Collecting Taxes During an Economic Crisis: Challenges and Policy Options; by John Brondolo; IMF Staff Position Note SPN/09/17; July 14, 2009.

INTERNATIONAL MONETARY FUND

IMF STAFF POSITION NOTE

John Brondolo

Collecting Taxes During an Economic Crisis:

Challenges and Policy Options

SPN/09/17

July 14, 2009

INTERNATIONAL MONETARY FUND

Fiscal Affairs Department

Collecting Taxes During an Economic Crisis:

Challenges and Policy Options

Prepared by John Brondolo

Authorized for distribution by Carlo Cottarelli

July 14, 2009

The views expressed in this Staff Position Note are those of the authors and should not

be attributed to the IMF, its Executive Board, or its management.

JEL Classification Numbers: E62, G01, H26, H27

Keywords: Tax administration, Financial crisis, Collection of taxes

Authors’ E-Mail Addresses: [email protected]

The author benefited from the comments and support provided by many IMF colleagues, particularly Marco

Cangiano, Carlo Cottarelli, Dale Hart, Mark Horton, Michael Keen, Victoria Perry, Cemile Sancak, and Juan

Toro. Helpful comments and guidance were also provided by officials from the Australian Taxation Office,

Chilean Internal Revenue Service, Danish Revenue Agency, Hungarian Tax and Financial Control Agency,

Inland Revenue Authority of Singapore, Netherlands Tax and Customs Administration, New Zealand Inland

Revenue Department, U.K. HM Revenue and Customs Department, and U.S. Internal Revenue Service.

Contents Page

Executive Summary ...................................................................................................................3

I. Introduction ............................................................................................................................4

II. The Economic Crisis and Its Implications for Tax Administration ......................................4

A. The impact of an economic downturn on taxpayer compliance ...............................5

B. A tax compliance strategy for the crisis ....................................................................7

III. Expanding Assistance to Taxpayers ....................................................................................9

A. Implementing government tax initiatives ...............................................................10

B. Adjusting advance payments...................................................................................11

C. Accelerating the issuance of refunds.......................................................................11

D. Making greater use of payment extensions.............................................................12

E. Providing targeted and proactive assistance............................................................13

IV. Refocusing Enforcement ...................................................................................................14

A. Safeguarding revenue collection from large taxpayers...........................................15

B. Securing tax withholding ........................................................................................15

C. Intensifying arrears collection.................................................................................17

D. Giving greater attention to loss-reporting businesses .............................................18

E. Enhancing the scrutiny of cross-border transactions...............................................19

F. Containing the cash economy..................................................................................21

V. Reforming Legislation ........................................................................................................22

VI. Enhancing Communication ...............................................................................................23

VII. Financial Sector Issues .....................................................................................................24

Reference ................................................................................................................................35

Figures

1. VAT Efficiency and Output Gap .........................................................................................16

Appendixes

1. Singapore: Managing Tax Arrears During a Financial Crisis .............................................27

2. Main Elements of a Refund Verification Program ..............................................................28

3. Australia: Cash Economy Strategy ......................................................................................29

4. New Zealand: Industry Partnership Program.......................................................................32

5. South Africa: Tax Agency-Banking Association Accord....................................................33

XECUTIVE SUMMARY

The global financial and economic crisis presents major challenges for tax administration.

With the economic downturn, tax agencies are encountering growing compliance risks and

greater demands for taxpayer support in the face of prospective budget cuts. This paper

examines these challenges and sets out a strategy and measures for responding to them.

Theoretical and empirical studies suggest that an economic downturn tends to worsen

taxpayer compliance in important aspects. While a drop in compliance may have some

countercyclical effects on the economy, tolerating noncompliance is not an appropriate

response to the crisis because it is distortionary, inequitable, and, perhaps most importantly,

hampers the rebuilding of tax bases over the medium-term.

In responding to the crisis, the paper encourages tax agencies to develop a tax compliance

strategy that is structured around two objectives: containing the growth in noncompliance

and helping taxpayers to cope with the crisis. To achieve these objectives, four sets of

measures are identified: (1) expanding assistance to taxpayers, (2) refocusing enforcement

on the highest revenue risks, (3) introducing legislative reforms that facilitate administration,

and (4) improving communication and outreach programs. Some measures—such as tax

amnesties and moratoria on audits—are counterproductive and should be avoided.

In implementing the proposed strategy, countries should keep in mind a number of key

points. First, early warning of emerging compliance risks is crucial for their mitigation.

Second, a high-level group needs to be established within the tax agency to coordinate the

development of the crisis strategy. Third, government support for tax administration is more

important than ever during a crisis. Finally, tax agencies should align their near-term

compliance strategies and medium-term modernizations plans.

I. I

NTRODUCTION

1. The current global financial and economic crisis presents major challenges to

revenue administration in many countries.

With worsening economic conditions, tax

agencies around the world face growing compliance risks involving such issues as tax

arrears, loss-reporting businesses, tax withholding, and the cash economy. At the same time,

agencies are being asked to provide taxpayers with additional support and assistance to help

them cope with their obligations. And complicating their response to the crisis, some tax

agencies face prospective budget cuts as governments wrestle with increasing fiscal

pressures.

2. In this context, this paper examines the emerging challenges to tax collection and

the measures for addressing them. The rest of the paper is structured as follows: Section II

assesses the implications of the economic crisis for tax administration and lays out a general

strategy for tax agencies to respond to the crisis. Sections III-VI provide examples of

measures to underpin the strategy, drawing on the experience from several leading tax

agencies and the work of the IMF. Finally, Section VII highlights emerging compliance risks

in the financial sector, which has come under severe economic stress in several countries.

II. T

HE ECONOMIC CRISIS AND ITS IMPLICATIONS FOR TAX ADMINISTRATION

3. The global economic crisis has led to a substantial decline in government

revenue relative to gross domestic product (GDP) in many countries, which seems likely

to continue for some time. For many countries, the revenue decline began in 2008 when

general government revenue dropped by an average of 0.8 percentage point of GDP

worldwide.

This decline appears to have accelerated in 2009: the annualized tax yield

decline averaged 4 percentage points of GDP across selected emerging and developing

economies in the first quarter of 2009.

