Do you see what I see? – Speech by the Commissioner of Tax in Australia
Speech by the Commissioner of Taxation
to the 22nd Australasian Tax Teachers Association Conference 2010,
University of New South Wales, Friday 22 January 2010
(Check against delivery)
As academics and teachers, and thus keenly interested observers of and commentators on all things tax-related, you will know that, for the most part, Australians will generally comply with the tax laws given the right circumstances.
The challenge for the ATO in both good times and not so good is to nurture an environment that is conducive to high levels of voluntary compliance, which engenders trust and confidence in the ATO and in Australia’s tax and superannuation systems.
The advent of the global financial crisis meant we had to be palpably responsive to the needs and circumstances of people and businesses facing genuine financial difficulties1 and to increasing risk levels that threaten the integrity of these systems.
The economic downturn created a very different and highly volatile risk environment. As a result, we saw a greater community need for assistance in meeting day-to-day tax obligations and a climate in which more aggressive practices ramp up in response to pressures to drive down costs.
Our approach to compliance has been to strike a balance between efficiency and fairness. We are not resourced to collect every last dollar owing. So we make informed, risk-based choices on where to best apply our efforts and resources.
We focus our compliance work on the highest risk areas identified through analysis techniques such as taxpayer risk profiling. By risk we mean areas where potentially the system may not be working as it should. This could mean that taxpayers are not accessing benefits they are entitled to, or that the law is not achieving its policy objective, or that people are not properly complying with the law.
As I said in my opening remarks, Australians generally comply with the tax laws given the right circumstances. Indeed, some studies have shown there are about twenty percent of people who will comply regardless of what influences there are to choose otherwise. Another sixty percent or so are influenced by what the remaining twenty percent do2.
One area of focus for us therefore is those taxpayers who are, or are likely to become, risk takers as far as compliance with tax or superannuation is concerned.
The concept of risk management also takes into account the consequences of certain activities on the community.
For example, the value, volume and complexity of transactions undertaken by large businesses have inherent risks for tax compliance. Even if the likelihood of potential non-compliance is low, the consequences may be significant. Importantly, what the higher risk taxpayers, or risk takers, do often sets the tone in the market. The 60 per cent that are influenced by the behaviours of others are more likely to take more risky positions if the higher risk taxpayers are seen to be prospering from their posture3.
For example, if we don’t get on top of a tax advance scheme early on, then risk-neutral people may well perceive that such activity reflects a legitimate market practice4. Similarly, some players adopt a practice over time and others, driven by competitive pressures, may follow, leading to an industry practice that may accord with neither the letter nor the spirit of the law.
This is a major challenge for us in managing the community’s tax system in a fair and effective manner. The specific task for the ATO is to allocate the scarce resources we have to deal most effectively with those and other risks. And if risks are not brought to our attention, or we do not identify them early, or if we misjudge their significance, then people might find solace in risky tax behaviour (whatever may have been their original intent).
Whatever the tax — and, as the Australia’s Future Tax System Review5 has identified, there are many possible variations — the real challenge for tax administrators is to administer the laws in a balanced manner that maintains high levels of community confidence. Our business model is about:
- helping people understand their rights and their obligations
- improving the ease of compliance and access to benefits, and
- managing non compliance, within the context of finite resources.
Australia’s strong culture of voluntary compliance means that our strategies are highly geared to helping people and businesses comply and can be summed up, wherever possible, as prevention is better than cure.
But supporting honest taxpayers means that we also have to be firm in response to tax avoidance or evasion. People who try to meet their obligations expect the ATO to pursue those that deliberately avoid theirs — this is the level playing field — and deterrence is one of the levers we use as part of our compliance model.
We also have a responsibility to challenge contentious issues, where there are reasonable legal grounds for doing so and the outcome is at odds with the underlying policy intent. Where the law properly interpreted produces results at odds with the policy intent, then we are bound by the law and the rights or consequences that it produces. Nevertheless, we also have a responsibility to bring such matters to the attention of the Government.
