Certainty in the self-assessment regime by lindayy

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									    THE IMPORTANCE OF CERTAINTY AND FAIRNESS IN A SELF-
                 ASSESSING ENVIRONMENT
                                  David R Vos AM, Inspector-General of Taxation

                                                   Tasos Mihail, Adviser 1



INTRODUCTION
         1.       An old aphorism says that only two things are certain in life—death and
         taxes. But whoever first spoke those now famous, and oft-quoted, words was surely
         not operating in a system of self-assessment. Today, the issue of certainty, together
         with simplicity, of the tax system, and in its administration, is the greatest challenge
         facing government and tax administrators. An ever-increasing move for taxpayers to
         understand and apply the law and determine their tax liability for a range of taxes,
         including income tax, fringe benefit tax and goods and services tax just to name a few,
         has placed an increased importance on the tax system and its administration being able
         to provide certainty and fairness.

         2.        This paper sets out a number of key requirements, both legislative and
         administrative, that are essential to promoting both certainty and fairness in a system
         of self-assessment. These include:

         • Due recognition of the impact of the complexity in our laws on taxpayers and tax
           practitioners operating in a system of self-assessment. This should include
           compensating protections for taxpayers and a penalty and interest regime that does
           not place an inappropriate burden on taxpayers for features inherent in a system of
           self-assessment.

         • Due recognition of the increased reliance on registered tax agents (‘tax agents’) by
           providing ‘safe harbours’ from penalties and interest where a taxpayer has taken
           reasonable care.

         • Administering the system of self-assessment system in a manner that promotes and
           recognises the different needs and risks of taxpayers and provides timely and
           accessible advice to taxpayers. This includes acting quickly and pro-actively where
           the Tax Office becomes aware of new risks and providing timely certainty to
           taxpayers involved in compliance activity involving major, complex issues.




1   Office of the Inspector-General of Taxation.


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The Importance of Certainty and Fairness in a Self-Assessing Environment



PRINCIPLES OF SELF-ASSESSMENT
      3.      Around 50 per cent of OECD countries have moved their systems of
      administration of income taxes to one based on self-assessment principles, as opposed
      to administrative assessment. 2

      4.        The move to self-assessment principles primarily reflects an abandonment of
      administrative assessment procedures on efficiency and effectiveness grounds, in
      favour of a more targeted verification approach to verify information contained in tax
      returns. For some, the desire to achieve administrative cost savings represents ‘…a
      transfer of costs from the Revenue to the taxpayers’. 3

      5.        The OECD indicates that where this change has been made, it has generally
      been initiated with the objective of improving overall compliance with the laws and
      efficiency through:

      • the earlier collection of tax revenue;

      • an expanded and better-targeted program of audit inquiries; and

      • reducing the incidence of disputed assessments. 4

      6.      Nonetheless, the move to a system of self-assessment has not been without
      additional cost and risk to the taxpayer:

             One of the significant implications of self-assessment is the transfer of the assessment
             functions from tax authorities to taxpayers, whereby lay taxpayers are now expected to
             exercise a function that was previously performed by trained personnel, specialising in
             taxation as a profession. Self-assessment operates on the premise that every taxpayer is
             capable of comprehending the tax law and the related rulings and procedures, and
             capable of interpreting and translating them into a quantitative figure, that is the tax
             liability. In addition, self-assessment placed heavier burdens and responsibilities on
             taxpayers to keep and maintain adequate records. These requirements have ultimately
             resulted in increased compliance cost to taxpayers in general. 5

      7.          It has been suggested that requiring taxpayers to assume a greater
      responsibility and awareness of their own tax affairs should encourage and enhance
      voluntary compliance and reduce non-compliance among taxpayers. Others have
      suggested that a system of self-assessment allows for ‘…the democratic exercise of
      taxpayers’ rights, resulting in an increase involvement by taxpayers in their own tax
      affairs’. 6



2 Organisation for Economic Co-Operation and Development (OECD), Tax Administration in OECD Countries:
    Comparative Information Series (2004), Centre for Tax Policy and Administration, at 18. Administrative
    assessment generally requires the examination of all or most returns by technical officers prior to issuing
    assessments to taxpayers.
3 Loo EC, McKerchar M & Hansford A, An International Comparative Analysis of Self Assessment: What Lessons

    Are There for Tax Administrators, (2005) Australian Tax Forum 669, at 671.
4 OECD, above, note 1, at 18.
5 Loo, McKerchar & Hansford, above, note 2, at 707.
6 Above, note 2, at 672.




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                                     The Importance of Certainty and Fairness in a Self-Assessing Environment



      8.       For administrators, a system of self-assessment should be more cost effective
      given that only select cases need to be scrutinised. However, from the taxpayers’
      perspective, in particular in Australia, an outcome of a system of self-assessment has
      been an increase in taxpayer compliance cost through a greater use of the services of
      tax agents and tax advisers. 7 It has been recently reported that these compliance costs
      have now reached approximately $1 billion. 8



HISTORY OF SELF-ASSESSMENT IN AUSTRALIA
      9.        The main objective of Australia’s tax system has been described as to
      efficiently raise revenue to be distributed to the community in accordance with
      government priorities. This is to be achieved by a system of tax administration that
      seeks to minimise compliance costs and administrative burden.

      10.        Self-assessment was introduced in Australia in 1986/87 for individuals and in
      1989/90 for companies and superannuation funds. Under this system tax returns
      lodged by companies and superannuation funds are deemed as assessments issued by
      the Commissioner of Taxation. For individual taxpayers, the Commissioner of Taxation
      still issues a notice of assessment. However, the Tax Office accepts most tax returns at
      face value and processes them without any pre-issue verification.

      11.        The move to a system of self-assessment came following a Tax Office review
      of the effectiveness of its traditional system of assessment of income tax returns. The
      Tax Office took the view that the assessment system was not cost effective and had
      little effect on taxpayer compliance with the income tax law. This was explained in the
      Discussion Paper published as part of the Review of Aspects of Income Tax Self
      Assessment.

             By the early 1980s, the need to process tax refunds quickly had placed considerable strain
             on the Tax Office’s resources. In 1984, the number of objections against assessments
             exceeded 236,000. Furthermore, with over 10 million income tax returns to assess
             annually, on average, a typical salary and wage tax return only received one minute of
             scrutiny by assessors. In the case of business returns, an average of four minutes’
             scrutiny applied. 9

      12.    The change in approach to administering the tax system was described in the
      government’s recent report into the review of the self assessment system:

             Essentially, self assessment requires taxpayers to perform certain functions and exercise
             some responsibilities that might otherwise be undertaken by the Tax Office. Before self
             assessment, taxpayers provided the Tax Office with the relevant information to apply the
             law and assess their liabilities accordingly. Under the former system, a taxpayer’s
             primary obligation was to make a full and true disclosure to the Tax Office and the
             assessment was left to the Tax Office. After making an assessment, the Tax Office could



7 Above, note 2, at 672.
8 Anderson F, Tax return fees blow out to $1bn, Australian Financial Review, 23 March 2006, at 1.
9 The Treasury, Review of Aspects of Income Tax Self Assessment – Discussion Paper, Commonwealth of Australia,

   Canberra, March 2004, at 2.


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                amend that assessment to correct errors of fact or calculation, but they could not fix their
                mistakes of law. In this way, taxpayers had a measure of certainty, while the costs of
                some Tax Office errors were borne by the community as a whole.

                With the move to self assessment, the Tax Office still issues notices of assessment (to
                create the formal obligation to pay tax), but returns are generally taken at face value,
                subject to post-assessment risk based audit and other verification checks. The Tax Office
                is allowed to amend errors of calculation, mistakes of fact and mistakes of law after
                processing the assessment and collecting the tax payable or paying a refund. Depending
                on the circumstances, returns may be re-opened many years after the original assessment.
                In this way, the introduction of self assessment meant a change in the balance of costs
                and risk between the Tax Office and the taxpayer. The change also meant that the Tax
                Office’s resources could be used more efficiently, so that more revenue could be collected
                for the same administrative cost. 10

         13.       Legislative amendments in 1992 sought to strengthen the operation of the self-
         assessment system. The changes were designed to give taxpayers greater equity and
         fairness, increased certainty, and simplicity through the introduction of the rulings
         system, a new system of penalties for understatements of income tax liability, based on
         the requirement that taxpayers exercise reasonable care and, in some cases, having a
         reasonably arguable position, a new interest system for underpayments or late
         payments of income tax and an extension of the timeframes for review of assessments.

