Review of Statistical Methodology used in producing Small Business Benchmarks
David Heath, Director, Cumpston Sarjeant Pty Ltd
Fellow of the Institute of Actuaries of Australia
30th September 2013
Executive summary
Cumpston Sarjeant Pty Ltd is an actuarial consulting firm, based at 160 Queen Street, Melbourne. As actuaries we have expertise in statistics and probability, as well as economic and financial analyses. Cumpston Sarjeant were appointed to review the statistical methodology in accordance with a recommendation from the Inspector General of Taxation (IGT) within its July 2012 report, 'Review into the ATO’s use of benchmarking to target the cash economy' ('the IGT report').
That IGT report was prompted by concerns from stakeholders over the production and use of the Small Business Benchmarks (SBB). It is not possible to assess the statistical methodology without simultaneous consideration of the context in which the SBB are used by the ATO and other stakeholders. Accordingly, our analyses and findings occur within the context in which the SBB are used.
Many of the aspects of the development and use of the SBB are regarded as policy decisions of the ATO, so are beyond the scope of our investigation. Nevertheless, there is considerable overlap between the policy decisions of the ATO and the practical assessment of the statistical methodology. The SBB have several uses in practice, including:
- To provide guidance to users on the typical ranges of certain financial ratios which can be calculated from data used in the completion of tax returns and Business activity statements.
- Use as a tool (amongst other tools) by the ATO to select higher risk businesses for the purpose of audit activity.
- In some cases, where a taxpayer cannot provide sufficient taxation records, the ratios may be used to provide deemed assessments for taxpayers. These are known as default assessments.
Having gained an understanding of the derivation of the published benchmarks, we requested further clarifying information from the ATO.
In order to perform some independent tests of the methodology, we selected 6 industries, and requested relevant data. This was supplied by the ATO, but in order to preserve confidentiality, did not contain any data that would allow identification of individual taxpayers.
For the sample industries, we are able to confirm that the published benchmarks for the 2010 financial year are in accordance with the methodology described by the ATO in its document, Small Business Benchmarks methodology and ratio calculations. The methodology outlined in that document is consistent with that described in the IGT report.
The document, Small Business Benchmarks methodology and ratio calculations provides a clear description of the process of the development of published benchmarks. Our analyses and assessment follow a similar path as described in that document.
In our assessment, we believe there are components of the methodology which while not strictly necessary, contribute to the objective whereby the published SBB appropriately reflect the financial performance of like businesses. The discrete steps employed by the ATO in the derivation of Small Business Benchmarks have been considered in our analyses. Some steps may be regarded as policy decisions, so are outside the scope of our investigation. Nevertheless, we believe that all steps described contribute to the appropriate identification of like businesses, and the derivation of ratios that reflect typical behaviour of these groups of like businesses.
While we have identified some steps which could be removed without significant differences to the published SBB, and without major loss of robustness, the use of all the procedures in the derivation of the SBB reflect an underlying thorough approach by the ATO in developing useful ratios for homogeneous groups. This is further indicated by the use of keywords to identify business type in order to maximise the relevant datasets.
Benchmark ratios are published as bands for relevant business types and within specified turnover ranges for a financial year. Clearly, they are calculated using business data from the relevant business type, turnover range and financial year. In turn, the ratios are used as a basis of comparison for businesses within that same business type and turnover range.
I understand the use of SBB is just one method to identify taxpayers for audit activity. I support the policy that SBB is not the sole indicator of further investigation. Given the relatively narrow range from which published ratios are derived, only those entities with ratios significantly outside the benchmark ratios should be targeted for audit on the basis of the benchmark ratios.
Overall, it is my opinion that the statistical methodology adopted in the production of Small Business Benchmarks is sound and robust. Our analyses indicate the published benchmarks are correctly calculated and published.
We thank the staff of the ATO for their assistance in this process, particularly members of the Cash Economy Risk and Strategy Tax Practitioner and Lodgment Strategy Division.
You can download the complete report Review of Statistical Methodology used in producing Small Business Benchmarks (PDF, 1.56MB)This link will download a file.
What you need to know about the methodology and labels used to develop small business benchmarks.