House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

The shortfall interest charge

Schedule 1 to this Bill amends the Taxation Administration Act 1953 to provide for a special interest regime - the shortfall interest charge - that will apply to under-assessments of income tax (known as 'shortfalls'). For income tax shortfalls, the shortfall interest charge will replace the existing general interest charge with a charge that is four percentage points lower than the general interest charge rate.

The Shortfall Interest Charge (Imposition) Bill 2005 is also being introduced to ensure the constitutional validity of the charge.

Date of effect: These amendments will apply to amendments of assessments for the 2004-05 income year and later income years.

Proposal announced: These amendments were announced in the Treasurer's Press Release No. 106 of 16 December 2004 as part of the Government's response to the Report on Aspects of Income Tax Self Assessment.

Financial impact: The financial impact of the amendments is expected to be:

Compliance cost impact: Nil.

Penalties

Schedule 2 to this Bill amends the administrative penalty regime in the Taxation Administration Act 1953 to repeal the penalty for failing to follow a private ruling, to require the Commissioner of Taxation to supply reasons why an entity is liable to a penalty and why the penalty has not been remitted in full, and to make a technical clarification of when a statement by an entity about a large income tax item is reasonably arguable.

Date of effect: The clarification of when a large income tax item is reasonably arguable applies from Royal Assent. The other amendments will broadly apply from the 2004-05 income year for income tax and from corresponding years for other taxes.

Proposal announced: These amendments were announced in the Treasurer's Press Release No. 106 of 16 December 2004 as part of the Government's response to the Report on Aspects of Income Tax Self Assessment.

Financial impact: Nil.

Compliance cost impact: Nil.

Summary of regulation impact statement

Regulation impact on business

Impact: All taxpayers whose assessments are amended to increase a liability will benefit from the reduced interest charges proposed by the changes to the interest regime.

The proposed penalties changes impact on entities who receive an administrative penalty for a shortfall amount. Entities will benefit from a shift in the balance of responsibility for accuracy in self assessing income tax liabilities in their favour in three ways.

Main points:

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Income tax shortfall currently incurs the general interest charge. The general interest charge is generally higher than commercial borrowing alternatives, to discourage using the Australian Taxation Office as a source of finance. However, in pre-amendment 'shortfall' cases, taxpayers are usually unaware of their debts, and so are unable to respond to this incentive premium. The measure introduces a new, lower shortfall interest charge in lieu of the general interest charge for the period before assessments are amended. This measure also allows for the Commissioner of Taxation (Commissioner) to remit the shortfall interest charge where the Commissioner considers it fair and reasonable to do so.

•

The Commissioner is currently required to notify a taxpayer that a tax shortfall penalty applies, but is not required to tell the taxpayer the reasons that the penalty applies. Similarly, if the Commissioner decides not to remit a penalty in full, the Commissioner is not required to give reasons for that decision. This measure amends the law to provide that when an administrative penalty applies and the Commissioner decides the penalty should not be remitted in full, the Commissioner will provide the taxpayer with an explanation of why the penalty applies and why it has not been remitted in full.

Chapter 1 - The Report on Aspects of Income Tax Self Assessment

Outline of chapter

1.1 This chapter summarises the self assessment system for income tax and explains the background to the Report on Aspects of Income Tax Self Assessment (the Report) that recommended the changes proposed in this Bill.

The self assessment system

1.2 Since 1986-87, income tax in Australia has operated under a self assessment system. Before self assessment, taxpayers were obliged by law to make a 'full and true disclosure' of the relevant information to the Australian Taxation Office (ATO) to permit the ATO to apply the law to their circumstances - in other words, assessment of taxpayers' liabilities was performed by the ATO.

1.3 Under the self assessment system, taxpayers' returns are generally accepted at face value, subject to post-assessment audit or other verification by the ATO. Under this system, while the ATO issues notices of assessment to create the formal obligation to pay tax, a taxpayer's statement in their return is taken to represent their view about how the law applies to their circumstances.

1.4 In 1989-90, the returns of companies and superannuation funds became subject to a system of full self assessment, under which the taxpayer calculates their liability and pays their tax when lodging their return. The ATO does not issue notices of assessment to these taxpayers.

1.5 For both individuals and full self assessment taxpayers, the ATO may review and amend an assessment within a prescribed period.

1.6 The self assessment system was modified in 1992 by the Taxation Laws Amendment (Self Assessment) Act 1992 to include:

•

a system to permit the ATO to issue binding public and private rulings

•

a regime of penalties for understatements of income tax liability

•

an extension of the period within which a taxpayer could object against an assessment, and

•

a system of interest for underpayments and late payments of income tax.

The Review of Aspects of Income Tax Self Assessment

1.7 On 24 November 2003, the Treasurer announced the Review of Aspects of Income Tax Self Assessment (the Review) (Press Release No. 98). The purpose of the Review, which was conducted by the Treasury, was to determine whether the self assessment arrangements struck the right balance between protecting the rights of individual taxpayers and protecting the revenue for the benefit of the Australian community.

1.8 In March 2004, the Government released a discussion paper that examined this balance in light of a number of aspects of Australia's income tax self assessment system and several comparable international arrangements. In response to the discussion paper, the Review received over 30 submissions, received a number of phone calls, emails and background papers from interested partes, and held face to face consultation with taxpayer representatives, professional bodies and other government agencies.

1.9 On 16 December 2004, the Treasurer announced the Government's response to the Report and released the Report to the public (Press Release No. 106). The Report identified a number of refinements to the self assessment system to reduce uncertainty and compliance costs for taxpayers, while preserving the ATO's capacity to collect legitimate income tax liabilities. The Treasurer announced that the Government would adopt the 30 legislative recommendations made in the Report, and that the Commissioner of Taxation had advised that the ATO would implement the relevant administrative recommendations as soon as practicable.

Implementing the legislative recommendations in the Report

1.10 This Bill implements part of the Government's response to the Report. It amends the existing law to reduce the consequences of the uncertainty that is inherent in a self assessment system by mitigating the interest and penalty consequences of taxpayer errors.

1.11 In particular, this Bill:

•

imposes a separate interest charge, with a lower rate than the general interest charge, for shortfalls of income tax

•

improves the transparency of the process of imposing penalties on taxpayers who understate a tax liability, and

•

abolishes the separate penalty for failing to follow an ATO private ruling.

1.12 In its response to the Report, the Government also announced that improvements would be made by:

•

providing for a better framework for the provision of ATO advice and introducing ways to make that advice more accessible, timely and binding in a wider range of cases, and

•

reducing the periods allowed for the ATO to increase a taxpayer's liability in a wide range of situations.

1.13 The Government will introduce the amendments necessary to implement these changes in a future Bill (or Bills).

Chapter 2 - The shortfall interest charge

Outline of chapter

2.1 Schedule 1 to this Bill amends the Taxation Administration Act 1953 (TAA 1953) to apply a special interest regime - the shortfall interest charge - to understatements of income tax liability.

2.2 The shortfall interest charge will replace the existing general interest charge with a charge at a lower rate for the period between when the shortfall amount would originally have been due and when the shortfall is corrected.

2.3 These provisions also allow for the remission of the shortfall interest charge in appropriate circumstances, with review rights where the shortfall interest charge is significant relative to the size of the shortfall.

Context of amendments

2.4 These provisions have been developed as part of the Government's response to the recommendations made in the Report on Aspects of Income Tax Self Assessment (the Report). Background to the Report, and the recommendations made, is in Chapter 1 of this explanatory memorandum.

