22 August 2011

Dear Sir

The Inspector General of Taxation's Review of the Self-Assessment System

The Group of 100 (G100) is an organisation of Chief Financial Officers (CFOs) from Australia's largest business enterprises with a purpose of advancing Australia's financial competitiveness and welcomes the Inspector General of Taxation's (IGOT) Review of the self-assessment system.

Executive Summary

The global effects of the recent financial crisis have led to significant pressure on western economy public balance sheets. As a result, tax authorities, including the Australian Taxation Office (ATO) are exerting more pressure on taxpayer risk management frameworks by new and increased auditing and monitoring methods. This pressure bears out the timeliness for the need to review the existing tax system and ensure that appropriate taxpayer protections exist within the legislative framework to cater for the new methods.

The G100 believes that the practical realities are that the ATO has, in many instances, moved away from the self-assessment system contemplated by the current legislative provisions of the Income Tax Assessment Act ('the Act'). In fact, for those taxpayers that the ATO determines are 'higher consequence' to the Revenue, a system of full and, in many cases, 'real time' assessment is in operation. That shift and the resultant fact that there are now effectively two assessing systems in place, needs to be recognised in a legislative context.

Moreover, for the reasons outlined herein, this shift in approach by the ATO has a number of significant shortcomings that have not been the subject of Parliamentary discussion or consideration.

There are broad concerns about the ATO Advice Framework, the ATO's recent stance on Reportable Tax Positions in a self-assessment system and the commercial focus of the ATO. For example

• The ATO advice framework is not sufficiently timely or responsive to the complexities of our tax system and the needs of taxpayers. Under the current system, taxpayers are faced with the choice of a Private Binding Ruling, which is an expensive and time consuming (60-90 days) exercise, or nothing. In practice, taxpayers often do not have the luxury of the time required to get a Ruling. A current topical example is the current uncertainty regarding the ability to frank a dividend declared from accumulated losses. ASX lodgement deadlines do not provide sufficient time to get a Tax Ruling. Ideally there would be a better alternative to the Private Binding Ruling System to give taxpayers a level of certainty where time (and cost) is of the essence.
  
  
• the requirement for some taxpayers to lodge a schedule of Reportable Tax Positions is a significant change to the self-assessment landscape. It should not be introduced without consideration of fairness and equity. At a very minimum it should be accompanied by reductions in interest and penalties (as is the case with voluntary disclosures) and some form of early closure of any review by the ATO of reported uncertain positions.
  
  
• The relationship between big business and the ATO would be enhanced if the ATO recruited more people with business experience to its senior ranks; eg Assistant Commissioners. This would hopefully engender a culture that is sympathetic to the needs and motivations of the business community, while not diluting the effectiveness of the ATO's core functions to protect the revenue and uphold the law.

We believe that it is now important to examine whether the existing self-assessment system is appropriate for the administration of Australia's tax law and, if not, for it to be replaced with a modified regime which has legislative support and adequate taxpayer protections that have had the benefit of community debate and Parliamentary consideration.

As a result, the G100 recommends that there be a consultative and detailed review of the enforcement and administrative regime of Australia's tax system performed by an 'independent body' (to be determined) involving both ATO and broad taxpayer community consultation.

Moreover, if it is ultimately determined that the existing self-assessment framework requires modification, the new regime should be installed by way of legislative reform and not by reliance upon the administrative practices of the ATO. The current enforcement and administration regime is based on a legislative regime different from and ill-suited to what is in fact being applied in practice.

Even if the view is that the existing self-assessment model be retained, it has become clear that a number of additional taxpayer protections are required in order to address the shortcomings of the existing system. These are outlined below.

Background

Prior to self-assessment, certainty was obtained by taxpayers by way of an assessment system which worked on the basis that the ATO, upon lodgement of a taxpayer's tax return and making an assessment thereof, was precluded from amending the taxpayer's return in respect of any matters that related to a question of the application of the tax law. Consequently, tax returns under the former full assessment system contained significantly more information than that required at the outset of the self-assessment regime. If a mistake of fact was detected by the ATO, it could amend the return retrospectively but not in respect of a matter that related to an interpretation of the tax law. As a result, this system provided a great deal of certainty for taxpayers when it came to matters involving the interpretation of the law.

With the advent of self-assessment, the ATO now has the opportunity to reopen an assessment for matters involving questions of fact or questions of law, generally for a period of four years but, in practice, even longer for reasons discussed below. As an incentive for taxpayers to correctly apply the law to their facts, the interest and penalty regimes for the tax law were significantly increased to provide a more robust deterrent to taxpayers who sought to take advantage of a self-assessment by, for example, taking on detection risk.

