Tax Administration
Preliminary Information on Selected Foreign Practices That May Provide Useful Insights
Gao ID: GAO-11-540T April 12, 2011
The Internal Revenue Service (IRS) and foreign tax administrators face similar issues regardless of the particular provisions of their laws. These issues include, for example, helping taxpayers prepare and file returns, and assuring tax compliance. GAO was asked to describe (1) how foreign tax administrators have approached issues that are similar to those in the U.S. tax system and (2) whether and how the IRS identifies and adopts tax administration practices used elsewhere. To do this, GAO reviewed documents and interviewed six foreign tax administrators as well as tax experts, tax practitioners, taxpayers, and trade group representatives. GAO also examined documents and met with IRS officials. This preliminary information is based on GAO's ongoing work for the Committee to be completed at a later date.
Foreign and U.S. tax administrators use many of the same practices such as information reporting, tax withholding, providing web-based services, and finding new approaches for tax compliance. These practices, although common to each system, have important differences. Although differences in laws, culture, or other factors likely would affect the transferability of foreign tax practices to the U.S., these practices may provide useful insights for policymakers and the IRS. For example, New Zealand integrates evaluations of its tax and discretionary spending programs. The evaluation of its Working For Families tax benefits and discretionary spending, which together financially assist low- and middle-income families to promote employment, found that its programs aided the transition to employment but that it still had an underserved population; these findings likely would not have emerged from separate evaluations. GAO previously has reported that the U.S. lacks clarity on evaluating tax expenditures and related discretionary spending programs and does not generally undertake integrated evaluations. In Finland, electronic tax administration is part of a government policy to use electronic services to lower the cost of government and encourage private-sector growth. Overall, according to Finnish officials, electronic services have helped to reduce Tax Administration staff by over 11 percent from 2003 to 2009 while improving taxpayer service. IRS officials learn about these practices based on interactions with other tax administrators and participation in international organizations, such as the Organisation for Economic Co-operation and Development. In turn, IRS may adopt new practices based on the needs of the U.S. tax system. For example, in 2009, IRS formed the Global High Wealth Industry program. IRS consulted with Australia about its approach and operational practices.
GAO-11-540T, Tax Administration: Preliminary Information on Selected Foreign Practices That May Provide Useful Insights
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United States Government Accountability Office:
GAO:
Testimony:
Before the Committee on Finance, U.S. Senate:
For Release on Delivery:
Expected at 10:00 a.m. EDT:
Tuesday, April 12, 2011:
Tax Administration:
Preliminary Information on Selected Foreign Practices That May Provide
Useful Insights:
Statement of Michael Brostek, Director:
Strategic Issues Team:
GAO-11-540T:
GAO Highlights:
Highlights of GAO-11-540T, testimony to the Committee on Finance, U.S.
Senate.
Why GAO Did This Study:
The Internal Revenue Service (IRS) and foreign tax administrators face
similar issues regardless of the particular provisions of their laws.
These issues include, for example, helping taxpayers prepare and file
returns, and assuring tax compliance.
GAO was asked to describe (1) how foreign tax administrators have
approached issues that are similar to those in the U.S. tax system and
(2) whether and how the IRS identifies and adopts tax administration
practices used elsewhere.
To do this, GAO reviewed documents and interviewed six foreign tax
administrators as well as tax experts, tax practitioners, taxpayers,
and trade group representatives. GAO also examined documents and met
with IRS officials. This preliminary information is based on GAO‘s
ongoing work for the Committee to be completed at a later date.
What GAO Found:
Foreign and U.S. tax administrators use many of the same practices
such as information reporting, tax withholding, providing web-based
services, and finding new approaches for tax compliance. These
practices, although common to each system, have important differences.
This testimony describes the following six foreign tax administration
practices that address common issues in tax administration.
Table: Selected Foreign Tax Administration Practices:
Foreign administrator: New Zealand;
Practice: Does integrated evaluations of tax expenditures and
discretionary spending programs to analyze their impacts and improve
program delivery.
Foreign administrator: Finland;
Practice: Uses the internet to calculate individual tax withholding
rates and revise pre prepared tax returns to improve service at lower
costs.
Foreign administrator: European Union;
Practice: Uses multilateral treaty information exchange on interest
payments to member nations‘ citizens to spur compliance by individual
taxpayers.
Foreign administrator: United Kingdom;
Practice: Uses information reporting and withholding so most wage
earners do not need to file a tax return.
Foreign administrator: Australia;
Practice: Uses a compliance program for high net wealth individuals
that focuses on their full set of business interests to improve
compliance.
Foreign administrator: Hong Kong;
Practice: Uses semiannual payments instead of periodic withholding for
the Salaries Tax.
Source: GAO analysis.
[End of table]
Although differences in laws, culture, or other factors likely would
affect the transferability of foreign tax practices to the U.S., these
practices may provide useful insights for policymakers and the IRS.