2.5 A shortfall is different from a late payment of tax, which occurs where a stated liability (whether correct or not) is not fully paid by the due date.

2.6 Currently, a shortfall is treated the same way as a late payment, with the general interest charge being applied from the due date of the original assessment to the time the amount is paid. This occurs because the due date for payment of a shortfall amount is the same as for the original (understated) assessment, automatically triggering the application of the general interest charge from that date. Thus, when the shortfall is corrected, the general interest charge will be imposed for the 'shortfall period' (the period between due date for the original assessment and the correction of the shortfall).

2.7 The general interest charge is set at a high rate (compared with indicator rates for commercial borrowing) to encourage prompt payment of tax liabilities.

2.8 The Report recommended that a lower interest charge should apply for the period prior to a taxpayer being notified of their shortfall, as they would not generally be in a position to respond to the incentive premium that is built into the general interest charge (see Chapter 5 of the Report).

2.9 These amendments implement these recommendations.

Summary of new law

2.10 Where a taxpayer's income tax assessment is amended so as to increase their liability, the taxpayer is liable to pay the shortfall interest charge on the increase - that is, on the shortfall amount. The shortfall interest charge replaces the current liability to pay the general interest charge during the shortfall period.

2.11 The shortfall interest charge rate is calculated in the same way as the general interest charge rate, but will be four percentage points less per annum. The shortfall interest charge has a three percentage point uplift over the base rate (which is an average of bank bill yields), in contrast with the seven percentage point uplift used by the general interest charge.

2.12 The shortfall interest charge applies on a daily compounding basis from the due date for payment of the earlier, understated assessment to the end of the day before the assessment is amended.

2.13 The due date for payment of the tax shortfall and the related shortfall interest charge is 21 days after the date on which the Commissioner of Taxation (Commissioner) gives the notice increasing liability. Once this due date for the amended assessment has passed, the general interest charge will apply automatically to any unpaid tax and shortfall interest charge.

2.14 The shortfall interest charge is tax deductible.

2.15 The Commissioner has the power to remit the shortfall interest charge where the Commissioner considers it fair and reasonable to do so. The Commissioner will give written reasons for rejecting remission requests.

2.16 Taxpayers whose unremitted shortfall interest charge exceeds 20 per cent of the shortfall have objection rights and appeal rights under Part IVC of the TAA 1953 (the generic objection and appeal provisions) available to them.

2.17 The shortfall interest charge applies to shortfalls in assessments for the 2004-05 and later income years. The general interest charge (and, where relevant, the older under-payment interest charge under section 170AA of the Income Tax Assessment Act 1936 (ITAA 1936)) will continue to apply to shortfalls in assessments relating to the 2003-04 and preceding income years - regardless of when those amendments are ultimately made.

Comparison of key features of new law and current law

Detailed explanation of new law

Creation and imposition of the shortfall interest charge

The role of the shortfall interest charge

2.18 The rationale for imposing an interest charge during the shortfall period is to ensure that taxpayers who understate their liability in self assessing do not receive an advantage - in the form of a 'free loan' - over those who meet their tax liabilities in full by the due date.

2.19 This goal suggests a charge aimed at neutralising the 'loan benefits' that taxpayers could otherwise receive from the temporary use of the shortfall amount.

2.20 The existing approach of applying the general interest charge to shortfalls has had significant administrative advantages. However, before the Commissioner notifies a taxpayer of a shortfall, the taxpayer would not generally be in a position to respond to the premium that is built into the general interest charge as an incentive for prompt payment.

2.21 Accordingly, the Government has decided to create a new, lower interest charge specifically for the shortfall period.

2.22 The loan benefits that can arise from a shortfall will vary according to the circumstances of the individual taxpayer, reflecting factors such as the taxpayer's usual borrowing rate, the rate of return earned from investing the shortfall amount or - where the shortfall amount was spent on consumption - whether the taxpayer would knowingly have borrowed for that purpose.

2.23 However, administrative practicality and transparency demand that a single rate of the shortfall interest charge be imposed for all affected taxpayers. The shortfall interest charge will not be fine tuned to offset the actual loan benefit (if any) received by a particular taxpayer from a particular shortfall. Rather, the shortfall interest charge rate will reflect benchmark business borrowing rates.

2.24 Accordingly, the objects clause is stated in terms of neutralising the general potential for taxpayers to receive loan benefits from shortfalls. [Schedule 1, item 1, section 280-50]

Liability for the shortfall interest charge

2.25 A taxpayer is liable to pay the shortfall interest charge on an additional amount of income tax they are liable to pay because the Commissioner amends their assessment for an income year. A shortfall does not exist unless the taxpayer's overall liability is increased - even though the Commissioner might have increased a particular element of the earlier assessment. [Schedule 1, item 1, subsection 280-100(1)]

Example 2.1: Amended assessment with no shortfall

John is an office worker in the 30 per cent tax bracket (plus a 1.5 per cent Medicare levy).

When preparing his tax return, John incorrectly claims a $380 deduction for his telephone line rental, but also neglects to claim a valid $603 deduction for work related car expenses.

A later audit of John's work related expense claims leads to the Australian Taxation Office (ATO) querying the deduction for telephone line rental. In reviewing the TaxPack, John acknowledges that he was not entitled to that deduction, but does become aware of his entitlement to the car deduction.

The amended assessment reduces John's overall liability by $70 (ie 31.5% * (380 - 603)). John does not have a shortfall and is not liable for the shortfall interest charge on the invalid $380 telephone line rental deduction.

Liability to the shortfall interest charge is unrelated to penalties

2.26 The shortfall interest charge applies regardless of whether or not the taxpayer is liable to any penalty. Liability to the shortfall interest charge does not depend upon - nor imply - culpability on the part of the taxpayer. [Schedule 1, item 1, subsection 280-100(4)]

Government bodies - liability to pay the shortfall interest charge

2.27 Neither the Commonwealth nor an authority of the Commonwealth is liable to pay the shortfall interest charge. [Schedule 1, item 1, subsection 280-100(5)]

2.28 State and territory bodies subject to income tax are liable to pay the shortfall interest charge on shortfall amounts of income tax.

Imposition of the shortfall interest charge

2.29 The Shortfall Interest Charge (Imposition) Bill 2005 accompanies this Bill, imposing the shortfall interest charge as a tax, but only to the extent to which it cannot otherwise be validly imposed.

The shortfall interest charge period

2.30 The liability exists for each day in the period during which the taxpayer's liability was understated. In most cases, the period will run from the due date of the original (understated) assessment to the day before the Commissioner gives notice that the assessment has been amended upwards on account of the shortfall (a 'debit amendment'). [Schedule 1, item 1, subsection 280-100(2)]

Example 2.2: Simple shortfall case

John is an office worker in the 30 per cent tax bracket (plus a 1.5 per cent Medicare levy).

John incorrectly claims in his 2004-05 tax return a $600 deduction for an ordinary business suit. The due date for payment of the assessment based on that return is 21 November 2005.

A later audit of John's work related expense claims results in his liability being increased by $189 (ie 31.5% * 600), with the amendment being notified to him on 30 January 2007.

The shortfall interest charge would apply on the $189 for the 435 days from 21 November 2005 to 29 January 2007 (inclusive).

