For 2020–21 we estimate a net small business income tax gap of $15.1 billion or 12.8%. This means we estimate around 87% of the total theoretical tax was paid. This gap forms part of our overall tax performance program.
Small business population
The small business population comprises a diverse range of structures and operations. It covers businesses with a turnover of up to $10 million.
Small business operating structures include:
- companies
- sole traders
- trusts
- partnerships.
There are around 4.5 million small businesses in Australia, plus a further 2.1 million individuals that are linked to a business (e.g. as a director, shareholder, partner, or beneficiary).
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.
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
The 2020–21 small business income tax gap estimate is preliminary and subject to revision as the random enquiry program sample informing the estimate is incomplete.
Tax gaps expressed as a percentage are typically regarded as the best measure of system performance.
In measuring the small business tax performance, our preliminary 2020–21 estimate net gap percentage has decreased compared to the updated 2019-20 estimate. This is because the theoretical liability has grown more than the net gap amount.
This may be attributable to a range of factors, including:
- economic factors
- possible changes in compliance
- the use of smaller samples due to limitations on data collection.
The sample size informing this estimate is similar to that used in the preliminary 2019–20 estimate published in 2022, but smaller than the samples used in earlier estimates. This reduction is the result of a redirection of resources:
- to support the community through natural disasters and the delivery of COVID-19 stimulus packages
- to address emerging compliance issues.
With the recent unstable operating environment and reduced insights available due to the smaller sample, it is difficult to draw conclusions on shifts in taxpayer compliance.
We will continue to build a more complete picture of the overall tax performance for small businesses as more data becomes available.
Table 1 shows:
- Compared to the 2019–20 estimate, in 2020–21, the voluntary expected collections (expected collections minus amendments) increased by 14.2% and the population has increased by 5.1%. These shifts have contributed to the growth in the theoretical liability and the net gap by dollar amount. The strong growth in theoretical liability has resulted in the decline of the net gap as a proportion of theoretical liability (net gap expressed as a percentage).
- The net tax gap has ranged between 12.0% and 14.4% over the 5 year period from 2015–16 to 2019–20.
- Over those 5 years, tax collected for this population has increased and the overall tax gap percentage has been relatively stable.
- Previously published estimates have been revised using updated data. This includes additional random enquiry program case outcomes to support the 2018-19 and 2019–20 estimates. These revisions have resulted in an increase in the net gap percentage, although this is not necessarily indicative of an increase in non-compliance. Some variability from year to year is expected and the trend continues to demonstrate a level of stability in small business tax performance.
Table 1: Income tax gap – small business income tax groups, 2015–16 to 2020–21
|
Element |
2015–16 |
2016–17 |
2017–18 |
2018–19 |
2019–20 |
2020–21 |
|---|---|---|---|---|---|---|
|
Population (m) |
4.76 |
4.83 |
4.92 |
5.06 |
5.13 |
5.39 |
|
Gross gap ($m) |
12,025 |
12,915 |
13,262 |
15,880 |
14,649 |
16,187 |
|
Amendments ($m) |
1,190 |
1,102 |
1,142 |
1,121 |
1,095 |
1,095 |
|
Net gap ($m) |
10,836 |
11,813 |
12,120 |
14,759 |
13,554 |
15,092 |
|
Expected Collections ($m) |
79,299 |
80,743 |
85,940 |
87,855 |
90,014 |
102,676 |
|
Theoretical liability ($m) |
90,135 |
92,555 |
98,060 |
102,614 |
103,568 |
117,768 |
|
Gross gap (%) |
13.3 |
14.0 |
13.5 |
15.5 |
14.1 |
13.7 |
|
Net gap (%) |
12.0 |
12.8 |
12.4 |
14.4 |
13.1 |
12.8 |
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 2020–21
Note: The estimate for 2020–21 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 about half of the overall gap (49%). Over-claimed business deductions also represents most of the rest of the gap (45%).
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 over claimed deductions 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, 2018–19 and 2019–20 years.
Our refreshed 2019–20 estimate is based on the findings of 1,671 reviews and audits conducted across a representative population sample for 2017–18, 2018–19 and 2019–20.
We used data from the 2018–19 and 2019–20 reviews and audits together with lodgment data from 2020–21 to give us the preliminary tax gap estimate for 2020–21.
Our observations highlight 4 key areas that need our attention, including:
- continuing to address shadow economy behaviour (deliberate attempts to avoid paying the right tax)
- continuing to provide education and support to ensure small businesses are aware of and understand their tax obligations
- integrating and improving the record keeping and reporting experience for small business taxpayers
- reducing complexity, particularly around law structures and multiple taxes.
Small business behaviours observed
Most taxpayers reviewed in the sample reported correctly or were considered to have genuinely attempted to do so.
In our random sample, we observed a range of errors resulting in income tax adjustments, including:
- undisclosed or omitted income
- over-claimed expenses (e.g. to fund personal lifestyle)
- record keeping inadequacies resulting in a variety of errors.
- failure to account for private use of business assets or funds
- errors in the application of the law
- minor mistakes in calculation
- deductions claimed without substantiation
- deductions claimed for expenses with no connection to income earning activities.
Our sample includes individuals in business. These taxpayers can have income and expenses from sources outside their business activities.
Errors in reporting income and expenses unrelated to business activities for these individuals contribute to the small business income tax gap. For example:
- underreported salary and wages from an unrelated entity
- underreported passive income from rental properties, gross interest and dividends
- miscalculated and underreported net capital gains
- overclaimed work-related expenses (car, clothing, travel) and gifts / donations.
Shadow economy behaviour observed
The tax effect of the shadow economy in 2020–21 is estimated to be $10.4 billion or around 64% of the gross gap. $7.9 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, approximately 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.