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All OECD member countries use a tax penalty system, but how many evaluate the effectiveness of their penalties? My working paper attempts to evaluate the effectiveness of Australia’s tax penalty regime in respect of its ability to penalise deliberate tax evaders. The paper draws on previously unpublished data from the Australian Taxation Office relating to payments of penalties by those taxpayers who make false and misleading statements in their tax returns. The data covers a five year period from 2011-12 to 2015-16. As this is exploratory research, there are a number of important limitations and qualifications pertaining to the new data which are detailed in the working paper.

The focus of the paper is on those taxpayers who deliberately evade tax. Previous reviews relating to deliberate tax evasion in Australia, such as the Australian National Audit Office’s review into the Administration of Project Wickenby, have found that “less than a quarter of all liabilities raised from… compliance interventions had been collected.” A growing body of research also indicates that non-payment of penalties is an increasing problem for regulators worldwide across many, if not most, regulatory areas (for example, see Ross & Pritikin 2010).

The key questions this paper attempts to answer are:

  • do deliberate tax evaders pay their penalties?
  • does widespread non-payment of these penalties pose a risk to the integrity of the tax system?
  • what can be done about it?

How many penalties are imposed and paid?

The newly released ATO penalty payments data shows that only a small proportion of Australian taxpayers are subject to false and misleading statement penalties. Less than 0.1% of Australian taxpayers are penalised for making a false and misleading statement in their tax return, and the majority of these are at the lower culpability level. The number of taxpayers receiving higher level culpability penalties, especially for intentional disregard of the tax law, is tiny. However, of significant concern is that payment rates for intentional disregard penalties are very low. Even allowing for more than 4 years for payments to be made, only 19% of intentional disregard penalties are paid. Table 1 compares penalty and tax payment rates by those taxpayers subject to false and misleading statement penalties.

Table 1: Penalty and tax payment rates as at 30 June 2016 for penalties imposed in 2011-12

Culpability % penalty paid
by 30 June 2016
% tax paid
by 30 June 2016
Failure to take reasonable care 62 88
Recklessness 47 69
Intentional Disregard 19 44

 

The data does not tell us why these taxpayers are not paying their penalties. They may be genuinely unable to pay, or they may be able to pay but unwilling and have effectively shielded their assets from recovery action. In either case, a financial penalty is not an effective penalty: “When people either can’t or won’t pay, fines become ineffective… fines become a meaningless sanction which can ultimately lead to contempt for the law” (Searle 2003).

The very low payment rates for intentional disregard penalties also undermine the policy intent of Australia’s tiered penalty regime where high level culpability is supposed to result in higher penalties. Table 2 illustrates how the effective penalty rate for taxpayers who receive intentional disregard penalties is actually lower than for those who exhibit failure to take reasonable care or recklessness.

Table 2: Effective penalty rates for penalties imposed in 2011-12

Culpability % Penalty rate % Penalty paid
after 4 years
% Effective penalty
rate*
Failure to take reasonable care 25 62 16
Recklessness 50 47 23
Intentional Disregard 75 19 14

* Calculated by multiplying the % penalty rate by the % penalty paid.

Tax evaders also have low average primary tax payment rates (of less than 50% of tax owed). Combined with the very low average payment rates for intentional disregard penalties, it can be inferred that the “average deliberate tax evader” pays less in tax and penalties than the original amount of tax they evaded. This means that even after being caught and penalised, the “average deliberate tax evader” may be financially better off.

The data indicates that false and misleading statements are less likely to be made by taxpayers when lodging their returns through a tax agent. Only 7% of individual taxpayers penalised for intentional disregard of the law over the 5 year period used a tax agent to lodge their returns. By contrast, the average national figure for individuals using tax agents is 78%. This suggests that tax agents do play an important role in preventing serious noncompliance.

Companies receive, and pay, even fewer intentional disregard penalties than individuals. On average, only 16 companies per year receive these penalties and three quarters of the companies that are penalised for intentional disregard of the law pay none of the penalty.

What are penalties for?

While the data suggests that Australia’s penalty payment rates are very low, other research shows that financial penalties often have low payment rates, for example around 30% [ALRC Report 95 at paragraph 31.28]. While a 100% payment rate would not be realistic, my research suggests that an acceptable “floor” payment rate for the community to view a penalty as being “effective” might be a 60% payment rate.

Penalties are also intended to both punish and deter noncompliance by the particular taxpayer (specific deterrence) and the general taxpaying population (general deterrence). However, the current penalty payment rates suggest that the penalty regime does not have this effect, especially for those who abuse corporate structures to evade tax. The corporate veil appears to be an effective shield from payment of penalties even where the controllers of the company have intentionally disregarded the law. Due to the low return on investment for the ATO in pursuing these cases, there may be a disincentive for the ATO to use its limited resources in auditing such companies.

