The objective of the audit was to assess the ATO's strategies to address tax evasion in the cash economy, with emphasis on: the ATO's strategic focus; aspects of governance, management processes and compliance activities; and responses to the ANAO Report No.35 2001–02 ATO Progress in Addressing the Cash Economy.
The Australian Taxation Office (ATO) is the principal agency charged with administering Australian tax law. The ATO defines the ‘cash economy' as ‘all legal transactions which are not disclosed and result in evasion of tax'. The ‘cash economy' is often synonymous with undisclosed or omitted income or supplies, but it also includes those operating outside the tax system. According to the ATO, the major tax risk arising from the cash economy is business income not being reported.
Since the cash economy is ‘hidden' activity, it is difficult to quantify with any precision. Estimates prepared by different parties, applying various methodologies and assumptions, vary widely and are subject to debate. At the lower end of the range of estimates, in 2003 the Australian Bureau of Statistics estimated that the cash economy was highly unlikely to understate the level of Gross Domestic Product in 2000–01 by more than about 2 per cent. This translates into a value of $13.4 billion in 2000–01. The Department of the Treasury considers that the Australian Bureau of Statistics' estimates, while at the lower bounds of estimates of the cash economy, come from a highly credible source and are calculated by reference to the maximum plausible extent to which industries and activities could be engaged in cash economy transactions.
The ATO does not attempt to estimate the size of the ‘cash economy tax gap' (the gap attributed to the use of cash and not declaring income). The ATO reasons, having also considered overseas practice in measuring the tax gap, that accurate and defensible measures of the tax gap are impossible to achieve in a practical sense. It considers that the time, cost and the intrusive burden on taxpayers imposed by an exhaustive exercise rule out conducting such an estimate.
Regardless of uncertainty around its actual size, the cash economy is a significant issue because it results in lost tax revenue and the unfair shouldering of the tax burden between taxpayers. The ATO has identified the cash economy as a focus area for its compliance efforts over successive years. In addressing the cash economy, the ATO aims to optimise revenue and maintain community confidence. The ATO seeks to implement an effective compliance regime that avoids excessive costs on taxpayers.
ATO organisation for the cash economy
The profile of the cash economy in the ATO has changed over time. In more recent years, there have been the rejuvenated activities of the Commissioner of Taxation's advisory body, the Cash Economy Task Force, the expanded cash economy program of compliance activities in 2002–03, the development and refinement of strategies and lines of responsibility and the formulation of dedicated cash economy teams in 2003–04. These initiatives flow, in part, from legislative changes associated with the Government's tax reform initiatives of 1999–2000. These include introduction of the Australian Business Number, activity statements and withholding arrangements.
As to staffing directly related to cash economy matters, the ATO had approximately 600 full time equivalent staff assigned to cash economy projects in 2004–05. In addition to these dedicated staff, some 162 staff worked on cash economy risk issues and cash economy-related complex audit matters but were not specifically or wholly engaged in cash economy work. The ATO spent a total of $53 million in 2004–05 (in direct costs) on dedicated cash economy projects. This compares to total ATO expenditure on compliance of over $1. 2 billion in the same period.
The Australian National Audit Office (ANAO) tabled Audit Report No.35 2001–02 ATO Progress in Addressing the Cash Economy in March 2002. The current audit found that the ATO had fully implemented four of the five recommendations of Audit Report No.35, but was still to fully implement an effective community education program, as recommended.
The ANAO reviewed overseas practice to appreciate the wider context for the ATO's cash economy administration and to compare the approaches used in other jurisdictions (namely New Zealand, United Kingdom, United States and Canada). As might be expected, the ANAO found that the cash economy is a problem in other countries. The ANAO review also highlighted that the ATO's strategic approach is consistent with other jurisdictions, but unlike the United Kingdom and the United States, the ATO does not measure the tax gap in aggregate for the reasons outlined earlier.
Audit objectives and scope
The objective of the audit was to assess the ATO's strategies to address tax evasion in the cash economy, with emphasis on:
- the ATO's strategic focus;
- aspects of governance, management processes and compliance activities; and
- responses to the ANAO Report No.35 2001–02 ATO Progress in Addressing the Cash Economy.
The ANAO focussed on the work of the ATO's dedicated cash economy teams. In examining the application of the ATO's management processes, the ANAO considered a selection of the ATO's cash economy projects (namely hotels and licensed clubs; the adult industry; restaurants, cafes and takeaways; fishing; and low documentation loans). This selection of cash economy projects allowed the ANAO to review some of the practical features of projects of different scope, size and degrees of maturity. Our comments on the ATO's strategy, management and governance arrangements seeking to address the cash economy reflect this focus.
