Chapter 2. Special Feature: Managing taxpayers’ compliance

Compliance risk management in Asia and the Pacific

In a survey1 conducted by the Asian Development Bank (ADB), revenue bodies in Asia and the Pacific were asked a number of questions concerning aspects of compliance risk management. The OECD report Tax Administration 2017, which is based on the ISORA survey, also contains information on revenue bodies in Asia and the Pacific. The following are the key findings and observations from the surveys (Table 2.1):

• Tax administrations were asked to identify the relative priority attached to a number of risk categories in their current compliance strategies. There was a high degree of commonality, with highest priority areas seen as: value added tax (VAT) fraud, aggressive tax avoidance schemes (including those leading to base erosion and profit shifting), the shadow economy and transactions involving zero or near zero tax jurisdictions. Many administrations also identified e-commerce, identity-fraud, and high net wealth individuals (HNWIs) as medium to high priorities.

• The high priority attached to VAT fraud reflects both its importance as a major source of revenue and the continued vulnerability of repayment mechanisms generally to organised fraud. VAT fraud and other refund-based fraud schemes are increasingly taking new and sophisticated forms involving the use of technologies and at times considerable resources on the part of the perpetrators (OECD, 2017_[2]).

Tax gap research

The tax gap is an estimate of the difference between the amount of revenue actually collected for a tax in respect of fiscal year and the amount that would have been collected with perfect compliance. It is typically measured on a “tax-by-tax” basis, exclusive of penalties and interest, and the results across all taxes are sometimes aggregated to give a “total tax gap” amount for a tax system. By its nature, tax gap estimation is an imprecise science and the various models and methodologies used in practice by revenue bodies and others for gap estimation purposes are subject to numerous qualifications and assumptions.

Drawing on international experience, tax gap estimation research has a number of potential uses, although its value at the individual tax level depends on the methodology used, the reliability of the information gathered, and the timeliness of research findings. While relatively few national revenue bodies undertake comprehensive programmes of tax gap research, interest in tax gap estimation, particularly in respect of VAT, has grown considerably in recent years as governments, tax administrators and others have sought to quantify the extent of revenue leakage from their tax systems and/or to better understand the overall impacts of revenue bodies’ compliance improvement activities. Australia, Canada and Finland are examples of economies where comprehensive research efforts have been launched in recent years, while countries such as Denmark, Sweden, United Kingdom and the United States have many years of experience. The European Commission arranges regular VAT gap estimation research for all of its 28 member countries and publishes the findings (CASE, 2017_[4]).

Only a few larger countries have conducted tax gap research across the Asia–Pacific region, although independent research institutes have looked into industry-specific cases of tax evasion (e.g. a report by the Oakland Institute on large scale tax evasion in the forestry sector in Papua New Guinea (Mousseau and Lau, 2016_[5])). Interest for tax gap research appears to have grown over the last five years or so and a number of revenue bodies have explored its use, have ongoing research programmes, or have had some exposure to such research:

• The Australian Taxation Office (ATO) has a comprehensive approach, with a programme of research introduced gradually over the last four years that, in 2018, includes all of the taxes under its responsibility. A programme of random inquiries is a core element of its approach to estimating the tax gap for income taxes. The findings of its research are released progressively, and are published on its website and in its annual performance report (ATO, 2018_[6]). At the time of finalising this report, tax gap estimates had been released for a range of taxes, including the goods and services tax (GST),2 corporate income tax (large taxpayers), the pay-as-you-go withholding regime for the personal income tax and some excises (ATO, 2018_[6]). Summary findings include:

  • GST gap – the net GST gap estimate for 2015-16 has trended slightly upwards from previous years to AUD 4.5 billion (7.3%). It is the highest gap among the taxes analysed to date, but compliance levels are quite stable. Australia ranks relatively well among similar nations that have estimated GST/VAT gaps.

