Four learnings from the release of large company tax gap estimate

October’s big tax news was the release of the ATO’s tax gap estimate for large corporates. For the first time we heard what tax was NOT collected for 2015 – an estimated AU$2.5 billion, or 5.8% of the potential tax take. But there were other telling revelations within the publication:
1. AU2.5 billion is big, but it is actually good news

The ATO commentary was generally very positive with comments that the numbers reflected a tax system operating well.

But the interesting analysis was in the comparisons. When you consider our voluntary compliance levels against other countries around the world, we compare pretty well. The UK has an estimated gap of approximately 5-6% for its large business segment and a SME income tax gap of approximately 10%. When published, Australia’s tax gap estimates for the SME market is expected to be similar.

AU$2.5 billion uncollected is undoubtedly still a big number (as is the GST gap estimated at AU$3.8 billion and the size of the black economy estimated at AU$35-$50 billion). However, it isn’t alone going to fix the 2017 underlying cash deficit of AU$33 billion, nor the 2017 Australian Government general government sector net debt of AU$322 billion.

A review of our overall tax system settings and a concentrated focus on other taxpayer segments, such as individuals and SMEs will also be needed. But it is right to focus on big corporates first, because of their concentration and influence on community compliance.

2. The ATO view of corporate culture raised some issues

Positively, the ATO acknowledged the large corporate market has mainly a “strong compliance culture”. Whilst there are some outliers who may engage in tax minimisation or avoidance, typically, the large corporate market is not reckless and does not evade tax.

Significantly, the ATO states “Most large corporate groups don’t consciously take on tax risk”. But whilst favourable, the flip side of this comment has some worrying implications.

If tax risk is not being calibrated and approved appropriately at board level, it must mean key senior decision makers are not being informed of the decisions made lower down or across the corporate chain. This is a significant problem of corporate governance.

The other inference is that there is a lack of awareness of the tax implications of operational decisions – which leads to questions of tax knowledge and interpretation within an organisation. For its part, the ATO is rolling out more guidance to corporates around measuring spectrums of corporate behaviour – a traffic light system – via practical compliance guidelines (PCGs) and tax alerts. The PCGs will allow corporate groups to make conscious choices as to whether they take a high, low or no risk position around certain tax matters, and give tax teams the opportunity to more easily raise these matters with boards.

3. Expect some substantial improvements to the tax gap in the next couple of years

The ATO’s stated goal is to sustainably reduce the tax gap to a “minimum achievable level”.

Between 2011 and 2016 the ATO made on average AU$1 billion in audit adjustments each year. Based on latest reports it has recently raised over AU$4 billion in assessments, and will raise significantly more, given the flow-on impacts of the Chevron Australia Holdings judgment (which is estimated to bring in more than AU$10 billion of additional revenue over the next 10 years regarding transfer pricing of related party financing alone). New laws have also strengthened the ATO’s hand.

The other significant game changer is how the ATO is settling its disputes. Far from being lenient, the new approach within the ATO is to generally only settle prior year disputes where there is also agreement to lock in structures and transfer pricing for future years. This approach generates huge efficiencies from the regulator’s perspective (no need to go back and audit) and essentially assures future collections. It’s a significant negotiating position and shouldn’t be underestimated.

4. The ATO has reason to be confident it has good knowledge of the large corporate market

This confidence is due to the concentration of our corporate tax base. In Australia, the largest 10 corporate groups contribute to 30% of all corporate income tax reported with the largest 100 corporate groups paying about half of all corporate income tax. Given the ATO likely almost lives at the top 10 taxpayers, conducts annual reviews with the top 100 and four yearly reviews of the rest, it would have to be aware of any big ticket issues.

Add this one-on-one engagement with information gained from country-by-country reporting, reportable tax position schedules, early engagement frameworks, and statutory powers, means their knowledge of the market is very comprehensive.

So whilst you cannot tax what you cannot see, the ATO’s domestic approach combined with unprecedented levels of global cooperation means that the ATO has strong visibility of global groups. It is a new world, and the ATO is taking a new approach in dealing with the corporate tax performance of big business.

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