Background
The information we gather from the individuals not in business tax gap work is giving us a better understanding of compliance in this segment. In turn, these insights will help us better tailor our compliance strategies, products and services so we can improve the way individuals experience the tax system.
Our best estimate of the net income tax gap for individuals in 2015–16 is 6.4%, or $8.4 billion. In other words, for this fiscal year, we estimate that individual taxpayers have contributed 93% of the estimated tax payable.
Our individuals not in business income tax gap estimate was informed by our operational programs for specific types of risk and by findings from a random enquiry program.
Random enquiry program for individuals
A random enquiry program (REP) involves reviewing the returns of a sample of taxpayers and applying them to the broader population. The reviews encompass the entire tax return (all items) and are considered best practice for a large group of this size. Random enquiry programs are commonly used by international tax jurisdictions (for example, Denmark, United Kingdom and United States) for estimating income tax gaps.
For the gap estimate to be robust, the random enquiry sample must be a sufficient size to provide a suitable representation of the population, but small enough to be practical and limit inconvenience to taxpayers. While methodologies and population definitions vary internationally, the sample size of Australia’s random enquiry program is proportionally similar, or greater, than the UK and US.
The sample we used was stratified across all income levels, and the proportion of agent-prepared and self-prepared returns was representative of the total of the individuals not in business population.
To ensure rigour around the methodology, sample size and process, we relied on an independent tax gap expert panel to assure the estimates. The panel provided guidance and endorsed the design of the random enquiry program and other aspects of the gap measurement for individuals not in business. Throughout the process, we sought ongoing feedback from the panel and validation of the execution of all methodologies involved.
To provide further assurance, we also engaged a former Deputy President of the Administrative Appeals Tribunal who confirmed the accuracy and quality of a sample of the audit results that underpin our gap estimate.
Our latest gap estimate covers a three-year period from 2013–14 to 2015–16.
Key findings to date
The random enquiry programs (REPs) for 2013–14 to 2015–16 saw 1,403 reviews undertaken across a representative sample of the individuals not in business population. We sampled 992 tax returns prepared by a tax agent (agent-prepared), and 411 returns prepared by a person themselves (self-prepared).
Overall, the incidence of adjustment of tax returns was 75%. We adjusted 80% of agent-prepared returns, compared to 61% for self-preparers.
Comparison of adjustments in the 2013–14 to 2015–16 REP samples – total cases
|
Total cases with adjustments |
Full sample |
Agent-prepared |
Self-prepared |
|---|---|---|---|
|
Number |
1,048 |
796 |
252 |
|
Percentage |
75 |
80 |
61 |
Comparison of adjustments in the 2013–14 and 2014–16 REP samples – total cases of adjustments in taxpayer's favour
|
Cases with adjustments in the taxpayer's favour only |
Full sample |
Agent-prepared |
Self-prepared |
|---|---|---|---|
|
Number |
21 |
12 |
9 |
|
Percentage |
1 |
1 |
2 |
On average, we adjusted three items in a return. The distribution of the value of the item adjustments show that 38% of adjustments are $150 or less and 23% are over $1,000. While the amounts can be small, they add up when viewed across the whole population.
|
Range of adjustments |
Self-prepared |
Self-prepared |
Agent prepared |
Agent-prepared |
Total adjustments |
Total values |
|---|---|---|---|---|---|---|
|
$0 – $150 |
9 |
<1 |
30 |
1 |
38 |
2 |
|
$151 – $300 |
4 |
1 |
12 |
3 |
16 |
4 |
|
$301 – $500 |
2 |
1 |
9 |
4 |
11 |
5 |
|
$501 – $1,000 |
3 |
2 |
9 |
7 |
12 |
10 |
|
More than $1,000 |
5 |
10 |
18 |
70 |
23 |
80 |
|
Total |
23 |
14 |
77 |
86 |
100 |
100 |
Across the random enquiries conducted to date, adjustments to income items are more prevalent in self-prepared returns. Adjustments to deduction items (including rental expenses, work-related expenses, gifts and donations and other deductions) are higher for agent-prepared returns.
Adjustments to deduction labels represent 80% of total adjustments made. Work-related expenses are key drivers of tax gap with 50% of adjustments being made at these labels.
Around 570 adjustments were made to rental items of which around 87% (or 494) relate to rental property expenses.
International comparison
Internationally, tax gaps are difficult to compare. This is due to variations in legal and tax systems, market definitions, availability of data and the methodologies used to estimate gaps across tax jurisdictions.
Other tax jurisdictions that have estimated personal income tax gaps have measured different populations or have significantly different systems (such as limited or no ability to claim deductions), which makes it difficult and misleading to draw comparisons.
Like all tax authorities, we are aiming for our tax gap to be as low as possible, given available resources and within the applicable law.
Reducing the gap
Our aim is to sustainably reduce the individuals tax gap by increasing willing participation in the tax system. Our approach is twofold – we want to:
- support compliance – with better use of data and technology to tailor advice and guidance products, target nudge messaging, auto-correct mistakes, streamline reporting and substantiation processes, and pre-fill more information in tax returns
- deter non-compliance – take firmer action with higher-risk taxpayers and agents including additional audits and pursue penalties or prosecutions in serious cases, particularly in areas driving the gap.
To help us make these improvements, the Australian Government announced additional funding in the 2018 Budget. This funding has allowed us to continue valuable income matching measures including for foreign source income, distributions of entities such as partnerships and capital gains information for property and shares.
Additionally, it has allowed us to increase our focus on reducing the key drivers of the gap, including work-related expenses and rental deductions. We will continue to improve services for tax agents who are willing to do the right thing, providing visibility of real-time prompter messages to alert agents to risks in their clients’ returns, and increasing access to pre-fill information.
Correspondingly, we will increase our action against tax agents who deliberately and repeatedly seek to undermine the tax system. We will be looking not just at the returns of their client base but also their own business and personal affairs.
We recognise this work is likely to take several years to flow through to our formal estimates of the tax gap. Importantly, we are not attempting to audit our way to success. We will use a range of strategies to improve correct reporting and increase willing participation in the tax system.
Key initiatives to reduce the gap
Some of the key initiatives to reduce the gap include:
- improving and tailoring our public advice and guidance material, tools and services
- increasing the quantity and quality of the data we collect
- adopting new ways of using data and technology to make lodging returns and substantiating deductions simpler for taxpayers and their agents. This includes streamlining reporting processes, enabling digital substantiation of claims and pre-filling more information in tax returns
- helping taxpayers and their agents report correctly up front, using prompter messages, emails and letters to alert them early where we see something unusual
- better understanding the circumstances of debt, doing what we can to prevent it and offering practical repayment options
- taking firmer action to address non-compliance among higher-risk taxpayers and agents including additional audits, particularly in areas driving the gap
- pursuing penalties or prosecution – or referring tax agents to the Tax Practitioners Board in the most serious of cases
We will continue to work closely with the Treasury to identify and respond to opportunities to improve the tax system through policy reform – either of an incremental nature or at a more systemic level.
See also:
The information the ATO gathers from the individuals not in business tax gap work is giving us a better understanding of compliance to improve an individual's tax experience.