4. Many different, but interrelated, factors could cause revenue to decline in

relation to GDP. Three particularly salient factors are (1) the tendency of some tax bases to

decline faster than GDP in the face of an economic downturn,

(2) a decline in commodity

prices and related revenues, and (3) discretionary changes in tax policy. A fourth factor that

The overall fiscal implications of the crisis are described in IMF (2009a). Crisis-related issues in tax policy are

set out in IMF (2009b).

Source: IMF (2009c).

Staff estimates based on 16 emerging and developing economies, for which revenue data were available for

the first quarter of 2009.

Profits, capital gains, excises, and imports tend to decline faster than GDP during a recession.

may significantly affect revenue performance in a crisis, however, has received less

attention: the possibility of changes in taxpayer compliance, which is the central focus of this

paper.

A. The impact of an economic downturn on taxpayer compliance

5. Noncompliance takes different forms, including individuals and businesses that

(1) engage in taxable transactions without having registered with the tax authorities, (2) fail

to file their tax returns by the statutory filing deadline, (3) underreport their tax liabilities or

illicitly claim tax refunds, or (4) underpay the amount of taxes due (tax arrears).

These forms

of noncompliance give rise to a tax gap representing foregone government revenue; reducing

this gap is an integral task for tax agencies both in good and bad economic periods.

6. Although some aspects of taxpayer compliance may actually improve during an

economic downturn, there is good reason to believe—as many tax administrators do—

that compliance will worsen in important respects. The basic models of income tax

compliance suggest compliance might in some respects improve as incomes fall during a

recession, both because individuals may become less willing to take the risk involved in

cheating on their taxes

and as a consequence of progressivity in the tax code.

The latter

means that a reduction in income implies a lower marginal tax rate—which leaves a smaller

gain from and, hence less incentive for, not declaring that income. Thus, some taxpayers’

compliance may actually improve. Other considerations, however, clearly point to an

increased risk of noncompliance:

x When credit is tight or unavailable, credit-constrained taxpayers may be tempted to

use tax evasion as an alternative source of finance for their operations. For example,

businesses may fail to remit to the government the taxes they have withheld from

their customers (value-added tax—VAT) or employees (payroll taxes).

x Taxpayers who face severe economic stress—such as the risk of bankruptcy—may

perceive the downside risks of tax evasion (penalties) to be minimal compared with

the potential upside gains (avoiding bankruptcy). Indeed it can be shown, for

Noncompliance also involves tax avoidance schemes through which taxpayers aim to reduce their tax

liabilities by means of arrangements that may be legal but usually contradict the intent of the law they purport to

follow.

See Brondolo, Silvani, Le Borgne, and Bosch (2008).

In the benchmark model of Allingham and Sandmo (1972), a fall in income leads to reduced evasion—both

absolutely and relative to income—if, as is normally assumed to be the case, relative risk aversion increases

with decreases in income.

Slemrod (2001).

instance, that if the bankruptcy costs are large enough, this effect—gambling for

resurrection by becoming less tax compliant—can outweigh the progressivity

consideration noted above.

x If an economic crisis leads to a shift in economic activity from the formal to the

informal sector, compliance is likely to decline, since it is widely recognized

(virtually by definition) that the rate of noncompliance is much higher in the informal

sector.

These conditions, moreover, may be reinforced by social norms: in a recession, taxpayers

may perceive (1) the tax agency to be less stringent in enforcing the tax laws or (2) that other

people are evading taxes more, making it less risky or more socially acceptable to evade

taxes themselves.

7. Empirical evidence on the impact of recession on taxpayer compliance is sparse,

but tends to confirm the likelihood of some worsening. The most comprehensive empirical

study on the determinants of individual income tax compliance in the United States (Plumley,

1996) found that taxpayers’ filing and reporting compliance are negatively correlated with

the unemployment rate.

There is also evidence that credit constraints reduce taxpayer

compliance. A recent study of close to 190,000 Chinese industrial firms (Cai and Liu, 2009)

shows that corporate income tax evasion is negatively correlated with access to credit,

suggesting that compliance can be expected to decline when an economic downturn is

combined with tight credit conditions. Another recent study (Schneider, 2009) reports that

the ongoing crisis will increase the shadow economy in 21 Organization for Economic

Development and Cooperation (OECD) countries by an average of 0.5 percent of GDP

during 2009 after a decline each year since 2001.

Finally, an ongoing study by the IMF’s

Fiscal Affairs Department has found evidence that VAT compliance tends to worsen as the

(negative) output gap grows.

8. The balance of evidence, as set out above, suggests that compliance could

reasonably be expected to decline during the ongoing crisis. It is even more probable that

the crisis will shift the incidence of noncompliance toward the sectors most affected by the

downturn

or cause some forms of noncompliance to become more pronounced. Both

In the U.S. study, filing compliance is measured by the percentage of tax returns that are filed on time,

whereas reporting compliance is defined as the proportion of income reported by taxpayers and the amount of

personal income in the national income accounts.

Schneider estimates the shadow economy in 21 OECD countries to have been equivalent to (an unweighted)

16.7 percent of GDP in 2001, 13.3 percent of GDP in 2008, and 13.8 percent of GDP in 2009.

See Section IV.B below.

In some countries, the real estate, finance, and automobile sectors have been hit particularly hard by the crisis.

situations—the possibility of compliance decline and the probability of a shift in the

incidence of noncompliance—warrant the attention of tax agencies.

9. A drop in taxpayer compliance may have some countercyclical effects on the

economy, but complicates fiscal management, and tolerating noncompliance is not an

appropriate response to the crisis. Tax-based automatic stabilizers and discretionary tax

policy changes can help dampen the negative effects of an economic downturn. For this same

reason, it could be argued that tax agencies should condone higher levels of noncompliance

during a crisis, since this could provide an additional boost to the economy. Indeed, such a

weakening of compliance has some attractive features in purely countercyclical terms,

especially where formal automatic stabilizers are weak: it is relatively quick acting (no

legislative changes are needed) and it may be self-targeted in the sense that those most in

distress will presumably be most likely, all else equal, to become less compliant. There are,

however, many serious objections to this argument. If a fiscal expansion is required, and

there is sufficient fiscal room, stimulus is best provided in a transparent and rule-based

manner, not by allowing some taxpayers to get away with noncompliance, which would be

unfair and distortionary. Moreover, and perhaps most important, the revenue decline might

not be temporary, because once noncompliance becomes entrenched within the taxpayer

population it tends to carry forward to future periods. This would make it harder to rebuild

the tax bases as the economy rebounds, which may be needed to support fiscal consolidation

over the medium-term.

