Part 3: A Strategy for Taxpayer Audit

Inland Revenue Department: Performance of Taxpayer Audit.

The IRD’s Strategic Direction

In July 2001, the IRD set out its vision in its new strategic business plan The Way Forward 2001 Onwards. This document identifies the IRD’s strategic direction, presents a framework for enhancing the tax administration business, and outlines the areas on which the IRD will focus over the coming years.

The Way Forward 2001 Onwards includes the following major themes, the first three of which have a direct impact on taxpayer audit:

  • to streamline and simplify tax processes;
  • to create an environment which promotes compliance;
  • to enhance people capability; and
  • to enhance the administration of non-tax business.

The Taxpayer Compliance Model

The Way Forward 2001 Onwards uses the IRD’s Taxpayer Compliance Model as the cornerstone of its aim to ensure that all taxpayers pay the correct amount of tax that is due (see Figure 5 on the next page). The model, originally created for the Australian Taxation Office:

  • is based on academic research undertaken across a number of regulatory agencies;
  • provides a framework for thinking about how the IRD can most appropriately interact with taxpayers; and
  • incorporates a range of activities designed to increase taxpayer compliance – including taxpayer audit, which the IRD identifies as fundamental to ensuring voluntary compliance by taxpayers with tax law.

The underlying principle of the model is that the IRD will tailor its actions to match the attitude of taxpayers to compliance. In Figure 5 on the next page, the circle shows the world of the taxpayer, and the factors that affect taxpayers’ decisions and behaviour. Taxation compliance behaviour is influenced by five factors – business, industry, sociological, economic and psychological – all of which interact and influence whether a person meets their tax obligations.

Each segment of the triangle in the model shows the range of taxpayer attitudes towards compliance. At the base of the triangle, taxpayers have the desired attitude of ‘willing to do the right thing’. At its top are the taxpayers who have decided not to comply – they choose to evade or opt out of the tax system. Individual taxpayers may, over time, change position in the model, as factors affecting their attitude change.

Figure 5
The Taxpayer Compliance Model

Figure 5.

The right-hand side of the triangle shows the IRD’s hierarchy of possible compliance responses. By understanding the factors that influence taxpayer decisions and behaviours, and the range of attitudes towards compliance, the IRD is able to select the most appropriate response. The model is constructed on the basis that:

  • For the majority of taxpayers who choose to pay the correct amount of tax on time, ongoing assistance will be the most helpful response to encourage continuing compliance. To keep taxpayers ‘willing to do the right thing’ the IRD uses strategies such as advisory visits, record-keeping tools and information.
  • At the level of ‘assist to comply’ the IRD might use reminder letters and helpful phone calls.
  • For taxpayers who have continued to be non-compliant after having been given reasonable opportunity to comply, actions increase in severity and frequency. Examples might include audits, final notices, and legal action.
  • At the top of the triangle, the severest responses – such as prosecution – are used only for the most non-compliant taxpayers.

Thus, the model implies that the IRD has the ability to influence taxpayers’ behaviour through the way in which it responds to them. And, rather than responding in the same way to all taxpayers, the IRD can distinguish between different sub-groups and tailor its response accordingly. For example, taxpayers who ‘get it wrong’ will not necessarily always be non-compliant.

The IRD might want to distinguish between taxpayers who have filed late on one occasion, and those who file late consistently. By responding to non-compliance in a positive rather than punitive way, the IRD intends to encourage future compliance, effectively moving taxpayers towards the base of the triangle.

In this audit we have examined the IRD’s taxpayer audit function in the context of the compliance model, to establish whether taxpayer audit is in a position to deliver the IRD’s strategic direction. We did not seek to measure the IRD’s success in increasing compliance.

Key Issues that Have Influenced Taxpayer Audit

A number of reviews and initiatives over the past few years identified issues that needed to be addressed to improve the taxpayer audit function. In many cases, projects were set up to address the issues identified.

We looked at what action the IRD had taken with regard to taxpayer audit as a result of these reviews and initiatives.

