House of Representatives

Explanatory Memorandum

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

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) in 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 comparable international arrangements. In response to the discussion paper, the Review received over 30 formal submissions, plus numerous phone calls, emails and background papers from interested parties, 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 in Press Release No. 106. The Report identified a number of refinements to the self assessment system to reduce uncertainty 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 the Treasurer that the ATO would implement the administrative recommendations as soon as practicable.

Implementing the legislative recommendations in the Report

1.10 This Bill implements the second part of the Government's legislative response to the Report, by amending the existing law to reduce the periods allowed for the ATO to amend a taxpayer's liability in a wide range of situations and establishes a new regime for ATO advice.

1.11 The amendment periods for most taxpayers will be shortened from 4 to 2 years, with the exception of large business taxpayers and taxpayers with complex tax affairs. The period for amendments relying on anti-avoidance provisions will be reduced from 6 to 4 years.

1.12 The advice and rulings provisions expand the scope for ATO advice, expand the number of products by which the ATO can be bound and give taxpayers more protection from primary tax, interest and penalties than the existing regime.

1.13 In its response to the Report, the Government also announced that improvements would be made to mitigate the interest and penalty consequences of taxpayer errors arising from uncertainties in the self assessment system. The amendments to implement these improvements were contained in the Tax Laws Amendment (Improvements to Self Assessment) Act (No. 1) 2005 , which received Royal Assent on 29 June 2005.