Transcript Auditing SMEs

Organisation for Economic Co-operation and Development
LOOKING BEYOND THE BORDER
Recent developments in Micro and Small
Business taxation in other regions
Matthijs Alink
Senior Advisor OECD/CTPA/GR
Conference on Taxing Micro and Small Businesses
Manila, Philippines, 2 – 5 March 2010
Centre for Tax Policy and Administration
Economic importance of SME
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SME potentially the most dynamic sector of economy
SME growth is key for overall economic well-being
SME represents 99% of all companies in EU
In China > 10 million SME representing 99% of total enterprises
Due to their small size and lean structures, SME are potentially
more dynamic than big enterprises, which make them particularly
important for job creation
But SME are also more vulnerable, lacking often access to capital
and to funding sources
SME are suffering from the administrative burden, especially SME
doing cross-border business
Reducing the Compliance Burden for SME
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The compliance burden created by the complexity of tax
law and administration is of special concern to SME,
and is considered as one of the important factors
determining the size of the informal economy
The fixed component of start-up and compliance costs
can place SME at a competitive disadvantage, and may
also have an adverse distributional impact
Governments must strive to find measures that reduce
the compliance burden, without undermining the quality
or availability of the information needed to enforce
compliance
Measures taken by governments
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Harmonizing/standardisation of definitions and language
in (tax) legislation
Use of single (Tax) Identification Number across
government
(Electronic) single business information point delivering
government wide information
Reuse of information
Standardisation of electronic information (processes,
architecture, infrastructure)
E-filing
Developing new ways of payment (banks, internet,
telephone)
Trends likely influencing tax compliance of
SME taxpayers
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Also small companies are becoming increasingly global
International transactions and investments no longer
mainly limited to large business
Today even small companies are able to compete and
exploit global niche markets
An important driver for this is the internet
Yet small companies face the same complex regulatory
tax environment that large companies do, however with
much less resources to comply
The scope of the risk of non-harmonized tax regimes
and administrative procedures is rapidly widening
Micro and Small Businesses
However in this presentation the main focus will be on
the traditional domestic issues regarding this group of
taxpayers
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Key challenges include:
Large number of taxpayers
High cost of administration
Informal economy
Constantly have new small taxpayers
Micro and Small Businesses form a group
of particular concern
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Micro and small businesses are the major contributors
to the cash economy
Compliance risks in this segment differ from other
groups of taxpayers such as large business and
individual taxpayers
Smaller business are more likely to engage in informal
economy activities
Characteristics of this type of non-compliant behaviour
include no registration as a taxpayer, no filing of returns,
none or poor payment record, underreporting of
turnover and profit, and none or poor bookkeeping
A substantial cash economy challenges
governance in a number of ways
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It reduces the legitimacy of the taxation system
It puts a disproportionate burden on the formal sector
It likely has a negative impact on tax compliance in the
formal sector
It distorts macroeconomic policy and can reduce
economic growth in the formal economy
It threatens the social contract between government and
the community
Compliance Risk Management approach
(reflected in tax administration work at the OECD)
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Well-developed compliance risk management
processes for the identification, assessment and
treatment of major compliance risks for each of the
major groupings of taxpayers
Risk assessment approach entails an element of
estimating the revenue potential of a particular risk ( e.g.
undeclared business income of self-employed persons,
over claimed employee work-related expenses)
Once the major risk areas are assessed and prioritized,
treatment strategies are developed
Complexity of taxpayers’ compliance
Academic research……….
 Academic research over last two decades has led to
increased awareness of the complexity of tax compliant
and non-compliant behaviour.
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The research has largely shifted from the “persuasion
versus punishment” (or service versus enforcement)
debate to what is the right mix of the two.
SERVICE + ENFORCEMENT = COMPLIANCE
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Emphasis on a regulatory model: Attempting co-operation
remains the best first choice for achieving compliance in
most situations.
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The enforcement compliance
pyramid model- explained
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Many factors influence whether a person chooses to meet
their obligations:
◊ Business
◊ Industry
◊ Sociological
◊ Economic
◊ Psychological
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The model shows a continuum of taxpayer attitudes towards
compliance – from taxpayers who have the desired attitude
of being willing to do the right thing to taxpayers who have
decided not to comply by choosing to evade tax or opt out.
The enforcement compliance
pyramid model- explained
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The model summarizes the different sorts of support & intervention that
Tax Administrations need to provide to collect the required revenue.
The model suggests that Tax Administrations have the ability to
influence taxpayer behavior through their responses and interaction.
The model suggests that the challenge for all Tax Administrations is to
get the right mix or balance of service and enforcement activities across
the different populations of taxpayers so that the best outcome may be
achieved.
◊ For taxpayers prepared to “willingly comply” this means making it
as easy as possible for them to comply.