B. A tax compliance strategy for the crisis

10. To address the emerging challenges to revenue administration, tax agencies

should develop a tax compliance strategy for the economic crisis. Like all good strategies,

this should be based on clear objectives and an appropriate set of measures for achieving

them.

11. A tax agency’s fundamental objective during an economic crisis should be to

contain a rise in noncompliance. If left unchecked, the rising tide of noncompliance could

lead to substantial foregone revenue as well as provide an unfair competitive advantage to

noncompliant businesses. Containing noncompliance in a crisis requires tax agencies to

adjust their taxpayer services and enforcement program for newly emerging compliance

risks.

12. A second objective should be to help taxpayers cope with the pressures of the

crisis. During a crisis, many viable businesses can be expected to experience severe financial

stress that could cause them to cease their operations and exit the tax system, resulting in

permanent revenue losses. Measures that could enhance the probability of taxpayers staying

in the tax system include adjusting advance payments, accelerating tax refunds, and making

greater use of payment extensions. To the extent that these measures provide an element of

fiscal stimulus, decisions on their introduction should be made at an appropriate level within

the government and factored into the country’s overall economic program for the crisis.

13. To achieve these objectives, supporting measures are needed. These can be

grouped under four pillars:

x expanding assistance to taxpayers,

x refocusing enforcement on the emerging areas of noncompliance that pose the

greatest risk to revenue collection,

x enacting legislative reforms that facilitate administration, and

x improving communication with the taxpayer population.

Although these pillars apply broadly in normal economic times, what distinguishes them in a

crisis is that their underlying measures should be focused on issues specific to the crisis.

14. The measures should be tailored to the compliance risks in each country.

Subsequent sections provide examples of measures that some tax agencies are implementing

in response to the crisis. These are not meant to be exhaustive or prescriptive for all

countries, but instead illustrate the types of actions that countries may consider. Before

proceeding, it is worth making several preliminary points.

15. First, early warning for shifts in taxpayer compliance is crucial for prevention.

The sooner a tax agency can identify an up tick in noncompliance, the faster it can respond.

Few tax agencies, however, have the capacity to estimate the precise level of the overall tax

gap. In this situation, tax agencies should identify and track compliance indicators that can be

more easily measured, such as increases in late filing of tax returns, growth in tax arrears,

and taxpayers’ attitudes toward compliance as measured by surveys.

16. Second, tax agencies should establish a high-level group to coordinate the

development of the tax compliance strategy. This group, which could be either an ad hoc

or permanent body, should comprise the tax agency’s senior management, include a small

staff, and interact closely with the operational departments. Its main responsibilities should

be to confirm the emerging revenue risks, coordinate the development of appropriate

treatments for these risks, ensure that the compliance strategy is properly planned and

resourced, and monitor results. Although such a high-level group should also exist in normal

times, it needs to operate in a more proactive, streamlined, and focused manner during a

crisis.

Some tax agencies also estimate the tax gap for the VAT using national accounts data, which is considerably

easier to calculate than the tax gap for income taxes.

17. Third, government support for tax administration is critical during the crisis.

Like all government agencies, tax agencies face the prospect of declining budget allocations

in an economic downturn as governments seek to create fiscal room for high-priority social

expenditures. However, it should be recognized that the task of tax administration becomes

more demanding during difficult economic times. In this situation, substantial cuts in tax

agencies’ budgets are likely to reduce the effectiveness of tax collection and further

aggravate a decline in revenue.

18. Finally, tax agencies should align their near-term compliance strategies and

medium-term modernization plans. Sustaining revenue collection over the medium term

will require tax agencies to address their most fundamental weaknesses (e.g., poor

organizational and staffing arrangements, weak taxpayer services and enforcement programs,

and outdated information systems). By their nature, such problems can be addressed only

over the medium term, but in developing a compliance strategy for the economic crisis, tax

agencies should not neglect their medium-term goals.

III. E

XPANDING ASSISTANCE TO TAXPAYERS

19. The first element in a tax compliance strategy for an economic crisis is to expand

assistance to taxpayers. Providing strong support to individuals and businesses is critical to

containing noncompliance and keeping taxpayers in the system. To this end, tax agencies

should review and adjust their full range of policy instruments, services, and information

products. Five measures are of particular importance:

x ensuring the smooth implementation of government tax initiatives, particularly those

involving stimulus programs;

x adjusting advance tax payments to reduce taxpayers’ cash-flow pressures;

x accelerating the issuance of tax refunds, subject to proper risk management;

x making greater use of payment extensions; and

x providing targeted and proactive assistance to high-risk taxpayers.

20. Some forms of taxpayer assistance are counterproductive and should be avoided.

In an effort to help taxpayers cope with the crisis, some countries are considering the

implementation of tax amnesties, moratoria on auditing taxpayers, and other similar

measures. International experience has shown that such measures are not effective tools for

improving revenue collection and create perverse incentives for currently compliant

taxpayers to stop complying with the tax laws (Baer and Le Borgne, 2008).

A. Implementing government tax initiatives

21. A number of tax agencies have been required to implement tax-based stimulus

initiatives. These initiatives commonly include tax rate cuts, new credits, and rebates. Recent

experience from the United States offers lessons in implementing such measures. In 2008,

the United States enacted the Economic Stimulus Act (ESA), which provided tax rebates to

low- and middle-income households. ESA mandated that the Internal Revenue Service (IRS)

begin issuing more than 100 million stimulus payments within about 12 weeks of its

enactment on February 13, 2008.

22. The IRS is considered to have successfully implemented the 2008 tax rebate

program, though at some cost to other activities.

As of September 2008, it had issued

more than 117 million stimulus payments, with a payment accuracy rate of 99.6 percent,

totaling US$94 billion, and responded to more than 118 million telephone calls relating to the

payments. Despite this general success, some complications arose during the implementation

process, stemming mainly from the program’s tight implementation schedule, which did not

provide the IRS with sufficient time to hire, conduct background checks, and train additional

staff for various aspects of the program. Instead, the IRS shifted hundreds of staff from

arrears collection activities to telephone services for refunds. Nonetheless, the level of

telephone service (defined as the percentage of calls answered by an IRS representative)

dropped sharply from the filing season target of 82 percent to 50–55 percent. In addition, the

reallocation of staff from arrears collection is estimated to have resulted in some

US$650 million in foregone arrears recovery.

