On Thursday 12 July 2018, the Commissioner released his income tax ‘gap analysis’ of gap between the tax individuals (not in business) ought to have paid, had they been fully compliant and the tax they actually paid. The head line is that the ‘gap’ is bigger than the corporate sector, but there is more to be said about that. Also, I’ve always wondered about how reliable this ‘gap analysis’ is, and what the procedure is.
The answers to some of these questions can be found in this week’s message, from The Tax Institute’s Senior Tax Counsel: Bob Deutsch, in their weekly broadcast email to Institute members: TaxVine (No. 26). I have reproduced it below.
**********************
Tax gap – no room for complacency!
The ATO has today released the individuals (not in business) tax gap information covering 2013-2014 and 2014-2015.
The income tax gap is an estimate of the difference between the total amount of tax that is collected from individual taxpayers who do not run any form of business and the amount which the Australian Taxation Office believes it would have collected from that group if every taxpayer was fully compliant with the law. In other words, this measures the deficiency in tax collected from individuals not in business in Australia. In the 2014-2015 year, that difference is about $8.7 billion and in the previous year about $7.4 billion. In percentage terms, the amount across the two years is very similar.
There are some limitations in the estimates, most particularly:
- The estimates only span two years and it may be that different results will emerge if the estimates are calculated for additional years. There is no way of telling in advance whether the figures for later years would be better or worse, but I would reasonably expect that they would be roughly the same;
- The gap analysis was conducted using international best practice which included random inquiries, but the total number of inquiries made was 858 cases out of a total possible 9.6 million taxpayers. This looks to be statistically on the low side, although we are given some assurance by the ATO that the sampling is in accordance with international best practice.
More importantly, in measuring the gap, an independent expert panel was used which included Professor Neil Warren from the University of NSW, Richard Highfield, a tax professional who has worked previously with the IMF and the OECD, and Saul Eastlake, an independent economist with experience in the area. In addition, Stephen Frost, a former Deputy President with the Administrative Appeals Tribunal has independently confirmed the accuracy and quality of the sample of the audit results that underpin the gap analysis. It would, in my view, be difficult to find more capable people to undertake this task.
There are some key findings that emerge from the analysis.
First, the individual tax gap sits at $8.7 billion which is substantially larger than the comparable figure for the corporate tax gap, namely $2.5 billion. On its own, this would suggest that the extent of non-compliance by individuals is substantially higher than by companies. However, upon closer examination it becomes clear that the figures are quite comparable – as a percentage of the tax that would have been collected if everyone was fully compliant with the law the individuals gap is 6.4% and the corporate gap is 5.8%. The individual gap estimate is still worse than the corporate tax gap estimate but not nearly to the extent suggested by the raw numbers.
Secondly, in conducting random reviews of tax returns of individuals not in business, the ATO has found 70% of returns had one or more error. Many of these errors were small but avoidable. Some were quite deliberate.
Thirdly, according to the information released by the ATO, the level of errors in returns prepared by agents were higher than in returns prepared by self-preparers. More specifically, of the 858 cases examined, 78% of the agent prepared returns were adjusted, whereas only 57% of the returns prepared by self-preparers were adjusted.
In agent prepared returns, the most prevalent error related to work related expenses with a number of claims being made for expenses that were actually paid for or reimbursed by the employer and many where the expenses looked legitimate but could not be substantiated. There were also mistakes relating to the apportioning of work-related expenses, and claims for standard deductions where exceptions to substantiation provisions exist.
Work-related expense adjustments were particularly prevalent in relation to clothing and cars.
While the error rate in tax agent prepared returns is clearly of concern to the Institute, the blame cannot sit entirely with agents for two reasons in particular:
- First, apart from pre-filled information (which usually does not extend to deductions), agents preparing tax returns are very much reliant upon information given to them by their taxpayer clients. If clients provide incorrect or misleading information which is not easily recognised as being incorrect or misleading on its face, it is difficult to see how agents can be held solely responsible;
- Secondly, the ATO took a long time to get on top of this issue particularly in relation to small claims which on a macro level add up to a lot of lost revenue. This resulted in an air of complacency which may have reflected the manner in which taxpayers interacted with their tax agents.
Notwithstanding all those caveats, looking to the future the message from all this for agents in the context of work-related expenses is abundantly clear – a clearer, more focussed and robust approach to the claiming of deductions by taxpayers is essential. Agents need to explain to taxpayers that:
- They must have incurred an expense before it can be claimed as a deduction;
- Reimbursed expenses cannot be claimed;
- The expense must have a reasonable and identifiable connection with their work;
- They need to be able to substantiate expenses beyond $300. Even below that figure, they need to be able to prove that the expense was incurred, and that it related to their work.
For too long, there has been a degree of complacency on both sides of the tax spectrum in relation to claiming deductions. The ATO is now taking active steps to address this and agents need to respond by ensuring better compliance by taxpayers to the extent that they are able to control that.
Kind regards,
Bob Deutsch, CTA
***********************
[ATO website: Individuals Tax Gap, Detail on Gap; Gap Methodology; LTN 132, 12/7/18; KPMG Daily Tax News, 12.7.18; Tax Month – July 2018]
Comprehension questions (answers available)
- Is the analysis for the 2016/17 year?
- Are the 858 individuals, selected for random audit, 1% of the total number of taxpayers who are individuals?
- Is this a statistically significant sample?
- Is this supposed to be ‘international best practice’?
- Does the Commissioner have an ‘expert panel’ trying to make the most of this very small sample?
- Is the gap for individuals $8.7 billion, compared with the equivalent corporate tax gap of $2.5 billion?
- Does this reduce to a very comparable level of compliance, between individuals and corporates of 6.4% and 5.8% respectively?
- Of the 858 sampled, were 78% of the agent prepared returns were adjusted, and only 57% of self-prepared returns adjusted?
- Can the Tax Institute, which represents a huge number of ‘tax agents’ just ignore this?
- Can deductions be claimed for amounts up to $300, without being incurred?
