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  • Large corporate groups income tax gap

    The large corporate groups income tax gap is the difference between the total amount of income tax collected and the amount we estimate would have been collected if every one of these taxpayers was fully compliant.

    A large corporate group is defined as a corporate group with gross income of over $250 million in a given income year.

    In 2015–16, large corporate groups reported $1.7 trillion in gross income and paid approximately $40 billion in tax.

    Our estimate of the net gap for large corporate groups covers a seven-year period from 2009–10 to 2015–16. For 2015–16, we estimate the net income tax gap to be $1.8 billion or 4.4% of tax payable for this group. The gap primarily reflects differences in the interpretation of complex areas of tax law.

    The large corporate groups income tax gap has been decreasing in recent years, coinciding with improvements we've made to our methodology to increase the accuracy of our estimates.

    For our current estimates undertaken in 2018, we made two significant improvements to our estimation methods:

    • The first involves incorporating information about the large corporates in which we have justified trust. Increasingly, more of this information becomes available through our assurance activities, allowing us to produce estimates we have greater confidence in.
    • The second is in the way we project the tax gap. While our latter year estimates were previously made up entirely of projections, we now use additional information that we currently have to inform these estimates. Combining this information with projections allows us to more accurately estimate the tax gap for years where we do not yet have complete information.

    The refined methodology has now been applied across the full data series, resulting in changes to previously published gross and net gap estimates for 2009–10 to 2014–15. This is a standard practice in gap estimation.

    In this document, we discuss the large corporate groups population, how we measure their income tax gap, and the action we're taking to sustainably reduce the gap.

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    Tax and large corporate groups

    The large corporate groups population makes a significant contribution to the Australian economy and the tax system. We talk about this in Tax and Corporate Australia, along with how our work with large corporate groups gives us confidence that the majority pay the right amount of tax. Our confidence comes from improved capability and targeted strategies, as well as legislative provisions strengthening the tax laws.

    We recognise and understand that economic cycles and timeframes for return on investment can affect the profitability and tax payments of large corporate groups. This means they may sometimes make economic losses and pay no tax.

    We also realise that some large corporate taxpayers undertake aggressive tax planning. We monitor and examine this activity closely to address interpretation issues, and respond with firm compliance action where it crosses into tax avoidance. The tax gap reflects where this planning crosses the line. Our public advice and guidance program is an important approach to reduce the spread of such tax planning and ensure the gross tax gap doesn’t increase.

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    Measuring the gap

    The large corporate groups income tax gap reflects only the compliance gap. It doesn't include the impact of tax concessions or other legislated benefits, meaning it doesn't measure the policy gap.

    The income tax gap estimate is calculated using a bottom-up illustrative approach, with expert views informing the assumptions. A high level of taxpayer engagement, combined with data we capture, also informs these estimates. We use our operational data to estimate the total value of non-compliance across the market.

    Each year, as more data comes to hand and matters are resolved, we not only estimate the most recent year, but also re-estimate the gaps of preceding years.

    Complexities around interpretation of the law are predominantly what drive the gap for the large corporate groups population. Some of the most common issues that have given rise to an adjustment in recent years are:

    • profit shifting (including transfer pricing and thin capitalisation)
    • treatment of offshore income and the use of controlled foreign companies
    • business restructures
    • debt–equity tax arbitrage.

    The reliability of the large corporate groups income tax gap is assessed as medium.

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    Trends and latest findings

    The tax gap for large corporate groups has been relatively steady for a number of years, decreasing slightly over the later years. The net gap has ranged between 6.5% and 4.4% over the period of the estimates.

    The net income tax gap for large corporate groups is estimated to be $1.8 billion in 2015–16 (4.4%). We note that many corporate groups have lower taxable incomes than economic profits, and tax is not simply 30% of gross income. We discuss this in detail in Tax and Corporate Australia.

    Our results are similar to the HM Revenue & Customs (HMRC) estimate for the large business population in the United Kingdom, noting that HMRC's approach uses a slightly different definition of large corporate groups and methodology.

    Income tax returns for large corporate groups are adjusted on average by around $1.8 billion each year, excluding interest and penalties. A small number of high value adjustments account for most of the total value.

    The downward trend of the gap from 2013–14 to 2015–16 coincides with the expansion of our justified trust program and the improvements to our methodology. This program seeks to assure the amounts paid by taxpayers, giving us confidence that we are receiving the correct amount of tax.

    The following tables show the tax paid, adjustments, and net and gross income tax gap estimates for the period 2009–10 to 2015–16.