For example, New Zealand integrates evaluations of its tax and
discretionary spending programs. The evaluation of its Working For
Families tax benefits and discretionary spending, which together
financially assist low- and middle-income families to promote
employment, found that its programs aided the transition to employment
but that it still had an underserved population; these findings likely
would not have emerged from separate evaluations. GAO previously has
reported that the U.S. lacks clarity on evaluating tax expenditures
and related discretionary spending programs and does not generally
undertake integrated evaluations. In Finland, electronic tax
administration is part of a government policy to use electronic
services to lower the cost of government and encourage private-sector
growth. Overall, according to Finnish officials, electronic services
have helped to reduce Tax Administration staff by over 11 percent from
2003 to 2009 while improving taxpayer service.
IRS officials learn about these practices based on interactions with
other tax administrators and participation in international
organizations, such as the Organisation for Economic Co-operation and
Development. In turn, IRS may adopt new practices based on the needs
of the U.S. tax system. For example, in 2009, IRS formed the Global
High Wealth Industry program. IRS consulted with Australia about its
approach and operational practices.
What GAO Recommends:
GAO makes no recommendations in this testimony. Understanding how
other tax administrators have used certain practices to address common
issues can provide insights to help inform deliberations about tax
reform and about possible administrative changes in the U.S. existing
system to improve compliance, better serve taxpayers, reduce burdens,
and increase efficiencies.
View GAO-11-540T or key components. For more information, contact
Michael Brostek at (202) 512-9110 or brostekm@gao.gov.
[End of section]
Chairman Baucus, Ranking Member Hatch, and Members of the Committee:
I appreciate this opportunity to discuss how some foreign tax
administrators have focused on issues similar to those faced by the
United States (U.S.). All tax administrators strive to address similar
issues regardless of the specific provisions of their laws.
Understanding how other tax administrators have used certain practices
to address these common issues can provide insights to help inform
deliberations about tax reform and about possible administrative
changes in our existing system to improve compliance, better serve
taxpayers, reduce burden, and increase efficiencies.
My statement today will draw from our ongoing work for the committee
to describe (1) how foreign tax administrators have approached issues
that are similar to those in the U.S. tax system and (2) whether and
how the Internal Revenue Service (IRS) identifies and adopts tax
administration practices used elsewhere. Our work includes selected
practices of New Zealand, Finland, European Union (EU), United Kingdom
(UK), Australia, and Hong Kong.[Footnote 1] Our report, to be issued
in May 2011, will provide our detailed descriptions of those tax
administration practices and their differences from U.S. practices.
We based our selection of these practices on several factors,
including whether the tax administrators had advanced economies and
tax systems, tax information was available in English, and the foreign
tax administrator's approach differed from how the U.S. approaches
similar issues. We reviewed documents and interviewed officials from 6
foreign tax administrations. We primarily used documentation from each
government's reports that are publicly available. When possible, we
confirmed additional information provided to us by officials and held
meetings with experts, public interest groups, and trade groups to
identify their views about these systems. To describe whether and how
the IRS identifies and adopts tax administration practices used
elsewhere, we reviewed related documents and interviewed IRS
officials. We discussed the information in this statement with
officials of IRS and six foreign tax administrators and incorporated
their comments as appropriate.
We conducted our work from October 2009 to March 2011 in accordance
with all sections of GAO's Quality Assurance Framework that are
relevant to our objectives. The framework requires that we plan and
perform the engagement to obtain sufficient and appropriate evidence
to meet our stated objectives and to discuss any limitations in our
work. We believe that the information and data obtained, and the
analysis conducted, provide a reasonable basis for any findings and
conclusions in this statement.
Although the descriptive information presented in this testimony may
provide useful insights for Congress and others on alternatives to
current U.S. tax policies and practices, comparisons across tax
administration systems or even within systems must include a separate
analytic step to identify the factors that might affect the
transferability of the practices, such as differences in law, to the
U.S. Based on such an analysis, countries determine whether others'
practices could be adopted. For example, nations have differing
cultures. Generally, attitudes toward government can affect voluntary
tax compliance. When taxpayers are more willing to accurately comply
with tax rules, less enforcement action by the administrators is
needed. Measurements of taxpayers' attitudes are not well defined or
uniform; nor are measurements of voluntary compliance.
Examples of Selected Tax Administration Practices to Address Known Tax
Administration Issues:
The following examples illustrate how New Zealand, Finland, EU, UK,
Australia, and Hong Kong have addressed well known tax administration
issues.
