public Accounts and Audit Committee Act 1951,
the Committee has the power to examine the accounts of the receipts and
expenditures of the Commonwealth. On 7 December 2005, the Committee resolved to conduct the inquiry under the terms of reference listed at the front of the
report. In the first week of January 2006, the Committee called for submissions
by placing advertisements in the national newspapers with a due date of 24 February 2006.
1.80
The Committee received 58 submissions for the inquiry. Submitters
included the ATO, Treasury, tax groups, the ATO’s external scrutineers,
ex-employees of the ATO and individuals who had had difficult experiences with that
organisation.
1.81
The Committee held public hearings in Canberra, Sydney, Melbourne and Launceston between June and November 2006. The Committee then commenced its
biannual hearings with the ATO in April 2007. This meant that the Committee was
able to obtain updates on tax administration following the initial evidence.
Bureaucratic anticipation
1.82
A feature of some committee inquiries is ‘bureaucratic anticipation’
where governments address inquiry issues before the committee tables its
report.[75] This occurred during the
inquiry. For example, Ruddicks Chartered Accountants raised the issue of
Division 7A of the Income Tax Assessment Act 1936 with the Committee
during the Launceston hearings. The problem here was that loans from companies
to related trusts and partnerships were deemed to be unfranked dividends
(incurring tax of 48.5 cents in the dollar), even where there were legitimate
cash management reasons for the transfers.[76] On 6 December that year,
the then Government announced that it would introduce a number of reforms,
including removing the automatic debiting of the company’s franking account
when there is a deemed dividend.[77]
1.83
Another example involved the ATO’s general administrative practice. In
its submission, the Institute of Chartered Accountants in Australia (ICAA)
noted that the ATO practice statement PS LA 2003/3 stated that all draft
rulings reflected the Commissioner’s general administrative practice. This gave
taxpayers protection against penalties and, after RoSA, interest as well.
However, the Explanatory Memorandum to some of the RoSA amendments stated that
a draft ruling would ‘usually’ reflect general administrative practice where
this was the Commissioner’s only public comment on an issue. This is much less
certain for taxpayers. Further, they cannot be expected to follow all of the
Commissioner’s public statements.[78]
1.84
On 8 June 2007, the ATO amended its practice statement on precedential
views, including general administrative practice. The statement does not
confirm that draft public rulings represent the Commissioner’s general
administrative practice. Rather, it states that taxpayers are protected from
administrative shortfall penalties and shortfall interest if they follow a
draft ruling. In effect, this is the same as if draft rulings were general
administrative practice.[79]
1.85
The Committee appreciates that a number of groups are responsible for
bringing these issues to the attention of government. This Committee has not
been the only party seeking improvements in tax administration during the
inquiry. However, the Committee believes that the inquiry and the increased
scrutiny of the ATO during this period has assisted in encouraging the ATO and government to expedite their responses to these issues.
Structure of the report
1.86
The report is broadly laid out according to the terms of reference:
n chapter two deals
with the first three biannual meetings between the Committee and the
Commissioner for Taxation
n the third chapter
covers the impact on taxpayers and tax agents of self assessment and complex
legislation
n chapter four examines
rulings
n the fifth chapter
deals with compliance
n chapter six covers
penalties and interest
n chapter seven
examines the pay-as-you-go (PAYG) system and other aspects of tax administration.
1.87
Part B of the inquiry dealt with the interaction between fringe benefits
tax and family tax benefits. Because this issue is straightforward, it is dealt
with below.
Part B – fringe benefits tax and family tax benefits
1.88
At first glance, the amount of family tax benefits payable to a parent is
not affected by the tax system because the amount of benefit is not used to
calculate an individual’s assessable income. In other words, it is an exempt
payment for income tax purposes.[80]
1.89
The Committee’s concern related to fringe benefits tax and the extent to
which receiving a fringe benefit (which has tax implications) could affect an
individual’s eligibility for family tax benefit.
1.90
Treasury argued that receiving a fringe benefit should be relevant to
determining how much family tax benefit an applicant should receive. Just as
fringe benefits threatened the integrity of income tax in the 1980s, they could
potentially threaten the integrity of government benefits. For example, some
segments of the population could arrange to receive much of their income
through fringe benefits. This would reduce their incomes for the means testing
of benefits, and allow them to receive higher benefits than a scheme was
designed to provide.[81]
1.91
Treasury stated:
Requiring the reporting of fringe benefits enhances the
overall fairness of the taxation and welfare systems, by enabling the value of
fringe benefits to be considered in income tests used to determine entitlements
to certain income tested government benefits and liability to taxes, surcharges
and income tested obligations.
This minimises the scope for employees with access to salary
packaging arrangements to avoid obligations and obtain government benefits to
which they would not otherwise be entitled on the basis of their total level of
remuneration. Consequently, the measures improve the equity of the taxation and
social security systems. [82]
1.92
The Committee accepts this reasoning. The amount of fringe benefits an
individual receives is factored into the income tests for a range of Commonwealth
Government systems, including child support, HECS repayments, the Medicare levy
surcharge and family tax benefits.[83]
1.93
In its submission, Treasury assured the Committee that fringe benefit
amounts are not included in calculations of income tax. As Treasury stated,
‘the reporting of fringe benefits does not result in double taxation.’[84]
Conclusion
1.94
In 1984, the ANAO completed an efficiency audit on the ATO. It found that the system of administrative assessment, where the ATO accepted most of the
risk in its relationship with taxpayers, was placing the ATO under considerable pressure. This led to the introduction of self assessment, which is the
driving principle of tax administration in Australia.
1.95
Self assessment requires taxpayers to accept a certain amount of risk.
If they make an error so that there is a tax shortfall, they must not only pay
this amount, but interest and possibly penalties as well.
1.96
This allocation of risk to taxpayers became very apparent following the mass
marketed investments schemes and employee benefit arrangements in the 1990s. Although
the ATO was legally justified in its delayed response to these avoidance
arrangements, its temporary inaction appeared to set a precedent to taxpayers
and led to rapid growth in the arrangements. This meant that when the ATO did take action, many taxpayers felt unfairly treated.
1.97
The main response was RoSA, which shifted some risk from the taxpayer back
to the ATO. The ATO now has less time in which to amend some categories of
assessments. A reduced interest rate (the Shortfall Interest Charge) is applied
to tax debts until the ATO issues the amended assessment.
1.98
Perhaps as a consequence of these schemes, some submissions sought to
shift some risk back to the ATO by arguing for a return to administrative
assessment. Given the experience of the 1980s, the Committee did not believe
this was appropriate. The lesson the Committee prefers to draw from this
history is that there is a fine balance of risk between taxpayers and the ATO under self assessment. This balance needs to be regularly monitored and refined when
necessary.