Small businesses wrongly penalised by the Australian Tax Office could be compensated by the federal government if recommendations made by the Inspector-General of Taxation are adopted.
Finance Minister Mathias Cormann said on Tuesday the government will consider proposals contained in a report from Inspector-General Ali Noroozi into the effectiveness of the ATO’s penalty regime.
While financial penalties are just one of the remedies available to the ATO when individuals and businesses fail to comply with tax laws, the report found micro and small and medium-sized businesses cop the majority of the ATO’s fines.
According to the report, the ATO charged $4.25 billion in penalties between mid-2011 and mid-2013.
Micro businesses bore the brunt of the ATO’s penalty regime during the period, with penalties for the sector amounting to $1.4 billion, or 51% of total penalties. SMEs were penalised $439.2 million over the period, making up 16% of all penalties imposed by the ATO.
This compares to the 525.9 million in penalties (19%) imposed on large businesses, and the $349.4 million (13%) imposed on individual taxpayers.
However, Noroozi found the penalties were reduced by 25% over the three years as a result of ATO reversal decisions.
Noroozi found decisions were reversed for a number of reasons, including situations when information is not provided to the ATO in tax audits, when tax officers are not able to correctly make decisions, and when the penalty decisions are not explained sufficiently.
The Inspector-General noted a perception that the ATO imposes penalties as a means of settling disputes and the costs of challenging a penalty decision by the ATO can be financially and emotionally damaging to companies and individuals.
“In the case of micro businesses, the penalties may be so large that the company may become insolvent if the penalty amount and the associated tax shortfall are required to be paid,” said Noroozi.
“Furthermore, they can damage taxpayers’ reputation and livelihoods, such as the requirement for a company director to be a fit and proper person.”
Cormann said in a statement on Tuesday the ATO agrees with nine of the 10 principles, either in full, in part or in principle, including recommendations to expand the amount of information needed to be gathered before a decision is made, and the government will consider the 10th recommendation relating to whether or not taxpayers should be compensated if they are wrongly penalised.
“Given interaction between the penalties regime and the broader system of taxation administration, the government will consider these issues once the tax white paper process has been finalised,” said Cormann.
Leon Mok, tax partner at Pitcher Partners, told SmartCompany this morning the recommendations are overall “very good and should be adopted”, but says he doesn’t believe this will be a high priority area for the government.
Mok says there is a danger of adding more complexity to the penalty regime, which is already difficult to understand for many business owners. Instead, he says the emphasis should be on codifying the existing system.
“The idea that the ATO should gather as much information as possible before imposing a penalty is clearly a good one, but there needs to be a balance between compliance and the administrative costs of that compliance,” says Mok.
“The very idea of a penalty regime is to encourage compliance, so if there is another extensive information gathering process again, it could defeat that purpose,” he says.
Mok says under the current penalty system, “the ATO starts high and makes you fight down low and that’s why you often see a reduction in penalties”.
But he says it could be more effective to impose a lower upfront penalty for businesses which choose to accept the ATO’s decisions, and then impose harsher penalties if the decision is challenged.
Adam Alexander, tax advisory principal at Crowe Horwath, also welcomed the recommendations, telling SmartCompany he welcomes the ATO’s positive response to Inspector-General’s report.
“My experience is that most taxpayers try to do the right thing but with the increasing size and complexity of tax law, it is difficult for the average person to get everything correct,” says Alexander.
“A focus on the so-called ‘reasonable person’ in determining the type and extent of penalties should mean that their imposition provides appropriate and due punishment only for those who aren’t doing or trying to do the right thing,” he says.