The ATO's Strategies
The ANAO found that the ATO has appropriate strategies for its cash economy work, identifying that the ATO's vision is to secure taxpayer compliance and apply targeted compliance approaches where necessary. The guiding principles of compliance management underpin the ATO's strategies and cash economy work.
The principal longer-term influence on the ATO's cash economy strategy directions comes from the Commissioner of Taxation's advisory body, the Cash Economy Task Force.
Although the ATO's Compliance Plan sets out publicly the ATO's proposed areas of attention and activities, the ATO does not have a clearly-expressed, public statement of its approach or rationale in applying its cash economy strategies. Such a statement could help to improve public understanding of the issue and the ATO's resolve to address it. Feedback to the ANAO from tax and accounting professional association stakeholders was that they would appreciate information on the ATO approach. The ANAO considers that the ATO should publicise such information.
Intelligence and risk
The ANAO found that the ATO's strategies and activities are informed by intelligence and risk management processes. These risk and intelligence management processes contributed to the ATO's planning and reporting processes and documents, at the corporate level, as intended.
The Cash Economy Steering Committee
The ATO has a matrix management approach to dealing with the cash economy, with responsibilities crossing ATO business line boundaries. The Cash Economy Steering Committee (CESC) is the ATO's key means for oversighting and coordinating its cash economy compliance activities.
The ANAO found that the ATO has not comprehensively documented the role or charter for the CESC. The ANAO considers that given the significance of the CESC as a management forum, the Committee's roles and responsibilities should be clearly set out.
Industry project management
At any one time the ATO has identified a number of distinct industry groupings to address as part of its cash economy work, with designated industry compliance teams addressing the different industries. These groupings include: property and construction; restaurants, cafes and takeaways; and the adult industry. The ANAO found that the ongoing management of individual industry projects occurs through a well-developed project management system.
Improved transparency in cash economy activity
The ATO's cash economy industry teams undertake a broad range of compliance work related to selected industries as part of their work on the cash economy. Work done by the cash economy industry teams resulted in revenue adjustments (not including penalties) of $196 million in 2004–05.
However, the ANAO found that there is a risk that the ATO could overstate the resourcing and results attributed to cash economy work by the cash economy industry teams. This risk arises by the ATO not explicitly recognising in the planning and reporting for cash economy industry teams that they will, by necessity, carry out certain work that is not cash economy (omitted income) compliance work.
The ATO advised that it has moved to improve the transparency and accuracy of cash economy planning and results reporting for 2005–06 and that the transparency of cash economy activity and results will be further enhanced from mid-2006 with the introduction of a new case management system. The system will allow for more detailed identification and monitoring of compliance activities and results.
Application of the Strategies
Applying the strategies, day to day, in the cash economy risk projects involves a large range of case selection and compliance activities. The case selection activities include profiling and analytical work using data matching, community information, project-based work and random selection of businesses. The compliance activities include advisory products and activities, review products and enforcement products. In 2004–05, staff in the designated cash economy risk projects undertook work on some 22 cash economy projects, involving 38 000 cases. The ANAO found that the range of case selection and compliance activities used by the cash economy teams is appropriate in applying the ATO's cash economy strategies.
The ANAO found that the emphasis in the risk projects' strategies, and the ATO's compliance approach more generally, tends to be on the ‘business end' of industries. The ATO's approach, including its communication and education dimension, is less well-developed in dealing with the ‘business-to-consumer' transactions.
The ATO accepted the Cash Economy Task Force's recommendations of 2003 that it develop its cash economy strategies with greater attention to cash dealings between businesses and consumers. The ATO conducts compliance treatments on business-to-consumer transactions and industries that deal directly with the general public. These include work as part of the adult industry; hotels and registered clubs; and the restaurants, cafes and takeaways industries projects. However, the ATO's ‘community education' work is still in its developmental phases. The ATO has commissioned research on community and business perceptions and is testing communication products (such as posters and advertising) in selected industries. In addition, the ATO intends to monitor community-focussed advertising activities conducted in overseas jurisdictions.
The ATO also advised that in 2005–06 its building and construction industry group is to undertake some specific compliance activities and interventions directed to consumers. This activity involves, for example, following up on consumers' renovations work by reviewing development applications to local councils and asking consumers about the value of work, payment and tax aspects of domestic construction work they have had done.
Given the significance of community attitudes in securing business-to-consumer compliance in the cash economy, the ANAO considers that it is important that the ATO expedites the formulation and implementation of a community education campaign.
Working with industry and professional bodies
The ATO has a wide span of relationships with industry parties. Industry and other representative bodies advised that overall, the relationship was productive and they appreciated the contacts they had with the ATO on industry, tax and cash economy matters and the occasions on which the ATO provided timely feedback on the matters on which they had been consulted.