    Income tax gap – large corporate groups, 2009–10 to 2015–16(a)

     

    2009–10 $m

    2010–11 $m

    2011–12 $m

    2012–13 $m

    2013–14 $m

    2014–15 $m

    2015–16 $m

    Tax paid

    34,940

    43,280

    45,776

    42,748

    43,744

    43,641

    39,775

    Gross gap

    3,307

    3,876

    4,739

    5,197

    5,153

    4,049

    3,774

    Amendments

    888

    1,373

    2,073

    2,213

    2,311

    1,983

    1,942

    Net gap

    2,420

    2,503

    2,666

    2,984

    2,842

    2,067

    1,833

    NOTE
    (a) The amounts for amendments include projections from 2011–12 onwards, as detailed in Step 2 of the methodology.
    Income tax gap – large corporate groups, 2009–10 to 2015–16

     

    2009–10 %

    2010–11 %

    2011–12 %

    2012–13 %

    2013–14 %

    2014–15 %

    2015–16 %

    Gross gap

    8.9

    8.5

    9.8

    11.4

    11.1

    8.9

    9.1

    Net gap

    6.5

    5.5

    5.5

    6.5

    6.1

    4.5

    4.4

    The following graphs show the trend in tax paid and the net income tax gap over the same period.

    Amount paid and net income tax gap – large corporate groups, 2009–10 to 2015–16

    This graph shows the amount of tax paid and the net tax gap in dollars, over the period 2009-10 to 2015-16. This information is available in the first table above this graph.

    Gross and net income tax gap (%) – large corporate groups, 2009–10 to 2015–16

    This line graph shows the gross and net large corporate groups tax gap as a percentage over the period 2009-10 to 2015-16. This information is available in the second table above this graph.

    Our actions to reduce the gap

    We understand the tax compliance of large corporate groups influences the confidence other taxpayers have in the fairness and integrity of our tax system. Addressing the large corporate groups income tax gap, therefore, improves willing participation by other taxpayers.

    By actively managing the key compliance risks that drive the tax gap, we seek to sustainably reduce that gap. We know that the best way to achieve a sustained reduction in the tax gap is to support high levels of voluntary compliance, and this recognition underpins all our strategies.

    The most significant compliance risks and how we are treating them are discussed in Tax and Corporate Australia. A key strategy is to provide targeted advice and guidance to the market, including safe harbours and self-assessment risk frameworks, to assist taxpayers to voluntarily comply and to reduce compliance costs.

    Our capacity and capability have further been bolstered with additional funding to establish the Tax Avoidance Taskforce. This funding has allowed us to expand our justified trust program to the largest 1,000 public and multinational groups. This will give us even greater insight into the compliance risks involved in the large corporate groups population and allow us to provide assurance over a significant portion of the tax paid by this population.

    We also provide advice to government, via Treasury, about potential opportunities for statutory law reform to improve the tax system. We do this when the law is difficult for both taxpayers and ourselves to apply, which can increase compliance costs. In addition, we suggest where the law can be strengthened to allow us to more effectively deal with compliance risks.

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    Methodology

    Income tax is payable by corporate groups to the Australian Government based on their annual taxable income. The tax rate applied to companies in the large corporate groups population is generally 30% of taxable income. However, there are instances where entities that are part of a large corporate group are eligible to apply the lower company tax rates.

    The large corporate groups income tax gap is the difference between tax paid by large corporate groups and the amount they should have paid. The gross gap is the difference prior to our compliance activities and the net gap is the difference after our compliance activities.

    The gap estimate is made on the basis of the law as applicable for the relevant income year. New or recent law changes will not be reflected in gap estimates.

    The methodology we have selected to estimate the large corporate groups tax gap is outlined below, along with details on assumptions made, limitations and data sources, and the reliability rating as assessed by an independent expert panel.

    Selecting the methodology

    In selecting a methodology, we researched and considered the full range of options available, including the various ‘top-down’ and ‘bottom-up’ methods.

    Following consultation with our independent expert panel, we produced our estimate using a bottom-up illustrative approach to determine the value of under-reported income tax from large corporate groups. This approach draws together detailed examination of data sources along with expert judgment and knowledge, which is used to estimate a picture of the tax gap across the whole large corporate groups population.

    The bottom-up approach is considered most suitable given the nature of the market, the design of the tax, and the data available. It is similar to the approach taken by other tax administrations, such as the United Kingdom’s HMRC estimates, which use risk registers and illustrative methods to estimate tax gaps for similar markets. HMRC's most recent large corporate groups estimate is available in Measuring tax gapsExternal Link on their website

    There is no independent data source that would make a top-down estimate a suitably reliable and credible estimate. While ABS data is available, data-sharing arrangements make this data partially circular with our data holdings.

