House of Representatives

Explanatory Memorandum

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

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.