Briefing for the Incoming Minister of Revenue - 2005 - Part 2
Addressing compliance issues
We are guided in our compliance activities by the compliance model that promotes a tailored, responsive approach to taxpayers and social support customers (see Figure 13). It takes account of the external factors that influence taxpayers' attitudes and behaviours. Our risk analysis recognises these differences in attitude and helps us develop appropriate ways of improving compliance.
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A key concept behind the model is that the majority of taxpayers comply voluntarily or aim to comply. For these taxpayers our response to a compliance concern is to make it easy for people to meet their obligations by tailoring our services to meet people's individual needs.
At the same time suitable sanctions are needed for cases where people deliberately do not comply. Enforcing the law in such cases helps to maintain overall taxpayer confidence in the tax system and encourages ongoing compliance. However, when we are undertaking work to enforce the law our approach needs to be designed to move taxpayers to a position where they are likely to comply voluntarily in the future.
This means that we need to use an integrated mix of activities and skills to address non-compliance areas, such as:
- compliance issues that have been identified by our enforcement activities (note that some of these issues are also discussed under "Tax policy" particularly tax sheltering and income splitting)
- effects of growth in the customer base (for example increasing levels of debt).
Compliance issues identified through enforcement activity
We continue to focus our audit activity on high-risk areas such as avoidance and evasion. Recent legal challenges to major avoidance schemes were successful and these send a strong message to promoters of such schemes and to potential investors. Legislation enacted in 2003 reinforced the message by including a new penalty on promoters of certain tax schemes.
A high priority was also given to tax evasion, particularly as a follow-up to the Industry Partnership initiatives to educate and promote compliance among taxpayers who were willing to do so. In auditing small- and medium-sized enterprises, our primary areas of focus included:
- real estate property where tax issues arise from timing of claims on property purchases and undeclared profits relating to GST and income tax for speculative transactions
- tax evasion and income suppression associated with taxpayers working outside of the tax system, failing to meet employer obligations and fraud cases (for example claiming false GST credits)
- tax avoidance associated with various schemes that are intended to reduce a taxpayer's tax liability. In many cases, these schemes are highly complex and often involve international arrangements or sophisticated structures that require lengthy audit work. Arising from this complexity, our auditors need to have highly developed technical knowledge and the skills to deal with these cases.
The Courts are also taking a serious view in the sentencing of people convicted of tax evasion and avoidance offences. During 2004-05, we took prosecution action under the Crimes Act in five cases and prosecuted 41 people under the Revenue Acts. For the 2005-06 year we have 20 pending prosecutions under the Crimes Act, 75% for evasion and 110 pending prosecutions under the Revenue Acts of which 73% are for evasion offences.
In addition, many of the concerns discussed under "Tax policy" are addressed in our audit activity, particularly:
- the use of trusts owning a trading company is becoming more common. We have evidence that taxpayers are using trading trusts to alienate personal service income to reduce the tax rate they would pay on their incomes. The policy issues surrounding income splitting, tax sheltering and discussions on tax rates are discussed in the tax policy section.
- New Zealand sourced-based income being artificially re-characterised as foreign income and taxed at the 15% withholding tax rate rather than the company tax rate of 33%. Issues around international tax are covered in the tax policy section. This highlights the fiscal risk posed by our relatively high reliance on company tax collections. Administratively, this means we need to maintain, if not enhance, our audit and litigation capability in dealing with corporate taxpayers.
- our audit activity has uncovered a number of GST fraud and avoidance schemes that revolve around input tax credit schemes to obtain tax refunds. Some of these schemes have involved identity fraud. GST schemes pose a high fiscal risk because if input credits are available with no offsetting output tax the result is a net government fiscal cost. International experience has demonstrated the high fiscal risks with GST-type taxes. The main response is likely to be audit and litigation but this may need to be backed by policy changes.
- Finally, the high effective marginal tax rates for many individual taxpayers as a result of the abatement of family assistance and related measures is likely to require increasing focus on various forms of income sheltering.
Debt management
Over recent years, the rising level of collectable debt[32] has become a concern (Figure 14). Over the years, revenue has continued to grow significantly, while resources to collect overdue debt have remained static. At 30 June 2005, collectable debt was $1,553 million, compared to $1,296 million in 2004.
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The main issues with debt include:
- the increase in the level of debt
- the older debt becomes the harder it is to collect, there is also the potential for more debt to be written off
- complex business structures used to frustrate the collection of debt, for example "phoenix" companies[33]
- the steady increase in the level of outstanding student loan debt.
Addressing outstanding debt requires us to focus on maximising the amount of debt paid on-time and also improving taxpayer compliance behaviour. Our current debt management focus is on high-value debt, industry partnership debt (predominantly owed by small and medium sized enterprises), old debt (debt older than two years old) and debt assessed through our auditing activity. We have been making good progress in these areas and will continue this focus in the coming year.
Child support
Total child support debt has now passed $1billion. As at 30 June 2005, the level of child support debt had grown to $987 million, 16% more than in 2003-04 (see Figure 15). Of the total debt, 43% is assessment arrears and 57% is penalties.[34]
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Over time we have made good progress in managing our child support responsibilities. As at 30 June 2005, we have collected 86.3% of all child support assessed since the programme began in 1992. However, the present level of debt presents a significant risk to public perception in regard to the effectiveness of the child support programme. Funding has been provided in the 2004 and 2005 budgets to address the debt issue through administrative initiatives and these are now gaining traction.
Child support legislative change
Legislative changes crucial to supplement administrative improvements were proposed in the Child Support Amendment Bill (No. 4). The Bill has lapsed and public confidence in the child support programme will continue to erode unless you reinstate the Bill. A key component of the Bill is intended to bring non-compliant parents back into the child support system by providing incentives for them to reduce their outstanding child support debt through pro-rata write-off of incremental penalties for parents who meet their current liability and keep to their arrangement to repay arrears.
Child support - international relationships
We have a close working relationship with the Australian Child Support Agency and operate a reciprocal agreement[35] with them. In Budget 2005, we received an appropriation to pay for Australia to initiate the collection of payments from an additional 6,629 New Zealand cases where the parent has recently been identified as living in Australia. We are also considering similar agreements with other countries where there are known to be child support debtors.
As part of our international relationships, we keep a watching brief on developments in other jurisdictions, for example, the Australian Government recently commissioned a Ministerial task force to review the Australian child support programme. Recommendations in the report dated May 2005 are presently being considered by the Australian Government. Given the close nature of our relationship with Australia, we will need to consider making changes to the New Zealand system once the Australian Government have made final decisions.
[32]Collectable debt includes debt for all tax types and ages. The newer debt is the easier it is to collect, however, as debt ages it becomes harder to collect. Collectable debt also includes debt that is currently under an active repayment arrangement, which accounts for 41% of collectable debt as at 30 June 2005.
[33]A "phoenix" company is a company that has been "reborn" soon after (and in some cases before) its failure. The new company takes on the failed company's business, often using a similar name, the same managers and directors, and the same assets, but without the previous company's tax liabilities.
[34]Currently there is no legislative flexibility to deal with the escalation in the level of child support penalties, which adds considerably to the level of total debt outstanding. Also, the incremental nature of the penalties can act as a disincentive to paying parents, which can result in them disengaging with the child support system.
[35]This agreement provides for the collection of child support payments from New Zealanders living in Australia and Australians living in New Zealand.
Date published: 13 Nov 2005
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