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  • Trends and latest findings

    Our current gap estimate for individuals not in business is based on findings from five years of our random enquiry program. We are seeing consistent downward trend in the tax gap estimate since 2015-16.

    Internationally, tax gaps are difficult to compare. This is due to the large variations in legal and tax systems, market definitions, availability of data and the methodologies used to estimate gaps across tax jurisdictions.

    While the individuals not in business tax gap estimate is not directly comparable for these reasons, we used methodology that is used in similar tax regimes. The United Kingdom (UK) and United States of America (US) also use random enquiry programs to estimate some income tax gaps. They are considered best practice when estimating from large and homogenous taxpayer populations.

    In our random enquiry program, we found adjustments were made in both tax agent and self-prepared income tax returns, including:

    • incorrect claiming of deductions for work-related expenses or rental property expenses (or both)
    • careless administration or careless preparation of an income tax return.

    Lack of connection to income earned or substantiation for expenses were also significant issues.

    Work-related expenses continue to be the single largest contributor to the tax gap. They account for $3.7 billion of the net tax gap with errors relating to incorrect claims for home office, mobile phone and internet.

    While the 2018-19 estimate is not impacted by COVID-19 lockdowns and higher than normal working from home arrangements, next year's estimate will see the first signs of impact through increased working from home deductions. With more claimants and higher claim amounts we expect to see a corresponding increase in the work-related expenses net tax gap.

    Another key contributor was unreported income from hidden wages contributed around $1.6 billion to the gap in 2018–19. This represents 17.5% of the gross tax gap. This activity is considered part of the shadow economy.

    While the amounts over-claimed and under-reported by individual taxpayers may be small, collectively across a large population the overall revenue impact is significant.

    Table 1: Income tax gap – individuals not in business, 2013–14 to 2018–19

    Element

    2013–14

    2014–15

    2015–16

    2016–17

    2017–18

    2018–19

    Population (m)

    10.3

    10.5

    10.7

    11

    11.1

    11.3

    Gross gap ($m)

    7,195

    8,499

    9,060

    9,215

    9,321

    9,162

    Amendments ($m)

    816

    802

    786

    855

    613

    734

    Net gap ($m)

    6,379

    7,697

    8,274

    8,360

    8,708

    8,428

    Tax paid ($m)

    111,268

    118,796

    125,650

    129,547

    139,035

    142,919

    Theoretical liability ($m)

    117,647

    126,493

    133,925

    137,907

    147,743

    151,346

    Gross gap (%)

    6.1

    6.7

    6.8

    6.7

    6.3

    6.1

    Net gap (%)

    5.4

    6.1

    6.2

    6.1

    5.9

    5.6

    Figure 1 displays these trends as a percentage.

    Figure 1: Gross and net tax gap percentage – individuals not in business, 2013–14 to 2018–19

    Figure 1 show the gross and net gap in percentage terms as outlined in Table 1.

    The random enquiry program

    Within our random enquiry program, we randomly select and profile a sample of individual taxpayers who are not in business. People in the sample identified as low risk are not inconvenienced by being investigated further.

    Details are verified where we can confirm the income tax return data by matching all material amounts with our third-party data. We refer to these taxpayers as the 'verified' portion of the sample. While these taxpayers are not manually reviewed, they remain part of our overall sample, contributing to our gap analysis.

    The remainder of the sample progress to a review (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 an income tax return to correct errors identified 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) who are incorrectly reporting.

    Findings from the random enquiry program

    The random enquiry programs from 2013–14 to 2017–18 saw 2,493 reviews undertaken across a representative sample of the individuals not in business population.

    The two years from 2016–17 to 2017–18 comprised a total of 1,090 cases that informed our most recent year's estimate. Of these cases, 899 involved manual reviews, while 191 were verified using third-party data.

    This sample was large enough to provide a suitable representation of the population. It is proportionally similar to, or greater than, other comparable countries' programs (for example, UK and US).

    During the selection process the population was stratified across all income bands to ensure the overall population was appropriately represented. Taxpayers in the tax-free threshold and low to very high incomes were represented as well as taxpayers with rental properties.

    The sample includes taxpayers who lodged through various channels. The proportion of agent-prepared income tax returns in the random sample was representative of the total individuals not in business population.

    We used a confidence interval to quantify the 'precision' of the estimate. This is discussed in detail in the Limitations section. We are confident that the true value of the net gap in 2018–19 lies between 4.8% to 6.4%, or $7.2 billion to $9.7 billion.

    In the full sample of 1,090 cases, the incidence of adjustment was 76%, with 83% of agent-prepared returns being adjusted. This compares with 61% of returns adjusted for people who prepared their own income tax return (self-preparers).

    On average we made three item adjustments per income tax return. The median increase to taxpayers' taxable income (income less deductions) was $1,552. While individually this amount may not be large, when aggregated across the whole population, the effect is significant.

    There were 57 cases where we decreased tax payable. This included seven cases where we adjusted solely in the taxpayer’s favour. There was one additional case where we adjusted solely in the taxpayer’s favour, but with no effect on tax payable.

    Across the random enquiry program, a greater proportion of self-prepared returns (17%) were adjusted at income labels compared to agent prepared returns (13%) Adjustments to deduction items (including rental expenses, work-related expenses, gifts and donations and other deductions) were higher in agent-prepared income tax returns.

    Table 2: Overview of the 2016–17 to 2017–18 random enquiry programs for individuals not in business

    Cases

    Sample
    (no.)

    Agent-prepared sample
    (no.)

    Agent-prepared sample
    (%)

    Self-prepared sample
    (no.)

