This Chapter discusses the principles of self assessment in Australia and provides an overview and important background to proposed changes to the system.
On 24 November 2003 the Treasurer announced the Review of Aspects of Income Tax Self Assessment (the Review).1 The Review was asked to examine aspects of Australia’s self assessment system for income tax to determine whether the right balance has been struck between protecting the rights of individual taxpayers and protecting the revenue for the benefit of the whole Australian community.
The Review was not asked to consider fundamental tax policy changes, such as the extent to which tax returns, or categories of tax deduction, could be dispensed with, and the Review did not examine tax collection issues or assessment of other taxes.
Late last year, a team in Treasury considered a wide range of published material on self assessment, held discussions with representatives of taxpayers and professional associations, and sought the views of government agencies with an oversight role in the tax system. Following that initial analysis, on 29 March 2004 the Treasurer released a discussion paper that covered a range of issues and possible options for reform.2 In response to the discussion paper, the Review received 30 comprehensive and detailed submissions from individuals, professional associations, companies and representatives of taxpayers.3 The ideas in the discussion paper, as modified and improved in light of the submissions in response, form the basis for the conclusions in this report.
The main objective of Australia’s tax system is to efficiently raise revenue to be distributed to the community in accordance with government priorities.4 The main aim of the system of tax administration is to collect that revenue with minimum administration and compliance costs.
Since 1986-87, Australia has operated a system of self assessment of income tax, under which taxpayers’ returns are accepted at face value in the first instance and the Tax Office may subsequently verify the accuracy of the information in the return within a prescribed period after that initial assessment. From 1989-90, the returns of companies and superannuation funds became subject to a system of full self assessment, under which the taxpayer calculates their liability and pays their tax when lodging their return.
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.5 After making an assessment, the Tax Office could 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.
By the early 1990s, problems had been identified with the initial self assessment arrangements, particularly in relation to penalties and interest and the need to provide greater taxpayer certainty. The Government of the day responded by introducing changes in 1992,6 the most notable being:
- a new system of binding public rulings
- a new system of binding private rulings
- an extension (to four years) of the period within which a taxpayer could
object against an assessment
- a new system of penalties for understatements of income tax liability,
based on the requirement that taxpayers exercise reasonable care
- a new interest system for underpayments or late payments of income tax,
based on commercial principles and market interest rates.
Over the last few years, the present Government has shortened the period of review for taxpayers with straightforward tax affairs, introduced binding oral advice,7 reduced the rate of interest on shortfalls and late payments,8 and introduced the office of the Inspector-General of Taxation, a new statutory officer with governance responsibilities.9
In forming its recommendations, the Review has examined income tax systems in a number of other countries, especially Canada, New Zealand, the United Kingdom and the United States.10 The Review has concluded that each system has a different mix of strengths. The Australian system is unexceptional on most points of comparison. The periods for amendment of assessment and the scale of penalties under the Australian self assessment system are broadly comparable with international systems. Australia has a more formal rulings system, but others achieve similar results through other means. While Australia’s headline General Interest Charge (GIC) rate is higher, it is tax deductible in all cases.
The discussion paper explained that one way to reduce the uncertainty faced by taxpayers under the self assessment system would be through taxpayers being confident that they are assessing their income tax liabilities in line with the Tax Office’s interpretation of the law (through rulings and other advice). Chapter 2 contains recommendations to improve the framework and practice of the provision of advice.
Another way to reduce uncertainty is to give earlier finality to taxpayers who have tried to comply by shortening the period in which their assessment can be amended to increase their liability. Once the Tax Office can no longer amend a particular year’s assessment, taxpayers can stop worrying about whether they ‘got it right’. Chapter 3 contains recommendations to shorten certain periods for the review of assessments.
Penalties and interest charges are potential consequences of uncertainty for taxpayers. Chapters 4 and 5 contain recommendations to improve the transparency and fairness of penalties and interest charges respectively.
Other sources of uncertainty (and compliance costs) derive from the Tax Office’s interaction with taxpayers and agents and from issues relating to the design of tax policy and laws. Chapter 6 makes recommendations on a range of administrative issues associated with the self assessment system. Chapter 7 contains recommendations for improvements to policy processes and law design.
As pointed out in the discussion paper, sometimes improving one aspect of the system might adversely affect another. For example, the shorter the period for the Tax Office to amend assessments, the sooner a taxpayer obtains finality for a particular income year. However, taking this approach to extremes could encourage non-compliance and prejudice revenue collection to the extent that the resources of the Tax Office would need to be significantly increased.
The Review has concluded that there are a number of refinements to the present arrangements that would improve certainty and reduce compliance costs for taxpayers without significantly affecting the capacity of the Tax Office to collect legitimate income tax liabilities. While few of the report’s 54 recommendations represent major changes to the established system, their collective effect will be considerable. These changes are not without costs — some will require the Tax Office to do more and others recognise that some revenue might be foregone.
The most important recommendations in this report:
- improve certainty through 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
- improve certainty by 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
- mitigate the interest and penalty consequences of taxpayer errors arising
from uncertainties in the self assessment system
- provide for future improvements through better policy processes, law design
and administrative approaches.
The recommendations in this report will move the balance of fairness markedly in favour of taxpayers who act in good faith and build flexibility into the self assessment system. However, nothing in these changes will weaken the capacity of the system to cope with aggressive tax planning, avoidance and evasion.
2 . The Treasury 2004, Review of Aspects of Income Tax Self Assessment Discussion Paper, Commonwealth of Australia, Canberra.
3 . All submissions, apart from those provided in confidence, are available on the Review website.
4 . The income tax system sometimes also has the subsidiary objective of influencing behaviour by reducing or increasing the economic cost of particular activities that are subject to or exempt from taxation.
5 . An assessment is the end result of the process of ascertaining a taxpayer’s taxable income and calculating the tax payable on that income (see Batagol v Federal Commissioner of Taxation  HCA 51; (1963) 109 CLR 243).
6 . Legislation giving effect to these changes was largely contained in the Taxation Laws Amendment (Self Assessment) Act 1992.
7 . Both measures were introduced under A New Tax System (Tax Administration) Act 1999.
8 . The rate of interest on shortfalls and late payments was reduced by Schedule 4 of the Taxation Laws Amendment Act (No.3) 2001.
9 . The Inspector-General of Taxation has responsibilities for (i) reviewing and reporting on the Tax Office’s systems for administering the tax laws and its systems for dealing and communicating with the public, individuals and organisations, and (ii) reviewing and reporting on the administrative aspects of systems established by the tax laws (see section 7 of Inspector-General of Taxation Act 2003).
10 . For a detailed comparison, see Appendix 4, the Treasury 2004, Review of Aspects of Income Tax Self Assessment Discussion Paper, Commonwealth of Australia, Canberra.