2.31 Under the current law, a 'nil assessment' (such as where the taxpayer has a tax loss for the income year) does not constitute an assessment. The Government will introduce amendments later this year, as part of its proposed improvements to self assessment for amendment periods, that will have the effect that the shortfall interest charge applies to cases where a taxpayer's liability is adjusted from nil to a positive amount. In such cases, the shortfall interest charge period will commence on the day that tax would have been due had a positive amount been assessed. [Schedule 1, item 1, paragraph 280-100(2)(a)]

2.32 In some cases the shortfall does not arise from an error in the original assessment, but from the taxpayer later requesting an amendment that incorrectly reduces their liability (an erroneous 'credit amendment'). Although a shortfall would arise, the taxpayer would not have received a benefit until they received the erroneous credit. Accordingly, in such cases the shortfall interest charge period will commence from the due date of the amended assessment that incorrectly reduced the previously assessed liability. (Due dates for amended assessments are explained in paragraph 2.43.) [Schedule 1, item 1, subsection 280-100(3)]

Example 2.3: An erroneous credit amendment

John is an office worker in the 30 per cent tax bracket (plus a 1.5 per cent Medicare levy).

John files his tax return for the income year 2004-05. The due date for payment of the assessment based on that return is 21 November 2005.

Later, a colleague remarks that he had claimed a workplace deduction for a suit, prompting John, who had purchased a $600 business suit in May 2005, to request an amendment to his assessment reducing his liability by $189 (ie 31.5% * 600). John is notified of this amendment, and receives a cheque for $189. The amended assessment has a due date of 20 December 2005.

A later audit of John's work related expense claims results in his liability being increased by $189, with the amendment being notified to him on 30 January 2007.

The shortfall interest charge would apply on the $189 for the 406 days from 20 December 2005 to 29 January 2007 (inclusive).

Cases of multiple amendment.

2.33 The cases outlined above demonstrate the principle that the shortfall interest charge, rather than the general interest charge, applies to income tax shortfalls during the period in which a taxpayer has not been notified of a shortfall.

2.34 Where complex overlays of debit and credit amendments arise, it is intended that the shortfall interest charge apply to the various shortfall amounts during their respective shortfall periods. The shortfall interest charge periods pertaining to multiple amendments may run concurrently.

Example 2.4: Multiple amendments

John is an office worker in the 30 per cent tax bracket (plus a 1.5 per cent Medicare levy).

When preparing his tax return, John omits to declare $800 in dividend income and incorrectly claims a $380 deduction for his telephone line rental. The due date for payment of the assessment based on that return is 21 November 2005.

Later, a colleague remarks that he had claimed a workplace deduction for a suit, prompting John, who had purchased a $600 business suit in May 2005, to request an amendment to his assessment reducing his liability by $189 (ie 31.5% * 600). John is notified of this amendment, and receives a cheque for $189. The amended assessment has a due date of 20 December 2005.

Computerised income matching identifies the omitted dividend income, resulting in an amended assessment increasing his liability by $252 (ie 31.5% * 800), being notified to him on 2 March 2006.

A later audit of the John's work related expense claims denies the deductions for telephone line rental and the business suit, resulting in an amended assessment increasing his liability by $308 (ie 31.5% * (380 + 600)), being notified to him on 30 January 2007.

The shortfall interest charge would apply as follows:

•

For the dividends: on $252 (ie 31.5% * 800) for the 101 days from 21 November 2005 to 1 March 2006 (inclusive).

•

For the phone: on $119 (ie 31.5% * 380) for the 435 days from 21 November 2005 to 29 January 2007 (inclusive).

•

For the suit: on $189 (ie 31.5% * 600) for the 406 days from 20 December 2005 to 29 January 2007 (inclusive).

The shortfall interest charge rate

2.35 The shortfall interest charge rate is a daily rate arrived at by dividing an annualised rate by the number of days in the calendar year - as occurs with the general interest charge. [Schedule 1, item 1, subsection 280-105(2)]

2.36 In annualised terms, the shortfall interest charge rate is four percentage points lower than the general interest charge, employing a three percentage point uplift factor over the same base rate that the general interest charge uses. [Schedule 1, item 1, subsection 280-105(2)]

2.37 The shortfall interest charge uses the same base rate as the general interest charge. The base rate is adjusted quarterly, as the mean yield on 90-day bank accepted bills for the middle month of the preceding quarter. [Schedule 1, item 1, subsection 280-105(2) and, item 22, subsection 995-1(1)]

Example 2.5: Calculation of the shortfall interest charge rate

Assume the mean yield on 90-day bank accepted bills for November 2005 is 5.5 per cent per annum. The base rate applying in the first quarter of 2006 would therefore be 5.5 per cent per annum.

The annualised shortfall interest charge rate applying during that quarter would therefore be 8.5 per cent (ie 5.5% + 3%) per annum, resulting in a (daily) shortfall interest charge rate of 0.02328767 per cent.

In contrast, the applicable general interest charge rate during the quarter would be 12.5 per cent per annum, corresponding to a daily general interest rate of 0.03424657 per cent.

Calculation of the shortfall interest charge

2.38 The shortfall interest charge rate is applied on a daily compounding basis to the shortfall amount, for the duration of the shortfall interest charge period. That is, for any day in the period, the shortfall amount and any shortfall interest charge accumulated to date is multiplied by the (daily) shortfall interest charge rate. [Schedule 1, item 1, subsection 280-105(1)]

Example 2.6: Calculation of the shortfall interest charge

A taxpayer has a $1,000 shortfall for (exactly) the whole of the first quarter of 2006, during which the base rate was 5.5 per cent.

•

On 1 January 2006 the shortfall interest charge would be $0.23 ($1,000 * 0.0002328767).

•

On 2 January 2006 the shortfall interest charge would be $0.23 ($1,000.23 * 0.0002328767).

Over the whole 90 days of the quarter, the total shortfall interest charge will amount to $21.18, compared with the general interest charge of $31.30 that would have been imposed on the shortfall under the current legislation.

Notification by the Commissioner

2.39 The Commissioner must give the taxpayer a notice stating the amount of the shortfall interest charge liability. This amount can be included in another notice that the Commissioner gives to the taxpayer - such as the notice of the amended assessment. The notice will serve as prima facie evidence of the shortfall interest charge liability. [Schedule 1, item 1, section 280-110]

2.40 Section 29 of the Acts Interpretation Act 1901 describes what is meant by 'give' in these provisions. In most cases the ATO will be considered to have given notice by addressing and posting a notice as a letter, and the notice is deemed to have been given to the taxpayer at the time the letter would be delivered in the ordinary course of the post.

Due date for payment of amended assessments

2.41 Under the current law, an amended assessment is due and payable at the same time as the original assessment. Also, the general interest charge that accrued each day during the shortfall period would have been due at the end of each day.

2.42 The new arrangements provide a prospective due date, allowing a 21 day payment period for notified amounts of shortfall and related shortfall interest charge. [Schedule 1, item 7, subsections 204(2) and (2A) of the ITAA 1936]

2.43 The amount of tax that a taxpayer is liable to pay because of an amended assessment will be due 21 days from when the taxpayer is given notice of the amendment. [Schedule 1, item 7, subsection 204(2) of the ITAA 1936]

2.44 Any shortfall interest charge that a taxpayer is liable to pay will be due 21 days from when the taxpayer is given notice of the charge. [Schedule 1, item 7, subsection 204(2A) of the ITAA 1936]

Credit amendments

2.45 The prospective due date will apply to all amended assessments - including amendments decreasing a taxpayer's liability (ie credit amendments).

