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  • Trends and latest findings

    Our current gap estimate for individuals not in business is based on findings from four years of our random enquiry program. We are seeing consistent results across years with the overall trend moving in a favourable direction.

    Internationally, tax gaps are difficult to compare. This is due to the large variations in legal and tax systems, market definitions, availability of data and the methodologies used to estimate gaps across tax jurisdictions.

    While the individuals not in business tax gap estimate is not directly comparable for these reasons, we used methodology that is used in similar tax regimes. The United Kingdom (UK) and United States of America (US) also use random enquiry programs to estimate some income tax gaps. They are considered best practice when estimating from large and homogenous taxpayer populations.

    In our random enquiry program, we found adjustments were made in both tax agent and self-prepared tax returns, including:

    • incorrect claiming of deductions for work-related expenses or rental property expenses (or both)
    • careless administration or careless preparation of a tax return.

    Lack of connection to income earned or substantiation for expenses were also significant issues.

    In establishing the gap estimate, we identified that unreported income from hidden wages contributed around $1.4 billion to the gap in 2017–18. This activity is considered to be part of the shadow economy.

    While the amounts over-claimed and under-reported by individual taxpayers may be small, collectively across a large population the overall revenue impact is significant.

    Table 1: Income tax gap – individuals not in business, 2013–14 to 2017–18

    Element

    2013–14

    2014–15

    2015–16

    2016–17

    2017–18

    Population (m)

    10.2

    10.4

    10.6

    10.8

    11.1

    Gross gap ($m)

    7,369

    8,560

    9,037

    9,013

    9,102

    Amendments ($m)

    823

    801

    707

    833

    770

    Net gap ($m)

    6,547

    7,759

    8,330

    8,181

    8,332

    Tax paid ($m)

    111,141

    118,588

    125,184

    128,643

    140,161

    Theoretical liability ($m)

    117,688

    126,347

    133,514

    136,823

    148,493

    Gross gap (%)

    6.3

    6.8

    6.8

    6.6

    6.1

    Net gap (%)

    5.6

    6.1

    6.2

    6.0

    5.6

    Figure 1 displays these trends as a percentage.

    Figure 1: Gross and net tax gap percentage – individuals not in business, 2013–14 to 2017–18

    Figure 1: Chart showing the gross and net gap in percentage terms as outlined in Table 1.

    The random enquiry program

    Within our random enquiry program we randomly select and profile a sample of individual taxpayers who are not in business. People in the sample identified as low risk are not inconvenienced by being investigated further.

    Details are verified where we can confirm the tax return data by matching all material amounts with our third-party data. We refer to these taxpayers as the 'verified' portion of the sample. While these taxpayers are not manually reviewed, they remain part of our overall sample, contributing to our gap analysis.

    The remainder of the sample progress to a review (the random enquiry program). Once we have gathered information from the random enquiry program, we estimate the gap by using the incidence rate of adjustments and mean value of amendments resulting from non-compliance. Adjustments refer to the changes we make to items on a tax return to correct errors identified as part of the review process.

    This method provides insights, not only into the value of non-compliance but also into the proportion of the sample (and by extension the population) who are incorrectly reporting.

    Findings from the random enquiry program

    The random enquiry programs from 2013–14 to 2016–17 saw 1,948 reviews undertaken across a representative sample of the individuals not in business population.

    The two years from 2015–16 to 2016–17 comprised a total of 1,090 cases that informed our most recent year's estimate. Of these cases, 897 involved manual reviews, while 193 were verified using third-party data.

    This sample was large enough to provide a suitable representation of the population. It is proportionally similar to, or greater than, other comparable countries' programs (for example, UK and US).

    During the selection process the population was stratified across all income bands to ensure the overall population was appropriately represented. Taxpayers in the tax-free threshold and low to very high incomes were represented as well as taxpayers with rental properties.

    We used a confidence interval to quantify the 'precision' of the estimate. This is discussed in detail in the Limitations section. We are confident that the true value of the net gap in 2017–18 lies between 4.9% to 6.3%, or $7.2 billion to $9.4 billion. The sample includes taxpayers who lodged through various channels. The proportion of agent-prepared tax returns in the random sample was representative of the total individuals not in business population.

    In the full sample of 1,090 cases the incidence of adjustment was 78%, with 85% of agent-prepared returns being adjusted. This compares with 63% of returns adjusted for people who prepared their own tax return (self-preparers).

    On average we made three item adjustments per income tax return. The median increase to taxpayers' taxable income (income less deductions) was $1,288. While individually this amount may not be large, when tallied across the whole population, the effect is significant.

    There were 53 cases where we decreased tax payable. This included 10 cases where we adjusted solely in the taxpayer’s favour. There were six additional cases where we adjusted solely in the taxpayer’s favour but with no effect on tax payable.

    Across the random enquiry program, there were more adjustments to income items in the self-prepared tax returns. Adjustments to deduction items (including rental expenses, work-related expenses, gifts and donations and other deductions) were higher for agent-prepared tax returns.

    Table 2: Overview of the 2015–16 to 2016–17 random enquiry programs for individuals not in business

    Cases

    Sample
    (no.)

    Agent-prepared sample
    (no.)

    Agent-prepared sample
    (%)

    Self-prepared sample
    (no.)

    Self-prepared sample
    (%)

    Manually reviewed cases

    897

    669

    75

    228

    25

    Verified cases

    193

    90

    47

    103

    53

    Total finalised cases

    1,090

    759

    70

    331

    30

    Table 3: Comparison of the incidence of adjustment in all finalised cases for the 2015–16 to 2016–17 random enquiry programs for individuals not in business

    Cases

    Full sample
    (no.)

