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  • Large super funds income tax gap

    The large superannuation (super) funds income tax gap is the difference between the total income tax collected and the amount we estimate would have been collected if every taxpayer was fully compliant.

    For the purposes of tax gap estimates, large super funds are funds regulated by APRA with five or more members. They typically have thousands or even millions of members as opposed to small APRA funds (SAF) who have less than five members and have similar characteristics to self-managed super funds (SMSFs).

    Our estimate of the net income tax gap covers a six-year period between 2010–11 and 2015–16. We used actual compliance results from the 2011 to 2013 income years and projected results to estimate the gaps for 2014 to 2016 due to the time lag in starting and completing compliance activities.

    For 2015–16, we estimate the net large super income tax gap to be $127 million or 1.5% of the theoretical tax liability.

    Super funds

    Super funds are concessionally taxed savings vehicles that help individuals save for their retirement. The large super fund sector is highly regulated and scrutinised. Increased regulation and growing complexity in operating and administering super funds has also led to a significant decline in employer-sponsored corporate funds and consolidation more broadly in the retail and industry super fund sectors.

    Income tax for super funds is applied at a flat rate of 15% on taxable income, half that of the large company tax rate of 30%. Various exemptions and deductions will mean for most funds their taxable income is much lower than gross or assessable income. For example, income derived from assets used to support the current pensions paid to members, is known as exempt current pension income (ECPI), and is exempt from tax.

    The tax payable by large super funds for the 2015–16 income year was $8.2 billion. Tax payable is calculated by deducting both refundable and non-refundable tax offsets from gross tax. Franking credits are the main offsets for large super funds.

    Large super funds generally seek to comply with their tax obligations and we consider them to have relatively lower tax risk than other taxpayers. Almost half of total assessable income for large super funds in 2015–16 came from member contributions (not accounting for the effect of ECPI); generally we don't find compliance issues relating to member contributions.

    Where we do observe non-compliance, it generally arises from differences in law interpretation regarding:

    • over claiming of Foreign Income Tax Offset (FITO)
    • incorrect use of the CGT discount and the capital losses offset provision in respect of gains from non-taxable Australian property of a foreign trust
    • over claiming of franking credits.

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    Measuring the gap

    The large super funds 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 gross tax gap is estimated after pre-lodgment activities but prior to compliance activities. The net gap is estimated post compliance activity.

    The 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 reliability of this method has been assessed as being medium by an independent expert panel.

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    Trends and latest findings

    This is the first year we have released the large super funds tax gap estimate.

    Large tax adjustments and changes in economic conditions, which tend to be sporadic in nature, lead to some volatility in this gap estimate.

    The large tax adjustments are due to our close engagement with large super funds which means the funds are quick to correct any misinterpretations of the law once we have brought them to their attention.

    The key contributing factors to the variability of the tax gap estimates are:

    • incorrect reporting of foreign income and the over claiming of FITO
    • incorrect use of the CGT discount and the capital losses offset provision in respect of gains from non-taxable Australian property of a foreign trust, which are often contingent on market and taxpayer specific conditions
    • over claiming of franking credits.

    Overall the net income tax gap ranges between 1.4% and 2.6% over the last six years.

    Income tax gap – large superannuation funds 2010–11 to 2015–16(a)

     

    2010–11 $m

    2011–12 $m

    2012–13 $m

    2013–14 $m

    2014–15 $m

    2015–16 $m

    Tax reported

    7,064

    7,594

    6,858

    6,332

    6,831

    8,166

    Gross gap

    159

    313

    112

    145

    240

    170

    Adjustments

    34

    112

    18

    35

    84

    43

    Net gap

    125

    201

    94

    110

    156

    127

    Income tax gap – large superannuation funds 2010–11 to 2015–16(a)

     

    2010–11 %

    2011–12 %

    2012–13 %

    2013–14 %

    2014–15 %

    2015–16 %

    Gross gap

    2.2

    4.0

    1.6

    2.2

    3.4

    2.0

    Net gap

    1.7

    2.6

    1.4

    1.7

    2.2

    1.5

    (a) Gap estimates are projected from 2013–14.