◊ For taxpayers “not prepared to comply” at all, it
means applying the full force of the law.
◊ The end goal should be to have as many taxpayers
as possible in the “willing to comply” category.
Determining treatment strategies –
the compliance pyramide
Have decided not to
comply
Don’t want to
comply but will if we
pay attention
Tries to but
don’t always
succeed
Willing to do the
right thing
Attitude to compliance
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Use the full force
of the law
Deter by
detection
Assist to comply
Our strategies aim to
create pressure
downwards
Make it easy
to comply
Compliance strategies
Make it easy to comply by providing services
Market segmentation:
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Delivering taxpayer services:
- The same services for everyone?
- Or a more targeted / differentiated approach?
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Fundamental principle of marketing- know your clients!
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Segmentation:
- aims to improve the knowledge of clients’ behaviour/ preferences.
- breaks down client populations into smaller groups of clients with
similar characteristics.
- is used to target specific approaches/ products.
- is being adopted by tax bodies world-wide for planning purposes.
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Which channels for which services?
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A “channel” is a means of delivering a service (e.g.
service counter in tax office, phone, Internet).
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Tax Administrations have “”channel” options for their
service delivery activities.
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Channels vary in their cost and effectiveness, for example:
- Electronic filing is cheaper and more effective than paper.
- Call centres are likely to be less costly than counter inquiries
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Technology is providing new and cheaper channels.
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Tax Administrations need to think carefully about how they
can optimize their use of the different channels.
Measuring satisfaction with taxpayer service
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Tax Administrations need to know:
- Are we delivering the right services?
- To the right taxpayers?
- Are our services having a positive or negative impact?
- What do we need to improve?
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The best way to find answers to these questions is to
ask those who need services to properly comply.
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Many Tax Administrations seek feedback from
taxpayers on their services, often using private research
firms.
Education and assistance programs
targeted at new small businesses
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Special education and assistance programs for newly
registered business aimed at encouraging compliance
with the laws as well as making it easy to comply.
Examples include:
Provision of simple record-keeping tools
Specialised explanatory materials / guides
Dedicated seminars for starting business
Central help desk for inquiries
Special electronic products
Service provision in summery
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Make it easy to comply and assist to comply
Self help through use of technology
Outreach and educational products
Enquiry functions
Telephone services
Industry based approaches
Life cycle approaches
Identification and registration of
taxpayers
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The record-compilation function, comprising
identification and registration of taxpayers, constitutes
an important task for the Tax Administration.
Tax Administrations tend to focus on taxpayers who are
already known and listed, but they should also make an
effort to include in their tax-return system all persons
and companies that have succeeded in escaping their
notice.
Management of taxpayers’ records may be divided into
three basic functions: creation, updating and deletion.
Creating and maintaining registration
systems
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Initial registration occurs when the taxpayer voluntarily fulfils his
legal obligation to file a tax return
A good tax assessment system encourages taxpayer compliance
with registration obligations.
Provide the public with clear and comprehensive descriptions of the
requirements that lead to registration.
Establish a system to notify all external events with tax implications
(setting-up of companies or one-man businesses, transfer of
registered offices, start of gainful employment for natural persons,
changes of residence, changes of activity, etc.
Cooperate and exchange information with chambers of commerce,
municipalities and other law enforcement agencies
Use of unique (Tax) Identification Number (TIN)
Actions aimed at detecting non-registration
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Surveys of potential taxpayers for instance by
physical inspection of business premises and private
residences in selected areas, by
visiting starting business,
on the spot checks at markets and other trade locations,
inspection of cars
searching sources of information on economic activities
such as newspapers and the internet.
Withholding at source
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Withholding at source arrangements are generally regarded as the
cornerstone of an effective personal income tax system
Obligation on third parties to withhold an amount of tax from
payments of income to taxpayers reduces / eliminates their ability
to understate such income for tax assessment purposes
Cost efficient both for taxpayers and Tax Administration
Reduces the incidence of unpaid taxes by taxpayers who otherwise
would properly report their income but are unable to pay
A small number of countries have extended the use of withholding
arrangements to income tax payable on payments made by
businesses and others to certain categories of selfemployed/contractors/SME
Tax Audit
General Principles and Approaches
The audit programme of a Tax Administration performs a number of
important roles:
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Promote voluntary compliance
Detect non-compliance at individual taxpayer level
Gather information on the “health” of the tax system (including
patterns of taxpayers’ compliance behaviour)
Gather intelligence
Educate taxpayers
Identify areas of the law that require clarification
Key principles audit programmes
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There should be a comprehensive documented set of audit policies
and procedures that is readily accessible to all audit staff
Audit policies and procedures should be based on principles of
accuracy, efficiency, fairness, objectivity, transparency,
completeness, consistency, and defensibility
Revenue bodies require a systematic approach to the planning of
individual audits
Necessary support tools include industry benchmark data, business
specific guidance materials, IT facilities, and the use of indirect
income measurement techniques
Indirect income measurement methods
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For many taxpayers there is a considerable risk that some income
will not be reported by them in their returns in order to minimise
their taxable income.