In the event that the ATO subsequently discovered an error on the part of the taxpayer, the interest and penalty regime was made to be quite harsh so as to provide a strong incentive for taxpayers to accurately self-assess.

In addition, a Ruling System was introduced to supplement self-assessment to enable taxpayers to get an answer in respect of difficult or uncertain matters. Coupled with this, the Statutory Amendment periods were amended to enable the ATO to retrospectively deal with questions of law. Effectively this aided the ATO in shifting resources away from assessing returns to the audit and compliance functions. However, other than the Rulings system, there is no formal mechanism for engagement with the ATO.

The self-assessment legislative framework intended by Parliament albeit subject to administration by the ATO included the need to carry out compliance activities. The question becomes: what has changed since its introduction to make the self-assessment system out-dated? At a high level the answers to that question are:

• the level of income tax return disclosure required by the ATO has and continues to increase, but with no obligation upon the ATO to reach any view about that information;
  
  
• legislation introduced into the Act post self-assessment (and in some instances prior) is littered with giving the Commissioner the power to exercise his discretion making it impossible for taxpayers to self-assess with any certainty. This includes Part IVA of the Act, the development of which was in its infancy at the time self-assessment was introduced;
  
  
• the Rulings system has not worked effectively or efficiently – see further comments below;
  
  
• the Commissioner is administering the law so that many taxpayers are subject to "full assessment"; and
  
  
• meanwhile, the self-assessment regimes in respect of interest, penalty and amendment periods are still relied upon.

These factors would of themselves tend to indicate that a review of the self-assessment system is warranted. However, what has been more disconcerting to taxpayers is that the system itself does not call or provide for 'engagement' with the ATO, yet 'engagement' with the ATO (or lack thereof) is perhaps the primary criterion for determining the level of compliance activity instigated by the ATO.

It is recognised that the Rulings system is not working very well in that it takes an inordinate amount of time to get Rulings and there is a perception that the Rulings are biased towards the Revenue. It is also common knowledge that the Rulings system has some unfavourable history providing some anxiety for those within the ATO responsible for providing ATO rulings.

As a result, there has been relatively modest engagement with the ATO; while noting that the system was designed for taxpayers to make their own assessment of their tax positions and to only seek Rulings where the items were uncertain or needed special attention.

The new regime now being applied by the ATO, including the Risk Differentiation Framework ('RDF') and the factors considered by the ATO in order to assess the risk to the Revenue, places an enormous weight on factors such as transparency and engagement by taxpayers with the ATO. This is even though the system itself has not been legislated or designed to encourage engagement.

The degree of transparency and engagement being used by the ATO to risk differentiate taxpayers is very much "in the eye of the auditor" and open to subjective context rather than quantitative assessment.

For example, in order to assess the risk attached to a particular taxpayer not complying with the law, one would have expected that a quantitative assessment of the number of times that a taxpayer has taken positions ultimately proven to be contrary to the law would be a significant factor, if not the key factor in assessing risk. This is not the key assessment factor under the ATO's RDF. Rather, the assessment is based on subjective transparency and engagement by the taxpayer, albeit in a system in which there is little legislative encouragement for such transparency and engagement and historically was not designed for such.

Where higher consequence (to the Revenue) taxpayers are not seen to be engaged with the ATO and/or their affairs are not seen to be transparent, they are subjected to a regime much more aligned to a full assessment system, but with none of the taxpayer protection normally associated with a full assessment regime.

Detailed Submission

There are a number of ostensible merits associated with the existing self-assessment regime that presumably formed the genesis of the movement during the 1990s from a full assessment system to a self-assessment regime. One obvious merit for the ATO is the fact that a self-assessment system places the cost and compliance burden and the obligation on taxpayers to properly assess the application of the law to their facts as opposed to having that burden fall on the ATO as previously was the case.

However, despite this shift of obligations from the public sector to the taxpayer community, the existing self-assessment regime has a number of disadvantages for the ATO. For example, the existing regime has no "real time" monitoring benefits for the ATO as it is essentially a "look-back" regime. The ATO has therefore sought over time to modify the administration of the law in such a way as to compensate for this.