Our compliance model
Crossing the ‘bridge’ to compliant behaviour requires taxpayers, or their agents, who:
- know what compliance is — they understand what is required of them and what they need to do to be compliant or to access their benefits
- want to comply — an attitudinal aspect influenced by many factors such as their moral compass, their immediate circumstances such as financial pressures, the behaviours of their peers, their view of risk, and the fairness of the system and its carrots and sticks, and
- can comply — a capability aspect influenced by their natural systems and the requirements of the law.
This is reflected in our compliance model, which is a framework for choice of remedy that explicitly takes into account the causes of non-compliance and the postures taken by different groups of taxpayers6.
Risk differentiation
So, our compliance model is strategic for informing a view as to the appropriate choice of remedy. But, with finite resources, we must also have a means of effectively determining where the risks lie in relation to particular taxpayers or groups of taxpayers.
For example, size differential follows a Pareto distribution, with only 20 per cent of businesses accounting for more than 80 per cent of total income tax collected. The same applies to risk with relatively few taxpayers being both relatively higher in likelihood and in consequence of non compliance. Looking at the Pareto nature of Australian taxpayers, it becomes obvious that we need to differentiate our engagement with different taxpayers.
The following illustrates how differentiation based on our risk framework works in the large business sector.
Higher and medium risk taxpayers
Higher risk are those taxpayers who are, or likely to become, risk takers in regard to their tax and the consequences of non-compliance by them are high7.
Indicative tax risk-taker attitudes include statements such as: ‘I’d rather pay lawyers than pay tax’, ‘lodging a tax return is the start of negotiations’, and ‘tax is an impost to be avoided where possible’.
Interestingly, when we do differentiate on the basis of risk, we find that in relation to large Australian businesses there are relatively few taxpayers that are high risk8.
Medium risk taxpayers are those taxpayers who are perceived to have a relatively higher likelihood of non compliance, but the consequences are considered to be relatively lower.
A more sizable percentage of large businesses fall into this category comprising not more than 250 corporate groups. Often the issues here relate to a particular transaction or arrangement, noting that there can often be reasonable differences on how the law operates in complex and dynamic real-world circumstances.
Key and lower risk taxpayers
Key taxpayers are taxpayers who are perceived to have a lower likelihood of getting the law wrong but, if non compliance occurred, it is likely to have a higher relative consequence. These taxpayers tend to be more tax risk neutral. If you look at the likelihood factors, key taxpayers tend to report the right amounts of profits and pay the right amount of tax given their own facts and circumstances. They pay about seventy percent of the tax base in the large market and there are some 80 or so corporate groups of this category in the large market.
Lower risk taxpayers make up the largest numerical group of taxpayers in the large market. They are perceived to have relatively lower likelihood and consequence of contravening tax laws or of not accessing their entitlements. The majority of our large corporate groups are in this category.
Depending on how you count the economic groups and their turnover for the year, that’s about six or seven hundred of them in the large market.
Key and lower risk taxpayers might be expected to have more of the following behaviours:
- relatively high effective tax rates over time that accord with expected patterns and trends, peers and past practice
- no significant history of material adjustments relating to aggressive tax planning (though that is not to say that we don’t have disputes or differences of opinion on the tax outcomes intended by law where the law is unclear)
- business driven structures and approaches
- significant transactions with related parties are at arms length rates with appropriate supporting documentation and governance
- use of advisers noted for advice that doesn’t push the boundaries of aggressiveness
- importantly, tax risk is an explicit, considered part of their corporate governance process. Due diligence is followed and objective advice is often sought, and
- upfront full and true disclosure of significant, potentially controversial tax positions via private or class ruling. They often seek our opinion regarding controversial issues and keep us informed of their decisions and actions.
A framework for risk differentiation
The intent of our risk differentiation framework is to suggest different treatment stances or engagement strategies to manage entities considered to be at ‘higher’ relative risk of non compliance to those perceived to be a ‘lower’ relative risk. It is really just basic commonsense, as well as a practical illustration of our risk management approach at work. It is also in line with a basic need that tax authorities internationally are responding to or looking to meet.
