• 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, based on our records of corporate group structures. It includes public and international corporate groups as well as private corporate groups not associated with a highly wealthy individual.

    In 2014–15, large corporate groups reported $1.5 trillion in gross income and paid approximately $41 billion in tax .

    Our estimate of the net gap covers a seven-year period between 2008–09 and 2014–15. For 2014–15, we estimate the net income tax gap for this group to be $2.5 billion in 2014–15 or 5.8% of tax payable. This trend has been steady for a number of years, and the gap primarily reflects differences in the interpretation of complex areas of tax law.

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

    Refer also to our media release on the large corporate groups income tax 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 their contribution and the key features of this population in Tax and Corporate Australia. In this publication we discuss how our work with this group gives us confidence the majority pay the right amount of tax. Our confidence comes from our improved capability and targeted strategies, as well as legislative provisions strengthening the tax laws.

    We also recognise and understand that economic cycles and return on investment timeframes can impact corporate groups profitability and tax payments. This means that sometimes large corporate groups make economic losses and pay no tax.

    We 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 that we use 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.

    The gap primarily reflects differences in the interpretation of complex areas of tax law. Some of the most common issues that have given rise to an adjustment in recent years are:

    • profit shifting (including transfer mispricing 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 group income tax gap is assessed as medium.

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    Trends and latest findings

    The tax gap trend for large corporate groups has been relatively steady for a number of years.

    The net income tax gap for large corporate groups is estimated to be $2.5 billion in 2014–15 (5.8%). 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.

    We consider our results to be similar to the HM Revenue & Customs' (HMRC) estimate for the large business population in the United Kingdom, noting that the HMRC 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 billion each year, excluding interest and penalties. A small number of high value adjustments account for most of the total value.

    The dollar value of the gap is impacted by fluctuations in the underlying tax base. Between 2008–09 and 2009–10, the percentage value of the gap remained relatively constant. This was while the dollar value fell due to declining corporate tax revenue in 2009. The fall in the estimate in 2010–11 was driven by lower levels of observed non-compliance in that year (noting that some of this compliance activity has not yet been resolved).

    The following table shows the tax reported, adjustments, and net and gross income tax gap estimates for the period 2008–09 to 2014–15.

    Income tax gap – large corporate groups 2008–09 to 2014–15(a)

     

    2008–09

    2009–10

    2010–11

    2011–12

    2012–13

    2013–14

    2014–15

    $m

    Tax reported

    39,794

    33,543

    40,896

    44,123

    40,736

    48,208

    40,728

    Gross gap

    3,876

    3,110

    2,744

    3,777

    3,487

    4,127

    3,487

    Adjustments

    1,214

    766

    715

    1,041

    961

    1,138

    961

    Net gap

    2,662

    2,344

    2,029

    2,736

    2,526

    2,989

    2,526

    %

    Gross gap

    9.1%

    8.7%

    6.4%

    8.1%

    8.1%

    8.1%

    8.1%

    Net gap

    6.3%

    6.5%

    4.7%

    5.8%

    5.8%

    5.8%

    5.8%

    (a) Gap estimates are projected from 2011–12.

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

    Amount reported and net income tax gap – large corporate groups, 2008–09 to 2014–15

     This graph shows the trend in tax reported and the net income tax gap for large corporate groups from 2008-09 to 2014-15

    Gross and net income tax gap (%) – large corporate groups, 2008–09 to 2014–15

     Graph displaying the gross and net tax gap percentages from 2008-09 to 2014-15.

    Our actions to reduce the gap

    We understand that perceptions of large corporate group tax compliance influence the confidence other taxpayers have in the fairness and integrity of our tax system. Addressing the large corporate group 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.

    We talk about the most significant compliance risks and how we are treating them 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 risks involved in the large corporate group population and allow us to provide assurance over a significant portion of the tax paid by this population.

    The ATO also provides 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 large corporate groups is 30% of taxable income.

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

    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 theoretic net large corporate groups tax gap is outlined below. We detail our assumption, limitations, data sources and 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. The results are extrapolated to estimate a picture of the tax gap across the whole large corporate group population.

    The botttom-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 HM Revenue & Customs estimates, which use risk registers and illustrative methods to estimate tax gaps for similar markets. The most recent large corporate groups estimate produced by HM Revenue & Customs is available in their publication, Measuring tax gaps 2016 edition (PDF, 1.98 MB)External Link.

    There is no independent data source that would enable a top-down estimate to provide a suitably reliable and credible estimate. While ABS data is available that could be used for such an estimate, data sharing arrangements render this data partially circular with ATO data holdings.

    In the large market, under-reported tax generally arises from differences in the interpretation of complex areas of tax law or tax planning. This, combined with the narrow and heterogeneous population, make bottom-up approaches using statistical methodologies and random audit programs difficult to implement to achieve credible and reliable results. Additionally, the cost and required number of random audits make such an approach too costly to implement. 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 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 actual amendment records, which restricts our analysis to years prior to 2012. This reflects the fact that it can take time to resolve large complex cases before they reach the stage where an amended assessment is issued.

