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Economic Roundup Autumn 2004

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The Review of Aspects of Income Tax Self Assessment

This article provides background on the Review of Aspects of Income Tax Self Assessment, outlines its processes and gives a brief summary of the discussion paper released by the Treasurer on 29 March 2004.

Uncertainty is the key issue for the Review. Under self assessment, taxpayers may be uncertain about how the law applies to their circumstances or they may be unaware of certain entitlements. Uncertainty has implications for taxpayer perceptions about the fairness of the tax system (which may impact on the level of voluntary compliance), or it may affect a taxpayer’s willingness to enter into an economically beneficial transaction, to the detriment of the economy as a whole.

Introduction

On 24 November 2003, the Treasurer announced the Review of Aspects of Income Tax Self Assessment.

The purpose of the Review is to assess 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. Finding the right balance is not an easy task.

The complexity of taxpayers’ affairs has increased in recent times, with many more individual taxpayers claiming deductions and sourcing income outside the traditional wage and salary categories. This has meant that some taxpayers need to understand a broader range of tax laws and may be experiencing increased uncertainty about their ability to apply the income tax laws to their circumstances.

The Review seeks to identify ways to refine Australia’s system to provide greater certainty and lower compliance costs, without jeopardising the capacity of the Tax Office to collect taxes.

Scope of the Review

The Review is examining aspects of Australia’s current income tax self assessment system, including:

The Review has not been asked to consider fundamental tax policy changes, such as the extent to which tax returns, or categories of tax deduction, could be dispensed with. The Review is not examining tax collection issues or assessment of taxes other than income tax.

Review process

The Review, which is being conducted by the Department of the Treasury, is reliant on extensive public consultation with stakeholders in the tax system, such as taxpayers’ representatives, professional bodies and government agencies with an oversight role in the tax system.

An initial round of consultations was held to aid development of the recently released ‘Review of Aspects of Income Tax Self Assessment’ discussion paper and the Government has now invited interested parties to make submissions in response by 21 May 2004. Views outlined in submissions, together with the outcomes of upcoming public consultations will assist consideration of all relevant issues before Treasury reports to Government in mid-2004.

The next section of this paper summarises the key ideas canvassed in the discussion paper.

Discussion paper summary

The discussion paper has six chapters, dealing with the following topics:

Chapter One — Background to self assessment and focus of the Review

Chapter One describes how the Australian system of partial self assessment evolved and identifies the changes that resulted from the shift to partial self assessment in 1986. Previously, a taxpayer would have to provide all information relevant to the calculation of their taxable income to the Tax Office and Tax Office assessors applied the tax laws and calculated the tax liability. The primary responsibility of the taxpayer was to make a full and true disclosure of all the material facts relating to their circumstances.

When partial self assessment was introduced for individual taxpayers, the responsibility for many aspects of applying the tax laws shifted to the taxpayer. As a result, an increased obligation on the Tax Office to provide information to taxpayers was accompanied by a new onus on taxpayers to understand the tax laws relevant to their circumstances. Tax Office resources were moved from assessing to taxpayer education and compliance activities.

To view these and other characteristics of the Australian self assessment system in a broader context, the Review has compared the Australian system with the systems in Canada, New Zealand, the United Kingdom (UK) and the United States (US). These comparisons reveal many similarities, but it is difficult to draw firm conclusions given the differences in tax policy and other factors.

In each jurisdiction there is an annual reconciliation of a taxpayer’s income tax affairs, through means such as a tax return, an income tax statement generated by the revenue authority or a withholding tax system. Revenue authorities provide taxpayers and their agents with a wide range of information and advice to assist them in discharging their obligations.

One substantial difference between the five countries is the extent to which particular categories of taxpayers are required to lodge annual income tax returns. In Australia, Canada and the US, most income earners are expected to lodge an annual income tax return containing information on their taxable income and deductions. However, New Zealand and the UK have removed this requirement for large numbers of taxpayers (generally individuals with simpler tax affairs), while those with more complex affairs are still required to lodge annual returns.