Academic research has cast doubt over the specific deterrent impact of penalties. This is primarily because when people are making the decision to evade the law (in this case, to evade tax), they are focussed on the short term benefits of their actions – how to pay less tax. They are not contemplating the costs of their behaviour which might be viewed as “amassing far into the future,” if at all. Risk seekers are more likely to discount future potential costs such as tax penalties.

The best way to produce tax compliance is to make it very difficult for taxpayers not to comply. For example, increased data matching, information reporting and withholding of tax at source.

However, penalties still play a crucial role in a functioning tax system. An effective regime to penalise taxpayers who intentionally disregard the tax law is important because it signals to the compliant community that deliberate tax evaders are being punished. If compliant taxpayers come to perceive that evaders are “getting away with it” then this can undermine community confidence in the tax system which is a strategic risk for the ATO.

The only alternative to administrative financial penalties for penalising deliberate tax evaders under the current tax penalty regime is to pursue criminal penalties. However, criminal penalties are difficult to apply, uncertain in outcome, very resource intensive and few are able to be imposed each year.

The hallmarks of an effective penalty

The paper identifies six hallmarks of effective penalties:

  1. Proportionate/fair;
  2. Swift;
  3. Certain;
  4. Memorable or result in highly visible enforcement;
  5. Cost effective; and
  6. Provide an incentive and pathway for the offender to re-integrate.

How can we improve the effectiveness of Australia’s tax penalty regime?

There are several options to improve the administration of the current tax penalty regime:

1. The ATO could work to improve the active enforcement and collection rates of higher level culpability penalties.

2. Require taxpayers who have been penalised for recklessness or intentional disregard, to lodge their future tax returns through a tax agent.

3. Increase the number of summary prosecutions for false and misleading statements by amending a provision which requires the administrative penalty to be withdrawn when a criminal prosecution is launched.

4. Use alternative penalties for companies that intentionally disregard the law. For example, a recent Federal Court judgment found that a company’s failure to comply with its tax obligations can expose the directors of the company to breaches of director’s duties (BCI Finances v Binetter (No 4) 2016). This and other ways to “pierce the corporate veil” may be more effective than imposing financial penalties on the companies.

Is there a role for different kinds of penalties for deliberate tax evaders?

The low penalty payment rates by deliberate tax evaders makes it clear that increasing penalty levels is not the answer. It will likely result in even higher rates of non-payment given the difficulties inherent in collecting financial penalties by those who already exhibit evasive behaviour. It might be time to consider alternative, non-financial administrative penalties, that can be targeted at deliberate tax evaders who do not pay their debts.

One option could be to cancel the passports of deliberate tax evaders with unpaid penalties. Australia has a Departure Prohibition Order regime but this is designed to protect the revenue rather than to punish tax evaders. This approach has recently been adopted in some other countries, including the United States. One of the key benefits of this penalty is that it provides an incentive for the deliberate tax evader to pay their penalty – that is the way to regain their passport.

Another option could be a “name and shame” public reporting system for deliberate tax evaders whose behaviour poses a high risk to the integrity of the tax system. Australia historically did name certain categories of tax evaders in the ATO annual report, but stopped this practice in the mid-1980s.

A “name and shame” penalty should be used as a scalpel rather than a sledgehammer, as misuse of this penalty could serve to further disengage the shamed taxpayer. It could also worsen community perceptions of unfairness in the tax system. A possible use of this penalty could be to apply it to tax evaders who are engaged in illegal phoenix activity. If designed well, this penalty could be used pro-actively to engage with high risk taxpayers, to give them the opportunity to change their behaviour before being “named and shamed”. It could also be used to protect the community and innocent creditors from being harmed by recidivists.

The ATO Community Perceptions Survey shows that the majority of respondents thought that there were not enough deterrents in place to stop people cheating the tax system. Penalising deliberate tax evaders in an effective manner is important in maintaining community confidence in Australia’s tax system. Without change to the current penalty regime, the community may come to perceive that deliberate tax evaders in Australia are “caught and released” rather than “detected, deterred and dealt with.”

 

This blog article does not represent the views of the Australian Taxation Office or Australian Government. It is a summary of the working paper available at the TTPI website.

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  1. It is indeed interesting that the ATO Community Perceptions Survey found that the majority of respondents thought that there were not enough deterrents in place to stop people cheating the tax system. Didn’t Second Commissioner Olsen, relying on 1991 research from the Uni of Canberra, say that imposing penalties and undertaking audits could have a detrimental effect on compliance? You just wonder how serious some of the Commissioners really are compliance?

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