Administration of capital gains tax for individual and small business taxpayers

25 Jun 2015

This audit assessed the effectiveness of the Australian Taxation Office’s administration of capital gains tax for individual and small business taxpayers.

To form a conclusion against this objective, the ANAO adopted the following high-level criteria:

  • management arrangements support the effective administration of CGT for individual and small business taxpayers;
  • compliance risks are assessed and a coherent strategy is in place to promote compliance with CGT requirements; and
  • compliance activities are appropriate and effective.

The ANAO focused on CGT activities undertaken in the Small Business and Individual Taxpayers Business and Service Line. The audit also includes a review of the implementation status of the seven recommendations from the 2006–07 ANAO audit report.

Overall conclusion

Australian taxpayers have been required to include net capital gains as part of their assessable income since 1985 when the capital gains tax (CGT) system was introduced. In 2013–14, CGT receipts were around $7.2 billion, which represented some 2.2 per cent of the $321.7 billion total net tax collected by the ATO. Based on the latest ATO estimates, in 2011–12, some 63 per cent of CGT was paid by individual taxpayers, with small business comprising around 14 per cent in that year.

The arrangements put in place by the ATO to administer CGT reflect its general approach to taxation administration. The ATO has provided a range of targeted marketing, communication and education activities explaining CGT requirements and encouraging compliance by individual and small business taxpayers, which are the focus of this audit. The ATO has also implemented sound management arrangements and suitable risk management processes to administer CGT for these taxpayers. Nevertheless, CGT presents particular compliance challenges for taxpayers intending to fulfil their tax obligations and administrative challenges for the ATO—essentially related to the one-off nature of capital events, extensive record keeping requirements for taxpayers and reliance on third-party data by the ATO, particularly for compliance activity with individual taxpayers. As a result, CGT has been classified as a high compliance risk for the ATO, requiring effective approaches to risk mitigation and active management oversight to monitor performance.

While the ATO’s general approach to the administration of CGT is sound, there has been a heavy reliance on taxpayers’ voluntary disclosures of CGT liabilities in their annual tax returns. Insufficient attention has been given to addressing the limited effectiveness of compliance activities for individual and small business taxpayers that have not met their CGT obligations. As a consequence, there has been a considerable reduction in the revenue raised from specific CGT compliance activities directed at individual and small business taxpayers in recent years. This aspect of CGT administration requires closer consideration by the ATO.

In relation to compliance activities, the ATO has programs for CGT that take into account the different elements of the individual and small business taxpayer market segments. CGT compliance activities for individual taxpayers are primarily conducted through correspondence (letters that draw on third‑party data), while reviews and audits are conducted for small business taxpayers. These active compliance programs raised some $546 million in liabilities from 2011–12 to 2013–14, of which around 30 per cent ($149 million) has been collected. Further, the liabilities raised and cash collected from these targeted CGT compliance activities are relatively small amounts in comparison to the voluntary disclosure of capital gains. The latest available ATO data indicates that in 2011–12 the estimated total tax payable on capital gains made by individual and small business taxpayers was around $4.3 billion, with around $150 million in liabilities raised and only $46 million (31 per cent) in cash collected from compliance activities conducted in that year.

To support the CGT compliance letter strategy for individual taxpayers, the ATO obtains extensive data from third-parties in relation to real property and share transactions. Although the ATO has implemented extensive data cleansing and filtering processes, problems in matching this data to taxpayer declarations limits the number of CGT cases the ATO reviews and the accuracy of the potential non-compliance that is identified. As a consequence, the active compliance programs for individual taxpayers have had a heavy emphasis on real property and a limited focus on shares and other types of assets. To achieve a more balanced coverage across asset types, there would be merit in the ATO reassessing its capacity to target compliance activities for individual taxpayers across all asset types.

Despite the known problems with third-party data, the ATO sends letters to thousands of individual taxpayers each year, questioning the accuracy of their declarations of CGT. The outcome of this correspondence can be that the taxpayer contacts the ATO and clarifies their situation to the satisfaction of the ATO, or the ATO amends their assessment. The ANAO’s sample of 322 letters sent to individual taxpayers found that most did not result in further action by the ATO (59 per cent) and that many (almost half) of the amended assessments were subsequently reversed. This largely reflects a lack of accuracy of information in these letters, which impacts on the taxpayer’s experience and the ATO’s prospects of securing appropriate revenue. On this basis, the ATO would benefit from evaluating the effectiveness of its CGT bulk letter compliance strategy for individual taxpayers.

As mentioned previously, there has also been a significant reduction in revenue from specific CGT compliance activities for small business taxpayers—from $59.0 million to $30.3 million from 2011–12 to 2013–14. In 2014–15, the ATO expects to raise only $13.1 million from 32 specific CGT small business cases, and to incorporate CGT into the broader small business compliance program. To gain assurance that its CGT compliance strategies for individual and small business taxpayers are targeted effectively across the major categories of CGT events and, in the light of recent changes to CGT administrative arrangements, it is important for the ATO to evaluate its strategies and activities.

To support the ATO’s administration of CGT, the ANAO has made one recommendation aimed at improving the effectiveness of CGT compliance strategies and activities for individual and small business taxpayers.

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