         14.       Over the last few years, in particular with the implementation of the
         recommendation of the Report on Aspects of Income Tax Self-Assessment, the present
         Government has introduced further legislative amendments to improve certainty and
         fairness in the tax system by:

         • providing for a better framework for the provision of Tax Office advice and
           introducing ways to make that advice more accessible and timely, and binding in a
           wider range of cases;

         • reducing the periods allowed to the Tax Office to increase a taxpayer’s liability in
           situations where the revenue risk of doing so is low or manageable;

         • mitigating the interest and penalty consequences of taxpayer errors arising from
           uncertainties in the self assessment system; and

         • providing for future improvements through better policy processes, law design and
           administrative approaches.

         15.       However, self-assessment as it operates and is currently administered, in the
         wider context of the tax system, is perceived to be weighted more in favour of the
         administrator and the revenue. Part of this is because of the inherent, and ever-
         increasing, complexity of the Australian tax system that makes it more and more
         difficult for taxpayers to comprehend and apply the tax laws and the shift in the
         balance of risk and uncertainty in the tax system. But equally important is the



10   The Treasury, Report on Aspects of Income Tax Self-Assessment, Commonwealth of Australia, Canberra, August
      2004, at 2.


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                              The Importance of Certainty and Fairness in a Self-Assessing Environment



    approach adopted by the Tax Office where there is uncertainty in the law or perceived
    compliance and revenue risks. The adoption of a ‘one size fits all’ approach and the
    application of penalties and interest without due regard to the individual
    circumstances of taxpayers can serve to encourage perceptions of unfairness and
    uncertainty in the system of self-assessment.



FRAMEWORK OF AUSTRALIA’S TAX SYSTEM
    16.     Certainty and fairness in a system of self-assessment is also influenced by the
    responsibilities and functions of each of the stakeholders to the tax system. Such
    stakeholders include the Government, Parliament, the Tax Office, the Courts and
    Tribunals, tax advisers, such as tax agents, accountants and lawyers, and taxpayers.

    17.       It is important that each of these stakeholders appropriately recognises the
    responsibilities and functions of others. This division of functions is premised on the
    principles of the rule of law, that is, that all authorities involving in rule making are
    subject to, and constrained by law. It is not only important from the perspective of
    providing certainty to the tax system but also acts as an appropriate balance and
    fairness to the exercise of both legal and administrative powers.

    18.      The Government has the responsibility to develop policy and propose laws
    and amendments. The Parliament has the responsibility of considering and enacting
    those proposed laws. For both Government and Parliament it is important, for a
    taxpayer in a system of self-assessment, that these laws are clear and enable the
    majority of taxpayers, with minimal advice from third parties, to correctly calculate
    their tax liabilities. The tax laws should enable ordinary taxpayers to readily
    understand their tax obligations and for business taxpayers to manage to know their
    positions with certainty for their tax obligations.

    19.      The Judiciary, as the third separate branch of government, alongside with the
    Executive and Parliament, is responsible for exercising judicial power. Courts have the
    responsibility to interpret and apply those laws so as to resolve disputes between the
    Tax Office and taxpayers. The role of the Administrative Appeals Tribunal is to
    provide independent merits review of administrative decisions. Clearly, if there is an
    ambiguity in the tax law, it ought to be the prime responsibility of the Government to
    ensure that the legislation is amended to overcome any so called unintended
    consequences. The Tax Office ought not to be expected to prop up deficient tax law by
    rulings and the like which at some stage or another might be withdrawn and the Tax
    Office change their direction.

    20.      Taxpayers have a responsibility to correctly meet their tax obligations. This
    requires taxpayers to take reasonable care in meeting their tax obligations including
    seeking advice from the Tax Office or their tax agent when in doubt and making full
    and true disclosures of all material facts.

    21.      Equally, tax agents and advisers should make reasonable enquiries to
    ascertain the current state of a client’s tax affairs and the accuracy and completeness of
    the information provided. They should also endeavour to interpret and apply the tax
    laws correctly and explain their interpretation and application of tax laws in a manner



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The Importance of Certainty and Fairness in a Self-Assessing Environment



         comprehensible to clients. If a tax agent or adviser is uncertain of how a tax law applies
         in a particular matter, they should consider and seek clarification from relevant
         authorities and material, including Tax Office rulings and determinations.

         22.      The Tax Office’s role in the tax system, under the leadership and authority of
         an independent Commissioner, is to administer the tax laws as enacted by Parliament
         and as interpreted by the courts and tribunal without fear or favour. In performing that
         duty, there is a strong community expectation that the Commissioner of Taxation will
         be an independent and impartial administrator. There is also a strong community
         expectation that the Commissioner of Taxation will perform that duty in a manner that
         acknowledges the role of Government, the role of Parliament and the role and
         independence of the Judiciary.

         23.       The basic duty of the Commissioner of Taxation is to implement and manage
         tax and related systems to meet government objectives. In a system of self-assessment
         most of the responsibility to correctly meet tax obligations rests with taxpayers,
         themselves. The Tax Office has a (subordinate) responsibility to provide guidance,
         advice and other support to taxpayers sufficient to enable them to correctly
         understand, calculate and meet their tax obligations. The Tax Office’s responsibilities
         are reflected in the Taxpayers’ Charter. At the administrative level, the Commissioner
         is also responsible for the integrity of the tax system, not only in the sense of its
         wholeness and soundness, but also its fairness and honesty. This is re-affirmed in the
         Tax Office’s Compliance Program with its two stated compliance roles:

         • to maximise the number of taxpayers who choose to voluntarily comply by making
           it as easy as possible for them to understand and meet their obligations; and

         • to have strategies to deter, detect and address non-compliance. 11

         24.      On the one hand this role requires the Tax Office to ensure that taxpayers are
         voluntarily complying with their tax obligations and paying or remitting to the Tax
         Office what is required under the law. As part of this role the Tax Office undertakes a
         variety of compliance activities, ranging from telephone calls, questionnaires to risk
         reviews and audits.

         25.      On the other hand, the advisory role requires the Tax Office to provide
         impartial and objective advice on the operation of the tax laws, even where there may
         be revenue consequences, so as to encourage voluntary compliance.

         26.      In most cases, these dual roles are complimentary, in the sense that the
         application of the law is clear and the Tax Office assists taxpayers to meet their tax
         obligations. However, it is where the application of the law is uncertain, or the
         outcome is inconsistent with what the Tax Office believes was intended or an
         interpretation of the law gives rise to an unintended revenue consequence that there is
         potential for tension between these dual roles. The consequence of such tension is the
         introduction of uncertainty for taxpayers and unfairness in the tax system.




11   Australian Taxation Office, Compliance Program 2005-06, at 1. Available at <http://www.ato.gov.au>


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                                       The Importance of Certainty and Fairness in a Self-Assessing Environment



THE IMPORTANCE OF CERTAINTY AND FAIRNESS
       27.     Over 200 years ago, Adam Smith, whom some describe as the father of
       modern economics, set out four maxims to which a ‘good tax’ should conform. One of
       the maxims provides that:

              The tax each individual is bound to pay ought to be certain, and not arbitrary. The time of
              payment, the manner of payment, and the quantity to be paid, ought all to be clear and
              plain to the contributor, and to ever other person. 12

       28.      The requirement for certainty is inextricably linked to ensuring fairness and
       simplicity in the tax system. Fairness means that taxpayers are not punished for
       uncertainties or the complexity of the law when the system has placed the onus on
       them to apply the law in their circumstances.

       29.      Equally important for a ‘good tax’ is the requirement of simplicity. This means
       that taxpayers and their advisers can understand and apply the law depending on the
       complexity of their circumstances.

       30.     Some have suggested that the price to pay for living in a complex society is
       complex law, including complex tax law. But as noted by one commentator:

              The attempt to regulate complex social interactive systems by statute results in an ever
              increasing complexity of enacted law that makes it for practical purposes impossible for
              the citizen to know what the law is. The more legislation there is and the more such
              legislation tries to deal with complex situations, the more likely it is that it will itself be
              complicated and therefore difficult to understand.