New Zealand Does Joint Evaluations of Tax Expenditures and
Discretionary Spending Programs to Analyze Their Effects and Improve
Program Delivery:
New Zealand, like the U.S., addresses various national objectives
through a combination of tax expenditures and discretionary spending
programs. Tax expenditures are the amount of revenue that a government
forgoes to provide some type of tax relief for taxpayers in special
circumstances, such as the Earned Income Tax Credit in the United
States.[Footnote 2] In New Zealand tax expenditures are known as tax
credits.
New Zealand has overcome obstacles to evaluating these related
programs at the same time to better judge whether they are working
effectively. Rather than separately evaluating certain government
services, New Zealand completes integrated evaluations of tax
expenditures and discretionary spending programs to analyze their
combined effects. Using this approach, New Zealand can determine, in
part, whether tax expenditures and discretionary spending programs
work together to accomplish government goals.
One example is the Working For Families (WFF) Tax Credits program,
which is an entitlement for families with dependent children to
promote employment. Prior to the introduction of WFF in 2004, New
Zealand's Parliament discovered that many low-income families were not
better off from holding a low-paying job, and those who needed to pay
for childcare to work were generally worse off in low-paid work
compared to receiving government benefits absent having a job. This
prompted Parliament to change its in-work incentives and financial
support including tax expenditures.
The Working for Families Tax Credits program differs from tax credit
programs in the United States in that it is an umbrella program that
spans certain tax credits administered by the Inland Revenue
Department (IRD) as well as discretionary spending programs
administered by the Ministry of Social Development (MSD). IRD collects
most of the revenue and administers the tax expenditures for the
government. Being responsible for collecting sensitive taxpayer
information, IRD must maintain tax privacy and protect the integrity
of the New Zealand tax system. MSD administers the WFF's program funds
and is responsible for collecting data that includes monthly income
received by its beneficiaries. This required that IRD and MSD keep
separate datasets, making it difficult to assess the cumulative effect
of the WFF program.
To understand the cumulative effect of changes made to the WFF program
and ensure that eligible participants were using it, New Zealand
created a joint research program between IRD and MSD from October 2004
to April 2010. The joint research program created linked datasets
between IRD and MSD. Access to sensitive taxpayer information was
restricted to IRD employees on the joint research program and to
authorized MSD employees only after they were sworn in as IRD
employees.
The research provided information on key outcomes that could only be
tracked through the linked datasets. The research found that the WFF
program aided the transition from relying on government benefits to
employment, as intended. It also found that a disproportionate number
of those not participating in the program were from an indigenous
population, which faced barriers to taking advantage of the WFF.
Barriers included the perceived stigma from receiving government aid,
the transaction costs of too many rules and regulations, and the small
amounts of aid for some participants. Changes made by Parliament to
WFF based on these findings provided an additional NZ$1.6 billion
(US$1.2 billion) per year in increased financial entitlements and in-
work support to low-to middle-income families.[Footnote 3]
While economic differences exist between the New Zealand and U.S. tax
systems, both systems use tax expenditures (i.e., tax credits in New
Zealand). Unlike the United States, New Zealand has developed a method
to evaluate the effectiveness of tax expenditures and discretionary
spending programs through joint research that created interagency
linked datasets. New Zealand did so while protecting confidential tax
data from unauthorized disclosure.
In 2005, we reported that the U.S. had substantial tax expenditures
but lacked clarity on the roles of the Office of Management and Budget
(OMB), Department of the Treasury, IRS, and federal agencies with
discretionary spending programs responsibilities to evaluate the tax
expenditures.[Footnote 4] Consequently, the U.S. lacked information on
how effective tax expenditures were in achieving their intended
objectives, how cost-effective benefits were achieved, and whether tax
expenditures or discretionary spending programs worked well together
to accomplish federal objectives.[Footnote 5] At that time, OMB
disagreed with our recommendations to incorporate tax expenditures
into federal performance management and budget review processes,
citing methodological and conceptual issues. However, in its fiscal
year 2012 budget guidance, OMB instructed agencies, where appropriate,
to analyze how to better integrate tax and spending policies that have
similar objectives and goals.
Finland Uses the Internet to Enable Taxpayers to Adjust Individual Tax
Withholding Rates and Revise Pre Prepared Tax Returns to Improve
Service at Lower Costs:
Finland better ensures accurate withholding of taxes from taxpayers'
income, lowers its costs, and reduces taxpayers' filing burdens
through Internet-based electronic services. In 2006, Finland
established a system, called the Tax Card, to help taxpayers estimate
a withholding rate for the individual income tax The Tax Card, based
in the Internet, covers Finland's national tax, municipality tax,
social security tax, and church tax.[Footnote 6] The Tax Card is
accessed through secured systems in the taxpayer's Web bank or an
access card issued by Finland's government. The Tax Card system
enables taxpayers to update their withholding rate as many times as
needed throughout the year, adjusting for events that increase or
decrease their income tax liability. When completed, the employer is
notified of the changed withholding tax rate through the mail or by
the employee providing a copy to the employer. According to the Tax
Administration, about a third of all taxpayers using the Tax Card,
about 1.4 to 1.6 million people, change their withholding percentages
at least annually. Finland generally refunds a small amount of the
withheld funds to taxpayers (e.g., it refunded about 8 percent of the
withheld money in 2007).