- ‘Put simply, tax authorities realised that they need to become better at predicting taxpayer behaviour and the consequent impact on tax revenue streams. They need to become better at allocating their limited resources to best effect, and they need to attract and retain a workforce with the diverse skills and abilities necessary to deal with the many different challenges that the broad spectrum of taxpayers presents. In this environment, high-quality risk assessment is seen as fundamental to the ability of tax authorities to deal effectively with these challenges’.9
Frameworks are, of course, broad guides providing suggested stances rather than definitive action plans for a taxpayer, and our frameworks are merely indicative of cases warranting further consideration.
The risk categorisation does not prejudge in any way the outcome of a review of the taxpayer, but is relevant to the likelihood of a review and of its intensity, formality and timing. Whether that review turns into an audit or adjustment depends entirely on the outcome of the review.
Our categorisation of a taxpayer’s risk is relative to other taxpayers (higher/lower) rather than absolute (high/low), so it is understandable that a taxpayer classified as higher risk may have a different view. Higher risk taxpayers are most likely to disagree with or dispute our categorisation of their risk. A relevant case in this regard is Industrial Equity Limited & Anor v. Deputy Federal Commissioner of Taxation & Ors 90 ATC 5008 which canvassed many of the issues and noted in its judgement:
- ‘It is entirely consistent with the Act that the Commissioner should, at one time, decide to look more closely into the affairs of particular categories of taxpayers as well as particular taxpayers, with a view to ascertaining their taxable income, irrespective of whether an assessment or an amended assessment has issued’.10
Strategies or engagement stances suggested by the risk framework
Key taxpayer and lower risk groupings
For our key taxpayer grouping, the framework suggests an ongoing engagement with this group of large taxpayers. They are responsible for paying most of the tax in the large market, and the withholding of substantial amounts of PAYG(W).
These taxpayers generally seek to comply with the law (particularly where we help clarify our view on contentious issues) or will dispute our view of the law in a relatively open fashion should they disagree.
Taxpayers in this category include most of Australia’s largest businesses. These taxpayers are material leverage points in the tax system — what they do matters a great deal to the overall health of the system.
We view these key taxpayers as generally compliant (though that does not mean we don’t sometimes have disputes or differences of view where the law is unclear) and they are more likely to have approached us for a ruling in regard to controversial or contentious tax matters.
We generally have a broadly cooperative and consultative relationship with them. Many of them are also members of our consultative forums such as the Large Business Advisory Group.
Increasingly, large businesses are subscribing to the benefits of a more open working relationship with the ATO. We have been pleased with the progress over the past few years. Our Annual Compliance Arrangements (ACAs) with large companies provide them with a new way of locking in high levels of practical certainty.
The strength of the ACA is in the dialogue between the taxpayer and the ATO which means uncertain, challenging or complex matters can be dealt with in real time. It’s all about managing tax risk with minimum compliance costs.
The ACAs and the Lead Relationship Manager service, which we are currently piloting with a group of large companies, are approaches that are part of this more cooperative service and certainty-oriented relationship11. They are based on the company group itself having a robust tax risk governance framework which guides its decision making:
- ‘While the context and content differ from country to country, there is a clear global trend toward more active engagement by tax administrators in understanding the tax risk management policies of their constituent taxpayers’.12
In a real sense we are relying on the strength of their risk management and governance frameworks to mitigate risk almost as much as these entities are.
Hence we have a particularly keen interest in how they go about this. Do their internal systems answer the right questions, or are they just collections of sanitised data that pass the weight test?13
Where there is a dispute, the focus is on a speedy resolution, for example, using alternate dispute resolution approaches to resolve matters quickly and efficiently. However, where matters of principle are at stake, the courts are available to clarify rights and responsibilities.
For our lower risk taxpayers, where the largest numbers of large taxpayers sit, our risk differentiation framework suggests regular and systemic monitoring through analytic risk tools. For example, looking for unexplained changes in effective tax rates, or significant transactions that allow for opportunistic tax planning, such as a merger, major acquisition or disposal that could shift the taxpayer to medium or higher risk.
To the extent that we can, we are happy to work with our key taxpayers and lower risk taxpayer groupings to make it easier for them to comply, reduce their compliance costs and provide greater practical certainty to them.
We don’t want to waste their time (and ours) chasing shadows or shadow boxing where a more open disclosure, discussion and understanding could quickly confirm good compliance habits and provide greater certainty for the taxpayer.