              It is of fundamental importance in a free society that the law should be readily
              ascertainable and reasonably clear. To the extent that the law does not satisfy these
              conditions, the citizen is deprived of one of his basic rights and the law itself is brought
              into contempt. Whatever may be the pressures to increase the volume and extend the
              scope of legislation, it is our firm view that legislation which is complex and obscure may
              for that very reason be oppressive. 13

       31.      The consequences of complex law have also been the subject of extra-judicial
       discussion, with Lord Denning and Sir John Donaldson MR remarking:

              If our Acts of Parliament cannot be understood even by the clever experts it not only
              brings the law into contempt, it brings Parliament into contempt. It is a disservice to
              democracy; it weakens the right of the individual; it eases the way for wrong-doers and it
              places honest, humble people at the mercy of the State. 14

       32.      Likewise, Sir Harry Gibbs, formerly Chief Justice of the High Court of
       Australia, outlined the requirements of certainty, clarity and simplicity in an income


12 Smith A, An Inquiry into the Nature And Causes of the Wealth of Nations, Adam Smith Institute 2001, viewed
     on 23 March 2006, <http://www.adamsmith.org/smith/won-b5-c2-pt-2.htm>
13 Walker G de Q, The Rule of Law: Foundation of Constitutional Democracy, in Inglis M, Is Self-assessment Working?

     The Decline and Fall of the Australian Income Tax System, (June 2002) 31 Australian Tax Review 64, at 75.
14 Inglis, above, note 10, at 75.




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         tax system and recognised the short-comings in the Australian income tax system, with
         the income tax system not satisfying the criteria of clarity, continuity and ease of
         compliance:

                Everyone recognises that one essential of a satisfactory system of tax administration is
                that the law should be clear. The individual should know, without difficultly, when tax
                will be payable and when it will not. Another essential is that the system should be stable
                and not subject to constant change. Also, of course, it should be efficient. Efficiency, in
                relation to the tax system, means that the cost and inconvenience to the taxpayer in
                complying with the law should be kept to a minimum. It also means that the tax should
                not obstruct the ordinary conduct of business and industry; it should not discourage
                productive activities or lead taxpayers to engage in activities that are inefficient or
                harmful to the economy simply for the purpose of gaining a tax benefit and it should not
                reduce the ability of taxpayers to compete in business with the rest of the world. 15

         33.       All would agree that our current tax laws are complex and difficult for all but
         a tax specialist to understand. To that end, the advisory Board of Taxation has
         reviewed the tax legislation with a view to initiating ways to promote the ease of use of
         the income tax law. The Board has provided a report to the Government on provisions
         of the tax law that are inoperative and can be repealed. The Board estimates that up to
         28 per cent, or 2,100 pages, of the combined Income Tax Assessment Acts can be
         repealed. 16

         34.       This is a significant step in reducing the strength of the perception of
         complexity in our tax laws. It will assist tax practitioners navigating the printed and
         electronic versions of the income tax law, and the size of the reprinted tax legislation
         will be reduced. However, all would agree that more would have to be done to reduce
         the complexity of the tax laws.



DUE RECOGNITION OF THE IMPACT OF THE COMPLEXITY IN OUR LAWS ON
TAXPAYERS AND TAX PRACTITIONERS OPERATING IN A SYSTEM OF SELF-
ASSESSMENT.

         35.      The impact of a system of self-assessment depends upon who you are in the
         system. Generally, self-assessment works well and to the benefit of the vast majority of
         taxpayers. It has provided efficiency gains to taxpayers, for example, those with
         simple affairs can lodge a return through their tax agent or e-tax and have their
         assessment issued within 14 days. It has certainly benefited the Tax Office, with it no
         longer being required to scrutinise every tax return. There can not be, and should not
         be, any question of turning back. However, notwithstanding the improvements
         introduced as a result of the implementation of the recommendations of the Report on
         Aspects of Income Tax Self-Assessment, there is still some significant re-balancing,
         requiring both legislative and administrative changes, needed to underpin a more
         certain and fairer system of self-assessment.



15   Above, note 10, at 76.
16   Costello P (Treasurer) 2005, Income Tax Act Reduced By Around 30 Per Cent, Press Release 102, 24 November
      2005.


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       36.       There is a presumption within a system of self-assessment of the capacity of
       taxpayers to interpret and apply the tax laws. There is also an onus on taxpayers to
       correctly apply the law in their circumstances with exposure to penalties and interest
       for failing to do so. Ideally, this requires a tax system that is simple, efficient and not
       subject to constant change. But where the tax system itself is complex or there is
       uncertainty amongst taxpayers about how the law applies to their circumstances, then
       taxpayers are potentially exposed to costs. These costs include a requirement to pay
       additional tax, penalties and interest and the costs of professional advice and litigation.

       37.       With the move to a system of self-assessment there has been a vast expansion
       of the tax laws including the introduction of a capital gains tax, a fringe benefit tax, a
       goods and services tax and recently the consolidations measures. At the very time that
       there has been an increase in the complexity of our tax laws, the system of self-
       assessment has placed a greater responsibility on taxpayers to understand the law and
       correctly determine how it applies in their circumstances. This has been recently re-
       iterated by the current Commissioner of Taxation acknowledging that the complexity
       of the tax system has meant that there is a heavy reliance by both taxpayers, and the
       Tax Office, on tax professionals.

       38.      The complexity of the Australian tax laws has been described as a major
       shortcoming of the self-assessment system as it creates many and various opportunities
       to deal with uncertainties:

              As a result of uncertainties in applying the law taxpayers tend to rely heavily on tax
              professionals for advice and lodgement of returns. While the Tax Office has endeavoured
              to educate taxpayers and provide guidance on applying the law, the ‘…tax
              administration and law still remain contentious, complex and ambiguous…’ and has
              resulted in increases in appeals against penalties, tax ruling and tax law interpretations. 17

       39.     The Joint Committee of Public Accounts in its report An Assessment of Tax also
       concluded that:

              …the self assessment system had been grafted upon an already unstable legislative base
              and as such had increased the cost to taxpayers of complying with the law. More
              significantly, the legislative base for self assessment had not been fully amended to take
              account of the requirement of administration and the rights of taxpayers. 18

       40.       The Committee went on to note:

              …the increased cost of compliance which had fallen upon taxpayers as a result of self
              assessment not being introduced in conjunction with a fundamental adjustment to the
              legislative framework of the Act. The Committee concluded that maximum efficiency in a
              self assessment system could only be achieved after a rewriting and recasting of the
              Act. 19




17 Loo, McKerchar & Hansford, above, note 2, at 696.
18 Australia, Commonwealth Parliament, An Assessment of Tax: Report from the Joint Committee of Public Accounts,
     Parliamentary Report No 326 (November 1993), at 80.
19 Id, at 81.




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         41.     In such an environment it is important that the Tax Office, as the
         administrator of those tax laws, duly recognises the impact of this complexity on
         taxpayers and tax practitioners operating in a system of self-assessment.

         42.       This due recognition should be through a fair and flexible approach in tax
         administration including the imposition and remission of penalties and interest and
         the provision of timely and objective advice. Such an approach should recognise the
         key role played by tax agents and practitioners in the tax system and the reliance by
         taxpayers on them for advice and guidance. Such an approach should also give due
         recognition to the increased expectation on taxpayers to correctly understand and
         apply an increasingly complex law to their circumstances with the introduction of a
         system of self-assessment.


         Impact of a system of self-assessment on taxpayers
         43.      The introduction of a system of self-assessment marked a fundamental, and
         significant, shift in what was required from taxpayers in complying with their tax
         obligations and the scope for the Tax Office to issue an amendment assessment. In
         particular the introduction of self-assessment shifted the balance of risk and
         uncertainty towards taxpayers.

         No longer does the Tax Office act as a ‘check step’ prior to the issuing of an assessment.
         Rather, this function is now effectively undertaken by tax agents.
         44.       Before self-assessment, the Tax Office was required to technically scrutinise a
         taxpayer’s income tax return. In effect, this ‘assessing’ function acted as a ‘check step’
         in the assessment process. 20 Obvious potential issues (for example, investments in an
         agricultural or film arrangement) were able to be detected and examined by assessors
         and, if required, further information could be sought from taxpayers.