    Accordingly, we project the average gap onto future years to give an estimate through to 2015. As we revise this analysis in future, we will use refreshed amendment information, and incorporate the outcomes of our revised approaches to client engagement.

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

    Steps to estimate the large corporate group gap

     This diagram outlines the five steps to estimate the large corporate group, which are described in the text that follows.      Step 1: Calculate the compliance results       Step 2: Estimate the compliance result forgone       Step 3: Estimate non-detection       Step 4: Determine the large corporate groups net tax gap (add the results of Step 2 and Step 3)      Step 5: Combine components to obtain gross tax gap and theoretical liability  (add the results of Step 1 and Step 4)

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    Step 1: Calculate the compliance results

    The results of our compliance activities 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
    • the projected results of open audits and reviews (including objections)
    • taxpayer voluntary disclosures.

    Also, as not all compliance activity for the year is completed when forming the estimate, we adjust for taxes in dispute, mutual agreement procedure cases and cases still in progress.

    We then sum all net positive compliance results for the population to determine the total compliance result.

    Step 2: Estimate the compliance result forgone

    Information from our compliance and other engagement activities is used to estimate the proportion of the tax base covered.

    The compliance result forgone is the additional tax expected to be raised if the ATO undertook compliance activity on the tax base that was not covered.

    We calculate average compliance yields on tax covered by compliance cases (total compliance results divided by total tax covered by compliance cases).

    We then use this to estimate the compliance yields on tax not covered. A yield reduction discount factor is applied to this estimate. This is to factor in the assumed lower risk for those not covered by our compliance activities. This reflects the fact that our compliance activities are targeted to areas of higher risk.

    To calculate the compliance result forgone in each year, we multiply tax not covered by the estimated compliance yield on tax covered by compliance cases.

    Step 3: Estimate non-detection

    The exact level of non-detection error in the large corporate group population is currently unknown. Therefore, we include an illustrative figure based on expert opinion and operational data. This shows the impact of a given level of non-detection. Non detection errors apply to both compliance results and compliance results foregone.

    Step 4: Determine the large corporate groups net tax gap

    We combine the final results determined in steps two and three to arrive at the net tax gap.

    Step 5: Combine the components to obtain the gross tax gap and theoretical liability

    Next we sum all results from steps one to three to determine the large corporate groups gross tax gap. We then bring in the tax payable amount and add the gross gap to determine the theoretical liability.

    Summary of estimation process ($ millions) by project period

    Step

    Description

    2008–09
    $m

    2009–10
    $m

    2010–11
    $m

    2011–12
    $m

    2012–13
    $m

    2013–14
    $m

    2014–15
    $m

    1

    Compliance result

    1,214

    767

    715

    1,041

    961

    1,137

    961

    2 to 4

    Net gap (estimate of compliance result forgone and non-detection)

    2,662

    2,344

    2,029

    2,736

    2,526

    2,989

    2,526

    5.1

    Gross tax gap

    3,876

    3,110

    2,744

    3,777

    3,487

    4,127

    3,487

    5.2

    Tax payable

    38,580

    32,777

    40,181

    43,082

    39,775

    47,070

    39,767

    5.3

    Theoretical liability

    42,456

    35,887

    42,925

    46,859

    43,262

    51,197

    43,254

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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. Furthermore, the estimates do not account for differences where there are alternative views as to the appropriate interpretation of the tax law. In such circumstances differences can exist between reasonably arguable positions presented by the ATO and taxpayers.

    The extent of non-detection is unknown and is extremely challenging to measure. We use a figure based on expert opinion and operational data.

    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. Key elements include:

    • 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.
       

    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 information on our website and the OECD guidelines in the Manual on Effective Mutual Agreement Procedures.

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    Data sources

    ATO records are used to estimate the gap. These include the results of audit, review and related activities (compliance activities) and demographic information extracted from income tax returns. This approach incorporates the:

    • value of adjustments – compliance results
    • level of engagement – number of cases
    • value of tax reviewed by the ATO – average coverage per case.

    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 group 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.

    We are looking to expand our data to improve future gap estimates. We are considering the following activities to facilitate this:

    • Conducting a comprehensive quantitative assessment of risk for the large corporate groups population that is less reliant on historic compliance results.
    • Improving estimates for tax covered in the model with compliance activities linked with our tax assurance measures in addition to pre-lodgment cases.
    • Improving indicators of non-detection for large corporate groups.

    We are enhancing the way we record information on issues we detect and the tax effect of our compliance activities – both prior to and after tax return lodgment. This data will become increasingly comprehensive over time and will be integrated into our methodology.

      Last modified: 11 Oct 2017QC 53445