Tax practitioners are a key leverage point between the ATO and taxpayers. Tax and accounting professional bodies consider that community engagement is an important influence on the success of the ATO's cash economy compliance work. The ANAO considers that there is merit in the ATO working with the tax and accounting bodies more extensively to promote cash economy compliance, including developing ideas on relevant cash economy compliance messages and ways to convey them through the professional associations' activities.
The ATO's Impact on the Cash Economy
Assessing the impact of the compliance activities
Since the cash economy is ‘hidden' activity and it is difficult to quantify the revenue gap in aggregate, the ATO needs some mechanism to judge the impact of its cash economy compliance projects and activities. Assessing impact involves determining whether compliance work improves overall industry compliance in cash economy areas. The key impact requiring measurement is the effect occurring from particular compliance treatments on the overall level of compliance and behaviour in specific cash economy industries, as demonstrated by tax revenue growth. Another impact that is useful for the ATO to measure is the effect on specific taxpayers who have been subject to compliance activity.
The ANAO found that the ATO's various cash economy activity reports do not allow the ATO to demonstrate reliably the impact of its activities in cash economy industries, over time.
Given the considerable attention and resources allocated by the ATO to cash economy compliance, the ANAO considers that the ATO should enhance the way it assesses its impact on the cash economy. The ANAO suggests that this could involve an evaluation strategy, building on its current approach. The evaluation strategy would: measure underlying movements in revenue collections in the cash economy industries that are being targeted (that is, abstracting from any external factors); measure changes in the attitudes of industry participants and consumers over a period of time (as reflected in changes in behaviour); and compare the tax payments of treated entities with those of non-treated entities (which the ATO already does).
In May 2000, before the introduction of the New Tax System, the ATO estimated that the compliance dividend it would obtain over the first three years of the operation of the New Tax System (2000–01 to 2002–03) would be $3.4 billion and the estimated cash economy contribution towards this would be $2.6 billion.
The Department of the Treasury incorporated the estimated compliance effect into the forward revenue projections for companies and ‘other individuals' for 2000–01 to 2002–03. The ATO and the Treasury point out that actual collections in the relevant period exceed the projected estimates (incorporating the compliance dividend and parameter changes). However neither the ATO nor the Treasury have been able to assess the extent to which the estimated compliance revenue gains for this period were specifically achieved. The ATO advised the ANAO in September 2005 that it considers that the compliance dividend cannot be measured with any reasonable degree of accuracy.
The cash economy is significant. Although it is difficult to quantify because the cash economy is hidden activity, it places billions of dollars of revenue at risk. Managing cash economy compliance is a challenging task for the ATO, particularly in finding effective compliance strategies that address community perceptions and avoiding excessive compliance costs on taxpayers. Overseas administrations face similar challenges. It is unlikely that there are strategies and a set of compliance activities that will entirely remove the cash economy.
The ATO has appropriate strategies to address targeted elements of the cash economy. Its strategic directions are risk-based, follow the expert advice of the Cash Economy Taskforce and are consistent with overseas approaches.
In its cash economy work, the ATO has sound governance arrangements with cross-line management arrangements and committee review structures for key functions. Governance can be enhanced by specifying the roles and responsibilities of the ATO's main cash economy management forum, the Cash Economy Steering Committee.
The ATO has well-developed management processes and diverse compliance activities to address the cash economy. This is characterised in the ATO's project management of cash economy risk projects operated by the dedicated cash economy teams and the targeted compliance measures applied by those teams and other parts of the ATO.
With regard to the ANAO Report No.35 2001–02 ATO Progress in Addressing the Cash Economy, the ATO has made good progress in implementing the Report's recommendations. Work still needs to be completed on the recommended community education program. This should include the significant issue of securing business-to-consumer compliance.
While recognising the challenges involved, the ATO does not have an effective evaluation approach to demonstrate the impact, over time, of the range of compliance activities it is undertaking in the cash economy industries that it has targeted.
The cash economy compliance management task is an ongoing one. The ANAO has made six recommendations to enhance the ATO's work addressing the cash economy.
The ATO's response
The report acknowledges the ongoing challenge of addressing tax compliance within the cash economy, with generally positive reflection on the ATO's strategies and application of targeted compliance approaches.
The ATO welcomes the ANAO's recognition of the progress the ATO has made in meeting the previous recommendations of the Progress in Addressing the Cash Economy audit report of March 2002, as well as the finding that we follow the expert advice of the Cash Economy Task Force.
The report's recommendations give guidance with respect to improvement of strategies which are substantially agreed. Implementation of recommendations is proceeding, balancing requirements for validity, practicality and impact on taxpayers and tax agents.
The ATO agreed to all of the ANAO's recommendations.