         45.      With the introduction of self-assessment, the Tax Office accepts virtually all
         income tax returns at face value without any pre-issue verification. 21 Rather, the role of
         the tax agents may now be reasonably compared to the ‘check step’ once undertaken
         by the Tax Office.

         Before self-assessment a taxpayer was obliged to make a full and true disclosure to the Tax
         Office of all material facts necessary for assessment. It was the responsibility of the Tax Office
         to apply the law to those facts. Under self-assessment a taxpayer has both the responsibility of
         determining the relevant facts and for correctly understanding and applying the law to their
         circumstances.
         46.      The move to self-assessment placed a greater responsibility on taxpayers to
         correctly interpret and apply the law to their circumstances.

         47.       Before self assessment, a taxpayer was only obliged to make a full and true
         disclosure of all material facts necessary for assessment. The Tax Office was required to
         technically scrutinise the income tax return (with supporting attachments) to make an
         assessment based on all the information supplied by the taxpayer. In a sense, there was
         symmetry between the taxpayer and the Tax Office – the taxpayer, who was in the best


20   Id, at 65.
21   This is also reaffirmed in the Taxpayers Charter and Tax Office’s Compliance Program 2005-06.


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                                        The Importance of Certainty and Fairness in a Self-Assessing Environment



         position to know the facts, was required by law to make a full and true disclosure, and
         the Tax Office, which was in the best position to know and understand the law, was
         obliged to apply the law to a taxpayer’s circumstances and ‘assess’ taxpayers.

         48.      Under the self-assessment system a taxpayer must ensure that they correctly
         apply the law to their circumstances taking into account the legislation, court and
         tribunal decisions and the vast array of rulings, determinations, interpretative
         decisions and other Tax Office publications. In order to accurately summarise the
         information for the Commissioner, taxpayers need to be able to correctly identify what
         income is assessable and which deductions are allowable. This is usually the most
         complex and difficult aspect of making an assessment – a task previously the
         responsibility of the Tax Office.

         49.       Approximately 73 per cent of individuals and 94 per cent of companies now
         rely on tax agents to comply with their tax obligations. 22 Rather than making a full and
         true disclosure of all material facts to the Tax Office, as occurred before self-
         assessment, taxpayers now make these disclosures to their tax agent. A significant
         difference though is that now, notwithstanding making a full and true disclosure to a
         tax agent and relying on the tax agent, taxpayers are exposed to penalties and interest
         where the Tax Office amends on the basis of an error in law.

         No longer is the Tax Office only limited to issuing amended assessment to correct errors of fact
         or miscalculations but rather is also able to issue an amended assessment to correct errors of
         law made by a taxpayer.
         50.      Before the introduction of the system of self-assessment there were specified
         limitations on the power of the Commissioner of Taxation to amend an assessment.

         51.       Where the Commissioner of Taxation issued an assessment based on a full
         and true disclosure of all the material facts, then the Commissioner of Taxation was not
         empowered to amend an assessment to increase a tax liability to correct an error of
         law. In such circumstances, this required the Tax Office to identify and correct errors of
         law in the course of making the original assessment. Risk of penalties or compounding
         interest did not arise from uncertainties as to the application of the law as the Tax
         Office was only able to issue an amended assessment to correct an error in calculation
         or mistake of fact. 23

         52.      Where a taxpayer made a full and true disclosure of all material facts
         necessary for assessment, the tax system provided that taxpayer certainty from errors
         of law once they were issued with a notice of assessment. Under this system the




22   D’Ascenzo M, Relationships between Tax Administrations and Tax Agents/Taxpayers. Presentation by the
      Second Commissioner of Taxation to the Asia-Oceania Consultants Association General Meeting, Manila 11
      November 2005. Available at <http://www.ato.gov.au>
23   The Explanatory Memorandum to the Taxation Laws Amendment Act 1986 provided that the limitation
      prohibiting the amendment of an assessment to correct an error in law was considered appropriate under the
      assessing system as all income tax returns were subject to examination by assessors and errors of law were
      generally identified and corrected by assessors in the course of making the original assessment. As was
      acknowledged at the time the system of self-assessment was introduced, a typical salary and wage tax return
      only received one minute of scrutiny by assessors and in the case of business returns, an average of four
      minutes’ scrutiny applied.


                                                                                                        Page 11
The Importance of Certainty and Fairness in a Self-Assessing Environment



      majority of risk and cost of mistakes of law by the Tax Office were borne by the tax
      system itself.

      53.      Under the system of self-assessment, an income tax return is not generally
      subject to a technical examination prior to issue of a notice of assessment to enable
      errors of law to be detected and corrected. The Commissioner of Taxation has the
      specific power to make an assessment based on the acceptance of information
      contained in the income tax return of the taxpayer. This means that the incorrect
      application of the law by taxpayers will ordinarily be identified only at post-
      assessment audit or examination stage.

      54.       Furthermore, the Commissioner of Taxation has the specific power to amend
      assessments to increase or decrease the liability of taxpayers, within the presently
      specified time limits, to correct errors of calculation, mistakes of fact and mistakes of
      law after processing the initial assessment and collecting the tax payable or paying a
      refund. These post-assessment amendments for errors of fact or of law may be subject
      to penalties and interest.

      55.      The basis for introducing self-assessment in 1986 was made in the context of a
      significantly different tax system and business environment. Since that time there has
      been an increase in the complexity of the business and investment environment
      together with the tax laws placing significant stress on taxpayers to understand and
      apply the law in their circumstances. This has been most pronounced in areas of
      uncertainty in the application of the law to the taxpayer’s circumstances. Although the
      vast array of Tax Office public rulings, interpretative advice and publications provide
      guidance and assistance to taxpayers in understanding the tax laws, the most difficult
      and important task of correctly applying the law, as expressed in the legislation and
      court decisions, and interpreted by the Tax Office, to the factual circumstances is now
      the responsibility of the taxpayer.

      56.       In most cases, this will not be a problem for taxpayers especially for those
      with simple tax affairs. However, where there are isolated or unusual transactions, for
      example selling of shares, acquiring a rental property or expanding a business
      internationally, or there is uncertainty in the application of the tax law to the
      transaction, then there is an increasing risk that taxpayers may make an error in
      applying the law to their circumstances. In this environment, taxpayers are exposed to
      not only retrospective liability to primary tax but also to the application of penalties
      and interest.

      There is a current lack of compensating protections for taxpayers placed at
      increased risk by a system of self-assessment

      57.      None of the design features of self-assessment, in isolation, are inherently
      unfair. But rather, it is the interaction of these design features that may lead to unfair
      outcomes for particular taxpayers.

      58.      For example, the design and administration of the penalty and interest
      regimes, the absence of a safe harbour from penalties and interest where a taxpayer
      relies on a tax agent and the inability of taxpayers to get certainty of the Tax Office




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                          The Importance of Certainty and Fairness in a Self-Assessing Environment



view of the application of the law prior to assessment, have contributed to perceptions
of uncertainty and unfairness in the current system of self-assessment.

59.        The introduction of self-assessment, and its interaction with these other
features of the tax system, has meant that the individual taxpayer has been expected to
shoulder the balance of risk and uncertainty in the tax system that was previously
borne by all taxpayers. Where self-assessment and complex laws interact, the
framework of administration must consider the risks to the taxpayer alongside the
risks to revenue, and do so with equal priority.

60.       The implementation of the recommendations of the Report of Aspects of Self-
Assessment has partially mitigated the lack of certainty caused by lengthy review
periods available to the Tax Office. These changes represent significant steps forward
in providing greater certainty and fairness in a system of self-assessment to a majority
of taxpayers but do not provide adequate protection to those taxpayers with more
complex tax matters including businesses. As is discussed below, more is required to
re-align this balance more fairly between taxpayers and the tax system as a whole so as
to duly acknowledge the complexity and uncertainty in the tax system. The risk of not
doing so has been succinctly set out in the Explanatory Memorandum to the Tax Laws
Amendment (Improvements to Self Assessment) Bill (No. 2) 2005:

     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.