23. The IRS’ experience points to a number of lessons that should be considered

when designing a tax rebate program. First, tax rebates can be handled more easily in

countries where individual refunds are a normal part of the tax system. Second, the

complexity of implementing a tax rebate program varies with the intricacies of the rules for

determining eligibility and the amount of the tax rebate. Third, a tax rebate program can be

implemented more easily and effectively outside the peak period for filing tax returns.

Fourth, a rebate program requires a comprehensive taxpayer register with sufficient data to

determine eligibility.

All these lessons confirm the importance of adequately designing,

planning, and managing a tax rebate program.

See MITRE Corporation (2008) and GAO (2008).

Such a register is more common in countries that require most people to file an annual tax return (e.g.,

Australia, Canada, United States). In countries where the tax agency does not maintain a universal taxpayer

security agency).

B. Adjusting advance payments

24. Some advance payment programs may exacerbate taxpayers’ cash flow

problems during an economic downturn. In most tax systems, businesses and the self-

employed individuals must make advance income tax payments during the year and a final

payment at year-end. If advance payments are calculated on the basis of the previous year’s

tax liability, an economic downturn will generally cause advance payments to be higher than

necessary, thereby aggravating taxpayers’ cash flow pressures.

25. To mitigate this problem, advance payments could be adjusted to more closely

approximate the taxpayer’s final tax liability. For example, payments could be calculated

as the product of current period sales and the ratio of the previous year’s tax liability to sales.

Alternatively, taxpayers could be permitted to calculate their advance payments, not based on

the previous year’s liability, but instead by estimating revenue and expenses for the current

year. In the latter case, the tax laws should (as they commonly do) impose a penalty if

advance payments prove to be significantly lower than the full-year tax liability.

26. A number of countries are taking steps in this direction. For example, Chile’s

advance payment system requires businesses and self-employed persons to calculate advance

payments as a fixed percentage of their current period sales. In applying this rule in 2009, the

authorities will allow taxpayers to reduce the amount of advance payments by 15 percent if

their gross income was equal to or less than about US$3.6 million in 2008 and by 7 percent if

gross income was above this threshold or if the business started operations after January 1,

2008. Similarly, Australia reduced its pay-as-you-go tax for qualified small businesses by 20

percent for the quarter that includes December 31, 2008.

C. Accelerating the issuance of refunds

27. Tax refunds can provide vital cash flow relief to financially distressed taxpayers.

Recognizing this, some tax agencies have accelerated issuance of all or part of tax refunds.

For example, Chile has recently introduced a reform allowing individuals to receive part of

their personal income tax refund six months before the close of the tax year, with the balance

issued at the end of the tax year.

Poland has recently reduced the statutory deadline for

issuing VAT refunds from 180 to 60 days. In a similar move, the United States has

liberalized the refunding of losses: small businesses are now permitted to carry back their net

operating losses to get a refund of taxes paid over the past five years instead of the usual two.

28. Tax refunds can be issued more quickly by streamlining refund management

processes. This can be done by assigning priority to processing tax returns that involve a

Specifically, taxpayers are entitled to receive an advance refund of 50 percent of the average refund received

in the three most recent tax years.

refund claim, temporarily reallocating staff to refund operations from other activities and

eliminating the requirement to audit all refund claims (where such a practice is required). To

reconcile the objectives of accelerating refunds and avoiding fraudulent claims, some tax

agencies are adopting (or refining) risk-based systems to select the most questionable claims

for audit and are also making greater use of post-refund audits (where the claim is audited

after the refund has been paid) for lower-risk claims while reserving pre-refund audits (where

the claim is audited before the refund is paid) for higher-risk claims.

29. Regrettably, some governments routinely delay the payment of refunds without

proper cause and without subsequent payment of interest. In some cases, the delays

appear to be a deliberate policy decision of using refund arrears to help achieve the

government’s budget targets and cash flow objectives. In other cases, the payment arrears

reflect poor administrative processes. Either way, such practices are highly counterproductive

in that they aggravate taxpayers’ cash flow problems at the worst possible time and

encourage them to withhold tax payments from the government. To avoid these problems,

governments should make adequate budgetary provisions for refund payments.

30. Cash flow relief can also be provided by deferring VAT payments for imported

capital goods. On this issue, some countries allow registered VAT taxpayers, who meet

certain standards, to defer VAT payment for large amounts of imports of capital goods. The

details for such programs are spelled out in Ebrill (2001; Chapter 15). It should be noted,

however, that deferral schemes are subject to abuse and revenue leakage if not carefully

administered. Therefore, they are best implemented in countries with strong revenue

administrations and should be restricted to taxpayers with proven compliance histories and

who post a financial security (e.g. a bond).

D. Making greater use of payment extensions

31. Installment arrangements provide an important tool for collecting tax revenue

from cash-strapped taxpayers. The tax laws in many countries include provisions that

allow financially distressed taxpayers, under certain conditions, to pay their tax liabilities in

installments. The installments typically span one to two years during which time interest

accrues but late payment penalties are usually waived. Such arrangements help promote

compliance because they allow the tax agency to bring a tax debt quickly under control and

usually require the taxpayer to stay current with all future tax payments; failure to do so

results in the plan’s termination and severe collection actions.

32. During a crisis, when increasing numbers of taxpayers face serious cash-flow

problems, a case can be made for greater use of installment arrangements for viable

businesses. By extending the timing of payment, installments have the potential to recover

Approaches for combating refund fraud are described in Section IV.B and Appendix 2.

more revenue from distressed taxpayers over the medium term and to keep viable businesses

afloat. The Inland Revenue Authority of Singapore provides a good example of introduction

of an enhanced installment program during a financial crisis (Appendix 1).

33. In some countries, the effective use of installment arrangements is constrained

by legal requirements or administrative practices that allow them only after exhausting

all other efforts at recovering the tax. To overcome this, criteria could be established under

which a taxpayer would be automatically entitled to an installment plan. These could include

the following:

x The taxpayer has submitted a financial statement that demonstrates (1) the viability of

the business and (2) an inability to fully pay the tax liability in the short term.

x The amount of the tax liability does not exceed a prescribed threshold.

x The taxpayer has filed all tax returns, has not failed to pay any tax within the past

three years, and has not recently entered into an installment plan.

In this connection, Hungary has recently granted all individual taxpayers (physical persons)

an automatic right to an installment plan for tax debts less than Ft 100,000 (approximately

€340), which must be paid in equal monthly installments over four months.