    Full sample
    (%)

    Agent-prepared sample
    (no.)

    Agent-prepared sample
    (%)

    Self-prepared sample
    (no.)

    Self-prepared sample
    (%)

    Cases with adjustments

    852

    78

    642

    85

    210

    63

    Cases with adjustments only in the taxpayer’s favour

    15

    1

    10

    1

    5

    2

    Note: The distribution of the value of the item adjustments show that 38% of adjustments are $150 or less and 24% are over $1,000.

    Table 4: Distribution of item adjustment rates and values in the 2015–16 to 2016–17 random enquiry programs (percentage) for individuals not in business

    Range of adjustments

    Self-prepared % of all adjustments

    Self-prepared % of values adjusted

    Agent-prepared % of all adjustments

    Agent-prepared % of values adjusted

    Total % of all adjustments

    Total % of values

    $0–$150

    8

    <1

    31

    1

    39

    2

    $151–$300

    4

    1

    11

    2

    15

    3

    $301–$500

    2

    1

    8

    2

    10

    3

    $501–$1,000

    3

    1

    9

    5

    12

    6

    More than $1,000

    5

    22

    19

    64

    24

    86

    Total

    22

    25

    78

    75

    100

    100

    Analysis indicated that adjustment rates were broadly similar across types of tax agent practices and locations, although rates for tax agents in small tiers were slightly higher.

    Based on the analysis and findings of the random enquiry program and insight from our overall engagement program, we can highlight themes that contribute to the gap.

    When we look at the most recent tax gap year estimate we draw on the last two years of the sample only. Figure 3 shows a breakdown of the individuals not in business tax gap by the different drivers for the most recent years estimate.

    Figure 2: Net tax gap breakdown by driver for individuals not in business, 2017–18

    Figure 2 Graph showing the breakdown of the net tax gap by the four main drivers: work-related expenses 52%, rental expenses 18%, hidden income 17% and other 13%.

    What is driving the gap

    Through our analysis, we have found several main areas that are contributing to the individuals not in business tax gap.

    Find out about:

    Work-related expenses

    Work-related expenses are a key component of the individuals not in business income net tax gap. The work-related expenses net gap was estimated to be $4.4 billion.

    Each case can have multiple adjustments across the tax return. Of the 3,505 adjustments made in identified cases, around 79% related to deduction items, with 48% or 1,688 of adjustments made at work-related expense items. Of those work-related expenses adjustments, 78%  or 1,320 were made in agent-prepared returns.

    Common reasons for adjustments in the random enquiry program included:

    • claims for expenses that were actually paid for or reimbursed by the employer
    • claims that appeared legitimate, but could not be substantiated
    • mistakes and guesswork relating to apportioning work-related expenses
    • claims for ‘standard’ deductions where exceptions to substantiation provisions exist.

    Many taxpayers believed they did not have to explain their claim if a substantiation exception was applicable.

    Work-related expenses adjustments and reasons

    The following two pie charts display the number of adjustments to work-related expense items and the reasons for these adjustments.

    The highest rate of adjustments was for 'other expenses' – in particular incorrect claims for home office, mobile phone and internet. Claims for clothing and car were also frequently adjusted.

    Figure 3 shows the number of adjustments to work-related expenses.

    Figure 3: Number of adjustments to work-related expenses

    Figure 3: Chart showing a breakdown of the types of work–related expenses adjustments and number of times they occurred: car 305, travel 127, clothing 529, self-education 63 and other 666.

    Figure 4 shows the reasons for these adjustments.

    Figure 4: Reasons for work-related expense adjustments

    Figure 4: Chart showing the percentage breakdown of the reasons for adjustments made for work-related expenses: nexus and substantiation 28%, substantiation 27%, over-claimed 11%, calculation error 7% and other reasons combined 16%.

    Undeclared income

    Income that has been omitted, particularly cash wages and income from the sharing economy, also contributes to the tax gap for individuals not in business.

    Some people don't declare income and payments to avoid paying the right amount of tax or superannuation. For example, some businesses may pay their employees 'cash-in-hand’ and some taxpayers do not report all the cash income they earn in their tax return.

    We estimate the portion of the tax gap for 2017–18 attributable to unreported income was $1.4 billion.

    Identifying non-declared wages is difficult, even in a random enquiry program. To account for the impact of undeclared cash wages (an aspect of the shadow economy), we take a different approach.

    In separate top-down methods (the pay as you go (PAYG) withholding gap and the super guarantee gap) we have identified that an uplift factor of 1.2% needs to be applied to the national accounts wages to account for cash wages.

    We convert this amount to an income tax amount. We apportion the amount to the individuals not in business population based on the population proportion.

    Our approach to addressing the non-reporting of cash wages is incorporated in our shadow economy strategy.

    Other findings and observations

    Observations from our broader compliance activities reinforce findings from our random enquiry program – further supporting our understanding of what is driving the gap.

    Deductions for rental property expenses are also a key contributor to the gap. The rental component of the individuals not in business net tax gap is estimated to be $1.5 billion.

    Our observations indicate that the most common reasons for adjustments to rental items on a tax return are a lack of, or incorrect, apportionment of expenses.

    This includes, for example, deduction claims where the property was only available to rent for part of the year. Or claims for interest expenses where a portion of the loan was used for private purposes. We also see mistakes relating to capital works and capital allowance deductions.

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      Last modified: 19 Oct 2020QC 56246