In the G100's view, the key disadvantages associated with the existing system both in terms of its theoretical flaws, as well as in terms of the way the system has been administered, which lead to an increased risk of "surprise" and tax uncertainty can be broadly summarised as follows:

1. The ATO is always looking in the rear view mirror in that it is seeking to review historic positions based on the law as it then stood - typically over a four year period but longer in some cases. As a result the ATO struggles to deal with contemporary issues as the legal framework is premised on it reviewing the past.
   
   
2. When reviewing taxpayers' affairs, the ATO often struggles to identify the issues that may ultimately prove to be important. Moreover, once found, the issues typically take a long time to be resolved thereby giving rise to ongoing penalty and interest exposures and increased uncertainty for taxpayers – this is especially so, in an environment that is increasingly focussed on the reliability of financial statement reporting.
   
   
3. Consistent with (2), the use of extensions of time beyond the legislatively prescribed statute of limitation periods (typically four years) mean that the statutory protections afforded to taxpayers under the self-assessment regime are often avoided by the ATO. Even though the taxpayer needs to agree to such extensions of time, taxpayers are often loathe to refuse the ATO such extensions when asked because of concerns with receiving 'protective assessments'. These assessments are ostensibly said to protect the Revenue, but in reality seek to sidestep the protections afforded to taxpayers by Parliament via the legislative time barring rules. As a result, there is often an inordinate amount of time in having matters determined with ongoing penalty and interest exposures.
   
   The ATO's increasing reliance on Part IVA to justify assessments also allows a six year period of amendment in respect of the 2004 and prior income years and a four year amendment period in respect of 2005 and subsequent years. This has the same consequences in terms of prolonged exposure to interest and penalties.
   
   
4. Often as a result of the ATO having an historic approach, issues do not come to the attention of the ATO until some years after they have become relevant in the market place. The lack of action then raises the spectre of "surprise" arising as a consequence of the ATO eventually forming a view which may differ from commonly accepted views or industry practices. This issue became particularly evident from the review by the IGOT of U-turns and similar market experiences.
   
   The ATO on their part acknowledge both the uncertainty and lack of timeliness brought about by the self-assessment system. However, rather than take steps to modify the legislative framework, the ATO has relied upon its administrative powers to increase targetted audit compliance and activities. That approach on the part of the ATO results in a desire for more information, real time interactions, increased disclosure (e.g. Reportable Tax Positions) and an expectation of increased taxpayer engagement coupled with a desire for transparency or put another way, a "you tell us what we should be looking at" mentality. This is achieved by the ATO applying significant resources and multiple ATO compliance products to targeted taxpayers. All of this activity is facilitated and directed by the ATO's risk profiling practices and, in particular, the RDF.
   
   
5. The ATO has for some time embarked on a process of "Tax Risk Profiling". However, the use of risk profiling of corporate taxpayers into various quadrants of risk, the RDF, has particularly irritated the corporate community.
   
   First, the risk profiling appears to be based largely on qualitative tests based on the ATO's subjective views of taxpayer cooperation and transparency levels, as opposed to quantitative tests – which are more appropriate and objective - based on, say, the number of times a taxpayer's position has ultimately been proven to be incorrect at law.
   
   In addition, there does not appear to be any natural justice in the process because taxpayers can be rated as "higher risk" with little or no practical avenue for contesting that view. As these ratings will inevitably become generally known in the market place, this has a very negative reputational impact on the tax director, the company's tax advisers, the company's management and its Board. Of course it is the taxpayer's placement within the RDF which determines the 'level of touch' from the ATO. Many G100 members are 'higher consequence' taxpayers which places them automatically in Quadrant 2 (and possibly Quadrant 1).
   
   
6. In addition to the issues historically associated with the ATO's information gathering (many of which are the subject of separate IGOT review), there is a focus by the ATO upon the subjective mind of taxpayers in order to assist in ostensibly determining the objective dominant purpose of an arrangement that may be subject to Part IVA. This, along with relevant "counter-factuals" that might have been considered by taxpayers, means that there is an increasing focus on the internal workings and mind of the taxpayer. This leads to very intrusive behaviour by the ATO in seeking to examine internal correspondence dealing with subjective intent and alternative hypotheticals – as opposed to the actual facts of what was done and its objective purpose.
   
   This approach has created quite a deal of friction in respect of the ability of taxpayers to have confidential matters respected throughout the audit process, including a lack of respect for Legal Professional Privilege, Accountants' Concession and Board Work Paper Privilege. This is not to say that the ATO does not afford a taxpayer the right to claim such privileges, but it is clear that the claiming of such privileges is frowned upon by the ATO and used by the ATO as evidence supporting (expressly or impliedly) a lack of transparency and co-operation by taxpayers.
   