E. Providing targeted and proactive assistance

34. In responding to the crisis, some tax agencies are providing more targeted and

proactive assistance to taxpayers. Targeted assistance aims at focusing the tax agency’s

limited resources on taxpayers and tax issues that present significant compliance risks as a

result of the crisis. Proactive service delivery also becomes more important in an economic

downturn because taxpayers at the highest risk for noncompliance are frequently the most

reluctant to seek the tax agency’s assistance. Two good examples of this approach are the

Australian Taxation Office (ATO) small business program and the IRS volunteer income tax

assistance program.

35. The ATO Small Business Assistance Program, created in 2007, provides targeted

assistance to small businesses at various stages of the business’ life cycle. It aims to help

businesses understand their registration requirements and how to comply with their tax

obligations (particularly VAT and employer withholding) and improve their business record

keeping. The program has recently been refined to provide more proactive assistance to high-

risk taxpayers, including by sending text message reminders to previous late filers in

particular demographic groups. In the current crisis, the program is being further refined by

using the ATO’s profiling capabilities to identify taxpayers considered at risk for financial

distress and contacting them by telephone to offer assistance before they have failed to meet

a tax obligation.

36. The ATO approach is based on the premise that preventing noncompliance is

more cost effective than curing it. ATO has found that if it waits for the normal

enforcement cycle to run its course—for example, by issuing a series of reminder letters to

taxpayers who have missed a filing or payment date—too many taxpayers will fall too far

behind in their taxes for there to be much chance of recovering the revenue. The ATO

approach mirrors a key lesson learned by leading companies in emerging markets when faced

with an economic downturn: keeping existing customers is a lot easier than trying to attract

new ones (Roth and Ettenson, 2009).

37. Tax agencies may need to provide additional tax services to offset the decline in

the use of professional tax advice. Developments in the United States suggest that taxpayers

are cutting back on their use of professional tax advice in the face of the economic decline. In

a recent media release, the largest U.S. tax return preparation company reported that for the

period ended April 15, 2009, total tax returns prepared fell by 667,000 returns (H&R Block,

2009b). The company believes that this shift is driven primarily by increased price sensitivity

of taxpayers because of current economic conditions (H&R Block, 2009a).

38. Some tax agencies are relying on volunteers to meet the growing demand for tax

services in the face of a fixed budget. For example, the IRS operates the Volunteer Income

Tax Assistance (VITA) program, which offers free tax help to low- to moderate-income

(generally, US$42,000 and below) people who cannot prepare their own tax returns. Under

this program, certified volunteers sponsored by various organizations receive training to help

prepare basic tax returns. VITA sites are located at community and neighborhood centers,

libraries, schools, and shopping malls. The number of tax returns prepared under the VITA

program increased by about 2.2 percent during the 2009 filing season, which helped offset

some of the decline in tax returns prepared by private sector tax professionals.

39. Targeted assistance is also required for large businesses. Although large taxpayers

usually possess sufficient expertise to address most tax issues, the crisis may raise many new

issues. For example, tax losses, payouts to laid-off workers, and capital-raising operations all

involve tax issues that are particularly relevant to the large-taxpayer segment in an economic

downturn. To avoid a possible misapplication of the tax law, tax agencies should proactively

convey their positions on these issues to large taxpayers through e-mail alerts, websites, and

discussions with corporate executives and tax professionals.

IV. R

EFOCUSING ENFORCEMENT

40. A tax compliance strategy for the economic crisis also needs to adjust

enforcement programs for emerging compliance problems. Controlling noncompliance in

a crisis environment will require enhanced enforcement in six directions (with the varying

specific emphasis, depending on country circumstances):

x safeguarding revenue from the largest taxpayers by reassessing the controls over this

segment in light of the crisis,

x intensifying arrears collection,

x securing tax withholding,

x giving greater attention to loss-reporting businesses,

x enhancing the scrutiny of cross-border transactions and offshore evasion, and

x containing the growth of the cash economy.

A. Safeguarding revenue collection from large taxpayers

41. Ensuring tight control over large taxpayers should be considered a top priority

by tax agencies during a crisis. In almost every country, a relatively small number of

taxpayers collectively account for the largest portion of tax revenue. This revenue

concentration poses a particularly significant risk in a crisis, since a decline in compliance by

just a few large taxpayers can lead to large amounts of foregone revenue.

42. To reduce the risks posed by large businesses, tax agencies should reassess their

controls over this taxpayer segment by

x consolidating the number of large taxpayer offices (LTO) and ensuring that they

report directly to a senior headquarters official instead of through a regional tax

office;

x reviewing the selection criteria for assigning taxpayers to the LTO to ensure that the

LTO controls, say, at least 60 percent of the tax base;

x increasing the number of LTO staff, particularly auditors, in line with any increase in

the number of taxpayers assigned to the LTO;

x shifting the focus of the LTO audit program toward industries most affected by the

crisis and making greater use of issue-specific audits to broaden audit coverage; and

x introducing or expanding the use of industry specialists at the LTO, including for

financial products, valuation, and computer-aided audit methods as well as for

complex issues that span industries, such as transfer pricing, thin capitalization, and

tax losses.

B. Securing tax withholding

43. Withholding taxes present a high risk to revenue collection during a crisis. This

is because increasing numbers of credit-constrained businesses can be expected to illicitly

retain the taxes they withhold from their customers (VAT) or employees (payroll taxes) to

finance their ongoing operations.

44. VAT efficiency—a measure of the effective coverage of the VAT—tends to

decline during an economic downturn, which is suggestive of a decline in VAT

compliance. A panel regression of the VAT C-efficiency ratio on the output gap points to a

positive and significant correlation between the two variables for European Union countries

during 1995–2008 (Figure 1).

Furthermore, there is a positive correlation for the majority of

the countries in the sample, when each country is examined separately. The positive

correlation may reflect a decline in taxpayer compliance during an economic downturn.

Sources: Eurostat; and IMF staff estimates.

C-efficiency is defined as the ratio of VAT revenue to consumption per point of the standard VAT rate; a

positive output gap means output above trend.

The decline in VAT C-efficiency could also reflect shifts in consumption patterns. For example, as incomes

go down, the share of consumption of “necessity” goods, which tend to be taxed at a low rate, goes up.