    Self-prepared sample
    (%)

    Manually reviewed cases

    899

    682

    76

    217

    24

    Verified cases

    191

    95

    50

    96

    50

    Total finalised cases

    1,090

    777

    71

    313

    29

    Table 3: Comparison of the incidence of adjustment in all finalised cases for the 2016–17 to 2017–18 random enquiry programs for individuals not in business

    Cases

    Full sample
    (no.)

    Full sample
    (%)

    Agent-prepared sample
    (no.)

    Agent-prepared sample
    (%)

    Self-prepared sample
    (no.)

    Self-prepared sample
    (%)

    Cases with adjustments

    833

    76

    643

    83

    190

    61

    Cases with adjustments only in the taxpayer’s favour

    8

    1

    6

    1

    2

    1

    Note: The distribution of the value of the item adjustments show that 38% of adjustments are $150 or less and 25% are over $1,000.

    Table 4: Distribution of item adjustment rates and values in the 2016–17 to 2017–18 random enquiry programs (percentage) for individuals not in business

    Range of adjustments

    Self-prepared % of all adjustments

    Self-prepared % of values adjusted

    Agent-prepared % of all adjustments

    Agent-prepared % of values adjusted

    Total % of all adjustments

    Total % of values

    $0–$150

    8

    <1

    30

    1

    38

    1

    $151–$300

    3

    <1

    12

    1

    15

    2

    $301–$500

    2

    1

    8

    2

    10

    2

    $501–$1,000

    2

    1

    10

    4

    12

    5

    More than $1,000

    4

    16

    21

    74

    25

    90

    Total

    19

    18

    81

    82

    100

    100

    Analysis indicated that adjustment rates were broadly similar across types of tax agent practices and locations, although rates for tax agents in small tiers were slightly higher.

    Based on the analysis and findings of the random enquiry program and insight from our overall engagement program, we can highlight themes that contribute to the gap.

    When we look at the most recent tax gap year estimate, we draw on the last two years of the sample only. Figure 3 shows a breakdown of the individuals not in business tax gap by the different drivers for the most recent years estimate.

    Figure 2: Net tax gap breakdown by driver for individuals not in business, 2018–19

    Figure 2 shows the breakdown of the net tax gap by the four main drivers: work-related expenses 44%, rental expenses 18%, hidden income 19% and other 19%.

    What is driving the gap

    Through our analysis, we have found several main areas that are contributing to the individuals not in business tax gap.

    Find out about:

    Work-related expenses

    Work-related expenses are a key component of the individuals not in business income net tax gap. The work-related expenses net gap was estimated to be $3.7 billion.

    Each case can have multiple adjustments across the income tax return. Of the 3,379 adjustments made in identified cases, around 77% related to deduction items (including rental deductions). Around 46% or 1,541 of adjustments were made at work-related expense items. Of those work-related expenses adjustments, 80% or 1,237 were made in agent-prepared returns.

    Common reasons for adjustments in the random enquiry program included:

    • claims for ‘standard’ deductions where exceptions to substantiation provisions exist (e.g. $300 for work related expenses without having spent the money)
    • no link between the expense and the taxpayer earning their income
    • incorrect apportionment (private use vs work-related use) – claiming expenses that aren’t apportioned for personal use, e.g. claiming 100% of mobile phone expenses
    • claims that appeared legitimate, but could not be substantiated (no receipts, logbook or diary entries)
    • claims for expenses that were actually paid for or reimbursed by the employer.
    Work-related expenses adjustments and reasons

    The following two pie charts display the number of adjustments to work-related expense items and the reasons for these adjustments.

    The highest rate of adjustments was for 'other expenses' – in particular incorrect claims for home office, mobile phone and internet. Claims for clothing and car were also frequently adjusted.

    Figure 3 shows the number of adjustments to work-related expenses.

    Figure 3: Number of adjustments to work-related expenses

    Figure 3 shows a breakdown of the types of work–related expenses adjustments and number of times they occurred: car 296, travel 125, clothing 469, self-education 46 and other 605.

    Figure 4 shows the reasons for these adjustments.

    Figure 4: Reasons for work-related expense adjustments

    Figure 4 shows the percentage breakdown of the reasons for adjustments made for work-related expenses: substantiation 31%, nexus and substantiation 25%, nexus 10%, over-claimed 10%, voluntary disclosure 7%, calculation error 5% and other reasons combined 12%.

    Undeclared income

    Income that has been omitted, particularly cash wages and income from the sharing economy, also contributes to the tax gap for individuals not in business.

    Some people don't declare income and payments to avoid paying the right amount of tax or superannuation. For example, some businesses may pay their employees 'cash-in-hand’ and some taxpayers do not report all the cash income they earn in their income tax return.

    We estimate the portion of the tax gap for 2018–19 attributable to unreported income was $1.6 billion.

    Identifying non-declared wages is difficult, even in a random enquiry program. To account for the impact of undeclared cash wages (an aspect of the shadow economy), we take a different approach.

    We draw on our other broader tax gap program, specifically, the pay as you go (PAYG) withholding gap and the super guarantee gap to help us estimate the undeclared wages in the individuals not in business population.

    Our approach to addressing the non-reporting of cash wages is incorporated in our shadow economy strategy.

    Other findings and observations

    Observations from our broader compliance activities reinforce findings from our random enquiry program – further supporting our understanding of what is driving the gap.

    Deductions for rental property expenses are also a key contributor to the gap. The rental component of the individuals not in business net tax gap is estimated to be $1.6 billion.

    Our observations indicate that the most common reasons for adjustments to rental items on an income tax return are a lack of, or incorrect, apportionment of expenses.

    This includes, for example, deduction claims where the property was only available to rent for part of the year. Or claims for interest expenses where a portion of the loan was used for private purposes. We also see mistakes relating to capital works and capital allowance deductions.

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      Last modified: 19 Oct 2021QC 56246