2.46 In the case of credit amendments, no additional amount of tax will become due and payable at that date. However, the due date for the amended assessment will be the starting point for any shortfall interest charge period that might arise from erroneous credits in that amended assessment. [Schedule 1, item 1, subsection 280-100(3)]

Ongoing relevance of previous due dates

2.47 Although an amended assessment has a new, prospective due date, the due date of the original assessment - and any intervening amended assessments - will continue to be relevant for determining any shortfall interest charge or general interest charge arising from those assessments.

2.48 The due date of an original assessment will continue to be the starting date for the shortfall interest charge on any further shortfalls arising from the original assessment and for the general interest charge on unpaid amounts from the original assessment.

Example 2.7: Relevant due dates and amended assessments

John is an office worker in the 30 per cent tax bracket (plus a 1.5 per cent Medicare levy).

When preparing his tax return for the income year 2004-05, John omits to declare $800 in dividend income and incorrectly claims a $380 deduction for his telephone line rental.

John files his tax return well before the 31 October 2005 lodgement deadline and, based on that return, receives a tax assessment for $10,000, due and payable on 21 November 2005. After allowing for $9,000 of tax that had been withheld from his salary over the course of the year, John has an outstanding tax liability of $1,000. John makes no payments against that $1,000, and the general interest charge commences to accrue from 21 November 2005.

Computerised income matching identifies the omitted dividend income. On 2 March 2006, John is notified of an amended assessment increasing his liability by $252 (ie 31.5% * 800) and of the shortfall interest charge on that amount for the 101 days from 21 November 2005 to 1 March 2006 (inclusive). John pays the increased liability and the shortfall interest charge before the due date of 23 March 2006.

The general interest charge, which has been accruing on a compound basis since 21 November 2005, will continue to accrue on the unpaid $1,000 from the original assessment and the unpaid general interest charge.

A later audit of John's work related expense claims denies the deduction for telephone line rental, resulting in a further amended assessment. On 30 January 2007 John is notified that his liability for 2004-05 has been increased by $119 (ie 31.5% * 380) and that the shortfall interest charge applies on this amount for the 435 days from 21 November 2005 to 29 January 2007 (inclusive). The due date for payment of these amounts is 20 February 2007.

As John has still made no payments against the unpaid $1,000 from the original assessment or the resulting general interest charge, the general interest charge on those overdue amounts continues to accrue daily.

2.49 Similarly, the due date of an amended assessment remains relevant even where that amended assessment is itself later amended:

•

The shortfall interest charge period for a shortfall that arises from an erroneous credit amendment always commences at the due date for that credit amendment (see Example 2.3) [Schedule 1, item 1, subsection 280-100(3)].

•

The general interest charge on any amounts remaining unpaid from an earlier amended assessment always accrues from the due date of that earlier amended assessment (see paragraph 2.53).

Interest charge implications of the prospective due date

2.50 Having a prospective due date for amended assessments has implications for interest charges.

The payment period

2.51 Consistent with the treatment of the original assessment, neither the shortfall interest charge nor the general interest charge will apply during the 21 day payment period. This ensures that the taxpayer can settle the matter by paying the notified amount by the due date, without further (un-notified) interest having accrued.

2.52 Similarly, to encourage immediate payment of notified amounts, taxpayers will be eligible for early payment interest under the terms of the Taxation (Interest on Overpayments and Early Payments) Act 1983. The prospective due date will automatically give rise to this entitlement for early payment of the increase in assessed liability. The amendments extend the entitlement to early payment of the shortfall interest charge. [Schedule 1, item 29, paragraph 8A(1)(a) of the Taxation (Interest on Overpayments and Early Payments) Act 1983]

The general interest charge

2.53 The general interest charge applies automatically from the due date of any unpaid tax liabilities, and so will commence to accrue daily at the end of the 21 day payment period on any unpaid shortfall amount. The amendments extend this treatment to unpaid shortfall interest charge. [Schedule 1, item 7, subsections 204(2), (2A) and (3) of the ITAA 1936 and item 24, subsection 8AAB(4)]

2.54 The higher general interest charge is applied in such cases because, once the amounts owing have been notified and a payment period allowed, the shortfall taxpayer would generally be in a position to respond to the incentive premium that is built into the general interest charge.

2.55 No shortfall amount will be subject to both the general interest charge and the shortfall interest charge in respect of the same day.

Interest charges and credit amendments

The shortfall interest charge

2.56 Where an assessment has been amended because of a purported shortfall and that shortfall is later overturned, the shortfall interest charge relating to that shortfall will be annulled. [Schedule 1, item 3, subsection 172(1) of the ITAA 1936; item 4, subparagraph 172(1)(a)(ii) of the ITAA 1936; item 6, subsection 172(2) of the ITAA 1936]

2.57 A taxpayer is generally eligible for overpayment interest on an overturned shortfall, under the Taxation (Interest on Overpayments and Early Payments) Act 1983. The amendments make the taxpayer also entitled to overpayment interest on the related shortfall interest charge that they had paid. [Schedule 1, item 27, subparagraph 3(1)(a)(iiia) of the Taxation (Interest on Overpayments and Early Payments) Act 1983; item 28, subparagraph 3(1)(a)(iv) of the Taxation (Interest on Overpayments and Early Payments) Act 1983]

The general interest charge

2.58 Under the current law, the uniform due date for all assessments and amendments of assessments means that a credit amendment automatically corrects any general interest charge implications of the earlier overstatement of a taxpayer's liability.

2.59 The amendments ensure that any such general interest charge implications continue to be corrected. Where a shortfall amount (and related shortfall interest charge) is not paid by the due date, that outstanding liability will initially be reflected in the general interest charge applying to the later period. Should the shortfall later be overturned, the general interest charge will be recalculated as if the unpaid shortfall amount (and related shortfall interest charge) had never existed. [Schedule 1, item 4, paragraph 172(1)(a) of the ITAA 1936]

Example 2.8: Credit amendment and the general interest charge

Assume the base rate is a constant 5.5 per cent.

Company F completes its income tax assessment for the income year 2004-05, which has a due date of 1 December 2005. From time to time, Company F has various outstanding tax liabilities posted to its ATO running balance account, which attract the general interest charge.

An ATO compliance program results in Company F's assessment being amended to increase the liability by $30,000. Company F is notified on 2 March 2006 of the amended assessment and the related shortfall interest charge of $642 (ie on an amount of $30,000 at a rate of 8.5 per cent for the 91 days from 1 December 2005 to 1 March 2006 inclusive), with the due date for payment being 23 March 2006.

Company F makes no payments against the shortfall amount or the shortfall interest charge, and from 23 March 2006 the $30,642 debt would be reflected in the daily general interest charge accruing on Company F's ATO running balance account.

Company F later successfully objects to the debit amendment. The general interest charge for the period from 23 March 2006 is recalculated with the effects of the unpaid $30,000 shortfall and $642 of the shortfall interest charge negated by equal credits with the same effective date of 23 March 2006.