Design and administration of the penalty and interest regimes

61.        An evaluation of the current system of self-assessment cannot be made in
isolation from its interaction with the respective penalty and interest frameworks. In
fact, it is these interactions which have the greatest potential to introduce community
perceptions of unfairness and uncertainty into the system of self-assessment. In some
case, such as the mass-marketed tax arrangements and the employee benefit
arrangements, the inadequacies in these interactions, caused both by legislative design
(allowing retrospective amendment up to fours years after the notice of assessment
was issued) and the Tax Office’s own administration (one size fits all approach in the
application of penalty and interest) resulted in much angst amongst taxpayers and
their advisers.

Penalty consequences – pre and post self-assessment
62.      Prior to the introduction of the system of self-assessment, a penalty would
have been imposed where a taxpayer made a statement to a taxation officer that was
false or misleading or omitted something from such a statement that rendered it
misleading. Also, it required that the amount of tax properly payable by the taxpayer
exceeded the tax that would have been payable if the statement had not been false or
misleading.




                                                                                         Page 13
The Importance of Certainty and Fairness in a Self-Assessing Environment



      63.       Taxation Ruling IT 2141 provided guidelines as to the approach which ought
      generally to be adopted by the Tax Office in deciding whether or not a statement was
      false or misleading or whether an omission from a statement rendered the statement
      misleading. In particular, the Ruling stated that information provided in relation to a
      deduction claimed in a return that is, without further information or enquiry, adequate
      to lead a reasonably prudent and competent taxation assessor or auditor to disallow
      the whole or part of the claim is not to be taken as misleading.

      64.         More importantly, the Ruling stated that:

             A statement as to a particular view of the proper operation of the law is not false or
             misleading even though it may be inaccurate. In context, and as a matter of the proper
             interpretation of the expression "false or misleading statement", it is clear that the
             legislature is directing its attention to statements of fact that are false or misleading and
             not to statements as to the application or interpretation of the law. A taxpayer who
             claims a deduction under a particular description, and who does so in a way that is not,
             having regard to the disclosure made, false or misleading in relation to the facts, will
             not incur a penalty even though the amount may not be deductible as a matter of law.
             While there will be some situations where the distinction is not entirely clear, it is
             unlikely to be difficult to make in the vast majority of practical situations. Where there is
             some doubt, fine distinctions are not to be made and the statement should be treated as
             one of law and not penalisable. [Emphasis added]

      65.       So, under the previous assessment regime, if a taxpayer arrived to a different
      conclusion as the application of the law to their circumstances but made a full
      disclosure of the facts to the Tax Office, then no penalty was applicable. It was clearly
      the role of the Tax Office to determine how the law applied to the facts of the taxpayer.

      66.      Contrast this situation to the current position under a system of self-
      assessment. No longer does the Tax Office undertake the technical scrutiny of a
      taxpayer’s return prior to issuing a notice of assessment as it once did. Rather a
      taxpayer must ensure that they correctly apply the law to their circumstances taking
      into account the legislation, court and tribunal decisions and the vast array of rulings,
      determinations, interpretative decisions and other Tax Office publications. Where a
      taxpayer fails to take reasonable care in understanding the law and applying it to their
      circumstances, or in some cases does not have a reasonably arguable position, then
      penalties and interest may be applicable.

      67.      Most taxpayers, not surprisingly, choose to go to a tax agent to assist them in
      correctly interpreting and applying the tax laws. As well, taxpayers will go to
      accountants and lawyers for advice, but the tax laws do not specifically provide
      protection to taxpayers seeking advice from these persons.

      68.     A taxpayer that uses a tax agent must provide the tax agent with all necessary
      information. To be taken to have exercised reasonable care, a taxpayer is expected to:

      • properly record matters relating to tax affairs

      • provide honest, accurate and complete information in response to questions asked
        by the agent, and



Page 14
                                      The Importance of Certainty and Fairness in a Self-Assessing Environment



      • bring to the attention of the agent information the entity could be reasonably
        expected to have known was relevant to the preparation of the return, activity
        statement or other document.

      69.      In doing so, taxpayers make the same full disclosure they once made to the
      Tax Office. Curiously, they are not afforded the same protection as they would have
      been afforded under the previous assessment regime.

      70.       Rather, where a taxpayer has used the services of a tax agent, both the
      taxpayer and the agent must take reasonable care. Where the taxpayer's agent does not
      exercise reasonable care, the taxpayer will be held liable for any penalty imposed. 24

      71.      The Tax Office’s Practice Statement sets out the standard of care expected
      from a tax agent:

             The standard of care required by a tax agent is higher than that expected of an ordinary
             person due to the knowledge, education, skill and experience of the practitioner obtained
             from continual exposure to the operation of the financial system and similar transactions
             for numerous clients. When examining an entity's affairs a tax agent would be expected
             to apply this experience to the entity's situation and to ask the questions necessary to
             correctly prepare the client's return. However, this does not mean that a tax agent will
             always be expected to display the highest level of skill or foresight of which anyone is
             capable. The standard is that of a prudent professional of normal intelligence in the
             circumstances of the tax agent. 25

      72.       It is clear that some rebalancing of the risks for taxpayers is required to ensure
      that, from a penalty perspective, taxpayers are no worse off under self-assessment. This
      means that only a very low level of risk should be acceptable to a taxpayer who has
      sought to do the right thing in a complex system including relying on tax professionals
      for advice.

      73.       In the past, a taxpayer who made a full and true disclosure of all material
      facts – aspects that a taxpayer would be expected to know and be in a position to
      understand and convey to the Tax Office – then they would be protected from
      penalties. Now, the system of self-assessment not only expects a taxpayer to make a
      full and true disclosure of the material facts but also to understand and apply the law
      in a manner that demonstrates both reasonable care and, in certain cases, a reasonably
      arguable position. Even where a taxpayer makes a full and true disclosure to a tax
      agent or accountant there is no protection afforded from penalties.

      Time delay between time a notice of assessment issues and time that an amended
      assessment issues – but who should bear this cost?
      74.     Following the move to a system of self-assessment the Tax Office shifted its
      emphasis from pre-assessment verification of returns to a greater reliance on audits
      and other processes to check and verify returns after assessment. The effect of this has
      been to introduce more instances of a time delay between the time a notice of


24  Practice Statement PS LA 2006/2 - Administration of shortfall penalty for false or misleading statement, at
     paragraph 75.
25 Id, at 78.




                                                                                                      Page 15
The Importance of Certainty and Fairness in a Self-Assessing Environment



      assessment issues and the time that an amended assessment issues. The economic cost
      for such a time delay is the application of the shortfall interest charge.

      75.       The Explanatory Memorandum to the Tax Laws Amendment (Improvements to
      Self Assessment) Act (No. 1) 2005 states that:

             The rationale for imposing an interest charge during the shortfall period is to ensure that
             taxpayers who understate their liability in self assessing do not receive an advantage - in
             the form of a 'free loan' - over those who meet their tax liabilities in full by the due date.

             This goal suggests a charge aimed at neutralising the 'loan benefits' that taxpayers could
             otherwise receive from the temporary use of the shortfall amount.

      76.      It is interesting though that the ‘loan benefit’ that the shortfall benefit is aimed
      at neutralising only arises due to the inherent nature of a system of self-assessment.
      Prior to self-assessment, most significant technical issues were more likely than not
      picked up during pre-assessment verification. Under self-assessment it is almost
      always during the Tax Office’s post-assessment verification processes that errors of law
      and fact will be picked up.

      77.      The question that arises for consideration is where there is complexity or
      uncertainty in the law is it to be expected that a taxpayer solely incur the cost for an
      error in the application of the law to their circumstances in all instances? Equally,
      should it be expected that, in all instances, a taxpayer solely bear the cost for the delay
      inherent in a system of self-assessment between the time a notice of assessment issues
      and the time that an amended assessment issues?



DUE RECOGNITION OF THE INCREASED RELIANCE ON TAX AGENTS BY PROVIDING
‘SAFE HARBOURS’ FROM PENALTIES AND INTEREST WHERE A TAXPAYER HAS
TAKEN REASONABLE CARE.