Finland also has been preparing income tax returns for individuals
over the last 5 years. The Tax Administration prepares the return for
the tax year ending on December 31st based on third-party information
returns, such as reporting by employers on wages paid or by banks on
interest paid to taxpayers. During April, the Tax Administration mails
the pre-prepared return for the taxpayer's review. Taxpayers can
revise the paper form and return it to the Tax Administration in the
mail or revise the return electronically online. According to Tax
Administration officials, about 3.5 million people do not ask to
change their tax return and about 1.5 million will request a tax
change.
Electronic tax administration is part of a government-wide policy to
use electronic services to lower the cost of government and encourage
growth in the private sector. According to Tax Administration staff,
increasing electronic services to taxpayers helps to lower costs.
Overall, the growth of electronic services, according to Finnish
officials, has helped to reduce Tax Administration staff by over 11
percent from 2003 to 2009 while improving taxpayer service.
According to officials of the Finnish government as well as public
interest and trade groups, the Tax Card and pre-prepared return
systems were established under a strong culture of national
cooperation. For the pre-prepared return system to work properly,
Finland's business and other organizations who prepare information
returns had to accept the burden to comply in filing accurate returns
promptly following the end of the tax year.
Finland's tax system is positively viewed by taxpayers and industry
groups according to our discussions with several industry and taxpayer
groups. They stated that Finland has a simple, stable tax system which
makes compliance easier to achieve. As a result, few individuals use a
tax advisor to help prepare and file their annual income tax return.
In contrast to Finland's self-described "simple and stable" system,
the U.S. tax system is complex and constantly changing. Regarding
withholding estimation, Finland's Tax Card system provides taxpayers
an online return system for regularly updating the tax amount
withheld. For employees in the U.S., the IRS's Website offers a
withholding calculator to help employees determine whether to contact
their employer about revising their tax withholding. Finland's system
prepares a notice to the employer which can be sent through the mail
or delivered in person, whereas in the U.S. the taxpayer must file a
form with the employer on the amount to be withheld based on the
estimation system's results.
In the U.S., individual income tax returns are completed by taxpayers--
not the IRS--using information returns mailed to their homes and their
own records.[Footnote 7] Taxpayers are to accurately prepare and file
an income tax return by its due date. In Finland, very few taxpayers
use a tax advisor to prepare their annual individual income tax
return. Unlike in Finland, U.S. individual taxpayers heavily rely on
tax advisors and tax software to prepare their annual return. In the
U.S. about 90 percent of individual income tax returns are prepared by
paid preparers or by the taxpayer using commercial software.
The EU's Multilateral Treaty Information Exchange on Interest Payments
Is Envisioned to Spur Compliance:
The European Union seeks to improve tax compliance through a
multilateral agreement on the exchange of information on interest
earned by each nation's individual taxpayers. This agreement addresses
common issues with the accuracy and usefulness of information
exchanged among nations that have differing technical, language, and
formatting approaches for recording and transmitting such information.
Under the directive, adopted in June 2003, the 27 EU members and 10
other participants agreed to share information about income from
interest payments made to individuals who are citizens in another
member nation. With this information, the tax authorities are able to
verify whether their citizens properly reported and paid tax on the
interest income. The directive provides the basic framework for the
information exchange, defining essential terms and establishing
automatic information exchange among members.[Footnote 8]
As part of the directive, 3 EU member nations as well as the 5
European nonmember nations agreed to apply equivalent measures (i.e.,
withholding tax with revenue sharing described below) during a
transition period through 2011, rather than automatically exchanging
information.[Footnote 9] Under this provision, a 15 percent
withholding tax gradually increases to 35 percent by July 1, 2011. The
withholding provision included a revenue-sharing provision, which
authorizes the withholding nation to retain 25 percent of the tax
collected and transfer the other 75 percent to the nation of the
account owner. The directive also requires the account owner's home
nation to ensure that withholding does not result in double taxation
by granting a tax credit equal to the amount of tax paid to the nation
in which the account is located.
A September 2008 report to the EU Council described the status of the
directive's implementation. During the first 18 months of information
exchange and withholding, data limitations such as incomplete
information on the data exchanged and tax withheld created major
difficulties for evaluating the directive's effectiveness. Further, no
benchmark was available to measure the effect of the changes.
According to EU officials, the most common administrative issues,
especially during the first years of implementation of the directive,
have been the identification of the owner reported in the computerized
format. It is generally recognized that a Taxpayer Identification
Number (TIN) provides the best means of identifying the owner.