Reversal of credit amendments

2.60 Where a credit amendment is later overturned, the general interest charge and the shortfall interest charge that had been eliminated by that credit amendment will be reinstated. [Schedule 1, item 5, subsection 172(1A) of the ITAA 1936]

Tax deductibility of the shortfall interest charge

2.61 The shortfall interest charge is tax deductible. This is consistent with the tax deductibility of the general interest charge and its predecessor the under payment interest charge. [Schedule 1, item 20, paragraph 25-5(1)(c)]

Remission of the shortfall interest charge

2.62 The Commissioner can remit all or part of the shortfall interest charge where the Commissioner considers it fair and reasonable to do so. [Schedule 1, item 1, subsection 280-160(1)]

2.63 Remission can be requested by the taxpayer or initiated by the Commissioner.

2.64 In considering whether to grant remission, the Commissioner must have regard to two key principles [Schedule 1, item 1, subsection 280-160(2)] :

•

Remission should not occur just because the benefit the taxpayer received from the temporary use of the shortfall amount is less than the shortfall interest charge [Schedule 1, item 1, paragraph 280-160(2)(a)]. In particular, a taxpayer should not expect that remission would be granted for the sole reason that their rate of finance is lower than the shortfall interest charge rate.

•

Remission should occur where the circumstances justify the Commonwealth bearing part of the cost of delayed receipt of taxes [Schedule 1, item 1, paragraph 280-160(2)(b)]. Such cases would usually entail delay, contributory cause or fault on the part of the ATO or others. Where the Commissioner is aware that these circumstances arise, the Commissioner should initiate remission.

2.65 The following examples illustrate where remission should be considered in accordance with this second principle, having regard to the extent to which factors beyond the taxpayer's control were responsible for the size and duration of the shortfall:

•

The ATO took longer to complete an audit than could reasonably have been expected, having regard to all the facts and circumstances of the case.

•

Even though there was no delay by the ATO, the complexity of issues involved resulted in an abnormal time between the commencement of the audit and the amendment of the assessment.

•

The ATO has, by advice or action, contributed to the taxpayer's error giving rise to the shortfall.

•

The taxpayer relied on judicial interpretation that was later overturned.

•

The taxpayer is affected by a retrospective change in legislation.

2.66 It is also intended that remission be considered in the following cases:

•

A shortfall caused negligible or no revenue impact. An example of this would be where joint income has been incorrectly apportioned between taxpayers with equal marginal rates.

•

The amount of the shortfall interest charge remitted is minor - for example, the Commissioner might round down the amount of the shortfall interest charge payable or remit in full a minor amount of charge.

•

Practical administration favours remission - for example, where calculation of the precise shortfall interest charge is complex, the Commissioner might apply an approximation that does not disadvantage the taxpayer.

2.67 Remission may also be considered to encourage taxpayers to voluntarily self amend when they become aware that they have a shortfall. This would not generally include cases where a taxpayer is merely responding to an ATO announcement that certain arrangements were ineffective - although the ATO may offer interest incentives to settle in such cases. Similarly, specific interest rate remission policies could be adopted by the ATO as part of particular compliance programs.

2.68 The considerations set out above are not intended to be exhaustive, and the Commissioner is given a broad discretion to remit where the circumstances make it fair and reasonable to do so. [Schedule 1, item 1, section 280-160]

2.69 Conversely, the Commissioner has the discretion not to remit where a taxpayer has acted in bad faith or where other circumstances mean that it would not be fair and reasonable to remit.

Reasons for remission decision

2.70 To improve confidence in the objectivity of ATO remission decisions, the Commissioner must provide reasons for the remission decision where a taxpayer requests remission of the shortfall interest charge and the Commissioner decides not to remit all of the amount. [Schedule 1, item 1, section 280-165]

2.71 The Acts Interpretation Act 1901 (section 25D) provides for what constitutes written reasons. This states that '...the instrument giving the reasons shall also set out the findings on material questions of fact and refer to the evidence or other material on which those findings were based.'.

2.72 In order for this provision to be administratively workable, reasons will only be required to be provided where the taxpayer has initiated the remission through making a remission request in the approved form.

2.73 Any existing right to request reasons under other administrative law mechanisms (eg the Administrative Decisions (Judicial Review) Act 1977) is not affected by these amendments.

Objection and appeal against certain remission decisions

2.74 The amendments introduce a new avenue of review for taxpayers with shortfalls. Under the general interest charge regime, there is no mechanism to challenge a remission decision under the tax law. No review of the merits of the decision is available.

2.75 As shown above, a range of judgements might need to be made by the Commissioner when deciding whether or not to remit some or all of the shortfall interest charge. It is appropriate therefore that merits review of remission decisions be available where the potential for the shortfall interest charge to have penalty effects is significant relative to the administrative costs of such a review process.

2.76 Accordingly, where the unremitted shortfall interest charge exceeds 20 per cent of the tax shortfall, the objection, review and appeal rights available in Part IVC of the TAA 1953 will be available to the taxpayer. The rights available include a right to object to the merits of a decision made by the Commissioner, a right to have the Administrative Appeals Tribunal review the objection decision and a right to appeal the decision to the Federal Court. [Schedule 1, item 1, section 280-170]

2.77 Without the 20 per cent threshold, the cost of objections and appeals is likely to be excessive relative to the potential penalty effect from the shortfall interest charge being above loan benefits that taxpayers receive from the temporary use of the shortfall funds.

2.78 It is recognised that large shortfalls can result in large amounts of the shortfall interest charge without exceeding the 20 per cent threshold. However, a large shortfall interest charge does not, of itself, imply a large penalty effect. As noted in paragraphs 2.22 and 2.23, determining the loan benefit for a particular taxpayer - and hence the actual penalty effect of the shortfall interest charge rate - can be complex and any decisions based on that judgement would raise concerns over transparency.

2.79 Accordingly, formal objection and appeal rights will not be available merely because the amount of the shortfall interest charge is large in absolute dollar terms. This does not prevent the Commissioner initiating remission (or further remission) where the affected taxpayer lacks formal appeal rights.

2.80 The provision applies regardless of whether the remission decision is initiated by the taxpayer or the Commissioner. However, a remission decision must have been made before the rights will be triggered. The taxpayer is not required to request remission before objecting to a failure to remit an amount of the shortfall interest charge if the Commissioner has already made a decision not to remit.

2.81 The provision applies regardless of whether the Commissioner has remitted in full or in part, so long as the total unremitted amount is more than 20 per cent of the shortfall amount.

2.82 The current review mechanisms (and any associated right to request reasons for a decision) available under the Administrative Decisions (Judicial Review) Act 1977 or other administrative law mechanisms are not affected by these amendments.

Overpayment interest on delayed remission of shortfall interest charge

2.83 Where a taxpayer requests and receives remission of the general interest charge, but there is a delay in granting that remission, the taxpayer can receive overpayment interest for the period from the beginning of the 30th day after the request was made. The amendments extend this entitlement to delayed remission of shortfall interest charge. [Schedule 1, item 30, subparagraph 12A(1)(ia) of the Taxation (Interest on Overpayments and Early Payments) Act 1983]

Consequential amendments

Definitions

2.84 Consequential amendments are made to include the new terms 'shortfall interest charge' and 'base interest rate' in the definition provisions in the ITAA 1936 and Income Tax Assessment Act 1997 (ITAA 1997). [Schedule 1, item 2, subsection 6(1) of the ITAA 1936; items 22 and 23, subsection 995-1(1) of the ITAA 1997]

Assessable recoupment

2.85 The shortfall interest charge will have equivalent treatment to the general interest charge as an assessable recoupment. [Schedule 1, item 18, subsection 20-25(2A); and item 19, paragraph 20-25(2A)(a) of the ITAA 1997]

2.86 An assessable recoupment occurs where the Commissioner has repaid an amount to the taxpayer. Because the taxpayer is entitled to claim a deduction for the shortfall interest charge, the taxpayer must include any recouped shortfall interest charge in their assessable income.

