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  • Tax gap research program

    Figure 1 below displays the various tax gaps in our overall research program, within the context of the Australian tax and superannuation systems.

    The gaps are grouped into three programs of analysis:

    • transaction-based tax gaps – taxes collected and paid by an entity further up in the supply chain (with the cost generally borne by the consumer), such as goods and services tax (GST) and fuel excises
    • income-based tax gaps – income tax for individuals and businesses, large and small super funds, and fringe benefits tax gaps
    • administrative gaps – these include programs that are administered by the government on behalf of the community, including pay as you go (PAYG) withholding, superannuation guarantee and other administered programs.

    Figure 1: Tax gap research program overview

    Figure 1: This image represents an overview of the tax gap research program. It places the gap estimations into their respective groups: transaction-based (such as GST), income-based (such as large corporate groups income tax), and administrative gaps (such as PAYG withholding). It also shows how the shadow economy touches on some of the gap estimates, such as GST, Individuals income tax and PAYG withholding.

    Relationship between gaps

    The relationship between the various gaps is complex. While some are mutually exclusive, some are closely related or form subsets within the established gap estimates. For example:

    • work-related expenses, levies, rebates and concessions are subsets of the income-based tax gaps for small business and individuals
    • some gaps arise through employment – employment-related gaps include PAYG withholding, superannuation guarantee and fringe benefits tax (for individuals).

    In addition, we see varying degrees of deliberate avoidance of tax, referred to internationally as the shadow economy. We see this in a number of gap estimates – for example, unreported income is included in individuals not in business, small business, PAYG withholding and superannuation guarantee.

    These complexities demonstrate why caution is needed when aggregating the gap estimates into one figure.

    Tax gap populations

    We have a specific tax gap population framework to define and allocate every taxpayer to a gap estimate to ensure we can construct a complete picture of the tax and superannuation systems. We develop a specific set of rules to use given the complexity in the populations, particularly in the business populations. These rules ensure there is no overlap between gap estimate populations.

    Our early gap estimates were transaction-based taxes, such as GST and excise. The populations for these estimates are readily defined. All taxpayers that interact with these taxes can be grouped together. For example, all entities pay the same rate of GST, regardless of their structure or turnover.

    As we began estimating income tax gaps, we realised the design of the gap program would require segmenting of the income-tax-paying population. We segment populations to ensure that gap research findings are meaningful for the community, government and us as an administrator of the system.

    Transaction-based tax gap populations

    Unlike income-based tax gaps, transaction-based gap populations are generally easier to determine.

    Broadly, an entity only needs to be registered to participate in that activity to be included in a transaction-based gap estimate. For example, a business can only charge or claim GST if it is registered for GST. Additionally, entities need to lodge the required forms (generally an activity statement) to demonstrate that they are an active business. This principle holds true regardless of the size or type of the entity being assessed.

    Income-based tax gap populations

    Taxpayers can only be allocated into one tax gap population. We allocate them in accordance with the hierarchy shown in Figure 2. All companies and individuals are allocated from left to right to the first relevant category in the hierarchy.

    Figure 2: Income tax gap population hierarchy

    Figure 2: All companies and individuals including large corporate groups, high wealth, individuals not in business, small business, and medium business.

    Large corporate groups

    As businesses tend to operate as a collection of entities, we consider business taxpayers from a group perspective. That is, one group may be made up of multiple tax entities that have a common owner. Our large corporate groups income tax gap estimate includes all economic groups with turnover greater than $250 million.

    High wealth

    We consider individuals and private groups that control total net assets of $50 million and over as high wealth private groups. Similar to large corporates, we consider the whole business group associated with the high wealth private group. The exception is any part of the group that is already included in our large corporate group analysis. This is in keeping with the tax gap principle of no double-counting.

    Individuals not in business

    These are taxpayers who mainly receive salary and wages with some other income, including non-business income from the sharing economy, and what we refer to as ‘passive income’. Passive income can include dividend, interest and rental income. In defining this taxpayer population, we exclude individuals that form part of the high wealth private groups to avoid double-counting. We refer to these taxpayers as individuals not in business.

    We recognise there are a large number of businesses that do not fall into these groups above. These businesses fall into the two categories of small or medium business, described as follows.

    Small businesses

    We define a small business as a business with an aggregate turnover of less than $10 million. This includes various operating structures, such as sole traders, corporate groups, small business proprietors, trusts and partnerships.

    These small businesses are subject to different tax treatments and certain concessions. The compliance challenges of these businesses are different from those of larger businesses. We differentiate them from larger business to enable us to have insights that are more appropriate to the small business population.

    Medium businesses

    We define the final group of taxpayers as medium businesses. These comprise corporate economic groups with an aggregate turnover of between $10 million to $250 million, as well as the individuals controlling these business groups. These businesses tend to have more complex structures compared to small businesses and, as a consequence, more complex tax affairs.

    Populations for super and fringe benefits tax are covered separately to the income tax populations and are expanded on within their own method sections.

    Administrative gap populations

    Broadly, the administrative gap populations are defined by legislation. For example, PAYG withholding gaps can only occur where an entity has an employee. Therefore, if a business has an employee, regardless of the type of business they are, they are captured as part of this gap population.

    Tax gaps internationally

    Other administrations measure and publish tax gaps, including:

    • Her Majesty’s Revenue and Customs (HMRC) – United Kingdom
    • Internal Revenue Service (IRS) – United States
    • Danish Customs and Tax Administration (SKAT) – Denmark
    • Canada Revenue Agency (CRA) – Canada.

    The European Commission (EU) uses external researchers to identify the value-added tax (VAT) gap in each of its 28 member countries. The International Monetary Fund (IMF) provides support to jurisdictions in estimating tax gaps.

    Our gap measurement methodologies draw on the experience of the above contemporary administrations. We also participate in international forums and communities of practice, such as the Organisation for Economic Co-operation and Development (OECD) Advanced Tax Gap Analysis Community of Practice. This was established in March 2019 for OECD member countries that have significant experience in tax gap estimation.

    Tax gap framework

    Our estimates aim to quantify the level of non-compliance across the four pillars of compliance – registration, lodgment, reporting and payment obligations.

    Where possible, we also estimate the amount of revenue not collected from those who fail to register or lodge. However, penalties and interest are not included in gap estimates.

    We have two measures of the tax gap – the gross gap and the net gap.

    The gross gap is the difference between:

    • the amount voluntarily reported to the ATO, and
    • the amount we would have collected if every taxpayer was fully compliant with tax law (that is, the theoretical tax liability).

    The net gap is the difference between:

    • the amount voluntarily reported to the ATO plus amendments as a result of compliance activities and voluntary disclosures, and
    • the amount we would have collected if every taxpayer was fully compliant with tax law.

    We estimate gaps for the year the economic activity occurred and are based on the law and the administrative approaches at that time.

    Figure 3 shows the components of the tax gap, including the net gap, the gross gap, the amount reported and theoretical tax liability.

    Figure 3: Components of tax gap

    Figure 3: The tax gap concepts include the amount voluntarily reported which is the majority, amendments due to compliance activities and voluntary disclosure, and the amount not paid, against the theoretical tax liability. The amount not paid is the net gap. The amount not paid plus the amendments is the gross gap.

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      Last modified: 19 Oct 2020QC 53168