All revenue authorities consider themselves to be bound by private rulings unless the information upon which they based the ruling was incorrect or incomplete. In Australia, Canada, New Zealand and the US, taxpayers can apply for a private binding ruling in advance of entering into an arrangement. Of the four countries, only Australia does not charge a fee for preparing a private ruling. The UK revenue authority will only provide taxpayers with a post-transaction ruling in limited circumstances and does not charge a fee to prepare them.

As the table below shows, the period in which a taxpayer’s assessment can be reviewed after they have submitted their return is broadly similar across all of the countries examined.

Table 1: Time limitations on tax amendments

Country

General rule from date of original assessment

Where taxpayer has misrepresented information or tax fraud occurs

Australia

4 years, 2 years for taxpayers with simple affairs

Unlimited

Canada

4 years for large corporations, 3 years for individuals and other businesses

Unlimited

New Zealand

4 years

Unlimited

United Kingdom

5 years and 10 months for self employed or individuals with complex affairs, 22 months for employed individuals without complex affairs (for the UK, this time period starts at the end of the tax year)

20 years and 10 months

United States

3 years from due date for filing return, 6 years for major understatements

Unlimited

Where an income tax shortfall is identified, taxpayers in all five countries are potentially liable to pay interest and penalties. Australia generally charges the highest rate of interest on amounts owed, however the amount of interest paid is tax deductible. None of the other countries examined allow an individual this deduction, although New Zealand, the UK and the US allow a deduction in limited circumstances for interest paid by a company.

The Review uses a framework incorporating confidence, finality and the consequences of uncertainty to analyse the issues under review, asking the questions:

The subsequent chapters discuss these issues of confidence, finality and the consequences of uncertainty, looking at ways to address the causes of uncertainty for that parameter.

Chapter Two — Rulings and other Tax Office advice

Chapter Two of the paper discusses the main types of advice the Tax Office provides, reviews major issues that have been identified in relation to this advice, and outlines options for improving the quality of Tax Office advice.

The Tax Office provides taxpayers and practitioners with a comprehensive range of advice on how to apply the income tax law, consisting of formal rulings (such as public rulings and private binding rulings) and other products (including TaxPack, oral advice in response to queries and taxpayer alerts). Whether the Tax Office’s advice is binding on the Tax Office depends on what type of advice it is.

The advice contained in formal rulings is binding by law on the Tax Office, whereas other advice is not, though some of it is treated by the Tax Office as administratively binding (effectively meaning that the Tax Office will stand behind it, even though it has no legal obligation to do so). Due to the different levels of bindingness, taxpayers may experience considerable uncertainty about their tax obligations when asking the Tax Office for advice, especially if the advice is of a type which cannot be relied on by the taxpayer.

The capacity of Tax Office advice to enhance taxpayer confidence that the taxpayer is acting in accordance with the Tax Office view depends on the accessibility, timeliness, accuracy and reliability of that advice. The discussion paper therefore examines a range of issues framed around these four factors, raising a number of options for reform.

Some of the issues and options explored in the Chapter include:

Chapter Three — Review and amendment of assessments

Chapter Three explains the current rules governing the amendment of assessments and discusses whether they should be changed to give taxpayers earlier finality as to their income tax liability. The current rules attempt to balance two competing objectives, namely:

The law seeks to balance these objectives by only allowing the Tax Office to amend assessments to correct errors within set time limits.

The discussion paper examines this topic from the perspective that, in order to promote certainty, the period permitted for amendment should approach the minimum required by the Tax Office (and the taxpayer) to identify incorrect assessments and take action to correct them.

Before self assessment, the Tax Office’s ability to amend an assessment depended on whether the taxpayer had made a ‘full and true disclosure’ of all the facts necessary for the Tax Office to make an assessment in their tax return. Where a taxpayer had done this, the Tax Office could only increase the assessment within three years to correct an error in calculation or a mistake of fact. The Tax Office could not amend an assessment to correct a mistake of law.