The shortfall interest charge as a tax liability

2.87 In order to trigger the appropriate collection and recovery provisions in the TAA 1953, the shortfall interest charge has been included as a tax related liability in the TAA 1953. [Schedule 1, item 25, subsection 250-10(2)]

2.88 Consequently, the shortfall interest charge is included in the provisions that allow for release from liability in a situation of serious hardship. [Schedule 1, item 26, subsection 340-10(2)]

Applying the shortfall interest charge where the general interest charge currently applies to shortfall cases

2.89 Consequential amendments are made to miscellaneous situations where the general interest charge can currently apply to a shortfall of income tax. These are:

•

negligence of registered tax agents

•

agents and trustees, and

•

persons in receipt or control of money from non-residents.

2.90 These amendments are needed to treat the shortfall interest charge in the same manner as the general interest charge, to include references to how the shortfall interest charge is worked out and in some cases to avoid confusion between the shortfall interest charge and the general interest charge where the term 'the charge' is used. [Schedule 1, items 8 to 17 and 21]

Application and transitional provisions

2.91 These amendments apply to amendments of assessments for the 2004-05 income year and later income years. [Schedule 1, item 31]

Chapter 3 - Penalties

Outline of chapter

3.1 Schedule 2 to this Bill amends the administrative penalty regime in Schedule 1 to the Taxation Administration Act 1953 (TAA 1953), which applies where entities fail to meet various tax obligations, to:

•

abolish the penalty for a tax shortfall resulting from a failure to follow a private ruling issued by the Commissioner of Taxation (Commissioner)

•

require the Commissioner to provide an explanation of why an entity is liable to a penalty and why the penalty has not been remitted in full, and

•

clarify the definition of when a statement by an entity about its income tax liability is 'reasonably arguable' (and therefore not subject to the penalty for a tax shortfall resulting from taking a position about a large item that is not reasonably arguable) in relation to income tax law.

Context of amendments

3.2 These provisions implement part of the Government's response to the recommendations made in the Report on Aspects of Income Tax Self Assessment (the Report). Background to this report and its recommendations are in Chapter 1 of this explanatory memorandum.

3.3 A generic administrative penalty regime applies to taxation laws administered by the Commissioner. The broad objective of the regime is to impose sanctions in the form of an administrative penalty where an entity fails to meet various obligations under the law. As the regime applies to various entities with taxation obligations, not just taxpayers, this chapter refers to 'entities', unlike Chapter 2 which discusses the introduction of the shortfall interest charge and refers to taxpayers.

3.4 Division 284 of Schedule 1 to the TAA 1953 sets out the circumstances in which administrative penalties apply for tax shortfalls resulting from making false or misleading statements, taking a position that is not reasonably arguable, entering into schemes, and for disregarding a private ruling. It also sets out how those penalties are to be calculated.

Abolishing the penalty for failing to follow a private ruling

3.5 Under the current law an entity is liable to an administrative penalty under subsection 284-75(4) of Schedule 1 to the TAA 1953 if there is a private ruling about the way a taxation law applies to the entity, and the entity does not follow the ruling and makes a statement treating the taxation law as applying in a different way, and a tax shortfall results.

3.6 This penalty has the potential to operate as an inappropriate disincentive to entities seeking Australian Taxation Office (ATO) advice and, accordingly, it is abolished.

Requiring the Commissioner to supply reasons why an entity is liable to a penalty and why the penalty is not remitted in full

3.7 The machinery provisions for the generic administrative penalties regime require the Commissioner to notify an entity that a tax shortfall penalty applies, but do not require the Commissioner to tell the entity the reasons that the penalty applies. Similarly, if the Commissioner decides not to remit a penalty in full, the provisions do not require the Commissioner to give reasons for that decision. However, the Commissioner could be required to give reasons if a taxpayer applied under the Administrative Decision (Judicial Review) Act 1977.

3.8 It is important that taxpayers who are subject to a penalty understand why they have been penalised. Accordingly, the amendments require the Commissioner to provide an explanation of why a penalty has been imposed and why a penalty has not been remitted in full.

Clarifying the definition of reasonably arguable

3.9 Subsection 284-15(1) of Schedule 1 to the TAA 1953 provides that a matter is reasonably arguable 'if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is as likely to be correct as incorrect, or is more likely to be correct than incorrect.' Under subsection 284-15(2), reasonably arguable has a corresponding meaning where the issue is how the Commissioner would exercise a discretion.

3.10 An entity is liable to an administrative penalty under subsection 284-75(2) of Schedule 1 to the TAA 1953 if the entity makes a statement to the Commissioner in which an income tax law is treated as applying to the entity for a large item in a way that is not reasonably arguable, and a tax shortfall results. For individuals and companies, an item is a large item if there is a tax shortfall exceeding the greater of $10,000 or 1 per cent of the income tax payable.

3.11 A shortfall amount arises where there is a difference between the amount of tax, credit or payment entitlement calculated on the basis of the entity's statement in a document, and the tax properly payable according to law.

3.12 The ATO has interpreted the current definition in accordance with the legislative intention that the relevant standard is about as likely to be correct as incorrect (or more likely to be correct than incorrect), not as likely to be correct as incorrect, consistent with the explanatory memorandum of the A New Tax System (Tax Administration) Act (No. 2) 2000. However, on their face, the words of the definition require a higher standard.

3.13 The definition of when a matter is 'reasonably arguable' is clarified to confirm that the relevant standard is about as likely to be correct as incorrect (or more likely to be correct than incorrect), not as likely to be correct as incorrect.

Comparison of key features of new law and current law

Detailed explanation of new law

Abolishing the penalty for failing to follow a private ruling

3.14 The provision that imposed an administrative penalty for not following a private ruling is repealed. [Schedule 2, item 7, subsection 284-75(4) of Schedule 1 to the TAA 1953]

3.15 The items relating to the shortfall penalty for not following a private ruling are also omitted. Consequently, the items in the table in section 284-80, which explain the concept of 'shortfall amount' in different situations, are also amended to remove a shortfall amount situation arising where a tax-related liability is less than what it would be if the statement had not been inconsistent with a private ruling. [Schedule 2, item 8, subsection 284-80(1) of Schedule 1 to the TAA 1953]

3.16 Similarly, the amendments omit the base penalty amount of 25 per cent of the shortfall which currently applies where an entity has a tax shortfall as a result of disregarding a private ruling. [Schedule 2, item 9, subsection 284-90(1) of Schedule 1 to the TAA 1953]

3.17 However, if an entity has a tax shortfall as a result of a statement they make (in a return or otherwise), they may still be liable to a shortfall tax penalty if, for example, they failed to take reasonable care or if they did not have a 'reasonably arguable position' on a large income tax item. If an entity obtains a private ruling on an issue but does not follow it, to satisfy the reasonable care standard they would normally need to have taken other steps, such as obtaining and following the considered advice of a tax practitioner about the issue.