   The focus on subjective purpose is often the basis for the ATO seeking to interrogate senior executives either in court or on oath before court hearings are definitive. This often leads taxpayers to want to settle matters rather than dispute them since taxpayers do not want their executives being subjected to such interrogatory style processing. Despite the fact that Part IVA is intended not to be a subjective purpose test, this is in fact how "purpose" type issues are being audited by the ATO.
   
   
7. The position of ATO interrogation of taxpayer affairs has been exacerbated further by pressure applied to the ATO by the Federal Court to suggest that the ATO must have available to it the sort of evidence that would typically be required if the matter went to Court. This has led to ongoing requests for information often using Section 264 notices even when matters are unlikely to go to Court and can be better expedited by other forms of negotiation, mediation or sensible dialogue rather than an intrusive legally based evidentiary processes.
   
   
8. Real time disclosures requiring constant updates to the ATO of factual and tax related matters including matters that have not yet been included in a lodged tax return or in some cases even before transactions are executed is also intrusive. The ATO wants to be put in the same position in terms of access to information as the company's executives or the Board that made a particular decision. In effect, the ATO wishes to be placed in the same position (or better) as if it were the tax advisor to the company.
   
   By accessing this information, the ATO is no doubt constantly looking for evidence that transactions, or parts of transactions, were conducted with tax planning motives in mind. This continues to build on the notion that companies that are engaged in tax planning should be viewed as therefore "higher risk" along with their advisors. Moreover, a consequence of this is to deter companies from appropriately planning their tax affairs.
   
   
9. The pilot scheme involving the disclosure of Reportable Tax Positions also contributes to the erosion of privilege and confidentiality in that it requires matters by which a company may well have sought tax advice (because of the very reason that they are sizeable and/or uncertain) to be disclosed to the ATO. It also is inconsistent with the policy of encouraging financial conservatism as it means that companies will be reluctant to make provisions, or raise contingent liabilities in their statutory accounts for a potential tax exposure, if they know that then has to be disclosed on a schedule which almost obligates the ATO to take the adverse view.

As a result of all of these factors, the existing system of self-assessment is for many taxpayers, and ostensibly G100 members, one of self-assessment in name only.

In this environment, the practice of the ATO has moved dramatically away from self-assessment and more towards a full assessment of an ongoing nature, including ongoing monitoring, real time reviews of taxpayer transactions and forced disclosure of sensitive uncertain tax positions. Unfortunately, this includes intrusive behaviour going to the inner workings of the taxpayer business operations, financial accounting provisioning and subjective tax planning purposes.

This new system is also imbued with the coercive administrative influence of the Commissioner seeking to change corporate behaviour toward tax planning, as well as a lack of respect for confidential communications between the company and its various internal and external advisors including its own Board. It also involves a lack of compliance with statutory liability limitation periods and a lack of advisory resources on the part of the ATO to be able to address real time issues as they arise.

This has led to increased tax risk, uncertainty and frustration and additional costs for both resident and non-resident corporate taxpayers trying to manage tax risks and compliance. The amount of management time and additional internal and external costs have increased significantly for those companies that have been subject to this new assessment process. On the ATO's part, this approach is justified as directing resources where the most revenue is at risk and providing certainty to taxpayers in circumstances where the self-assessment regime does not.

It is clear that the existing legislative provisions do not adequately cater for what has effectively become a unilateral departure by the ATO without the benefit of Parliamentary consideration from the self-assessment system envisaged by legislature when introduced. In the meantime the law is becoming more complex and broader in scope. For example, the introduction of TOFA, mining taxes, potential carbon taxes, uncertainty regarding transfer pricing rules and the application of Part IVA and further uncertainty arising from principles based drafting. Notably, the notion of principle based drafting appears to be that the legislation should be rather broadly drafted to then allow the ATO to somehow "interpret" the legislation by the issue of Rulings and determinations as to how the legislation should work.

The G100 considers that these elements converge to effectively place the ATO in a position of advisor, assessor and interpreter of the law in place of the Courts. This has the effect of further exacerbating the level of concern and uncertainty within the taxpayer community. Further and more importantly, this ATO activity that takes place under an ATO regime that is predicated on the grounds of providing the taxpayer with certainty.

