The work-related expenses tax gap

5 Sep, 2018


On 12 July 2018, the ATO published the income tax gap for ‘individuals not in business’, comprising around 9.6 million individuals who are not in business and earn income from salary and wages and investments. The estimated net tax gap for these individuals in relation to the 2014–15 income year is 6.4 per cent, or $8.7 billion. The ATO claims that this tax gap is ‘primarily driven by incorrectly claimed work-related expenses’.

The ATO defines the tax gap as:

… the difference between the estimated amount of a liability or obligation theoretically payable and the amount actually reported to, or collected by, the ATO over a defined period. The gap includes amounts that are incorrectly reported, as well as amounts that [the ATO does] not expect will ever be paid.

The latest tax gaps reported by the ATO include:

Tax gap item Amount Percentage
2014-15 income year
Individuals not in business
PAYG withholding
Superannuation guarantee
Large corporate
Wine equalisation tax
$8.7 billion
$3.1 billion
$2.85 billion
$2.5 billion
$4.7 million
2015-16 income year
Fuel excise gap
Fuel tax credits
$4.5 billion
$594 million
$325 million
($19 million)

How work-related expense claims affect the gap

ATO analysis shows the main components driving the total net tax gap of 6.4 per cent ($8.76 billion) for individuals not in business include:

  • incorrect claims for work-related expense deductions;
  • omitted income — particularly in relation to undeclared cash wages; and
  • deductions for rental property expenses.

Of those who lodge tax returns, around 68 per cent did so through a tax agent in 2014–15.

How the ATO measured the individuals not in business gap

The ATO reviewed the tax returns of a random sample of taxpayers, and then applied the results to the broader population. The ATO also used operational data including results from compliance activities on risk areas.

The ATO randomly selected a sample of individuals. People in the sample who were identified as low risk were not investigated further. The remainder of the sample progressed to an audit (i.e. the REP).

For the 2013–14 and 2014–15 income years, 858 reviews were undertaken, with the following results:

Agent-prepared returns Self-prepared returns Total
Sample size 614 244 858
Returns adjusted — No. 476 139 615
Returns adjusted — % 78% 57% 72%
Adjustments in taxpayer’s favour —  No. 7 9 16
Adjustments in taxpayer’s favour — % 1% 4% 2%

Of the total 2,388 adjustments made, 51 per cent (or 1,212) were for work-related expenses. The ATO has reported in a media release that common mistakes include:

  • claiming deductions where there is no connection to income;
  • claims for private expenses; and
  • no records to show that an expense was incurred.

The ATO has expressed concern that a minority of tax agents are exaggerating or falsifying claims to attract or retain clients. The ATO will work alongside the Tax Practitioners Board (TPB) to identify and closely monitor these agents.

How the ATO is addressing the gap

To address the individuals not in business gap, the ATO is taking a two-fold approach to:

  • support compliance — with better use of data and technology to tailor advice and guidance products, target nudge messaging, auto-correct mistakes, streamline reporting and substantiation processes, and pre-fill more information in tax returns; and
  • deter non-compliance — take firmer action with higher-risk taxpayers and agents including additional audits and pursue penalties or prosecutions in serious cases, particularly in areas driving the gap.

The ATO’s key initiatives to reduce the individuals not in business gap include:

  • improving and tailoring public advice and guidance material, tools and services;
  • increasing the quantity and quality of the data it collects;
  • adopting new ways of using data and technology to make lodging returns and substantiating deductions simpler for taxpayers and their agents, including streamlining reporting processes and pre-filling more information in tax returns;
  • helping taxpayers and their agents report correctly up front, using prompter messages, emails and letters to alert them early where there is something unusual;
  • better understanding the circumstances of debt, doing what it can to prevent it and offering practical repayment options;
  • taking firmer action to address non-compliance among higher-risk taxpayers and agents including additional audits, particularly in areas driving the gap (this would include work-related expenses); and
  • pursuing penalties or prosecution — or referring tax agents to the TPB in the most serious of cases.

ATO response

In the 2018–19 Federal Budget, the Government announced additional funding of $130.8 million for the ATO to increase compliance activities targeting individual taxpayers and their tax agents.

The extra funding will allow the ATO to — amongst other initiatives — increase its focus on reducing the key drivers of the gap, including work-related expenses.

The ATO will improve services for tax agents who are willing to do the right thing. However, the ATO has warned that, with the additional Government support, it will also increase action against tax agents who deliberately and repeatedly seek to undermine the tax system. It will be looking not just at the returns of their client base but also their own business and personal affairs.

This year, the ATO expects to undertake over one million interactions with taxpayers and tax agents claiming work-related expenses. These interactions will encompass everything from help and education through to reminders, reviews and audits.