Especially where it is easy to conceal income, as the income is not
subject to any systematic third party reporting to the revenue body
and/or it is difficult for auditors to otherwise directly verify such
income with third party sources
There is also a risk that expenses against business income may be
overstated by taxpayers
There is also a risk of poor quality, or non-existent, books and
records
Formal indirect methods used by revenue
bodies to varying degrees
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Source and application of funds method
(comparison of expenditures and receipts for the period; the excess
of expenditures over the sum of reported and non taxable income is
unreported taxable income)
Bank deposits and cash expenditure methods
(computing income by showing what happened to a taxpayer’s
funds based on the idea that what a taxpayer receives can either
be deposited or it can be spent)
Mark-up method
(reconstruction of income based on the use of percentages or ratios
considered typical for the business under examination)
Formal indirect methods used by revenue
bodies to varying degrees(2)
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Unit and volume method
(gross receipts determined or verified by applying the
sales price to the volume of business done by the
taxpayer; volume might be determined from taxpayers
cost of goods sold or expenses)
Net worth method
(increases in a taxpayer’s net worth during a taxable
year, adjusted for non deductible expenditures and non
taxable income, indicate taxable income)
When to use a formal indirect method
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A taxpayer’s known business and personal expenses exceed
the reported income per the return and non-taxable sources of
funds have not been identified to explain the difference
Irregularities in a taxpayer’s books and weaknesses in internal
control
Gross profit percentages differ significantly from year to year or
are unusually high or low for that market
Bank accounts show unexplained items of deposit
A taxpayer does not make regular deposits of income, but uses
cash instead
A significant increase in taxpayer’s net worth not supported by
reported income
No book and records available
Enforcement communication targeted on
consumers
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Consumers also play a role in cash economy
Explain to consumers the risks of cash deals hiring
contractors who don’t issue receipts and don’t prepare
contracts (accidents, mistakes, losing advance
payments, poor quality or incomplete work and no
assurance)
Explain to consumers that if they participate in the
underground economy , they affect the governments
ability to provide services such as education, health
care, pensions and infrastructure
The Management of Tax Debt Collection
Activities
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Growing awareness of importance of the debt collection function
Tax debt collection is an important and integral part of the overall
tax administration process
Where taxpayers have difficulty in paying, arrangements can be
made to allow taxpayers to pay by instalments.
By designing arrangements for taxpayers personal circumstances
and the ability to meet future obligations should be taken into
account.
If taxpayers fail too come to an arrangement or fail to comply with
arrangements, stronger actions will be required.
These firmer actions include legal proceedings and recovering the
debt from bank accounts or from other income sources for instance
by using wage garnishments.
Finally the tax administration can start action to effect bankruptcy or
liquidation.
Risk based monitoring
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It is very important for the tax administration to detect
timely and monitor continuously taxpayers who have
serious difficulties to pay their debt
The development and use of a risk – oriented approach
is recommendable.
Voluntary disclosure programs
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Voluntary Disclosure programmes can be used by tax
administrations to encourage people to file and pay their
back taxes.
The taxpayer must disclose and pay the entire amount
of taxes due (plus interest) by a certain deadline. The
taxpayer can (and should) also be asked to sign an
agreement to pay and file his taxes on time in the future.
In exchange no penalty or other sanction applied
There is a good reason for this quite unique
legal rule.
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A taxpayer, who once started to underreport, is forced to
continue this behaviour to prevent discovering.
Voluntary disclosure provides an opportunity for
taxpayers to step out this forced ongoing pattern of
underreporting and it turns non-compliant taxpayers into
compliant taxpayers.
Up till recently the use of the voluntary disclosure
regulations was generally initiated by the taxpayer. This
has changed. The voluntary disclosure regulations have
become a strategic instrument of Tax Administrations.
Also in countries where voluntary disclosure is not a
legal provision (US), but is based on (published) internal
practice.
Selected other measures taken by Tax
Administrations
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Mandatory E-filing for business (Netherlands, US)
Mandatory registration of employees in certain types of
business such as restaurants and hairdressers
(Sweden)
Electronic invoice systems (Chile)
Standard Business Reporting (Netherlands, Australia)
Mandatory Certified Cash Registers for cash payments
(Sweden)
Horizontal monitoring - Building a common tax control
framework (Netherlands)
In conclusion:
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Challenges are significant
Essential to know and understand this particular
category of taxpayers,
and to have:
- effective risk management
- the right mix of strategies to improve compliance
- cooperation where possible, but also
confrontation where needed
To provide tax treatment that is simple and fair.