100

120

VAT efficiency (percent)

-5

0 5

Output gap (percent)

EU countries, 1995-2008

Figure 1. VAT Efficiency and Output Gap

45. Because tax withholding accounts for a large revenue share in many countries

and payment of these taxes to the government tends to decline in a crisis, tax agencies

should take steps to strengthen enforcement in this area. Measures could include

broadening audit coverage for tax withholding, assigning higher priority to recovery of

arrears involving these taxes, enhancing the exchange of information with other agencies

(e.g., customs, social insurance funds) that play a role in administering tax withholding, and

reviewing or increasing penalties.

46. The VAT refund mechanism is particularly vulnerable to abuse during a crisis,

since increasing numbers of cash-constrained businesses may be tempted to file illicit

refund claims. A tax agency’s capacity to prevent fraudulent claims, while ensuring the

timely issuance of legitimate ones, depends on a well-designed and -executed audit strategy.

This involves a few simple principles: (1) distinguishing between refund claimants with a

good compliance history and those with poor or unknown compliance histories, (2) using

pre-refund audits for high-risk refund claims and post-refund audits for claims of lower risk,

(3) applying analytical criteria to determine the likely extent of revenue risk associated with

each refund claim, and (4) focusing the scope of a refund audit on issues material to the

refund claim (see Appendix 2).

C. Intensifying arrears collection

47. Tax arrears tend to rise sharply during an economic downturn. Tax agencies

should consider liberalizing the use of payment arrangements to assist distressed taxpayers

(see Section III), but firm enforcement action should be taken against businesses that have

the capacity to pay their taxes but refuse to do so.

48. Good debt collection practices are even more important during a crisis. This is

because the window for collecting tax debts may close more quickly in a recession, when

taxpayers’ cash-flow problems worsen and bankruptcies increase.

In this situation, it is

essential for tax agencies to (1) ensure early detection of tax arrears and establish appropriate

time standards for follow-up, (2) maintain the quality and timeliness of tax arrears data,

(3) target enforcement efforts on recoverable arrears—usually by focusing on the most recent

and largest arrears first, (4) leverage the telephone context center to place outgoing debt

collection calls, (5) write off arrears deemed unrecoverable, (6) implement proper

organizational and staffing arrangements for collection enforcement, including a greater

organizational focus for large tax debts, and (7) be vested with a full set of enforcement

powers.

International experience has shown that the probability of debt recovery declines rapidly when a debt remains

outstanding after 60–90 days.

49. In addition, tax agencies need to give greater attention to recovering tax arrears

from bankrupt companies. Bankruptcies present many challenges to debt recovery because

the collection process is normally taken out of the tax agency’s direct control and placed

under a country’s bankruptcy judicial system. To address these complexities, some tax

agencies are allocating more enforcement staff to bankruptcy cases; others are creating a

special bankruptcy unit within their debt collection departments. Some, like those in

Denmark, are working to improve coordination between the tax agency and the bankruptcy

court.

50. The number of taxpayers who fail to file a tax return can also be expected to rise

during an economic downturn. To cope with this problem, tax agencies should make

greater use of default assessments

in determining the tax liability while reserving audits

(which are more time consuming and difficult to estimate) for larger nonfiling cases. To

avoid the risk that default assessments will lead to large amounts of uncollectible tax debts,

the assessments should be screened for reasonableness before being issued to taxpayers.

D. Giving greater attention to loss-reporting businesses

51. Tax laws often include provisions that provide some relief for losses. Most

countries allow losses to be carried forward and offset against future income. Some countries

also permit losses to be carried back and refunded against taxes paid in earlier periods. In

addition, a number of countries allow losses to be transferred between firms in the context of

a merger. These provisions can provide a lifeline to distressed businesses as well as facilitate

corporate restructurings.

52. In an economic crisis, tax losses present a growing compliance risk. Some

businesses may declare illicit losses, believing that the tax agency cannot distinguish them

from bona fide losses in a general environment of decreased profitability. Failure to control

losses may put significant revenue at risk (loss carry forwards can generate tax deductions for

many years to come, loss carry backs can lead to immediate refunds, and loss transfers may

encourage inefficient trafficking in the sale of loss-making companies).

53. While permitting bona fide loss claims, tax agencies should give greater attention

to possible abuses by (1) verifying doubtful claims, particularly in cases of larger claims,

(2) determining whether the conditions and limitations have been correctly applied for

carrying forward, carrying back, and transferring losses, and (3) checking for possible

manipulation of losses by consolidated groups and partnerships. More generally, tax agencies

need to sharpen their audit focus on businesses that report tax losses year after year.

Default assessments establish the amount of tax owed by using information already available to the tax office,

such as by charging a multiple of the previous period’s tax assessment.

E. Enhancing the scrutiny of cross-border transactions

54. The crisis has brought cross-border compliance issues into sharper focus.

Globalization has been accompanied by a rise in international tax compliance issues, ranging

from legitimate but highly complex cross-border tax planning to deliberate concealment of

income and assets in tax havens. With the crisis, a number of tax agencies are strengthening

their enforcement efforts against cross-border noncompliance, including the abuse of

offshore tax centers.

55. Shifting offshore losses through nonmarket pricing is of growing concern. Recent

market events have led to losses, or lower-than-expected profits, for many multinational

groups. These groups will find incentives to report their losses in countries where they can be

used to best advantage (i.e., high-tax jurisdictions). In this situation, some tax agencies are

paying more attention to the illicit importing of losses through nonmarket pricing. For

example, increases in inbound management service charges with a view to recovering

increased global costs—without regard to the specific nature of the services received in the

home country and the related arm's length value of those services—are being more closely

reviewed.

56. Tax avoidance schemes involving repatriated funds are receiving increased

attention. Some tax agencies believe the crisis will create additional pressure for local

subsidiaries to repatriate funds to overseas parents. In addition to transfer-pricing concerns,

this may lead to adoption of aggressive tax practices concerning nonresident tax withholding

and foreign tax credit regimes. Similarly, a number of tax agencies have pointed out that

during previous recessions money was brought back from offshore bank accounts to support

small and medium-size businesses, which required investigation.

57. The crisis has also drawn attention to international tax evasion involving

offshore tax havens. In recent years, a significant increase in offshore activity has been

noted by some countries. For example, U.S.-based corporations more than tripled their total

foreign profits between 1994 and 2004, with 58 percent of that profit earned in low-tax or no-

tax jurisdictions (IRS, 2008a). The large amount of offshore assets combined with tax

havens’ limited cooperation on tax matters has raised concerns that substantial tax revenue

may be at risk, either through unintended loopholes that allow companies to legally avoid

paying taxes or through the illegal use of hidden accounts by individuals. These concerns

have intensified with the deteriorating fiscal balances in a number of countries.