      78.      The introduction of a system of self assessment and the Tax Office’s shift of
      emphasis of the Tax Office from pre-assessment technical scrutiny to advisory services
      and post assessment verification has placed a greater reliance on taxpayers, tax agents
      and advisers to apply the law. In a sense, the system of self assessment and the Tax
      Office’s administration of this system have abrogated the pre-assessment technical
      scrutiny of returns to tax agents and advisers. The removal of the ‘check step’ of Tax
      Office assessment has effectively meant that tax agents could be considered as the
      unofficial but professional replacement for the pre-assessment processes that the Tax
      Office undertook under the old assessing regime. Taxpayers confronted with complex
      laws in a self-assessment system have, in practical terms, nowhere else to go for help in
      meeting their obligations.




Page 16
                                         The Importance of Certainty and Fairness in a Self-Assessing Environment



         79.        In a recent speech, the Commissioner of Taxation noted that:

                In Australia intermediaries such as tax agents have a symbiotic relationship with the tax
                administration. These intermediaries provide a key leverage point to influence taxpayer
                behaviour and to facilitate streamlined and increasing online dealings with the ATO. 26

         80.       The requirement of influencing taxpayer behaviour through tax agents and
         advisers has become more important given the absence of pre-assessment scrutiny of
         returns. It is clear that the Tax Office intends to continue to use tax agents, accountants
         and advisers as leverage to encourage compliance.

         81.      In undertaking this role it is agreed that tax agents and the tax profession
         generally do an excellent job in helping people understand their rights and obligations
         under the tax law and making it easier for people to meet their tax responsibilities. The
         complexity of the tax system has meant that taxpayers are more reliant on tax agents
         and advisers to help them understand their tax liability.

         82.       While the proposed promoter penalties provisions and the proposed
         legislative framework for tax practitioners are part of the current legislative agenda,
         the administration of self assessment remains seriously deficient without them,
         notwithstanding that some improvements have been made through implementation of
         the recommendations contained in the review of self-assessment.

         83.      There have been extreme delays in putting in place the new rules for tax
         practitioners with the consultation process beginning in the early 1990s and was
         announced as Government policy in 1998. These delays are no doubt explainable
         because the intervening period includes the introduction of Tax Reform, extensive
         consultation periods and many other legislative demands.

         84.         The policy announcement made by the Government in 1998 said that:

                The concept of reasonable care is central to the responsibilities of tax agents and
                taxpayers under self assessment. Tax agents and taxpayers for the first time can be
                confident that they will not to be penalised where they satisfy this standard…. A
                taxpayer will be considered to have exercised reasonable care where the taxpayer can
                demonstrate that a tax shortfall is not due to failure by the taxpayer to:

                • provide the tax agent with a copy of the last lodged return, including schedules;

                • meet the record keeping requirements of the law;

                • provide accurate and complete information in response to questions asked by the
                  agent;

                • conform with the tax agent's advice; and




26   D’Ascenzo M, It is the community’s tax system, Address by the Commissioner of Taxation to the Australasian Tax
      Teachers’ Association – 18th Annual Conference, Melbourne, Australia, 30 January 2006. Available at
      <http://www.ato.gov.au>


                                                                                                          Page 17
The Importance of Certainty and Fairness in a Self-Assessing Environment



                • bring to the tax agent's attention all the information they could have been reasonably
                  expected to have known was relevant to the preparation of the return. 27

         85.       Seen in the light of the fact that the safe harbour proposals were an
         announced policy intention of Government, and had indeed been in prospect for some
         time preceding that, it is pertinent to consider if the then Commissioner should have
         considered using that framework in resolving compliance issues such as the mass-
         marketed tax arrangements and employee benefit arrangements regardless of the fact
         that the laws were not yet in place.

         86.       If the administration of the self assessment system is to be reliant upon tax
         agents to undertake, in effect, the pre-assessment technical scrutiny once undertaken
         by the Tax Office, a safe-harbour from penalties and interest for taxpayers relying upon
         the advice of tax agents, accountants and advisers is essential to the certainty and
         fairness of this system.

         87.       This means that a taxpayer that makes a full and true disclosure to a tax agent
         and relies upon the expertise of their adviser should be protected from the imposition
         of penalties and the shortfall interest charge.

         88.      This should be irrespective of whether the penalty is a tax shortfall penalty or
         a penalty relating to schemes. There is nothing in this policy announcement made in
         1998 that limits the protections from administrative penalties. Of course, exceptions to
         this general ‘safe harbour’ would apply in instances or fraud and evasion or where a
         taxpayer has not exercised reasonable care in furnishing all relevant information to the
         tax agent and following the tax agent's advice. However, current Tax Office
         approaches tend not to give any quarter to taxpayers who it believes have attempted
         avoidance or who have had Part IVA of the Income Tax Assessment Act 1936 or other
         anti-avoidance provisions used against them.

         89.       Given the complexities and importance of Part IVA, both from the
         perspective of its application and the potential public stigma attached, there should be
         no reason why a taxpayer who has relied on a tax agent or accountants advice on the
         application of Part IVA should not be able to avail themselves of the ‘safe harbour’
         protections. In situations where a tax agent or, indeed other regulated adviser has
         actively been involved in advising the taxpayer on the arrangement in question, the
         contemplated protections would be even more relevant.

         90.       The Commissioner of Taxation has acknowledged that the tax system is
         complex. He has also acknowledged that there is a heavy reliance by both the Tax
         Office and ordinary taxpayers on well-regulated advisers to cope with this complexity.
         So much is obvious - without them, the system would not function. There is therefore a
         real and urgent need to ensure that where taxpayers rely on tax agents and do all that
         is reasonably expected of them, and there is no evidence of fraud or collusion, then
         they are adequately protected from penalties and interest.




27   Assistant Treasurer, New Legislative Framework for Tax Agent Services, Press Release No. AT/14, 6 April 1998.
      Available at <http://assistant.treasurer.gov.au/old/assistant2000/pressreleases/1998/014.asp>


Page 18
                                        The Importance of Certainty and Fairness in a Self-Assessing Environment



ADMINISTERING THE SYSTEM OF SELF-ASSESSMENT SYSTEM IN A MANNER THAT
RECOGNISES THE DIFFERENT NEEDS AND RISKS OF TAXPAYERS AND PROVIDING
TIMELY ADVICE TO TAXPAYERS


         The need for differentiation
         91.     Given the inherent features of a system of self-assessment, the Tax Office’s
         approach in how it administers the tax system is crucial in minimising uncertainty and
         unfairness to taxpayers.

         92.       A consistent underlying issue has been that the Tax Office continues to
         construct some compliance strategies with an undue bias towards administrative
         efficiency at the expense of sufficiently individualised treatment of taxpayers. Reviews
         by the Inspector-General of Taxation into the remission of the General Interest Charge
         for groups of taxpayers in dispute with the Tax Office, small business debt collection
         and GST refund administration provide examples and made specific recommendations
         in this area. The mass-marketed tax arrangements along with the employee benefit
         arrangements are also testament to such compliance strategies.

         93.       A key element of the Tax Office’s business model is that with its limited
         resources it aims to administer the tax system by tailoring its approaches in ways that
         differentiate its compliance responses on the basis of taxpayer circumstances,
         behaviour and risk profiles. However, where the Tax Office merely ‘ramps up’
         resources in an area and fails to identify key demographics, or sufficiently disaggregate
         those demographics, the Tax Office may miss opportunities to devise strategies that get
         closer towards providing sufficiently tailored treatments with its limited resources.
         This approach continues to expose the Tax Office to community criticisms that it takes
         a largely ‘one size fits all’ approach. The transparency with which the Tax Office carries
         out its operational activities in these areas and, in appropriate circumstances, its
         strategy development appear to fuel further these community criticisms.