Requiring the Commissioner to supply reasons why an entity is liable to a penalty and why the penalty is not remitted in full

3.18 This Bill amends the law to provide that when an administrative penalty applies and the Commissioner decides the penalty should not be remitted in full, the Commissioner will provide the entity with an explanation in writing of why the penalty applies and why it has not been remitted in full. The Commissioner is not required to give reasons if he or she decides to remit the entire penalty. [Schedule 2, items 12 and 14, section 298-10 and subsection 298-20(2) of Schedule 1 to the TAA 1953]

Example 3.1

Cecelia fails to include a significant amount of interest from her bank account with Megabank in her income tax return. The facts show that the statement was made as a result of Cecelia not taking reasonable care. This is the third time that Cecelia has been liable to a penalty for a false or misleading statement. She did not voluntarily disclose the omission, so a penalty is imposed at 30 per cent of the shortfall amount (ie 25 per cent for lack of reasonable care increased by 20 per cent for previous shortfall amounts arising from false or misleading statements).

The Commissioner will give Cecelia a notice explaining:

•

that the penalty was imposed because she had not taken reasonable care

•

the finding of fact (that she had omitted a material amount from her return) that grounded the conclusion that she had not taken reasonable care

•

the evidence on which the finding was based (here, the statements of interest paid by Megabank)

•

that the penalty was increased because the same type of penalty had been imposed on previous occasions, and

•

that the penalty was not remitted because the same type of penalty had been imposed on previous occasions.

3.19 Section 25D of the Acts Interpretation Act 1901 requires that written reasons set out the findings on material questions of fact and refer to the evidence or other material on which those findings are based. Notes adverting to this provision will be inserted. [Schedule 2, items 13 and 15, section 298-10 and subsection 298-20(2) of Schedule 1 to the TAA 1953]

3.20 All penalties imposed under Part 4-25 of Schedule 1 to the TAA 1953 are subject to generic machinery provisions, which means that reasons must be supplied for all penalties within the generic penalty regime.

3.21 The law does not specify when the reasons must be supplied. However, it is intended that the Commissioner supply the reasons at the same time as, or as soon as possible after, the Commissioner notifies the entity of the penalty. In some cases, the Commissioner may supply reasons before issuing notice of the penalty.

3.22 An entity continues to have a right to object to an assessment of a tax shortfall penalty, and the Commissioner's decision on the objection will still be reviewable under Part IVC of the TAA 1953.

Amending the definition of reasonably arguable

3.23 The Report recommended that the definition of when a matter is reasonably arguable should be clarified to confirm that the relevant standard is about as likely to be correct as incorrect (or more likely to be correct than incorrect), not as likely to be correct as incorrect.

3.24 This recommendation is implemented by inserting the word 'about' in the relevant subsections of the definition of 'reasonably arguable'. [Schedule 2, items 3 and 4, subsections 284-15(1) and (2) of Schedule 1 to the TAA 1953]

Application and transitional provisions

3.25 These amendments will generally apply from the 2004-05 year, as announced by the Treasurer in Press Release No. 106 of 16 December 2004.

3.26 The abolition of the penalty for not following a private ruling will apply to:

•

In the case of income tax - the 2004-05 income year and later years.

•

In the case of fringe benefits tax - the year of tax starting on 1 April 2004 and later years.

•

In the case of other taxes - the year starting on 1 July 2004 and later years.

[Schedule 2, subitem 16(1)]

3.27 The new requirement to give reasons why a penalty has been imposed and not remitted in full applies to notices given and decisions made after Royal Assent in relation to:

•

In the case of income tax - the 2004-05 income year and later income years.

•

In the case of fringe benefits tax - the year of tax starting on 1 April 2004 and later years.

•

In the case of other taxes - the year starting on 1 July 2004 and later years.

[Schedule 2, subitem 16(2)]

3.28 The clarification of the meaning of reasonably arguable position applies from Royal Assent because it confirms how the law is currently administered.

Consequential amendments

3.29 As a consequence of abolishing the penalty for failing to follow a private ruling, references to that penalty in the objects clause and the guide provisions in the generic administrative penalties provisions are deleted. [Schedule 2, items 1, 2, 5, 6, 8 and 9, sections 284-10, 284-70 and 284-80 of Schedule 1 to the TAA 1953]

3.30 At present, an entity does not have a shortfall if the entity makes a statement to the Commissioner that is inconsistent with a private ruling if there is a court order or decision of the Administrative Appeals Tribunal that supports the statement that he or she made. Since the general rule against disregarding a private ruling is abolished, this consequential rule is deleted. [Schedule 2, item 10, subsection 284-215(3) of Schedule 1 to the TAA 1953]

3.31 Under the current law, there is a 20 per cent increase in the base penalty amount for failing to follow a private ruling where a penalty for failing to follow a private ruling was incurred for a previous accounting period. Since that penalty will no longer exist, the law is amended to remove this rule. [Schedule 2, item 11, paragraph 284-220(1)(d) of Schedule 1 to the TAA 1953]

Chapter 4 - Regulation impact statement

Background

4.1 Since 1986-87, Australia has operated a system of self assessment of income tax. Under self assessment, taxpayers' returns are generally accepted at face value in the first instance and the Australian Taxation Office (ATO) may verify the accuracy of the return and, if necessary, amend an assessment within a prescribed period. From 1989-90, the returns of companies and superannuation funds became subject to a system of full self assessment under which the taxpayer calculates their liability and pays their tax when lodging their return.

4.2 Before self assessment, taxpayers provided the ATO with relevant information and the ATO applied the law to assess their liabilities accordingly. While errors of fact could be corrected by the ATO, mistakes of law could not be. Under that system, the majority of risk and the cost of mistakes of law by the ATO were borne by all taxpayers. Self assessment relieved the ATO of the obligation to examine returns lodged by taxpayers and allows it to amend errors of calculation, mistakes of fact and mistakes of law after processing the initial assessment and collecting the tax payable or paying a refund. In some circumstances, returns may be re-opened many years after the original assessment. In this way, the introduction of self assessment increased uncertainty for taxpayers and shifted the balance of risk towards individuals. The change to self assessment meant that the ATO's resources could be used more efficiently, allowing more revenue to be collected for the same administrative cost.

4.3 Under self assessment, taxpayers may be uncertain about how the law applies to their circumstances. Uncertainty exposes taxpayers to costs (such as a requirement to pay additional tax, penalties and interest, or the costs of professional advice and litigation) if a shortfall is detected by the ATO. Uncertainty may have implications for taxpayer perceptions about the fairness of the tax system (and consequently may affect the level of voluntary compliance by taxpayers). Finally, uncertainty about the tax consequences of a proposed transaction may have adverse economic implications, as taxpayers may be unwilling to enter into economically beneficial transactions if they are not able to obtain assurance about their taxation consequences.

4.4 In Press Release No. 098 of 24 November 2003, the Treasurer commissioned the Review of Aspects of Income Tax Self Assessment (the Review) to examine whether the right balance has been struck between protecting the rights of individual taxpayers and protecting the revenue for the benefit of the whole Australian community.

4.5 The Review identified refinements to the present system to reduce both the level of uncertainty for taxpayers and the compliance costs associated with self assessment, while preserving the capacity of the ATO to collect legitimate tax liabilities.

Specification of policy objectives

4.6 The broad policy objective is to reduce the level of uncertainty for taxpayers and the compliance costs associated with self assessment, while preserving the capacity of the ATO to collect legitimate tax liabilities.