    In the large corporate groups population, under-reported tax generally arises from differences in the interpretation of complex areas of tax law or tax planning. When combined with the narrow and heterogeneous population, bottom-up approaches that use statistical methodologies and random audit programs are difficult to implement to achieve credible and reliable results. Additionally, the number of random audits that would be required for a random audit program would make it too costly. Instead, our independent expert panel has endorsed the use of the illustrative approach to estimate the large corporate groups tax gap.

    We do not observe that these taxpayers participate in the black economy or related fraud and evasion and, therefore, have not made allowance for the impact of the black economy. We generally find that large corporate groups lodge income tax returns as required and pay the liabilities that are due.

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    Applying the methodology

    The gap is established on an accrual-based concept and, as such, late payments do not contribute to the gap. We use amendment data and assurance activities as the basis for our analysis.

    We followed six steps in applying the bottom-up methodology to estimate the large corporate groups tax gap.

    Steps to estimate the large corporate groups gap

    A visual representation of the six steps outlined below.

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    Step 1: Calculate amendments

    The results of amendments, both ATO initiated and client-initiated, are used to estimate the tax gap for the entire population. We use:

    • the actual result of compliance activities, including the adjustments from completed audits and reviews
    • taxpayer voluntary disclosures
    • expected future compliance outcomes for material amounts in dispute.

    We then sum amendments for the population to determine the total amendment result.

    Step 2: Project future amendments and calculate tax paid

    We project future amendments to account for the time lag between a return being lodged, and any final amendments that will be made. As complex cases often take a number of years to resolve, we may not receive additional income from the amendments until a number of years after the initial form was lodged.

    To account for future amendments, we use data on the value and timing of past amendments to project amendments we are likely to receive in the future.

    As we revise the gap in future years, we will use refreshed amendment information to update our amendment results and improve future projections.

    We calculate tax paid by adding the amendments from Step 1, which includes an amount of projected future amendments, and the total of voluntarily paid tax.

    Step 3: Integrate tax assured data

    We use our tax assured data in our estimation, so we can more accurately calculate expected amendments and derive a figure for non-detection. To obtain assurance over the tax we have received, we seek objective evidence that would lead a reasonable person to conclude a particular taxpayer paid the right amount of tax.

    Step 4: Calculate expected amendments

    Expected amendments consist of the additional tax expected to be raised if the ATO undertook compliance activity on the portion of the tax base that was not covered.

    We calculate factors based on the actual and projected amendments, and then discount these to account for the assumed lower risk of those not covered by our compliance activities. This reflects that our compliance activities are targeted to areas of higher risk.

    These factors are applied over the base to estimate the amount of expected amendments if compliance activity had been undertaken for the whole tax base. We apply the factor at a further discounted rate where the tax paid has been assured, to reflect our confidence in those amounts of tax paid.

    Step 5: Apply non-detection factor

    We uplift the estimates preceding this step to account for factors that are not detected. This figure is derived by applying uplift factors to the tax amounts based on the level of assurance. Given the higher intensity and confidence of amounts positively assured through our justified trust program, we apply a lower non-detection to those amounts factor compared to amounts we have not assured.

    Step 6: Estimate theoretical liability, gross gap and net gap

    We add together the results from Steps 2, 4 and 5 to determine the total theoretical liability. Voluntary tax paid (Step 2 minus Step 1) is subtracted from the theoretical liability to determine the gross gap. Amendments (Step 1) are subtracted from the gross gap to determine the net gap.

    Summary of estimation process ($ millions) by project period

    Step

    Description

    2009–10
    $m

    2010–11
    $m

    2011–12
    $m

    2012–13
    $m

    2013–14
    $m

    2014–15
    $m

    2015–16
    $m

    1

    Amendments(a)

    888

    1,373

    2,073

    2,213

    2,311

    1,983

    1,942

    2

    Tax paid(b)

    34,940

    43,280

    45,776

    42,748

    43,744

    43,641

    39,775

    3

    Tax assured(c)

    310

    1,193

    17,557

    19,724

    4

    Expected amendments

    1,332

    1,170

    1,255

    1,657

    1,507

    1,059

    987

    5

    Non-detection

    1,088

    1,333

    1,411

    1,326

    1,335

    1,007

    846

    6.1

    Net tax gap

    2,420

    2,503

    2,666

    2,984

    2,842

    2,067

    1,833

    6.2

    Gross tax gap

    3,307

    3,876

    4,739

    5,197

    5,153

    4,049

    3,774

    6.3

    Theoretical liability

    37,359

    45,783

    48,442

    45,732

    46,586

    45,708

    41,608

    NOTES
    (a) The amounts for amendments include projections from 2011–12 onwards, as detailed in Step 2 of the methodology.