         94.       The importance of recognising the different individual circumstances of
         taxpayers in a self-assessment cannot be understated. Enforcement, without properly
         distinguishing between intentional and unintentional non-compliance, only serves to
         discourage voluntary compliance in a self-assessing environment. As noted in a
         comparative analysis of self-assessment:

                …different taxpayers may encounter different individual circumstances that under self-
                assessment could give rise to unintentional non-compliance. Unintentional non-
                compliance arises as a result of non-deliberate decision. This may be due to an inability
                by taxpayers to comprehend or keep abreast with the frequent changes of tax law.
                Furthermore taxpayers may be unaware of their entitlement with regards to deductions
                or allowances or reliefs available to them. Therefore ‘…the tax administration should be
                sufficiently flexible to allow for the equitable treatment of different taxpayers’. 28

         95.    The Tax Office has made some positive statements in its 2005/06 Compliance
         Program regarding the need to better differentiate its responses to compliance risks. It


28   Loo, McKerchar & Hansford, above, note 2, at 706.


                                                                                                       Page 19
The Importance of Certainty and Fairness in a Self-Assessing Environment



         has also outlined new directions in the individuals and large business segments of its
         compliance program to offer the prospect of greater certainty for those who adopt low-
         risk practices in meeting their responsibilities.

         96.       For individuals, this involves the Tax Office providing taxpayers or their
         agents with access to information from government and non-government agencies to
         help them prepare their electronic returns – saving time and reducing the chance of
         mistakes. Those receiving a payment summary from Centrelink for an allowance,
         benefit or pension can access that information through e-tax. Some taxpayers will also
         be able to electronically access their Medicare expenses information from the Health
         Insurance Commission when preparing their return.

         97.       The Tax Office has also recently announced that it intends to advise those it
         identifies as low risk – for example, those with a history of lodging and paying on time
         – that their tax assessment for the year is finalised and that it will not be taking any
         further action on that year’s assessment. 29


         The need for accessible and timely advice that provides certainty
         98.      Self assessment requires taxpayers to perform certain functions and exercise
         certain responsibilities in complying with their taxation obligations. As such,
         Australia’s system of self assessment for income tax relies on the principle of voluntary
         compliance and taxpayers, and their advisers, having a good understanding of the
         taxation laws in order for them to meet their obligations.

         99.        This has meant that taxpayers are more reliant upon the Tax Office to provide
         summarised, understandable statements that taxpayers may rely upon. In a system of
         self-assessment taxpayers expect that these statements will be timely, accurate and
         objective acknowledging court and tribunal decisions. Clearly it is the responsibility of
         the Tax Office to act promptly and decisively when it becomes aware that taxpayers
         may be in conflict with the Tax Office’s view and educate and assist taxpayers in areas
         of risk likely to affect them.

         100.     It is also agreed that the successful implementation of a system of self-
         assessment relies very much on the tax authorities developing good public relations
         with taxpayers, promoting tax education, assisting taxpayers by way of guidance and
         services as well as exercising enforcement activities. In addition:

                 …taxpayers’ confidence in the tax system must be developed through fair and
                 transparent practices by the authorities. Rulings and guidelines to provide for greater
                 consistency and more certainty with fewer ambiguities would help to simplify
                 understanding of complex tax codes. Shortcomings, such as irregular practices,




29   The Tax Office is currently trialling this approach this year with a small group of individual taxpayers with
      simple tax affairs, for example, those with only salary and wages or government pension income. The Tax
      Office has indicated that subject to an evaluation of the trial and in conjunction with improvements in its risk
      profiling, it will expand the initiative to cover a broader range of individuals.


Page 20
                                       The Importance of Certainty and Fairness in a Self-Assessing Environment



              confrontational approaches and the exercise of too much discretionary power on the part
              of the tax authorities should be avoided. 30

       101.      The Tax Office accepts the importance of this advising role and acknowledges
       that, as the administrator of tax laws, it must operate as a trusted authority on the law
       and a professional adviser and educator, ensuring that people have the information
       and support needed to meet their obligations. 31

       102.      On the whole, the Tax Office performs this task well. It makes publicly
       available a wide range of rulings, determinations and interpretative decisions that set
       out the Tax Office’s technical view on the operation of the tax laws. The Tax Office also
       makes publicly available practice statements and policy documents that outline how it
       will administer the tax laws.

       103.     In addition the Tax Office releases a range of publications to support
       taxpayers and their advisers, including booklets on specific tax topics such as capital
       gains tax to more general publications such as TaxPack and Retirees TaxPack.

       104.     Recently, the Tax Office has also published its Compliance Program with the
       goal to openly share with the community the strategies and the results achieved in the
       previous year.

       105.     However, although the Tax Office readily seeks to educate taxpayers and
       provide them with supporting materials, there is a need to make timely and objective
       Tax Office advice more accessible to all taxpayers. Short-comings in the advice
       mechanisms within the current system of self-assessment have meant that many
       taxpayers have no practical and inexpensive way of obtaining certainty from the Tax
       Office regarding the application of the law to their circumstances. Taxpayers have a
       need for, and probably a right of, a high degree of certainty when they prepare and
       lodge their income tax returns.

       106.     The legislative changes introduced in 1991, in particular the private binding
       ruling (PBR) system, to give taxpayers greater equity and fairness and increased
       certainty, have not had this desired effect especially amongst those taxpayers most at
       risk.

       107.       Private binding rulings replaced the system of advanced opinions and section
       169A requests. 32 Section 169A requests allowed taxpayers to, at the time of lodgement
       of their income tax return, raise questions to be considered by the Tax Office in relation
       to their tax affairs. Advanced opinions were similar to the current private binding
       rulings whereby a taxpayer may seek the Tax Office’s view concerning the taxation
       consequences arising from a transaction.

       108.   It is understood that the concept of private rulings as originally envisaged
       was a mechanism for taxpayers to obtain some degree of certainty in respect of



30 Loo, McKerchar & Hansford, above, note 2, at 710.
31 The Treasury, Report on Aspects of Income Tax Self-Assessment, August 2004, Commonwealth of Australia,
    Canberra, p 7. This is re-affirmed at page 8 of the Taxpayers Charter.
32 Australia, A Full Self Assessment System of Taxation: A Consultative Document, Canberra, 13 December 1990, at 14.




                                                                                                           Page 21
The Importance of Certainty and Fairness in a Self-Assessing Environment



      particular aspects of their tax liability. The ability to obtain a private ruling is a key
      feature of the self assessment system.

      109.      However, the private binding ruling system has not been used as an avenue
      for individual and small business taxpayers to obtain advice and certainty from the Tax
      Office. Few taxpayers caught up in the mass marketed and employee benefit
      arrangements sought private binding rulings from the Tax Office regarding their own
      tax affairs instead relying on their tax adviser. It is these taxpayers that are at a greater
      risk of non-compliance or error because they can never hope to understand the
      complexities of the tax laws.

      110.      Predominantly individuals and small businesses, often with investments,
      have little choice but to rely on their advisers, including accountants, lawyers and
      particularly tax agents. This is supported by the fact that only approximately 15,000
      private binding rulings are issued each year in a complex tax system with millions of
      taxpayers. It is well known that small medium enterprises and micro businesses have
      virtually opted out of the PBR system because it takes too long, is too expensive or
      there is a perception that the issue is low risk given the trust they have in their
      advisers. Likewise, tax agents seldom seek a PBR for the same reasons and because
      their clients refuse to bear this additional cost.

      111.     Seen in this light, the PBR system has not, as intended, adequately replaced
      the opportunity to gain pre-assessment certainty that they formerly could under the
      assessing regime and the section 169A requests.

      112.     Research from the current review of the Potential for Revenue Bias in Private
      Binding Rulings in complex matters indicates that amongst large corporate taxpayers
      that have sought a private binding ruling over recent years, approximately 72 per cent
      consider that the Tax Office has a bias towards revenue protection. It must be stressed
      that these perceptions are based on their experience and expectations.

      113.    There have been ongoing improvements to the private and public ruling
      systems as a result of the recommendations of the Review of Aspects of Self-
      Assessment. These include:

      • The range of matters, on which legally binding private rulings can be given, has
        been expanded to include those relating to collection, procedure, administration and
        ultimate conclusions of fact. The last category includes private rulings on matters
        requiring the market value, for example, of an asset.

      • A new practice statement on the provision of advice by the Tax Office is being
        prepared that will explain the forms of advice the Tax Office provides, and the
        protection available to people who rely on that advice.

      • All private advice will clearly advise the protection from primary tax, penalty or
        interest that is available to the entity to which it relates.

      114.       Other improvements that have already been introduced include the following:

      • Tax agents are now able to lodge applications for private rulings electronically using
        the Tax Agent Portal.