As Drucker said ‘there is nothing so useless as doing efficiently that which should not be done at all’.14
Medium risk
For our medium risk taxpayers, lower on the consequence side of things, but considered higher on likelihood of potential non compliance, the risk differentiation framework suggests a periodic, leveraged review and treatment approach.
We are looking to have more efficient, timely and focused reviews of these taxpayers on the specific issues that arise with this group.
Their risk reviews are more likely to be part of a project involving taxpayers with fairly similar issues so that we can more efficiently and consistently deal with such matters.
We piloted this project approach in the large market with what we called ‘Book to Tax’ reviews. Those taxpayers reviewed as part of this project had significantly shorter cycle times for a similar outcome to those reviewed using our more traditional comprehensive review approach.
The Book to Tax project was initiated on 1 July 2008 with a focus on approximately $9 billion of book to tax differences.15 The project approach delivered intensive risk reviews that examined tax reconciliation adjustments, group structures, tax returns and schedules, financial statements, and other sources of information, culminating with a visit or phone discussion with the taxpayer about the outcomes. The reduced cycle time not only has opportunity cost benefit for the ATO but is also less intrusive for the taxpayer (thereby reducing their compliance costs).
We will be extending this type of approach to projects on transfer pricing, loss generation and utilisation, and capital gains tax this year.
Higher risk
For our higher risk grouping, our risk differentiation framework suggests ongoing and visible coverage through review and treatment of the relatively few taxpayers who are considered by us to be relatively more likely to be non compliant and presenting a relatively higher consequence if they are.
We aim to be ‘real time’ with this group because it matters to the rest of the market and sets the tone of compliance in the broader market as well as the community more generally.
These higher risk taxpayers are usually less likely to have approached us for a ruling or to be open and transparent with us in relation to all the relevant facts.
Certainty for these taxpayers is not in relation to their tax position but rather a certainty that they will be reviewed by us. Such an experience will be fair and professional but may also be quite formal and intense.
Responsive regulation
With the best will in the world, we will not be able to review or audit every taxpayer, nor would we want to.
What we are increasingly saying to taxpayers and their advisers is, ‘here are the behaviours that would cause us to look at you. If you exhibit any of these, you will probably hear from us’. This dialogue is part of helping taxpayers keep ‘between the flags’. It also assists companies with their corporate governance. Our intense focus on the few higher risk taxpayers is also deliberate as it supports a more level playing field.
If we are unsuccessful in deterring, detecting and dealing appropriately with aggressive behaviours, then the bar of what is acceptable in the market is lowered and more taxpayers may become accepting of risky behaviours.
Breakouts of behaviours that push the envelope on what is legitimate are more likely to occur when the regulatory system is slower than market cycle time to act. Where there is a lack of transparency in what is happening in the marketplace, and if communication between taxpayers, their advisers and professional associations and the ATO is poor, Australia’s tax system suffers.
Seeking real time intelligence
To enhance certainty for business, our framework emphasises action (compliance activity, including reviews) in ‘real time’. In terms of knowing our taxpayers, the idea with key taxpayers and higher risk taxpayers is to know what they’re doing now — not what they did four or five years ago.
The more efficient we are with our medium risk and lower risk taxpayers, the more we can afford to invest in our higher risk taxpayers and on behaviour that pushes the envelope on what is fair and reasonable in accordance with the law.
Conclusion
Ultimately it is the taxpayer’s choice as to the level of risk they want to take. Where the tax outcomes are material such a choice should be an informed and considered choice. This is where good tax governance and robust due diligence intersects with management arrangements and the appearance (which may possibly be an illusion) of a more favourable short term bottom line.
Indeed, managing tax risk within a sound governance framework is the best strategy for companies seeking to avoid unwanted attention by the tax administrator, the distractions and demands of such attention, as well as any disputes, consequences and reputational risks that may arise.
Where risk levels are high (and arguably beyond the boundaries set by the law) the courts or Parliament will be the final arbiters.
One of the changes that appears to be emerging from the global financial crisis is a greater understanding of the importance of prudent risk taking — with a long term view of profitability and sustainability.
