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  • Small super funds income tax gap

    Small superannuation (super) funds, and in particular SMSFs, are an increasingly significant and integral component of Australia's superannuation system.

    For the purpose of the 2014–15 small super funds income tax gap estimate, small super funds:

    • consist of approximately 550,000 self-managed super funds (SMSFs) and approximately 2,200 small APRA-regulated funds (SAFs)
    • have no more than four members.

    While super funds are subject to concessional treatment for income tax purposes, it is still important that they pay the correct amount of tax within the concessional framework.

    We used a random enquiry program (REP) to provide an initial estimate of the income tax gap in the small super funds population for the 2014–15 income year. The estimated net tax gap for small super funds was relatively small.

    The small size of the gap can be largely attributed to the following reasons:

    • Superannuation is a concessionally taxed environment.
    • Super funds in accumulation phase are generally taxed at 15% while those in retirement phase generally have a zero tax rate.
    • Approximately 47% of all small super funds are in retirement phase significantly reducing the opportunity for a tax gap to be present.

    The tax payable from small super funds for the 2014–15 income year was approximately $1.2 billion.

    The small super funds 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 with the law.

    Our estimate of the net gap covers only a single year period. For the 2014–15 income year, we estimate the net income tax gap for this group to be $39.9 million, or 3.2% of the total theoretical liability.

    Overall, compliance within small super funds is very good, with most errors identified through the random enquiry program not having a tax consequence.

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    Measuring the gap

    The small super funds income tax gap does not measure the policy gap, for example the tax effect of concessional income tax treatment. It is a measure of the difference between the total amount of income tax collected and the amount we estimate would have been collected if every taxpayer was fully compliant with the income tax laws, therefore the compliance gap.

    We used a random enquiry program to estimate the income tax gap for small super funds. Random enquiry programs review the whole return (all items) and are considered best practice when producing estimates for large populations.

    Given the characteristics of this population, random enquiry programs are considered best practice when estimating from large populations with lower levels of administrative coverage that can be split into broadly similar groups.

    We use a bottom-up approach to measure the small super funds income tax gap drawing on results of our random enquiry program.

    Random enquiry program

    To undertake our random enquiry program, we randomly select a sample of small super funds for profiling. Funds in this sample who are identified as low risk are not investigated further. The remainder of the sample progress to an audit (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 identified errors 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) that is incorrectly reporting.

    The small super funds income tax gap reflects the compliance gap. That is, it is an estimate of the tax revenue which is not collected as a result of funds failing to comply with the law at the time, whether inadvertently or intentionally.

    The reliability of this method and the estimation has been assessed by an independent external expert panel as medium with reference to a reliability assessment framework based on guidance provided by the International Monetary Fund approach to gap estimation.

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    Trends and latest findings

    The net tax gap for small super funds for the 2014–15 income year is $39.9 million (3.2%). This outcome is expected to be refined in future year estimates as more returns are lodged and finalised, and additional random enquiry programs are undertaken.

    This is the first year that we have released findings for a tax gap estimate in the small super funds population. Therefore, we are not able to provide information regarding any trends for this estimate over time.

    This is the first random enquiry program undertaken for this population. As the program continues our understanding will increase as the number of reviews increases.

    From our random enquiry program, the following major themes were identified as key aspects of non-compliance:

    • misunderstanding in the application of exempt current pension income (ECPI) provisions
    • incorrect reporting of franking credits
    • over-claimed deductions.

    The gap is the result of small errors mostly due to over-claimed franking credits and over-claimed deductions that when extrapolated over a large population produce a relatively small tax gap.

    Income tax gap – small superannuation funds 2014–15

     

    2014–15 $m

    Tax reported

    1,240

    Gross gap

    42.8

    Adjustments

    2.8

    Net gap

    39.9

    Income tax gap – small superannuation funds 2014–15

     

    2014–15 %

    Gross gap

    3.4

    Net gap

    3.2

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

    Amount reported and net income tax gap – small superannuation funds, 2014–15

    This graph shows the dollar value of small superannuation funds income tax reported and net gap over the period 2014–15.  

    ATO action to reduce the gap

    While the concessionary tax environment afforded to super funds means that the tax consequence of errors is less than in other populations the ATO still has a focus on ensuring that small super funds pay the right amount of tax.

    The bulk of a small super funds' assessable income will come from either assessable contributions or as a return on its investments. Therefore a key focus for the ATO is on identifying contributions into the fund to ensure they have been taxed at the appropriate point and at the appropriate rate.

    Another key area of focus is ensuring that SMSF's return on investments are assessed properly (whether that be 15% or exempt) and that wealth held outside of super is not streamed inappropriately into super's concessionally tax environment. Profit shifting of this nature may then contribute to the tax gap outside of superfunds – for example, the small business tax gap. These arrangements include dividend stripping, related-party property development ventures, non-arm's length income (NALI), and personal services income (PSI).

    We actively monitor and respond to these key focus areas. Our responses include applying the income tax general anti avoidance provisions (Part IVA), the non-arm's length income provisions, promoter penalty provisions and where appropriate we apply penalties including disqualifying Trustees. Through this approach we assure that these related party transactions are taxed at the appropriate rate.