  • Large corporate income tax gap – in 2014-15, the net large corporate income tax gap is estimated to be AUD 2.5 billion (5.8%). This figure has been steady for a number of years, and the gap primarily reflects differences in the interpretation of complex areas of tax law.

  • Tobacco tax gap – for the 2015-16 year, the net tobacco tax gap is estimated to be AUD 594 million (5.6%). ATO analysis indicates that sea and air cargo is the most significant source of detected illicit tobacco entering Australia.

• China’s State Administration of Taxation (SAT) has a comprehensive programme. SAT’s representative noted that the knowledge gained from its tax gap research efforts (i) assists in the development of uniform tax payment arrangements, (ii) improves the efficiency of tax collection, (iii) improves targeting of revenue management, and (iv) supports tax reform. SAT employs both the “top down” methodology to estimate the tax gap for indirect taxes and the “bottom up” methodology for direct taxes. Concerning the VAT, findings from 2001 to 2009 had revealed progressively improving tax compliance, with the estimated VAT tax gap declining from around 40% to 25% across China over the period studied (Zhong, 2016_[7]).

• The Philippines’ Bureau of Internal Revenue (BIR) also has experience with tax gap research. As part of a technical assistance agreement between the governments of the United States and the Philippines, the BIR participated with the IMF from 2011 to 2015 to produce a series of gap estimates for the VAT making use of the IMF’s Revenue Administration Gap Analysis Program (RA-GAP) assistance. In a presentation made in December 2017, the BIR’s representative reported that its findings from 2008 to 2015 reveal a marginally declining trend in the gap which is estimated at 38% for the 2015 fiscal year (ADB, 2018_[8]).

• Indonesia’s Directorate General of Tax (DGT) at the Ministry of Finance regularly conducts assessments of the income tax coverage ratio. Since 2005, the agency has given sectoral estimates for the potential tax revenues, to detect weaknesses in its compliance system. The publication of these results is irregular, and the latest official figures date back to 2011 when the tax gap was 29.20% (APBN, 2014_[9]).

• Nepal’s Inland Revenue Department (IRD) has collected statistics on tax compliance for VAT in 2015 with the support of the Fiscal Affairs Department of the IMF (IMF, 2017_[10]). The IRD has also systematised its income tax gap measurement to a yearly basis (IRD, 2016_[11]).

Global developments to reform the international tax system

International efforts to address weaknesses in the international tax system rely on two building blocks: (i) promoting transparency and exchange of information among jurisdictions for tax purposes and (ii) tackling tax avoidance with the OECD/G20’s Base Erosion and Profit Shifting (BEPS) project. With considerable progress made over recent years to develop comprehensive proposals for reform in both areas, the focus of these international efforts has shifted to their global implementation.

Promoting transparency and exchange of information for tax purposes

The work of tax transparency has been at the heart of the OECD’s role in the international tax area. With its peer reviews of the standard for exchange of information on request (EOIR) and its monitoring of the implementation of the standard for automatic exchange of financial account information (AEOI), the Global Forum on Transparency and Exchange of Information for Tax Purposes has played a crucial role in establishing and maintaining a level playing field and in ensuring that the voices of all relevant jurisdictions are heard (OECD, 2018_[18]).

The OECD’s base erosion and profit shifting project

The past two to three decades have seen dramatic changes in many economies as a result of globalisation. Technological advancements, increased mobility of capital and labour, the shift in manufacturing bases from high to low cost jurisdictions, and the gradual lifting of trade barriers, are some of the many developments that have boosted foreign direct investment in many economies. However, there have been a number of downsides, including in the area of taxation, where it is widely agreed that international tax rules have not kept up with the pace of change. A major consequence of this deficiency has been revenue leakage; from research conducted in 2013, global revenue losses from BEPS were conservatively estimated at USD 100 billion to 240 billion annually, which is equivalent to between 4% and 10% of global revenues from corporate income tax. Developing countries’ higher reliance on corporate income tax means they suffer from BEPS disproportionately (OECD, 2015_[19]). More broadly, BEPS weakens tax system integrity and undermine citizens’ trust in government.