However, the current directive does not require paying agents to
record a TIN. Using names has caused problems when other EU member
states tried to access the data. For example, a name that is
misspelled cannot be matched. In addition, how some member states
format their mailing address may have led to data-access problems. EU
officials told us that the monitoring role by the EU Commission, the
data-corrections process, and frequent contacts to resolve specific
issues have contributed to effective use of the data received by EU
member states.
Other problems with implementing the directive include identifying
whether investors moved their assets into categories not covered by
the directive (e.g., shifting to equity investments), and concerns
that tax withholding provisions may not be effective because
withholding rates were low until 2011 when the rate became 35 percent.
The EU also identified problems with the definition of terms, making
uniform application of the directive difficult. Generally these terms
identify which payments are covered by the directive, who must report
under the directive, and who owns the interest for tax purposes.
Nevertheless, EU officials stated that the quality of data has
improved over the years. The EU officials have worked with EU member
nations to resolve specific data issues which have contributed to the
effective use of the information exchanged under the directive.
Comparing the EU and U.S. practices on exchanging tax information with
other countries, the U.S. agreements and the directive both allow for
automatic information exchange.[Footnote 10] The U.S. is part of the
Convention on Multilateral Administrative Assistance in Tax Matters,
which includes exchange of information agreement provisions and has
been ratified by 15 nations and the U.S.[Footnote 11] However, the
U.S. is prevented by IRC 6105 from releasing data about the extent of
information exchanged with treaty partners or the type of information
exchange used.
The UK Uses Information Reporting and Withholding So Most Wage Earners
Do Not Need To File a Tax Return:
The UK promotes accurate tax withholding and reduces taxpayers' filing
burdens by calculating withholding rates for taxpayers and requiring
that payers of certain types of income withhold taxes at standard
rates. The UK uses information reporting and withholding to simplify
tax reporting and tax payments for individual tax returns. Both the
individual taxpayer and Her Majesty's Revenue and Customs (HMRC)--the
tax administrator--are to receive information returns from third
parties who make payments to a taxpayer such as for bank account
interest. A key element of this system is the UK's Pay As You Earn
(PAYE) system. Under the PAYE system HMRC calculates an amount of
withholding from wages to meet a taxpayer's liability for the current
tax year.
According to HMRC officials, the individual tax system in the UK is
simple for most taxpayers who are subject to PAYE. PAYE makes it
unnecessary for wage earners to file a yearly tax return, unless
special circumstances apply. For example, wage earners do not need to
file a return unless income from interest, dividends, or capital gains
exceeds certain thresholds or if deductions need to be reported.
Therefore, a tax return may not be required because most individuals
do not earn enough of these income types to trigger self-reporting.
For example, the first £10,100 (US$16,239) of capital gains income is
exempt from being reported on tax returns.[Footnote 12] Even so,
payers of interest or dividend income withhold tax before payments are
made.
PAYE also facilitates the payment of tax liabilities by periodic
withholding at source for wages under the PAYE system. The withheld
amount may be adjusted by HMRC to collect any unpaid taxes from
previous years or refund overpayments. HMRC annually notifies the
taxpayer and employer of the amount to withhold.
Taxpayers can provide HMRC with additional information that can be
used to adjust their withholding. If taxpayers provide the information
on their other income such as self-employment earnings, rental income,
or investment income, HMRC can adjust the PAYE withholding.
Individuals not under the PAYE system are required to file a tax
return after the end of the tax year based on their records.
In addition, HMRC uses information reporting and tax withholding as
part of its two step process to assess the compliance risks on filed
returns. In the first step, individual tax returns are reviewed for
inherent compliance risks because of the taxpayers' income level and
complexity of the tax return. For example, wealthy taxpayers with
complex business income are considered to have a higher compliance
risk than a wage earner. In the second step, information compiled from
various sources--including information returns and public sources--is
analyzed to identify returns with a high compliance risk. According to
HMRC officials, these assessments have allowed HMRC to look at
national and regional trends. HMRC is also attempting to uncover
emerging compliance problems by combining and analyzing data from the
above sources as well as others.
The UK and U.S. both have individual income tax returns and use
information reporting and tax withholding to help ensure the correct
tax is reported and paid. However, differences exist between the
countries' systems.
* The U.S. has six tax rates that differ among five filing statuses
for individuals (i.e., single, married, married filing separately,
surviving spouse, or head of household) and covering all types of
taxable income. In general, the UK system has three tax rates, one tax
status (individuals), and a different tax return depending on the
taxable income (e.g., self-employed or employed individuals).
* U.S. income tax withholding applies to wages paid but not interest
and dividend income as it does in the UK.
* U.S. wage earners, rather than the IRS, are responsible for
informing employers of how much income tax to withhold, if any, and
must annually self assess and file their tax returns unlike most UK
wage earners.