Where a taxpayer had not made a full and true disclosure (for example, by not giving the correct details about a deduction claimed), or had been involved in a tax avoidance scheme, the Tax Office could alter the assessment for up to six years. If the underpayment of tax was due to fraud or evasion, the Tax Office could amend the assessment at any time.

With self assessment, the concept of ‘full and true disclosure’ was removed from the amendment rules and taxpayers were no longer required to disclose the full details of their income and deductions in their returns. Assessors no longer scrutinised that information before an assessment was issued.

The standard period now allowed for the Tax Office to amend an assessment (either to increase or reduce a taxpayer’s liability) is four years. For certain individuals with very simple tax affairs, the period is two years. As with the previous system, the Tax Office has up to six years to amend an assessment to cancel a tax benefit under Part IVA (the general anti-avoidance provision). Where the Tax Office considers that there has been fraud or evasion, there continues to be no time limit on amending an assessment.

Chapter Three discusses a series of approaches that could be adopted to give taxpayers earlier certainty as to their income tax liability.

The first is to reduce the amendment period for individuals and very small businesses. Since the Tax Office generally completes its compliance activity for these taxpayers within about two years of the original assessment, it may be possible for the period of review for these classes of taxpayers to be reduced without affecting compliance or revenue collection at all.

Another issue canvassed is reducing the amendment period for arrangements covered by the general anti-avoidance provision from six years to four years, to bring it into line with the amendment period for other complex taxpayers and issues.

The paper also invites comment on the introduction of fixed periods of review for loss and nil liability returns equivalent to those applying to assessments of a positive liability and other special cases that currently have unlimited review periods.

Another concept is to introduce early notification of intended compliance activity, so that taxpayers who are not notified would know that the Tax Office will not amend their assessments, except in limited cases. Under this system, the Tax Office could have, say, half of the applicable amendment period to notify a taxpayer that they will be subject to further scrutiny. Once the Tax Office has notified a taxpayer within that period, the normal amendment times would apply for all issues in the income year. If however, a taxpayer was not notified within the period, the Tax Office would be unable to amend (other than to address fraud or evasion).

The final idea considered in this Chapter is to extend existing pre-assessment agreements to cover a wider range of transactions or circumstances. There are a number of types of transactions for which a pre-assessment agreement would require a significantly shorter amount of time and less resources than an audit on the same topic. Examples of transactions for which pre-assessment agreements could be made include the application of losses and research and development expenditure.

Chapter Four — Penalties

Chapter Four deals with the penalties that can apply if a taxpayer has a tax shortfall resulting from a range of culpable acts or omissions.

The amount of the shortfall penalty depends on the reason for the shortfall, and may be varied up or down depending on whether the taxpayer has hindered the Tax Office in investigating the shortfall, has previously had a shortfall amount with a similar cause, or has made a voluntary disclosure of the shortfall.

Penalties are a potential consequence of uncertainty for taxpayers. During consultation, practitioners have suggested that:

Chapter Five — The General Interest Charge

Chapter Five outlines the operation of the GIC and explores the implications for self assessment. The GIC applies a uniform rate of interest to late payments of any type of tax, compounding daily from when the tax was originally due. This means that where a taxpayer under-assesses their liability, a substantial amount of GIC may have accumulated before the Tax Office informs the taxpayer of the shortfall in tax.

The Chapter discusses whether the way the GIC applies to shortfalls provides the right incentives, and discusses options for reducing the amount of GIC that currently accrues in relation to income tax shortfall amounts during the period between the issue of an initial assessment and an amended assessment.