As part of the educational aspect of its campaign for Tax Time 2018, the ATO has released some useful and colourful fact sheets relating to claiming various types of work-related expenses, and some fact sheets tailored for taxpayers in specific occupations.

The fact sheets can be downloaded here.

ATO fact sheets

  • Car expenses: what’s under the bonnet
  • Clothing and laundry: it pays to learn what you can claim
  • Travel expenses: what you need to know before you go
  • Employees working from home: the other kind of housework
  • Self-education expenses: it pays to learn what you can claim at tax time

Occupation-specific fact sheets

  • Australian Defence Force
  • Cleaners
  • Construction workers
  • Doctors, specialists and other medical professionals
  • Flight attendants
  • Hospitality workers
  • IT professionals
  • Miners
  • Nurses, midwives and carers
  • Office workers
  • Police officers
  • Public servants
  • Real estate professionals
  • Retail
  • Sales and marketing
  • Teachers
  • Tradespersons
  • Truck drivers.

Methodology behind the tax gap

Why does the ATO measure the tax gap?

The ATO estimates and publishes the tax gaps for several key reasons:

  • The Australian community expects the ATO to manage all aspects of the tax and superannuation systems, including advising on the tax gaps and what it is doing about them.
  • Tax gap estimates are important for the ATO to better understand levels of compliance and risk in the tax and superannuation systems, to inform resource allocation, and to assess the effectiveness of its work.
  • Insights gained from tax gap analysis guides the ATO in determining priority risks and developing strategies in a number of areas including administrative design, help and education and audit.

Overview of the ATO’s tax gap research program

The tax gaps are grouped into three programs of analysis:

  1. Transaction-based tax gaps — for taxes collected and paid by an entity higher up in the supply chain (with the cost generally borne by the consumer), such as GST and fuel excises.
  2. Income-based tax gaps — for income tax (for both individuals and businesses), large and small superannuation funds, and FBT.
  3. Administrative gaps — non-tax gaps, including for PAYG withholding, superannuation guarantee and other administered programs.

This graph is a visual representation overview of the tax gap research program as discussed in the tax gap research paragraphs. It groups the gap estimations into their respective groups: transaction-based (such as GST), income-based (such as large corporate groups income tax), and administrative gaps (such as PAYG withholding). It also shows how the black economy touches on some of the gap estimates, such as GST, Individuals income tax and PAYG withholding.

Source: (QC 53161)

Input from stakeholders and experts

In developing its tax gap estimates, the ATO engages key stakeholders and subject matter experts within the ATO and the community. These include tax gap experts, researchers, academics, government agencies and taxpayer representative groups.

In 2013, the ATO established an independent expert panel to provide advice on the suitability of the gap estimates and methodologies. The panel currently comprises two economists and a tax professional, all of whom also hold academic roles.

How the ATO measures the tax gap

The ATO’s tax gap estimates aim to quantify the level of non-compliance across the ‘four pillars’ of compliance:

Where possible, the ATO also estimates the amount of revenue not collected from those who do not register or lodge.

There are two measures of the tax gap:

  1. The gross gap is the difference between:
  • the amount voluntarily reported to the ATO; and
  • the amount that would have been collected if every taxpayer was fully compliant (i.e. the theoretical tax liability).

2. The net gap is the difference between:

  • the total amount reported (the amount voluntarily reported to the ATO, plus amendments as a result of compliance activities and voluntary disclosures); and
  • the amount that would have been collected if every taxpayer was fully compliant.

This diagram shows the tax gap concepts. We look at the amount voluntarily reported, amendments due to compliance activities and voluntary disclosure, and the amount not paid, against the theoretical tax liability.

Source: (QC 53161)

The estimates reflect the gap in compliance with the law and the administrative approaches at the time. Estimates do not include tax forgone as a result of policy decisions (which are ‘tax expenditures’ dealt with by the Treasury). Gap estimates include tax evasion, fraud, incorrect reporting, non-payment of liabilities, non-registration and non-lodgment. They exclude penalties and interest.

Methodologies employed

The ATO uses a combination of methods to estimate tax gaps. Generally, data availability and data quality are the key deciding factors for the approach used. All gap estimates are assessed for reliability against a set of ten standard criteria by the independent expert panel.

The ATO’s tax gap measurement and methodologies draw on the experience of overseas tax administrations:

  • United Kingdom — Her Majesty’s Revenue and Customs (HMRC);
  • United States — Internal Revenue Service (IRS);
  • Danish Customs and Tax Administration (SKAT); and
  • Canada Revenue Agency.

Further, the European Commission (EU) identifies the value-added tax (VAT) gap in each of its 28 member countries. The International Monetary Fund (IMF) provides support to jurisdictions in estimating tax gaps.

The ATO shares its tax gap information with HMRC and the IRS.

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