The goal of the BEPS project is to realign the international tax rules with developments in the world economy, to restore trust and ensure profits are taxed where economic activities are carried out and value is created, while maintaining the ability to eliminate double taxation. In September 2013, G20 leaders endorsed a comprehensive action plan developed by the OECD to address BEPS. This action plan on BEPS identified a series of domestic and international actions to address the problem and set timelines for their further development. After considerable consultation over the ensuing two years, the BEPS project delivered outputs for all elements of the action plan to G20 Finance Ministers in October 2015. In November 2015, G20 leaders endorsed the measures and expressly called for an implementation framework that would be open to all interested countries and jurisdictions, including developing economies. The BEPS measures aim to close gaps in international tax rules that allow multinational enterprises to legally, but artificially, shift profits to low or no-tax jurisdictions. The measures seek to achieve this by improving the coherence of tax rules across borders, tightening substance requirements, and ensuring increased transparency and certainty.

Employment income

Cumulative withholding regimes are widely used in developing economies, limiting the numbers of employees who are required to file annual tax returns or undergo some other form of reconciliation (e.g., Japan). In Viet Nam for instance, employers must withhold the income taxes of their employees and deposit them with the State Treasury before the 20th of the following month, employers also fill in the personal income tax declarations on behalf of their employees if they are their sole source of revenues and submit them before the end of the year (KPMG, 2018_[23]). Similar systems exist in smaller economies such as Nauru where tax payments by the employer need to be made 15 days after the end of the month of withholding. In a few economies [i.e., Hong Kong, China; and Singapore], tax withholding at source is not applied and employees must make their own advance payments and file returns.

Other categories of income

Some revenue bodies report that withholding provisions apply to prescribed categories of interest and dividend incomes, for both resident and non-resident taxpayers. Revenue bodies in Bangladesh, China, Indonesia, Kazakhstan, Mongolia, the Philippines, and Thailand report extensive use of withholding across the main categories of incomes surveyed – i.e. employment income (wage and salary), dividends, interest, rents, specified business income, royalties and patents, share sales and purchases, real estates sales and purchases, and other income – for both resident and non-resident taxpayers. In the Philippines, revenues are withheld from passive incomes such as interest and dividends at levels of 20 and 10% respectively (BIR, 2018_[24]). Lao PDR has a similar system but at a flat rate of 10% (Lao PDR Government, 2018_[25]). Revenue bodies in Australia, Hong Kong, China, Malaysia, Maldives, New Zealand and Singapore report they make relatively limited use of tax withholding across the main categories of personal income, although relaying on reporting regimes to gather data on taxpayers’ incomes. Countries also target very specific forms of income using withholding taxes, for example the Solomon Islands which target goods such as marine products or cocoa.

Computer processing of third party income reports

There are many benefits of using third party data in enhancing tax compliance and service delivery. These data include wage and salary information from employers as well as data from financial institutions, property sales, other government agencies, and information exchanged with other jurisdictions.

Many revenue bodies (e.g., Australia, Korea, Malaysia, New Zealand, Singapore, and Thailand) reported having computerised processes for the bulk capture and processing of large volumes of taxpayer income data reported by third parties. Papua New Guinea has indicated that as part of its reform plan for its taxation authority it wishes to make much greater use of third party information sources; as such, it intends to use data from the national Investment Promotion Authority (IPA) to cross check businesses’ compliance (TRC, 2015_[26]). Similarly, the tax authorities of the Solomon Islands, Samoa and Fiji indicate that they use many information streams to detect misconducts. For instance, the Samoa tax authorities use data from different ministries, the Samoa National Provident Fund (SNPF), the central bank and commercial banks (MFRS, 2017_[27]).