    Methodology

    Income tax is payable by small super funds to the Australian Government based on their annual taxable income. 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 that for most funds, their taxable income is much lower than gross or assessable income.

    The small super fund tax gap is the difference between tax paid by small super funds 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 small super funds 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

    The selection of an estimate methodology depends heavily on the design of the tax system, the characteristics of the population, and the data available. In the case of income tax small super funds, there are no aggregate macroeconomic measures suitable for estimating the value of a tax gap with sufficient reliability or accuracy. Therefore, the use of a top-down approach is not possible.

    We examined bottom-up approaches based on extrapolating the results of ATO operational audits (that is, the amounts of non-compliance detected in audits of small super funds).

    However, given the large number of taxpayers in this population, there is insufficient audit coverage to allow such a method to be reliable. In addition, operational audits are targeted at taxpayers predicted to have a high risk of non-compliance in specific areas. Therefore, operational audit results are not representative of the wider taxpayer population. Consequently, we discarded this approach as not being able to generate a gap estimate of sufficient credibility or reliability.

    In order to generate suitable data for estimation and avoid selection bias, a random sampling method was adopted. A randomly selected sample of small super funds is subject to internal profiling.

    We are conscious of the potential inconvenience such programs have on taxpayers, and have implemented them in a manner that minimises impact on the community. Key to this is verifying taxpayers by drawing on the data we have matched to ensure we only contact taxpayers in the sample where we need to.

    From this profiling, where a risk is identified, the sample is escalated to an audit (the random enquiry program). Where a taxpayer is deemed to have an immaterial risk, it is the intention of the program that the shortfall identified for that risk is recorded for inclusion in the estimate. This shortfall is the amount determined by the random enquiry program as an amount payable by the taxpayer for their income tax obligation.

    The random sampling method is considered to be highly credible, and is commonly used by other tax jurisdictions for tax gap estimation of large homogenous taxpayer populations.

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    Applying the methodology

    There are six steps in applying the random enquiry program bottom-up methodology to estimate the small superannuation funds income tax gap.

    Steps to estimate the small fund income tax gap

    A text version of this image is available below.

    Step 1: Estimate unreported amounts and extrapolate to the population in each stratum

    The sample population is split into two key areas; those that progressed to review and those who were verified. Once this adjustment is made we combine the incidence rates and means from the gap stratum to estimate the unreported tax liability.

    Step 2: Estimate for errors not detected

    We apply an uplift to the unreported tax estimate to correct for errors not identified through the random enquiry program.

    Step 3: Estimate for non-pursuable debt

    We add the value of non-pursuable debt.

    Step 4: Estimate the gross gap

    Next, we add together the results of Steps 1 to 3 to arrive at the gross gap estimate.

    Step 5: Estimate the net gap

    In Step 5, we take the gross gap amount determined in Step 4 and deduct the compliance outcomes and voluntary disclosure amounts (sum of all positive amendments) to arrive at the net gap estimate.

    Step 6: Estimate theoretical liability

    We then add the gross gap (determined in Step 4) to the tax voluntarily paid amount (being total tax paid minus negative amendments and non-pursuable debt) to estimate the theoretical tax liability.

    Summary of the estimation process

    The following table provides a summary of each step of the estimation process and the results for each year.
    Summary of estimation process ($ million)(a)

    Step

    Description

    2014–15
    $m

    1

    Extrapolate result to determine unreported tax liability

    11.1

    2

    Non-detection

    9.9

    3

    Non-pursuable debt

    21.7

    4

    Gross gap

    42.8

    5.1

    Compliance outcomes and voluntary disclosures

    2.8

    5.2

    Net gap

    39.9

    6.1

    Tax voluntarily reported and paid

    1,215

    6.2

    Theoretical liability

    1,258

    6.3

    Gross gap %

    3.4%

    6.4

    Net gap %

    3.2%

    (a) Amounts are rounded, and therefore may not sum exactly.

    Limitations

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

    • The precision of the tax gap estimate is limited by the relatively small sample size. The estimates will have wide confidence intervals as a result.
    • There is no independent data source which can provide a credible or reliable macroeconomic-based estimate (unlike indirect taxes).
    • A further limitation of the random enquiry program and of other similar programs undertaken by tax administrators in other jurisdictions is the uncertainty around the impact of the non-detection error. The enquiries undertaken do not discover the full extent of non-compliance.

    Definitions

    Bottom-up approaches

    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.

    Random enquiry program

    A random enquiry program (REP) is a randomly selected sample of small super funds that are subject to internal profiling. From this profiling, where a risk is identified, the sample is escalated to an audit (the random enquiry program). The results of the enquiries are extrapolated to the population using standard statistical formulae to provide a tax gap estimate.

    Top-down approaches

    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.

    Voluntary disclosures

    If 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 ATO’s part.

    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 reliability of the small super funds income tax gap has been assessed by an independent external expert panel as medium with reference to a reliability assessment framework based on guidance provided by the International Monetary Fund approach to gap estimation. Details of the assessment framework are described in Principles and approaches to measuring gaps.

    Based on advice from the independent expert panel, the reliability rating for the small 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 small 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 small super funds.

    We are enhancing the way we record information on issues we detect and the tax effect of our compliance activities – both before 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 56336