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  • Estimating the tax gap for individuals not in business

    The information we gather from the individuals not in business tax gap work is giving us a better understanding of compliance in this segment. In turn, these insights will help us better tailor our compliance strategies, products and services so we can improve the way individuals experience the tax system.

    Our best estimate of the net income tax gap for individuals in 2014–15 is 6.4%, or $8.7 billion. In other words, for this fiscal year, we estimate that individual taxpayers have contributed 93% of the estimated tax payable.

    Our individuals not in business income tax gap estimate was informed by our operational programs for specific types of risk and by findings from a random enquiry program.

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    Random enquiry program for individuals

    A random enquiry program (REP) involves reviewing the returns of a sample of taxpayers and applying them to the broader population. The reviews encompass the entire tax return (all items) and are considered best practice for a group of this size. Random enquiry programs are commonly used by international tax jurisdictions (for example Denmark, United Kingdom and USA) for estimating income tax gaps.

    For the gap estimate to be robust, the random enquiry sample must be a sufficient size to provide a suitable representation of the population, but small enough to be practical and limit inconvenience to taxpayers. While methodologies and population definitions vary internationally, the sample size of Australia’s random enquiry program is proportionally similar, or greater, than the US and UK.

    The sample we used was stratified across all income levels, and the proportion of agent-prepared and self-prepared returns was representative of the total of the individuals not in business population.

    To ensure rigour around the methodology, sample size and process, we relied on an independent tax gap expert panel to assure the estimates. The panel provided guidance and endorsed the design of the random enquiry program and other aspects of the gap measurement for individuals not in business. Throughout the process, we sought ongoing feedback from the panel and validation of the execution of all methodologies involved.

    To provide further assurance, we also engaged a former Deputy President of the Administrative Appeals Tribunal who confirmed the accuracy and quality of a sample of the audit results that underpin our gap estimate.

    We have now undertaken random enquiry programs relating to two income tax years and are beginning work on a third. We are working to develop a four-year bundled sample of over 2,000 random enquires.

    Key findings to date

    The random enquiry programs (REPs) for 2013–14 and 2014–15 saw 858 reviews undertaken across a representative sample of the individuals not in business population. We sampled 614 tax returns prepared by a tax agent (agent-prepared), and 244 returns prepared by a person themselves (self-prepared).

    Overall, the incidence of adjustment of tax returns was 72%. We adjusted 78% of agent-prepared returns, compared to 57% for self-preparers.

    Comparison of adjustments in the 2013–14 and 2014–15 REP samples – total cases

    Total cases with adjustments

    Full sample
    858 cases

    Agent-prepared (614 cases)

    Self-prepared (244 cases)

    Number

    615

    476

    139

    Percentage

    72%

    78%

    57%

    Comparison of adjustments in the 2013–14 and 2014–15 REP samples – total cases – adjustments in taxpayer's favour

    Cases with adjustments in the taxpayer's favour only

    Full sample
    858 cases

    Agent-prepared (614 cases)

    Self-prepared (244 cases)

    Number

    16

    7

    9

    Percentage

    2%

    1%

    4%

    On average, we adjusted three items in a return. Adjustments tended to fall between $100 and $1,000 – of these, 37% of adjustments were $150 or less and 25% were over $1,000. While the amounts can be small, they add up when viewed across the whole population.

    Comparison of item adjustment rates and values for 2013–14 and 2014–15 REP samples

    Range of adjustments

    Self-prepared
    % of adjustments

    Self-prepared
    % of values

    Agent prepared
    % of adjustments

    Agent-prepared
    % of values

    Total % of
    adjustments

    Total % of values

    $0 – $150

    9%

    <1%

    28%

    1%

    37%

    2%

    $151 – $300

    4%

    1%

    12%

    2%

    16%

    3%

    $301 – $500

    2%

    <1%

    9%

    3%

    11%

    4%

    $501 – $1,000

    3%

    2%

    10%

    7%

    12%

    8%

    More than $1,000

    5%

    12%

    20%

    71%

    25%

    83%

    Total

    22%

    15%

    78%

    85%

    100%

    100%

    Across the random enquiries conducted to date, adjustments to income items are more prevalent in self-prepared returns. Adjustments to deduction items (including rental expenses, work-related expenses, gifts and donations and other deductions) are higher for agent-prepared returns.

    Of the 2,388 adjustments made in these cases, almost 70% relate to deductions, with 51% (or 1,212) of those for work-related expenses.

    Around 363 adjustments were made to rental items of which around 13% (or 318) relate to rental property expenses.

    International comparison

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

    Other tax jurisdictions that have estimated personal income tax gaps have measured different populations or have significantly different systems (such as limited or no ability to claim deductions), which makes it difficult and misleading to draw comparisons.

    Like all tax authorities, we are aiming for our tax gap to be as low as possible, given available resources and within the applicable law.

    Reducing the gap

    Our aim is to sustainably reduce the individuals tax gap by increasing willing participation in the tax system. Our approach is twofold – we want to:

    • support compliance – with better use of data and technology to tailor advice and guidance products, target nudge messaging, auto-correct mistakes, streamline reporting and substantiation processes, and pre-fill more information in tax returns
    • deter non-compliance – take firmer action with higher-risk taxpayers and agents including additional audits and pursue penalties or prosecutions in serious cases, particularly in areas driving the gap.

    To help us make these improvements, the Australian Government announced additional funding in the 2018 Budget. This funding will allow us to continue valuable income matching measures including for foreign source income, distributions of entities such as partnerships and capital gains information for property and shares.

    Additionally, it will allow us to increase our focus on reducing the key drivers of the gap, including work-related expenses and rental deductions. We will also improve services for tax agents who are willing to do the right thing, providing visibility of real-time prompter messages to alert agents to risks in their clients’ returns, and increasing access to pre-fill information.

    Correspondingly, we will increase our action against tax agents who deliberately and repeatedly seek to undermine the tax system. We will be looking not just at the returns of their client base but also their own business and personal affairs.

    We recognise this work is likely to take several years to flow through to our formal estimates of the tax gap. Importantly, we are not attempting to audit our way to success. We will use a range of strategies to improve correct reporting and increase willing participation in the tax system.

    Key initiatives to reduce the gap

    Some of the key initiatives to reduce the gap include:

    • improving and tailoring our public advice and guidance material, tools and services
    • increasing the quantity and quality of the data we collect
    • adopting new ways of using data and technology to make lodging returns and substantiating deductions simpler for taxpayers and their agents. This includes streamlining reporting processes and pre-filling more information in tax returns
    • helping taxpayers and their agents report correctly up front, using prompter messages, emails and letters to alert them early where we see something unusual
    • better understanding the circumstances of debt, doing what we can to prevent it and offering practical repayment options
    • taking firmer action to address non-compliance among higher-risk taxpayers and agents including additional audits, particularly in areas driving the gap
    • pursuing penalties or prosecution – or referring tax agents to the Tax Practitioners Board in the most serious of cases

    We will continue to work closely with The Treasury to identify and respond to opportunities to improve the tax system through policy reform – either of an incremental nature or at a more systemic level.

    See also:

    Last modified: 12 Jul 2018QC 56237