The 1992 Audit Strategy identified work required to improve taxpayer audit.6 Many of the aspects requiring improvement – risk analysis, case selection, audit methodologies, best practice case management techniques, and industry profiles – were also identified in the Audit 2000 project. However, the IRD’s senior management postponed many of these improvements to allow efforts and resources to be concentrated on improvements that they judged to be a higher priority – for example, enabling many salary and wage earners to cease filing a tax return, and reducing compliance costs for small businesses.

This reprioritisation meant that much of the work required to improve taxpayer audit was not completed. The improvements remain key priorities for the audit strategy currently being prepared by the IRD and it is crucial that this work is now completed.

In the last few years, other events have had an impact on the attention given to taxpayer audit. For example:

  • Changes in priorities by successive new Commissioners. Several individuals have held that post over a relatively short period.
  • The IRD has been subject to a number of major external reviews that have required time and attention, particularly at a senior level. The IRD’s response to these reviews has involved implementing substantial changes to its organisation.

We interviewed Sir Ivor Richardson, Chairperson of the 1994 Organisational Review, who confirmed that the IRD had made the major changes in specialisation that the review recommended. These changes included the establishment of the Policy Advice Division, Adjudication and Rulings Groups, and Technical and Legal Support Group.

Sir Ivor indicated that the Review Team had hoped that after a period of time there would be plenty of evidence of knowledge transfer from these specialist centres of excellence to lift the general skills levels and enhance the culture for the staff in audit. We saw examples of transfer of knowledge, but it was not happening consistently. The IRD is looking at putting further resources into building more technical capability in the Corporates Division, Technical and Legal Support Group, Technical Standards Group, and Litigation Management Unit, so that the relationships between these groups and investigators can be further enhanced.

The recommendations agreed to by the Government arising from the 1999 inquiry by the Finance and Expenditure Committee7 have been adopted, although some matters (e.g. time bars) are being addressed as part of other reviews.

A New Strategy for Taxpayer Audit

When we started our audit in April 2002, the IRD did not have a current strategy for taxpayer audit. In September 2002, it set up a small team in its Design and Monitoring Group to start preparing a strategy, comprising a sector manager seconded from the Corporates Division and a national adviser in the Design and Monitoring Group. At that time, preparation of a strategy for taxpayer audit was less formal than the arrangements for preparing and maintaining the IRD’s technology strategy, which were well established and headed by a governance board.

Taxpayer audit consumes nearly one quarter of the IRD’s annual operating expenditure. In our view, preparation and communication of the audit strategy needs to be given the same high profile as other major strategies. The IRD is now increasing its focus on the audit strategy through the changes outlined on page 20.

There appeared to be slippage with progress on the strategy at the time of our audit. As at February 2003, the IRD had not completed its assessment of the current status of the audit function, which had been due for completion by 30 December 2002. A draft audit strategy has since been completed and was presented to the Business Initiatives Governance Board (see paragraph 2.11 on page 32) in May 2003. A revised version was approved at the Board’s June meeting.

As at 30 June 2003, the IRD had identified the range of initiatives required to successfully implement the audit strategy. By September 2003 it expects to have finalised implementation plans – including prioritisation, detailed scope, and resourcing requirements. The IRD will regularly review and revise the plans as necessary.

Implementing the New Audit Strategy

The successful implementation of the new audit strategy will entail fundamental changes in working practices and substantial new initiatives. It will require changes in the approach of audit staff, as well as technical changes, if the strategy is to be successfully implemented.

The IRD has acknowledged the significance of the changes required and the need for them to be effectively managed in its decision to establish the Business Initiatives Governance Board. The Board’s role will be to ensure that senior management signs off new initiatives and agreed strategies, and that an appropriate level of resources and full commitment are applied to implementing them.

6: A number of significant changes followed – such as the establishment of the Corporates Segment and the Risk and Research Unit, the development of the current audit methodologies, and the computerised Taxpayer Audit Case Selection, Management and Reporting System (TACTICS).

7: Inquiry into the powers and operations of the Inland Revenue Department, parliamentary paper I.3I.

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