Implementation and analysis

4.7 The Review examined many aspects of the income tax assessment system and recommended Government:

•

improve certainty through providing for a better framework for the provision of ATO advice and introducing ways to make that advice more accessible and timely, and binding in a wider range of cases

•

improve certainty by reducing the periods allowed for the ATO to increase a taxpayer's liability in a wide range of situations

•

mitigate the interest and penalty consequences of taxpayer errors arising from uncertainties in the self assessment system, and

•

provide for future improvements through better policy processes, law design and administrative approaches.

4.8 An analysis of each aspect will not be addressed within this chapter due to the complexity of the advice and amendment period measures. It is proposed that an impact analysis of these measures will be handled separately.

4.9 The Review considered a range of approaches and recommended more balanced penalty and interest charge arrangements to better reflect the inherent uncertainties within the system. The broad categories are described in more detail below.

General impact group identification

4.10 The measures would have an impact on all taxpayer groups (individual self preparers, individuals who use tax agents, very small businesses, superannuation funds, trusts, partnerships, small and medium businesses and large business) and their advisers.

4.11 The proposals would also have an impact on the ATO as administrator of the tax law.

4.12 The total administrative cost of the following two measures is estimated to be $17.8 million over five years. The cost to revenue of these proposals is estimated to be $131.0 million over five years. Although these costs are considerable, the package would significantly benefit taxpayers by improving certainty and reducing compliance costs.

General interest charge

Specific objective

4.13 This measure reduces the consequences of the uncertainty that is inherent in a self assessment system by mitigating the interest and penalty consequences of taxpayer errors.

Specific implementation options

4.14 The existing general interest charge was introduced in 1999 to simplify a complex array of penalties and interest charges applying to late payments and tax shortfalls. In the case of shortfalls only, this simplification exercise resulted in higher interest charges for the period between the original assessment by the taxpayer and any amendment made to that assessment.

4.15 The general interest charge is set at a high rate (compared with indicator rates for commercial borrowing) to encourage prompt payment of tax liabilities and to discourage using the ATO as a bank. However, in pre-amendment shortfall cases, taxpayers are usually unaware of their debts, and so are unable to respond to this incentive premium. Rather, any differential between the general interest charge rate and their alternative borrowing rate strikes them as a penalty, even though the conditions for a formal culpability penalty (such as lack of reasonable care) may not be satisfied.

4.16 The Review proposed, in the Report on Aspects of Income Tax Self Assessment (the Report), to remove this 'incentive to pay premium' in shortfall cases. It proposes that a new shortfall interest charge apply in lieu of the general interest charge in the period prior to assessments being amended. The shortfall interest charge will use a three per cent uplift over the base rate, rather than the seven per cent uplift used by the general interest charge. Over the last two years, such a shortfall interest charge would have been comparable with benchmark business borrowing rates.

4.17 These measures will give the Commissioner of Taxation discretion to remit the new shortfall interest charge where he considers it fair and reasonable to do so. Remission should generally occur where circumstances such as delay, contributory cause or fault on the part of the ATO justify the revenue bearing part of the cost of delayed receipt of taxes.

4.18 These proposals would apply to amendments of assessments for the 2004-05 and later income years.

Impact group identification and analysis

4.19 All taxpayers could potentially benefit from the changes to the interest regime.

Benefits

4.20 All taxpayers whose assessments are amended to create a liability would benefit from reduced interest charges proposed by the changes to the interest regime. (As an indication of the number of taxpayers that would benefit from this, 270,000 taxpayers in 2003-04 had their assessments amended to create a liability.)

4.21 One aspect of this measure is that the shortfall interest charge rate would be lower than the current general interest charge rate, reflecting benchmark business borrowing rates. An immediate impact would be a reduction of the resulting interest charge. By way of illustration, were recent market rates to continue unchanged, a taxpayer with a $1,000 shortfall over two years would incur a shortfall interest charge around $100 less than would apply under the general interest charge.

4.22 Another aspect is that a taxpayer should be able to seek a merits review of an ATO decision not to remit shortfall interest in cases where the unremitted interest exceeds 20 per cent of the tax shortfall. This proposal is estimated to directly affect thousands of (predominantly large) business taxpayers where the interest charged exceeds 20 per cent of their tax shortfall, through the introduction of greater appeal rights. (As an indication of the number of taxpayers that could benefit from this, 3,000 taxpayers in 2003-04 would have access to these objection rights under the proposed rules.)

Costs

4.23 The effect of these measures is estimated to create a cost to revenue due to the introduction of a lower uplift factor. The administrative costs of these measures are estimated to be $15.0 million over five years. The estimate provides $2.8 million for changes to existing ATO business systems, approximately 60 publications, training for staff, and the increase in labour required to handle the increased volume of work anticipated by the ATO.

Penalties

Specific objective

4.24 This measure improves the transparency and fairness of the uniform penalty regime for tax in the Taxation Administration Act 1953.

Specific implementation options

4.25 The proposal is to:

•

abolish the penalty for a tax shortfall resulting from a failure to follow a private ruling

•

require the ATO to provide an explanation of why the penalty has been imposed and has not been remitted in full, and

•

clarify the definition of 'reasonably arguable position'.

4.26 The measures under the proposal would take effect in respect of assessments arising from the 2004-05 and later income years.

Impact group identification and analysis

Benefits

4.27 All taxpayers who have their assessments amended making them potentially liable to penalties (270,000 in 2003-04) could benefit from these recommended changes to the penalty system.

4.28 The measures improve the transparency of the process of imposing penalties on taxpayers who understate a tax liability and the abolition of the separate penalty for failing to follow an ATO private ruling. It also recommends administrative action to clarify the standard of care required of taxpayers.

Costs

4.29 The revenue effect of these proposals would be negligible. The ATO has indicated that minor changes may be required, but the proposal does not translate into an increase in administrative costs.

Consultation

4.30 The Review invited public submissions and there has been extensive consultation with tax practitioners, business groups and agencies with a governance role in the tax system (namely the Australian National Audit Office, the Commonwealth Ombudsman, and the Office of Small Business).

4.31 Consultation for the Review included:

•

The Review's discussion paper (released on 29 March 2004) outlined details for making a submission to the Review. The Review received over 30 comprehensive and detailed submissions from individuals, professional associations, companies and representatives of taxpayers.

•

A website containing information on the Review including details for contacting the Review, as well as an electronic registration form to receive a copy of the Review's discussion paper on its release.

•

The Review held consultative meetings with professional representatives around Australia.

•

All formal public submissions received were published on the Treasury website when the Report was released on 16 December 2004.

•

Confidential consultation on the legislative provisions for these measures was conducted in early 2005 with industry groups and tax practitioners.

4.32 These measures have been prepared in consultation with the Inspector-General of Taxation and the ATO. In addition, comments received after the release of the Report indicate the changes have broad support from industry groups, tax professionals and Government.

Conclusion

4.33 It is expected that the range of measures recommended by the Report will facilitate greater taxpayer confidence and a more balanced penalty and interest charge arrangement to better reflect the inherent uncertainties within the system. While these measures should considerably improve certainty, they will not affect the capacity of the ATO to collect legitimate income tax liabilities.

4.34 The proposed measures will move the balance of fairness markedly in favour of taxpayers who act in good faith and will build flexibility into the self assessment system.

4.35 The Treasury and the ATO will monitor the implementation of these measures, as part of the whole taxation system, on an ongoing basis.

Index

Schedule 1: Shortfall interest charge

Schedule 2: Penalties