58. At their April 2009 meeting in London, G-20 leaders called on countries to adopt

the international standard for exchanging tax information (G-20, 2009).

At the same

The internationally accepted standard, developed under the auspices of the OECD, requires exchange of

information on request in all tax matters for the administration and enforcement of all domestic tax law without

regard to a domestic tax interest requirement or bank secrecy for tax purposes. It also provides safeguards to

(continued)

time, they made clear that they stood ready to take action against jurisdictions that do not

meet the international standard. To this end, G-20 countries have agreed to develop a toolbox

of countermeasures against noncooperative jurisdictions, including increased disclosure

requirements on transactions involving noncooperative jurisdictions, tax withholding on a

wide variety of payments, and denial of tax deductions for expense payments to payees

resident in a noncooperative jurisdiction.

59. In the lead-up to and aftermath of the London meeting, a raft of additional

countries (including several tax haven countries) committed themselves to adopting the

international standard for exchanging tax information.

For these countries, the priority

now shifts to fully implementing their commitments by swiftly negotiating, concluding, and

introducing tax information exchange agreements or through the exchange of information

articles of double-taxation agreements. A key issue here is to ensure that non-OECD

countries share with OECD countries in the benefits of the new cooperative tax environment.

60. In this situation, additional countries should adopt and fully implement the

international standard for exchanging tax information. It is recognized that some low-

income countries may face many difficulties in implementing the international standards and

responding to requests for information. These countries may require support from the

international community, through technical assistance and/or cost-sharing arrangements, in

order to effectively fulfill their commitments to exchange tax information.

61. In addition, tax agencies should strengthen their international enforcement

programs by (1) developing a targeted audit program to address cross-border evasion;

(2) expanding the number of audits of international issues, increasing the number of

international tax auditors (particularly within the LTO), and providing greater technical

guidance to auditors on international issues; (3) increasing disclosure requirements on

international transactions;

(4) publishing warnings on specific international tax planning

protect the confidentiality of the information exchanged. This standard was endorsed by the G-20 in 2004 and is

reflected in the UN Model Tax Convention. See G-20 (2009).

As of June 24, 2009, the OECD reported that all 84 countries surveyed by the Global Forum on Transparency

and Exchange of Information have agreed to the internationally accepted standard, and more than half have

substantially implemented it (OECD, 2009).

Disclosure requirements may involve resident taxpayers’ foreign transactions and/or their relationship with

foreign affiliates. Regarding foreign transactions, some tax agencies require taxpayers—when seeking a

deduction in their tax return for payments of interest, royalties, and with respect to patent rights, trademarks,

etc.—to report the name of the country to which these payments have been made and the amount of the

payment. In addition, some tax agencies require taxpayers to report new offshore bank accounts, the

establishment of foreign trusts, or the acquisition of foreign property. Regarding foreign affiliates, a number of

tax agencies require corporations to include in their tax return a list of nonresident related or associated

corporations with which there were transactions during the year. It must be indicated on the list, for each

(continued)

schemes that are deemed to improperly exploit loopholes in the tax laws; (5) promoting the

exchange of information with the country’s anti-money-laundering agency to verify

compliance and identify aggressive international tax practices;

(6) entering into tax

information exchange agreements with other jurisdictions and effectively using this

information for control purposes; and (7) introducing a voluntary disclosure program that

encourages taxpayers to declare previously unreported income in offshore accounts.

Regarding the latter, voluntary disclosures represent permanent programs (which are better

described as part of the penalty structure) and should be distinguished from one-off tax

amnesties, which suffer from many drawbacks.

F. Containing the cash economy

62. The cash (shadow) economy represents an increasing risk to tax collection. As

mentioned earlier, Schneider (2009) indicates that the cash economy will increase in OECD

countries by an average of 0.5 percent of GDP during 2009 as increasing numbers of persons

attempt to make up for lost income in the formal economy through greater participation in

the cash economy. If this development materializes, significant amounts of revenue could be

put at risk, since taxpayers’ compliance rates in the cash economy are substantially lower

than in the formal economy (GAO, 2007).

63. Tax agencies that have succeeded in containing the cash economy have done so

on the basis of a multifaceted strategy that includes (1) identifying high-risk sectors and

developing an understanding of taxpayer behavior in those sectors, (2) encouraging

compliance through proactive and innovative measures, (3) an escalated regime of

enforcement methods, and (4) partnerships with relevant civic associations that may

influence cash economy businesses. The ATO’s cash economy strategy is a good example of

this approach (Appendix 3).

corporation, the approximate total of intercompany sales and purchases and amounts paid or received for

services.

For example, the ATO uses reports from Australia’s anti-money-laundering agency (AUSTRAC) to (1)

profile individual industries, occupations, and geographical areas; (2) identify potentially high risk transactions;

and (3) select cases for further investigation.

In the United States, the IRS introduced a voluntary disclosure program in 2009 that offers a reduced civil

penalty and a likely waiver of criminal charges for taxpayers who (1) voluntarily disclose unreported offshore

income and pay all taxes and interest going back six years, (2) file or amend their tax returns, and (3) pay a

penalty equivalent to 20 percent of the value of an offshore account during the tax year in which it had its

highest value.

Baer and Le Borgne (2008).

64. A tax agency’s response to the cash economy should be proportionate to the

magnitude of the problem. While taking steps to contain the cash economy, tax agencies

should not lose sight of the fact that other compliance challenges—such as those involving

large taxpayers and cross-border issues—may present larger revenue risks.

V. REFORMING LEGISLATION

65. A third element in a tax compliance strategy for the crisis is legislative reform.

Although it is generally not advisable to implement comprehensive tax reform in the midst of

a crisis—which could add uncertainty to a country’s business climate—some targeted

changes in legislation may facilitate the tax agency’s response. Some of the reform priorities

in this area were highlighted in earlier sections of this paper.