Another major difference is that the U.S. automatically matches data
from information returns and the withholding system to data from the
income tax return to identify individuals who underreported income or
failed to file required returns. Matching is done using a unique
identifier TIN. HMRC officials told us that they have no automated
document-matching process and the UK does not use TINs as a universal
identifier, which is needed for wide-scale document matching. HMRC
officials said that they may do limited manual document matching in
risk assessments and compliance checks. For example, HMRC manually
matches some taxpayer data--such as name, address, date of birth--from
bank records to corresponding data on tax returns. The closest form of
unique identifier that HMRC uses with some limitations is the national
insurance number. HMRC officials said they are barred from using the
national insurance number for widespread document matching, which
leaves HMRC with some unmatchable information returns.
Australia Uses a Compliance Program for High Net Wealth Individuals
That Focuses On Their Full Set of Business Interests to Improve
Compliance:
High wealth individuals often have complex business relationships
involving many entities they may directly control or indirectly
influence and these relationships may be used to reduce taxes
illegally or in a manner that policymakers may not have intended.
Australia has developed a compliance program that requires these
taxpayers to provide information on these relationships and that
provides such taxpayers additional guidance on proper tax reporting.
The Australian High Net Wealth Individuals (HNWI) program focuses on
the characteristics of wealthy taxpayers that affect their tax
compliance. According to the Australian Tax Office (ATO), in the mid-
1990s, ATO was perceived as enforcing strict sanctions on the average
taxpayers but not the wealthy. By 2008, ATO found that high-wealth
taxpayers, those with a net worth of more than A$30 million (US$20.9
million), had substantial income from complex arrangements,F which
made it difficult for ATO to identify and assure compliance. ATO
concluded that the wealthy required a different tax administration
approach.
ATO set up a special task force to improve its understanding of
wealthy taxpayers, identify their tax planning techniques, and improve
voluntary compliance. Due to some wealthy taxpayers' aggressive tax
planning, which ATO defines as investment schemes and legal structures
that do not comply with the law, ATO quickly realized that it could
not reach its goals for voluntary compliance for this group by
examining taxpayers as individual entities. To tackle the problem, ATO
began to view wealthy taxpayers as part of a group of related business
and other entities. Focusing on control over related entities rather
than on just individual tax obligations provided a better
understanding of wealthy individuals' compliance issues.[Footnote 13]
The HNWI approach followed ATO's general compliance model. The model's
premise is that tax administrators can influence tax compliance
behavior through their responses and interventions. For compliant
wealthy taxpayers, ATO developed a detailed questionnaire and expanded
the information on business relationships that these taxpayers must
report on their tax return. For noncompliant wealthy taxpayers, ATO is
to assess the tax risk and then determine the intensity of ATO's
compliance interventions.[Footnote 14]
According to FY 2008 ATO data, the HNWI program has produced financial
benefits. Since the establishment of the program in 1996, ATO has
collected A$1.9 billion (US$1.67 billion) in additional revenue and
reduced revenue losses by A$1.75 billion (US$1.5 billion) through
compliance activities focused on highly wealthy individuals and their
associated entities.[Footnote 15] ATO's program focus on high wealth
individuals and their related entities has been adopted by other tax
administrators. By 2009, nine other countries, including the U.S., had
formed groups to focus resources on high wealth individuals.
Like the ATO, the IRS is taking a close look at high income and high
wealth individuals and their related entities. As announced by the
Commissioner of Internal Revenue in 2009, the IRS formed the Global
High Wealth (GHW) industry to take a holistic approach to high-wealth
individuals. The IRS consulted with the ATO as GHW got up and running
to discuss the ATO's approach to the high wealth population, as well
as its operational best practices. As of February 2011, GHW field
groups had a number of high wealth individuals and several of their
related entities under examination.
One difference is that Australia has a separate income tax return for
high-wealth taxpayers to report information on assets owned or
controlled by HNWIs. In contrast, the U.S. has no separate tax return
for high-wealth individuals and generally does not seek asset
information from individuals. According to IRS officials, the IRS
traditionally scores the risk of individual tax returns based on
individual reporting characteristics rather than a network of related
entities.[Footnote 16] However, the IRS has been examining how to do
risk assessments of networks through its GHW program since 2009.
Another difference is that the ATO requires HNWIs to report their
business networks and the IRS currently does not.
Hong Kong Uses Semiannual Payments Instead of Periodic Employer
Withholding for the Salaries Tax:
Although withholding of taxes by payers of income is a common practice
to ensure high levels of taxpayer compliance, Hong Kong's Salaries Tax
does not require withholding by employers and tax administrators and
taxpayers appear to find a semiannual payment approach effective. Hong
Kong's Salaries Tax is a tax on wages and salaries with a small number
of deductions (e.g., charitable donations and mortgage interest). The
Salaries Tax is paid by about 40 percent of the estimated 3.4 million
wage earners in Hong Kong, while the other 60 percent are exempt from
Salaries Tax.