    (b) Tax paid also includes amendments from step 1.
    (
    c) Tax assured amounts are not used directly in the calculation, but feed into our calculations of expected amendments (Step 4) and non-detection (Step 5).


     
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    Limitations

    Tax gap estimation for large corporate groups is difficult, with inherent uncertainty. Tax issues and the tax law are complex and contestable. Further, the estimates do not account for differences where there are alternative views on the appropriate interpretation of the tax law. In such circumstances, differences can exist between reasonably arguable positions presented by the ATO and taxpayers.

    Non-detection estimates are extremely challenging to measure. We have used new information, sourced through the justified trust program, to improve these estimates.

    The current methodology only provides an aggregated estimate of the large corporate groups tax gap. This may allow generalised comparisons with other taxes. But it doesn't measure relative risk between corporate groups or particular issues within this market.

    The gap estimate is a lagging measure, as compliance results take several years to flow through. This is due to the complexity of the market and the elapsed time associated with finalising ATO compliance activities.

    The assumptions used to construct this illustrative estimate are informed by actual data and expert opinion. The key assumptions are listed below.

    For large corporate groups we don't audit or review, we assume that: 

    • a certain degree of non-compliance with tax law occurs
    • the degree of non-compliance in these groups is less than those we do audit or review due to our risk-based approaches to engagement.

    For large corporate groups we do audit or review, we assume that: 

    • adjustments to their tax liabilities are representative of the value of non-compliance with tax law
    • we don't detect all instances of non-compliance
    • adjustments to their tax liabilities from completed audits and reviews are correct at law, at the time of estimation.

    For projected estimates, we assume that: 

    • past outcomes of audits, reviews, settlements and objections are accurate representations of future outcomes.
    • our assurance activities under our justified trust initiative will continue to change our gap estimates.

    Updates and revisions to previous estimates

    The figure below displays the gross gap and net gap from our current model compared to the previous estimate, undertaken in 2017.

    Current and previous tax gap estimates, 2008–09 to 2015–16

    This line graph is a visual representation of the data in the following table. It shows the current and previous gross and net large corporate groups tax gaps, over the period 2008-09 to 2015-16.

    The flat trend of the previous gap from 2012 onwards reflects the projection method used at that time. The current estimate uses a more sophisticated method of projecting results and also incorporates data from our justified trust program, to provide a more accurate picture of the gap.

    Summary of published tax gap percentages

     

    Release year

    2008–09
    %

    2009–10
    %

    2010–11
    %

    2011–12
    %

    2012–13
    %

    2013–14
    %

    2014–15
    %

    2015–16
    %

    Gross gap

    2018

    na

    8.9

    8.5

    9.8

    11.4

    11.1

    8.9

    9.1

    2017

    9.1

    8.7

    6.4

    8.1

    8.1

    8.1

    8.1

    na

    Net gap

    2018

    na

    6.5

    5.5

    5.5

    6.5

    6.1

    4.5

    4.4

    2017

    6.3

    6.5

    4.7

    5.8

    5.8

    5.8

    5.8

    na

    Definitions

    Top-down approaches – use externally provided aggregated data sources to estimate the size of the tax base. From this we estimate theoretical tax liability. The difference between the theoretical tax liability and the amount we receive is the estimated tax gap. A top-down approach is typically used for indirect taxes.

    Bottom-up approaches – involve a detailed examination of data sources. These include tax returns, audit results, risk registers or third-party data-matching information. We then extrapolate the results to establish the extent of non-compliance across the whole population. From this we estimate the tax gap. This approach generally involves applying statistical techniques to estimate the incidence and value of non-compliance. A bottom-up approach is typically used for direct taxes.

    Mutual agreement procedure – is a means through which competent authorities consult to resolve disputes about the application of double-tax conventions. For more details, refer to our website, and the OECD's Manual on effective mutual agreement procedures.

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    Data sources

    We use ATO records to estimate the gap. These include the results of audit, review and related activities (compliance activities), and demographic information extracted from income tax returns. We have also incorporated data from our justified trust program.

    Reliability

    The ATO estimate of the large corporate groups income tax gap has been assessed by an independent expert panel, as described in Principles and approaches to measuring gaps.

    Based on advice from the independent expert panel, the reliability rating for the large corporate groups income tax gap estimate is medium. Our gap estimates remain sensitive to assumptions made, particularly to non-detection and the imputed result of compliance activities not undertaken.

    While the estimates are sensitive to these assumptions, the underlying data and population coverage informing the estimates is high. In particular, our integration of tax assured data has significantly improved the accuracy of our estimate.

      Last modified: 13 Dec 2018QC 57641