    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 superannuation funds, 2010–11 to 2015–16

    This graph shows the dollar value of large superannuation funds income tax reported and net gap over the period 2010-11 to 2015-16.

    Gross and net income tax gap (%) – large superannuation funds, 2010–11 to 2015–16

    This graph displays the gross and net gap percentages from 2010–11 to 2015–16.

    ATO action to reduce the gap

    Large super funds are subject to significant prudential and regulatory supervision in addition to high levels of ATO attention and engagement. We work closely with them to help them pay the right amount of tax. These factors are reflected in the relatively low tax gap estimate for this group.

    As outsourcing is a significant feature of the industry, the quality and integrity of third-party data is essential for accurate reporting by the funds. This can lead to third party reporting errors and therefore unpaid tax. We recognise the quality and integrity of third-party data is key to accurate reporting by funds, and are broadening our existing focus on fund governance to ensure appropriate checks and controls are in place to provide added levels of assurance around third party data.

    We gather intelligence through pre and post lodgment compliance reviews and industry consultation to identify emerging risks.

    We focus on preventative action including treatment strategies to address legal or systemic issues. We also work with industry to resolve unsettled interpretive matters to promote willing participation.

    Key strategies include:

    • working with Treasury to support law design and settling areas of interpretative uncertainty
    • identifying existing and emerging areas of uncertainty and consulting with industry to develop public advice and guidance to help large super funds comply (for example PCG 2018/2 Propagation arrangements adopted by registrable superannuation entities)
    • early engagement with key industry participants
    • our Top 100 and Top 1000 programs to assure these funds are paying the correct amount of income tax
    • continuing our focus on fund governance to provide added levels of assurance around third party data
    • undertaking assurance activities in respect of key service providers
    • measuring the impact of our activities and long-term investment in law design and interpretation.

    Methodology

    The large super fund income tax gap is the difference between tax paid by large super funds and the amount they should have paid, assuming full compliance with the law as it stood in the relevant income year. Therefore, new or recent law changes are not reflected in gap estimates.

    The methodology used to estimate the large super funds tax gap is outlined below.

    Selecting the methodology

    We selected a bottom-up illustrative approach to determine the value of under-reported income tax from large super funds to estimate the income tax gap, on the basis of expert opinion. We chose this method given the nature of the market, the design of the tax, and the lack of suitable external data to produce a top-down estimate.

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    Applying the methodology

    The large super income tax gap is established on an accrual-based concept and, as such, late payments don't contribute to the gap. We use actual amendment records, which restricts our analysis to years prior to 2013. This reflects the fact it can take time to resolve large complex cases before an amended assessment is issued.

    Accordingly, we project the average gap for future years to estimate through to 2016. In future, as we revise this analysis, we will use updated amendment information, and incorporate the outcomes of our revised approaches to client engagement.

    We followed six steps in applying the illustrative bottom-up methodology to estimate the gap.

    Steps to estimate the large super fund income tax gap

    A text version of this image is available below

    Step 1: Calculate the tax payable

    The total tax payable for the income year is the sum of tax payable for all large super funds as stated in the original return lodged for the year.

    Step 2: Calculate the compliance results

    We include all net positive amendments, whether client or Commissioner initiated, to determine the total compliance result.

    For 2010–11 to 2012–13, we use actual compliance outcomes recorded from processed income tax return amendments and recently finalised or pending compliance cases.

    For 2013–14 to 2015–16, we project results based on the average income tax return amendments for the prior three years as a percentage of the original tax payable for those years.

    Step 3: Extrapolate the compliance results to the super fund population

    This step involves extrapolating a proportion of the compliance results from those funds with amendments, to those funds without amendments. That is, we allow for fact that higher risk funds are selected for audit.

    This involves two components where we determine each fund's share of total assets in accumulation phase (only assets in accumulation phase are taxed) in each year, then extrapolate the compliance results across the population.