To collect the Salaries Tax, Hong Kong does not use periodic (e.g.,
biweekly or monthly) tax withholding by employers. Rather, Hong Kong
collects it through two payments by taxpayers for a tax year. Since
the tax year runs for April 1st through March 31st, a substantial
portion of income for the tax year is earned by January (i.e., income
for April to December), the taxpayer is to pay 75 percent of the tax
for that tax year in January (as well as pay any unpaid tax from the
previous year). The remaining 25 percent of the estimated tax is to be
paid 3 months later in April.
By early May, Inland Revenue Department (IRD)--the tax administator--
annually prepares individual tax returns for taxpayers based on
information returns filed by employers. Taxpayers review the prepared
return and make any revisions such as including deductions (e.g.,
charitable contributions), and file with IRD. IRD then will review the
returns and determine if any additional tax is due. If the final
Salaries Tax assessment turns out to be higher than the estimated tax
previously assessed, IRD is to notify the taxpayer who is to pay the
additional tax concurrently with the January payment of estimated tax
for the next tax year.
Hong Kong's tax system is positively viewed by tax experts,
practitioners, and a public opinion expert based on our discussions
with these groups. They generally believe that low tax rates, a simple
system, and cultural values contribute to Hong Kong's collection of
the Salaries Tax through the two payments rather than periodic
withholding. Tax rates are fairly low, starting at 2 percent of the
adjusted salary earned and not exceeding 15 percent. Further, tax
experts told us that the Salaries Tax system is simple. Few taxpayers
use a tax preparer because the tax form is very straightforward and
the tax system is described as "stable." Further, an expert on public
opinion in Hong Kong told us that taxpayers fear a loss of face if
recognized as not complying with tax law. This cultural attitude helps
promote compliance.
Unlike Hong Kong's twice a year payments for the Salaries Tax, the
U.S. income tax on wages relies on periodic tax withholding in which
tax is paid as income is earned. IRS provides guidance (e.g.,
Publication 15) on how and when employers should withhold income tax
(e.g., every other week) and deposit the withheld income taxes (e.g.,
monthly). Further, the U.S. individual tax rates are higher and the
system is more complex. These tax rates begin at 10 percent and
progress to 35 percent. Further, the U.S. taxes many forms of income
beyond salary income on the individual tax return.
IRS Considers Foreign Tax Practices That Might Merit Adoption:
IRS officials learn about foreign tax practices by participating in
international organizations of tax administrators. By doing so, IRS
officials say they regularly exchange ideas and learn about other
practices. As the IRS learns of these practices, it may adopt the
practice based on the needs of the U.S. tax system.
IRS is actively involved in two international tax organizations and
one jointly run program that addresses common tax administration
issues. First, the IRS participates with the Center for Inter-American
Tax Administration (CIAT), a forum made up of 38 member countries and
associate members, which exchange experiences with the aim of
improving tax administration. CIAT, formed in 1967, is to promote
integrity and transparency of tax administrators, promote compliance,
and fight tax fraud. The IRS participates with CIAT in designing and
developing tax administration products and with CIAT's International
Tax Planning Control committee.[Footnote 17] Second, the IRS
participates with the Organisation for Economic Co-operation and
Development (OECD) Forum on Tax Administration (FTA), which is chaired
by the IRS Commissioner during 2011. The FTA was created in July 2002
to promote dialogue between tax administrations and identify good tax
administration practices. Since 2002, the forum has issued over 50
comparative analyses on tax administration issues to assist member and
selected nonmember countries.
IRS and OECD officials exchange tax administration knowledge. For
example, the IRS is participating in the OECD's first peer review of
information exchanged under tax treaties and tax information exchange
agreements. Under the peer-review process, senior tax officials from
several OECD countries examine each selected member's legal and
regulatory framework and evaluate members' implementation of OECD tax
standards. The peer-review report on IRS information exchange
practices is expected to be published in mid 2011.
As for the jointly run program, the Joint International Tax Shelter
Information Centre (JITSIC) attempts to supplement ongoing work in
each country to identify and curb abusive tax schemes by exchanging
information on these schemes. JITSIC was formed in 2004 and now
includes Australia, Canada, China, Japan, South Korea, United Kingdom
and the U.S. tax agencies. According to the IRS, JITSIC members have
identified and challenged the following highly artificial arrangements:
* a cross-border scheme involving millions of dollars in improper
deductions and unreported income on tax returns from retirement
account withdrawals;
* highly structured financing transactions created by financial
institutions that taxpayers used to generate inappropriate foreign tax
credit benefits;[Footnote 18] and:
* made-to-order losses on futures and options transactions for
individuals in other JITSIC jurisdictions, leading to more than $100
million in evaded taxes.