The reasons why the current full assessment methods currently being applied do not result in providing taxpayers with certainty is because:

• The ATO only reviews the issues it believes will increase revenue. The assessment process is not complete in that not all positions are reviewed;
  
  
• Where the ATO reviews an issue and does not proceed to amendment, there is no sign-off provided to the taxpayer that their position is correct, but almost invariably it is left as "no further action at this stage";
  
  
• Where the taxpayer seeks to actively engage the ATO to determine the correct treatment of a position, then outside the Rulings system or a compliance product (designed to remediate risks to the Revenue only) the ATO has no means (or 'ATO Product') by which certainty can be provided – the ATO only has compliance products directed at raising revenue – some taxpayers have of course assumed that their filing position over many years was correct because of, for example, the Commissioner's passive acceptance of the position, only to find that this is not the case – as identified in the IGOT review into ATO 'U turns';
  
  
• If after this full assessment process the ATO amends the taxpayer's position, the taxpayer is subject to the interest and penalty regime designed for self-assessment and remains in the hands of the ATO's administrative practices as to how those deliberately harsh regimes are applied; and
  
  
• Notwithstanding this full assessment process, it is only the passage of the statutory amendment periods, designed to be elongated for a self-assessment regime, which bring the requisite certainty to a taxpayers' affairs.

The ATO's methods of imposing a full assessment environment upon taxpayers cannot be justified under the guise of providing taxpayer certainty. There are many outcomes that arise from the current methods used by the ATO - unfortunately taxpayer certainty is definitely not one them. In conclusion, the self-assessment system has not provided taxpayer certainty, partly because of the vagaries of the law and partly because of the way the ATO administers the law. New compliance and processes designed by the ATO purportedly to deal with those shortcomings are misdirected and unsuccessful.

Recommendation

While the G100 acknowledges that there may be a case for a departure from self-assessment as it was originally introduced, we strongly believe that it is vitally important that such a departure be the subject of broad taxpayer and ATO consultation and for consideration by Government and ultimately Parliament. The G100 recommends that legislative provisions to cater for the modern era of ATO auditing and monitoring be developed.

As a result, we would welcome the opportunity for the enforcement and administration of the tax system to be the subject of a consultative based review by an independent body (to be determined) with a view to suggesting legislative provisions that would adhere to a more relevant and updated tax administrative regime.

Interim Issues

Without wanting to pre-empt the findings of any broader review of the self-assessment system, there are a number of issues which go to the ATO's current administration of the self-assessment system which need to be addressed in the short term:

• Provide review mechanisms in respect of the ATO's application of the RDF and introduce more objective measures of taxpayer compliance and hence the level of risk posed to the Revenue;
  
  
• Revise the Commissioner's Rulings, Practice Statements and the like dealing with the remission of interest and penalties in order to acknowledge the fact that where a taxpayer has been subject to a process of ongoing 'full assessment' it is grounds for remission;
  
  
• Consider introducing a broader advice framework similar to that used by the UK Inland Revenue to enable taxpayers who are so inclined to engage more often with the ATO outside of the formality of the Rulings system and compliance activity;
  
  
• Consider a more independent appeals process whereby there is effective separation within the ATO of those responsible for initial decision making and those responsible for review and appeals of those decisions. The model used by the US Internal Revenue Service should be examined together with the potential for the Administrative Appeals Tribunal ('AAT') to play a role;
  
  
• To overcome issues associated with the Rulings process and in particular Revenue bias, Rulings of a significant nature could be dealt with by the AAT;
  
  
• Provide unequivocal protection from intrusive ATO process that threaten both the legal and cultural attitudes towards claiming Legal Professional Privilege, Accountants' Concession and Board Work Paper Privilege;
  
  
• Avoid enquiry into the subjective intent of the taxpayer given that the provisions of the tax law are (and should be) concerned with objective intent based on actual factual circumstances as opposed to what was in the mind of the taxpayer or its adviser;
  
  
• Encourage engagement by providing genuine benefits in both penalties and interest exposure trade-offs to taxpayers and therefore provide increased certainty;
  
  
• Provide time limits such that if the ATO takes no action in respect of matters disclosed after a period of say two years (assuming the ATO has been given all the facts), that the position of the taxpayer should not be capable of challenge.
  
  This is consistent with the notion of statutory time limits that currently exist in the law but which have been the subject of widespread extensions of time effectively sidestepping and elongating such limits.

We trust the above submission is of some assistance and should you require us to supplement any of the areas we will be pleased to do so. Should you have any questions or comments in relation to this submission, please do not hesitate to contact the G100 Secretariat at 03 9606 9661.

Yours sincerely
Group of 100 Inc

Peter Lewis
President