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                                         The Importance of Certainty and Fairness in a Self-Assessing Environment



          • Where appropriate, private rulings now carry commentary about the Tax Office’s
            consideration of the application of Part IVA of the Income Tax Assessment Act 1936.

          • Individuals enquiring about their personal tax affairs are now able to apply for oral
            rulings on a broader range of topics. However, in should be noted that there are
            restrictions on who can request an oral ruling and the subject matter. For example, it
            is limited to individuals with straightforward issues, leaving complex issues and
            business taxpayers to rely on the PBR system for advice and certainty.

          115.      Notwithstanding these recent improvements in allowing taxpayers to seek
          Tax Office advice, there is a need, in certain circumstances, to allow taxpayers or their
          advisers to seek such advice, or bring to the Tax Office’s attention potential issues in
          their return, at the time of lodgement. Although there are strong administrative
          efficiency grounds for not allowing taxpayers to request advice at the time they lodge
          their income tax returns, there are equally strong equity grounds for some mechanism
          to allow taxpayers, in certain circumstances, to seek such certainty.


          Certainty through administration
          116.     Under a system of self-assessment, while the Tax Office undertakes important
          pre-lodgement awareness strategies in some risk areas, most Tax Office active
          compliance casework is done well after returns are processed, refunds issued and self-
          assessed liabilities paid. Taxpayers caught up in these processes are exposed for up to
          four years to potentially having to fund unexpected bills for primary tax,
          compounding interest and possibly penalties. 33 Costs of defending their reputation or
          explaining their position are also likely. There can be no better examples of this than
          the plight of thousands of taxpayers caught up in the mass marketed tax arrangement
          and employee benefit arrangements. It has been clear that managing these situations
          under a system of self-assessment has also not been easy for the Tax Office.

          117.       For those subject to Tax Office compliance action there are disadvantages and
          risks that did not exist before the introduction of self-assessment. Apart from the
          increased compliance costs now borne by taxpayers there has been a corresponding
          increase in the risk for mistake where there is uncertainty in the law in the form of
          penalties and interest. This risk is borne by taxpayers in the form of cash-flow
          difficulties by way of an amendment giving rise to a tax liability some time after the
          relevant income year, the imposition of penalties and interest.

          Greater use of pre-assessment verification

          118.      While a predominately post-assessment approach is taken to compliance,
          there is no reason why the Tax Office could not examine problems in known risk areas
          before finalising a return if risks to the taxpayer, as well as those perceived for the
          revenue, are foreshadowed.




33   With the introduction of the Tax Laws Amendment (Improvements to Self Assessment) Act (No. 2) 2005 the period in
      which the Commissioner can amend an assessment for most individuals or very small business taxpayers will
      be standardised at 2 years. A 4-year period of review will apply for taxpayers with more complex affairs.


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The Importance of Certainty and Fairness in a Self-Assessing Environment



         119.      The Tax Office already automatically checks assessments against a set of risk
         criteria based on intelligence from its compliance activities before they are issued. If
         risk indicators are triggered, then a refund is not issued until the case has been
         reviewed. 34 A similar approach is adopted by the Tax Office in protecting the revenue
         risk on Business Activity Statements (BAS). The Tax Office’s activity statement
         systems are set to identify high risk statements using very specific criteria. Where a
         potential problem is picked up, the statement is taken off-line, checked and cleared
         before issuing refunds. Not only is the revenue protected, but the taxpayer is not at
         risk of having received a wrong refund either.

         120.      It might be considered whether the Tax Office should do more pre-assessment
         verifications in areas of income tax that it perceives as high risk. These high risk areas
         are already identified in the Tax Office’s Compliance Program, which describes the six
         market segments (individuals, micro-businesses, small to medium enterprises, large
         business, non-profit organizations and government organizations) and the compliance
         issues that affect each segment. It may be that a taxpayer could be subject to pre-
         assessment verification where they are in an identified high compliance risk category.
         Taxpayers subject to pre-assessment verification would be protected from retrospective
         amendment by the Tax Office for errors of law and the imposition of penalties and
         interest.

         121.     The Tax Office will probably point to the potentially higher costs of these
         approaches compared to those where it takes post-assessment compliance at its relative
         leisure. But the Tax Office has done well out of self-assessment, and it continues to be
         very well funded. It should take a broader view which includes considerations of
         taxpayer risks and costs.

         122.     Questions of efficiency should be balanced with the need to provide greater
         certainty and fairness to taxpayers where the Tax Office becomes aware of new risks. It
         must act quickly and pro-actively, which should include a greater reliance on pre-
         assessment verification as part of its overall compliance approach. It is also clear from
         the on-going mass-marketed tax arrangement and employee benefit arrangements
         experience that, where disputed items are picked up all too late, the Tax Office also
         incurs major additional costs. Relying on its right of up to four years of retrospective
         action against affected taxpayers will not provide adequate an adequate level of
         certainty to taxpayers involved, will expose them to unexpected risks, and will
         undermine the integrity of the tax system overall.

         123.     The Inspector-General of Taxation is also currently undertaking a review into
         the Tax Office’s ability to identify and deal with major, complex issues within
         reasonable timeframes. As part of this review the Inspector-General will be examining,
         as case studies, the Tax Office’s handling of compliance activity relating to research
         and development (R&D) syndication arrangements, living away from home
         allowances and service entity arrangements.




34   The types of things identified through high-risk refund checks include over-claimed tax withheld, excessive
      interest deductions and the use of fraudulent payment summaries.


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                             The Importance of Certainty and Fairness in a Self-Assessing Environment



   Providing taxpayers with an opportunity to seek pre-assessment certainty

   124.      It may also be that a more flexible system of self-assessment, in a sense a
   hybrid between a full self-assessment and a full assessment regime, could provide a
   better balance between compliance costs and certainty for a taxpayer dependent upon
   the perceived level of risk. This could involve taxpayers or tax agents, at the time that
   an income tax return is lodged, making a full and true disclosure to the Tax Office
   regarding an issue that they are uncertain about how the law applies to their
   circumstances. In effect, this would be similar to the section 169A requests or if a
   taxpayer lodged a private binding ruling together with their income tax return.

   125.     This could have allowed, for example, a taxpayer who entered into mass-
   marketed tax arrangement, or their tax agent, to make a full and true disclosure of the
   material facts to the Tax Office. This requirement could have increased a taxpayer’s
   compliance costs but provided them with increased certainty in a timely manner. By
   the Tax Office determining the application of the law to the taxpayer’s circumstances in
   respect to the particular issue, a taxpayer would have had protection from
   retrospective amendments for errors of law and against the application of penalties
   and interest.

   126.     Alternatively, there are opportunities with today’s technology for taxpayers to
   protect themselves in the way they used to be able to (using section 169A provisions)
   by drawing to the Tax Office’s attention potential issues in their return. Such a system
   would not only protect taxpayers from penalties and interest but also have the added
   benefit of providing the Tax Office with the intelligence to identify and respond
   quickly to emerging compliance issues.

   127.     For a taxpayer with simple tax affairs or where there is greater certainty in the
   application of the law due to court and tribunal decisions, then self-assessment
   provides them with ability to meet their tax obligations without significant compliance
   costs. While the choice to self-assess may decrease a taxpayer’s compliance cost it will
   also mean less certainty as such an assessment will be open to retrospective
   amendment.



CONCLUSION
   128.     To date, Australia has been a world-leader in the implementation and
   administration of its system of self-assessment. There can not be, and should not be,
   any question of turning back from self-assessment. However, the introduction of self-
   assessment in Australia marked a fundamental, and significant, shift is what was
   required from taxpayers in complying with their tax obligations and the scope for the
   Tax Office to amend assessments. Notwithstanding recent improvements, there is still
   some significant re-balancing, requiring both legislative and administrative changes,
   needed to underpin a more certain and fairer system of self-assessment. Essential in
   achieving this is the need for adequate compensating protections for taxpayers
   operating in a system of self-assessment involving complex and uncertain laws.
   Likewise, in administering a system of self-assessment, there is a need for further
   improvements in the ability to recognise and respond to the circumstances of
   individual taxpayers in a manner that differentiates the needs and risks of taxpayers.


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