Two further issues discussed in this Chapter are those of Tax Office initiated remission and the standardisation of tax deductibility. During initial consultations, practitioners suggested that remission could be streamlined if the Tax Office were to initiate remission in more circumstances, and more frequently. Standardising tax deductibility would eliminate the current diversity in after tax shortfall GIC outcomes. This could be achieved by replacing tax deductibility with an offset of, say, the top marginal rate for individual taxpayers and 30% for companies. Alternatively, tax deductibility could be abolished altogether, with a commensurate reduction in the uplift factor.

The following table shows interest charges applied by the revenue authorities on tax shortfalls in Australia, Canada, New Zealand, the UK and the US, noting that Australia is the only country that allows individual taxpayers a deduction for GIC.

Table 2: Interest payable on tax shortfalls

Country

Rate of interest

Interest tax deductible?

Australia

Bank Accepted Bill rate plus 7%

Yes

Canada

Canadian 90 day Treasury Bill rate plus 4%

No

New Zealand

New Zealand business base lending rate plus 2%

Only for businesses

United Kingdom

4.75% for corporations which pay their tax in quarterly instalments

6.5% for individuals and corporations which pay their tax annually

Only for corporations

United States

Federal short term rate plus 3% for individuals

Only for corporations

Chapter Six — Other Issues

Chapter Six collects issues that do not fall directly within the main themes of the previous chapters.

A number of issues relate to tax agents. Over 75 per cent of taxpayers in Australia use tax agents, so the relationship between tax agents and the Tax Office, and the systems used by tax agents, are important issues in the Australian self assessment system.

These issues include review of tax agents’ systems by the Tax Office, obligations to provide information, obligations to keep records and lodgement records. Most of these issues are also relevant to individual taxpayers. Other issues discussed are taxpayer awareness of self assessment obligations, an option for earlier examination of returns, and discretions and elections.

Another issue is the perception of a power imbalance between the Tax Office and the taxpayer when it comes to formal disputation. From the point of view of many taxpayers, the Tax Office is a very powerful adversary with virtually unlimited resources and finances. In other situations where an imbalance of resources exists, mechanisms such as alternative dispute resolution have proven successful. This non-adversarial approach could improve relations between individual and small business taxpayers and the Tax Office and remove the perception of the Tax Office aligning its resources against a single taxpayer in a court setting. The Tax Office itself may benefit, in terms of costs, public image and ease of administration. Of course, this approach would not help clarify areas of the law.

Other issues discussed in this Chapter relate to obligations to keep records and provide information, which become important to the Tax Office’s tasks of identifying revenue risks and make accurate assessments of tax liability. At the tax agent level, the Tax Office assists tax agents to perform these roles to gain mutual assurance that tax agents’ systems are accurate and reliable. There are some suggestions in the paper as to how these processes could be improved and streamlined.

The final section of Chapter Six discusses discretions and elections, and outlines some issues that practitioners have raised relating to how discretions are determined and elections are made. The paper acknowledges the importance of administrative discretions (for example, to extend the time to do something), but suggests that the discretions going to the determination of liability that are causing practical difficulties could be identified and dealt with. With respect to elections, as a result of changes made in 1992, elections generally do not have to be lodged with the Tax Office. The discussion paper invites comments on any specific elections that are still causing difficulty for taxpayers.

Conclusion

This paper has given some background on the Review of Aspects of Income Tax Self Assessment, including outlining the content of the Review’s recently released discussion paper. The discussion paper outlines a range of issues and approaches for refining the operation of Australia’s income tax self assessment system and to date the reaction from industry has been positive. Government agencies including the Tax Office, the Department of Prime Minister and Cabinet, the Department of Finance, the Inspector-General of Taxation, the Australian National Audit Office, the Office of Small Business and the Commonwealth Ombudsman have contributed to the Review to date.

The Review team will continue to consult with taxpayers, tax practitioners, government agencies and industry groups until submissions close on Friday 21 May 2004. Further information about the Review and a copy of the discussion paper, can be accessed at the Review’s website, at http://selfassessment.treasury.gov.au

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