    For 2013–14 to 2015–16 years we project the assets we would expect to relate to funds with amendments by taking the average assets of funds with amendments in 2010–11 to 2012–13 years.

    Step 4: Apply estimate for non-detection

    Here we uplift the gap estimate to account for a non-detection component. We use expert judgment and evaluate a range of factors.

    The lower tax rate for super funds and regulatory oversight by APRA indicate a relatively low non-detection rate. However, feedback from our compliance areas suggests other factors serve to justify a larger non-detection factor.

    These include the interaction of structural and information complexity for these funds in addition to the potential historical understatement of net capital gains.

    Step 5: Determine the gross and net tax gap

    Combine the results from Steps 1 to Step 4 to obtain the gross and net tax gaps.

    Step 6: Determine the theoretical liability and gap percentages

    The theoretical liability is determined by adding steps 1 through to 5. The percentage gaps are determined by dividing the gap estimate by the theoretical tax liability.

    Summary of estimation process ($ million)(a)(b)

    Step

    Description

    2010–11
    $m

    2011–12
    $m

    2012–13
    $m

    2013–14
    $m

    2014–15
    $m

    2015–16
    $m

    1

    Tax payable (at lodgment

    7,031

    7,482

    6,840

    6,296

    6,747

    8,123

    2

    Compliance result

    34

    112

    18

    35

    84

    43

    3

    Extrapolate

    22

    47

    7

    11

    26

    20

    4

    Non-detection

    103

    154

    87

    98

    130

    107

    5.1

    Gross tax gap

    159

    313

    112

    145

    240

    170

    5.2

    Net tax gap

    125

    201

    94

    109

    156

    127

    6.1

    Gross tax gap

    2.2%

    4.0%

    1.6%

    2.2%

    3.4%

    2.0%

    6.2

    Net tax gap

    1.7%

    2.6%

    1.4%

    1.7%

    2.2%

    1.5%

    6.3

    Theoretical liability

    7,189

    7,795

    6,953

    6,441

    6,987

    8,293

    (a) Gap estimates are projected from 2013–14(b) Amounts are rounded, and therefore may not sum exactly

    Limitations

    The following caveats and limitations apply when interpreting this tax gap estimate.

    • The estimate doesn't reflect the difference between reasonably arguable positions presented by the ATO and taxpayers where tax law is open to interpretation.
    • There is no independent data source that can provide a credible or reliable macroeconomic-based estimate (unlike indirect taxes).
    • Due to the heterogeneous nature of the market and the complexity of the large superannuation funds, a statistical approach based on auditing a random sample of funds with a large enough sample to provide a reliable indication of the tax gap would be impractical.
    • While coverage of large superannuation funds is significant, it is mostly done through pre-lodgment activities. We don't currently have comprehensive estimates of the impact of these activities. Compliance assurance is also done through industry wide consultation and education campaigns. The impact of this is extremely difficult to measure.
    • Superannuation funds rely on third party data to complete income tax return data. Failure in corporate governance may result in funds understating their tax position, and could also be hiding a larger gross gap than currently estimated.
    • We recently clarified our position relating to unit trust distributions in respect of gains from non-taxable Australian property of a foreign trust. We published guidance on the correct application of the capital losses offset provision and the impact of understated capital gains due to an incorrect cost base and use of the CGT discount. These items were not reviewed in previous compliance activities and would not be included in amendment records. An allowance for this issue has been included in the tax gap estimate in years up to the release of the guidance.

    Definitions

    Bottom-up approaches

    A bottom-up approach involves 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.

    Top-down approaches

    A top-down approach uses 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.

    Voluntary disclosures

    A voluntary disclosure is where a taxpayer tells us about a false or misleading statement they've made to us or a change that increases their tax or reduces their credits, without prompting, persuasion or compulsion on the Commissioner’s part.

    Data sources

    The methodology draws on the operational data of the ATO. These include the results of audit, review and other related 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 large super income tax gap estimate 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 super funds 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 super funds 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 super funds.

    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: 06 Sep 2018QC 56335