The ATO has estimated the size of the “tax gap” between the tax the ATO collects and the amount it would collect if all taxpayers fully complied with the law.

The ATO has published the income tax gap for individuals not in business in 2014–2015. The gap is an estimate of the difference between the tax the ATO collects and the amount that would have been collected if every one of these taxpayers was fully compliant with the law. While no country will ever have a zero tax gap, revenue authorities continually strive to keep the gap to a minimum.

The estimated net tax gap for such individuals in 2014–2015 is approximately 6.4%, or $8.8 billion. In other words, the ATO estimates that individuals not in business paid over 93% of the total theoretical tax payable in 2014–2015.

Key components of the tax gap are:

  • deductions for work-related expenses – common mistakes include deduction claims where there was no connection to income, claims for private expenses and claims where there are no records to show that an expense was incurred;
  • omitted income, particularly in relation to undeclared cash wages (an element of the black economy) – the ATO’s estimate of the proportion of the $8.8 billion tax gap for individuals not in business that is attributable to unreported income from cash wages is $1.4 billion; and
  • deductions for rental property expenses – the most common reasons for adjustments to rental items on a tax return are a lack of, or incorrect, apportionment of expenses. This includes, for example, deduction claims where the property was only available to rent for part of the year or claims for interest expenses where a portion of the loan was used for private purposes. The ATO also sees mistakes relating to capital works and capital allowance deductions.

Each case of taxpayer error or non-compliance that the ATO identifies (as part of the random enquiry program it uses to estimate the gap) can involve multiple adjustments across the return. Of the 2,388 adjustments made in identified cases, the ATO said almost 70% related to deduction items, and 51% (or 1,212) of all adjustments made were at work-related expense items. Of those work-related expense adjustments, 78% (or 949) were made in tax agent-prepared returns.

Adjustments to items tended to fall between $150 and $1,000 in value, with the median adjustment being $210. While these adjustments are individually small, the ATO notes that when they are tallied across the whole population, the effect is significant. On average, three items were adjusted in each tax return.

The ATO observed claims for expenses that were actually paid for or reimbursed by the employer, as well as claims that appeared legitimate, but could not be substantiated. The ATO also saw mistakes and guesswork relating to apportioning work-related expenses along with claims for “standard” deductions where exceptions to substantiation provisions exist. Many taxpayers believed they did not have to explain their claim if a substantiation exception was applicable.

ATO Deputy Commissioner Alison Lendon said, “seven out of ten returns randomly selected for review had one or more errors. A smaller number of people are deliberately doing the wrong thing – that has a significant impact on revenue. These people can expect closer attention from us, especially this tax time.” The ATO will increase the use of data and technology to identify outliers, streamline processes, access third party data and provide pre-filled information in tax returns.

Additional note: The ATO reportedly has 500 tax agents in its sights and expects to review the practices of about 150 of them this year. With around 41,500 registered tax agents in Australia as at 30 June 2017, this is a low percentage so some perspective is required here. The ATO is concerned that too many of the errors it detected are what it terms “avoidable mistakes”, eg not checking records thoroughly.

Professor Bob Deutsch, Senior Tax Counsel at The Tax Institute, says the individual tax gap figure “suggests that the extent of non-compliance among individuals is substantially higher in macro terms than for large corporate groups.” However, in percentage terms, Professor Deutsch points out that there is approximately only a half percentage point difference – 6.4% for individuals versus 5.8% for companies. He says individuals contribute roughly 40% of the tax revenue and large corporate groups only contribute about 12%.