To date, the IRS has implemented one foreign tax administration
practice. As presented earlier, Australia's HNWI program examines
sophisticated legal structures that wealthy taxpayers may use to mask
aggressive tax strategies. In 2009, the OECD issued a report on the
tax compliance problems of wealthy individuals and concluded that
"high net worth individuals pose significant challenges to tax
administrations" due to their complex business dealings across
different business entities, higher tax rates, and higher likelihood
of using aggressive tax planning or tax evasion.[Footnote 19]
According to an IRS official, during IRS's participation in the OECD
High Wealth Project in 2008, IRS staff began to realize the value of
this program to the U.S. tax system. As we stated, the IRS now has a
program focused on wealthy individuals and their networks.
Chairman Baucus, Ranking Member Hatch, and Members of the Committee,
this concludes my statement. I would be happy to answer any questions
you may have at this time.
Contacts and Acknowledgments:
For further information regarding this testimony, please contact
Michael Brostek, Director, Strategic Issues, on (202) 512-9110 or
brostekm@gao.gov. Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this
statement. Individuals making key contributions to this testimony
include Thomas Short, Assistant Director; Leon Green; John Lack; Alma
Laris; Andrea Levine; Cynthia Saunders; and Sabrina Streagle.
[End of section]
Footnotes:
[1] The Hong Kong Special Administrative Region is part of the
People's Republic of China. Throughout this statement we will use Hong
Kong as the abbreviation for this region.
[2] The Earned Income Tax Credit (EITC) is a refundable credit to
reduce individual income tax for certain people who work and have less
than $48,362 of earned income for tax year 2010. The amount of the
credit varies depending on the filing status and number of qualifying
children.
[3] To adjust foreign currencies to U.S. dollars, we used the Federal
Reserve Board's database on foreign exchange rates. New Zealand
dollars converted to U.S. dollars as of December 31, 2004.
[4] GAO, Opportunities to Reduce Potential Duplication in Government
Programs, Save Tax Dollars, and Enhance Revenue, [hyperlink,
http://www.gao.gov/products/GAO-11-318SP] (Washington, D.C.: Mar. 1,
2011).
[5] GAO, Government Performance And Accountability: Tax Expenditures
Represent a Substantial Federal Commitment and Need to Be Reexamined,
[hyperlink, http://www.gao.gov/products/GAO-05-690] (Washington, D.C.:
Sept. 23, 2005).
[6] Individuals who are members of the Evangelical-Lutheran Church or
the Orthodox Church pay a flat-rate church tax. Local church
communities determine the tax rate, which varies between 1 and 2
percent of taxable income. Individuals who are not members of either
church do not pay the tax.
[7] If the taxpayer fails to file a return and enough information
returns reporting income have been filed, the IRS can create a return,
based on that information and mails it to the taxpayer for acceptance
or adjustment. IRS prepares these returns under a compliance program
and the taxpayer may be assessed penalties.
[8] Under automatic information exchange, countries agree to routinely
provide information about tax-related transactions.
[9] These nations are the Swiss Confederation, the Principality of
Liechtenstein, the Republic of San Marino, the Principality of Monaco,
and the Principality of Andorra. The information upon request exchange
generally requires a specific justification for the information needed
by the requesting tax authority.
[10] U.S. agreements include tax treaties, tax information exchange
agreements, mutual legal assistance treaties, and mutual legal
assistance agreements.
[11] The Convention is in force among Azerbaijan, Belgium, Denmark,
Finland, France Iceland, Italy, the Netherlands, Norway, Poland,
Slovenia, Spain, Sweden, Ukraine, and the United Kingdom.
[12] We used rates that matched the time period cited for the foreign
amount. The currency conversion for the capital gains amount is as of
February 25, 2011.
[13] Australian dollars converted to U.S. dollars as of December 31,
2008.
[14] For more information on IRS's related entities program see GAO,
IRS Can Improve Efforts to Address Tax Evasion by Networks of
Businesses and Related Entities, [hyperlink,
http://www.gao.gov/products/GAO-10-968], (Washington, D.C.: September
24, 2010).
[15] Australian dollars converted to U.S. dollars as of December 31,
2007.
[16] GAO, IRS Can Improve Efforts to Address Tax Evasion by Networks
of Businesses and Related Entities, [hyperlink,
http://www.gao.gov/products/GAO-10-968] (Washington, D.C.: Sept. 24,
2010).
[17] Center for Inter-American Tax Administration, [hyperlink,
http://www.ciat.org].
[18] When JITSIC uncovered transactions used by large corporations to
generate inappropriate foreign tax credit benefits, the information
was shared among members. The IRS made the generator a compliance
concern for large corporations and has been pursuing these cases.
[19] OECD, Engaging with High Net Wealth Individuals on Tax
Compliance, 2008.
[End of section]
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