For 2019–20 we estimate a net small business income tax gap of $11.9 billion or 11.6%. This means we estimate around 88% of the total theoretical tax was paid. This gap forms part of our overall tax performance program.
Small business population
There are over 5 million small businesses in Australia and they contribute around 30% of income tax paid. The small business population comprises a diverse range of structures and operations. It covers business with a turnover of up to $10 million.
Small business operating structures include:
- companies
- sole traders
- small business proprietors
- trusts
- partnerships
The taxation of small business differs depending on the structure of the business, turnover and relevant tax rates for the income year.
When calculating the income tax gap, our primary focus is on entities that have an income tax obligation. In our small business population, this includes:
- companies with a turnover up to $10 million
- individuals associated with small business entities including partnerships, trusts and companies with a turnover up to $10 million
- sole traders receiving business income up to $10 million.
Around 96% of small business seek advice and services from a tax practitioner to help operate their businesses. This may be an accountant, tax agent, BAS agent or bookkeeper.
The small business income tax gap forms part of our overall tax performance program. Find out more about the concept of tax gaps and the latest gap available.
About the estimate
This estimate is preliminary and subject to revision. The random enquiry program sample that supports the preliminary 2019-20 financial year estimate is incomplete and smaller than the sample used in the preliminary 2018–19 estimate that was released in last year's annual report. This is because we redirected resources to support the community through natural disasters and the delivery of COVID-19 stimulus packages.
As a result, the reliability rating has reduced. As more data becomes available in future years, we will have a more complete picture of the overall tax performance for small businesses.
Our preliminary 2019–20 estimate shows a decrease on the previous year. This may be attributable to methodological factors, including:
- smaller sample size due to limitations on data collection because of COVID
- economic factors
- possible changes in compliance.
With the reduction in the reliability rating and the recent unstable operating environment, it is difficult to draw conclusions on shifts in taxpayer compliance.
Table 1 shows:
- The net tax gap has ranged between 12.6% and 13.2% over the 4-year period from 2015–16 to 2018–19.
- Over those 4 years, tax collected for this population has increased and the overall tax gap percentage has been relatively stable.
- In 2019–20, the voluntary tax paid (tax paid minus amendments) increased by 4.2% and the size of the population has increased by 3.1%.
Figure 1 displays the gross and net gap for small businesses as a percentage over the same period.
Figure 1: Gross and net tax gap percentages, 2015–16 to 2019–20
Note: The estimate for 2019–20 is preliminary and subject to revision.
Tax gap components
The main components of the small business income tax gap are:
- omitted income
- over-claimed deductions
- people outside the tax system, for example, cash-only businesses operating without an Australian business number (ABN)
- non-pursuable debt that is not economical for us to pursue.
The extent to which these components impact the tax gap varies depending on the segment of the population.
The following figures split the tax gap by population and the main drivers of non-compliance for each of them.
Figure 2: Small companies
For the companies component of the gap, omission of income accounts for over half of the overall gap (58%). Over-claimed business deductions also represent a significant portion of the gap (32%).
Figure 3: Individuals in business
For the individuals in business component, the main driver of the gap relates to omission of income (72%). We also recognise the influence of people outside the system contributing to the overall gap.
Figure 4: Combined small business
The final combined view shows the overall influence of omitted income on the gap (70%).
Findings from the random enquiry program
Through the small business random enquiry program, we conduct reviews and audits on randomly selected taxpayers for the relevant year. This helps us calculate the tax gap estimate and identify the most common issues and behaviours driving the gap.
COVID-19 and other events have impacted our ability to complete these reviews and audits, which has reduced our sample for the 2017–18 and 2018–19 years.
Our refreshed 2018–19 estimate is based on the findings of 1,788 reviews and audits conducted across a representative population sample for 2016–17, 2017–18 and 2018–19.
We used data from the 2017–18 and 2018–19 reviews and audits together with lodgment data from 2019–20 to give us the preliminary tax gap estimate for 2019–20.
Our observations highlight 3 key areas that need our attention, including:
- addressing shadow economy activity which are deliberate attempts to avoid paying the right tax, also known as shadow economy activity
- continuing to provide education and support
- making it easier to comply with the law, particularly where there are multiple layers of complexity.
Small business behaviours observed
Most taxpayers reviewed in the sample reported correctly or were considered to have genuinely attempted to do so.
The most common issues included:
- undisclosed income
- over-claimed deductions
- failure to account for private use of business assets or funds.
We observed a range of behaviours relating to adjustments, including:
- misunderstanding or misapplication of tax law
- mistakes like transposition errors or one-off omissions
- inadequate record keeping systems or owners not keeping the required records
- opportunistic behaviour and deliberate attempts to avoid paying the right tax – this behaviour is known as shadow economy behaviour.
Shadow economy behaviour observed
The tax effect of the shadow economy in 2019–20 is estimated to be $8.0 billion or around 62% of the gross gap. $5.7 billion of this is associated with deliberate under-reporting of income and over-claiming of deductions. The remainder is made up of hidden wages and people operating outside the tax system.
While shadow economy behaviour still contributes significantly to the gap, only 4.5% of taxpayers reviewed as part of the random enquiry program sample clearly made deliberate attempts to avoid paying the right tax.
Tax practitioner behaviours observed
Most small businesses have some form of tax practitioner. Tax practitioners can play a role in shaping their reporting behaviours.
In the random enquiry program, we saw many examples of tax practitioners helping small businesses report correctly. However, we also identified:
- mistakes because tax practitioners failed to show reasonable care
- a small number of tax practitioners aiding a taxpayer's deliberate attempt to avoid paying the right tax.