Other important provisions

include the following:

x To better address cross-border compliance risks, transfer-pricing rules may require

strengthening (including, possibly, through the enactment of a general anti-avoidance

rule).

x To address taxpayers’ payment problems, tax agencies should have broad authority to

arrange installment plans (with reasonable terms and conditions) for genuinely

distressed taxpayers and enforce collection from uncooperative tax debtors, including

by seizing physical and financial assets).

x To discourage nonpayment of tax withholding, tax agencies should have authority to

recover tax arrears directly from corporate officers under prescribed conditions.

x To address a rise in nonfiling, tax agencies should be permitted to use all reasonable

means (including default assessments and indirect audit methods

) to assess the

amount of taxes owed by taxpayers who fail to file a tax return.

x To deal with underreporting of taxes or overreporting of losses (and refunds), the tax

administration needs the authority to summon a taxpayer and third parties to provide

evidence and testimony on relevant tax matters.

For example, (1) adjusting advance payment methods to reflect current economic conditions; (2) tax loss

provisions that provide reasonable relief to bona fide loss-sustaining firms, but that are consistent with the tax

agency’s administrative capacity; (3) tax agencies that have broad authority to arrange installment plans for

genuinely distressed taxpayers and enforce collection against uncooperative tax debtors; and (4) tax agencies

that are vested with the power to require taxpayers to disclose additional information on international

transactions.

If the taxpayer has failed to file a return and/or the taxpayers’ records are deemed inadequate to determine tax

liability, the tax authorities are often authorized to assess tax on the basis of best judgment, using indirect

assessment methods.

x To protect the government’s interest, country bankruptcy laws should accord tax

debts an appropriate ranking in the hierarchy of a bankrupt company’s creditors.

x To enforce the tax laws, bank confidentiality restrictions should not impede a tax

agency from accessing a taxpayer’s financial information held by a bank, provided

such access involves a bona fide tax enforcement action and is subject to due process

protections.

VI. ENHANCING COMMUNICATION

66. A special communication program for taxpayers and other key stakeholders in

the tax system should aim at clearly conveying to stakeholders the various elements of

the tax agency’s compliance strategy. Tax agencies should use their full set of service

channels (website, e-mail, telephone contact centers, walk-in offices) and products in

publicizing their compliance strategy to the public.

67. Communicating with taxpayers. To promote compliance in a crisis, tax agencies

need to explain to taxpayers the tax implications and steps they should take for such events as

job loss, debt forgiveness, cashing in a retirement fund, and tax benefits under the

government’s economic stimulus program. For instance, the IRS has posted on its website a

list of What If ? scenarios—in question-and-answer format—that provides practical guidance

in responding to events that have significant tax consequences (IRS, 2008b). To dissuade

taxpayers from noncompliance, tax agencies should inform the taxpayer community that they

are aware of the types of noncompliance that are emerging from the crisis, explain the

consequences of engaging in noncompliance (including penalties, assessment of additional

taxes, seizure of assets, and, in extreme cases, prosecution), and publicize the results of

actual enforcement cases.

68. Communicating within the tax agency. Managers and staff require timely, accurate,

and specific guidance on how to apply the new policies and administrative practices under

the tax compliance strategy. Internal directives and newsletters, intranet postings, senior

management presentations, and training programs are all vital. For example, the Netherlands

Tax and Customs Administration has issued a communication package to all regional tax

offices consisting of (1) a memorandum outlining the need for specific attention to be given

to emerging tax issues, (2) a questionnaire on the impact that the recession is having on the

offices’ various projects, (3) an analytical report on economic sectors in financial distress,

Due process protections could include the following: limiting access to information on a specific taxpayer in

relation to a specific tax issue, requiring court approval for bank information on general classes of taxpayers,

subjecting requests for banking information to management review by the tax agency, and subjecting tax

officers to the tax agency’s own obligations governing the confidentiality of taxpayer information and imposing

penalties for violating these obligations.

and (4) information for taxpayers on the fiscal stimulus package and temporary regulations

on the postponement of tax payments and other collection measures.

69. Communicating with other stakeholders. Tax agencies should establish or, where

already established, make better use of consultations with industry associations and tax

professionals (tax agents, bookkeepers, other tax intermediaries). These types of associations

often have substantial influence over taxpayers’ behavior and can provide the tax agency

with valuable assistance in understanding crisis-driven compliance problems, developing

workable solutions, and communicating the solutions to taxpayers. A good example is New

Zealand’s Inland Revenue Department, which launched an industry partnership program in

February 2002 (Appendix 4).

VII. F

INANCIAL SECTOR ISSUES

70. Even before the current crisis, the financial sector’s size and complexity made

for a difficult and specialized environment for tax agencies. Financial institutions are

often one of the largest sectors in the economy, accounting for an average one-quarter of

GDP among OECD countries (Zee and Schenk, 2004) and contributing substantial amounts

of tax revenue. The sector comprises a wide range of entities and offers a vast array of

financial products, which, over the years, have become increasingly complex in their

structure and tax treatment. Moreover, many large financial institutions operate globally,

making it difficult for tax agencies to get a complete picture of the institutions’ overall

operations.

71. Since the onset of the crisis, the financial sector has become even more

challenging for tax administration. During 2008 and into 2009, many financial institutions

have experienced large losses, some have collapsed, and others are undergoing restructuring

or mergers. These developments have often been accompanied by growing tax compliance

risks. Some of these risks—such as those involving tax-leveraged products and tax avoidance

schemes—have been of central concern to tax agencies for some time. Others are by-

products of the crisis, including valuation difficulties for illiquid assets, capital-raising

operations, reported financial losses, and mergers. These compliance risks need to be kept in

perspective: not all financial institutions are noncompliant and, similarly, some are shared

equally by risks in enterprises in other economic sectors.

72. Some of the largest compliance risks posed by financial institutions involve tax

avoidance schemes. In recent times, tax agencies in some countries (e.g., United Kingdom,

United States) have uncovered a number of substantial tax avoidance schemes engineered by

major international financial institutions. These schemes have commonly featured highly

structured financial transactions, circular and cross-border flows of funds, and intra-group

exchanges. Although many of these transactions are used for legitimate reasons and are also

carried out by enterprises in other sectors, some appear to have been designed mainly to

create artificial tax losses, inappropriate foreign tax credits, and other unintended tax

benefits. In response, some tax agencies are allocating more resources to examining high-risk

avoidance arrangements engineered by financial institutions.

73. Banks’ capital-raising operations present another risk. During the financial crisis,

many banks have suffered significant declines in their capital and now need to raise

additional capital to meet their regulatory requirements. In meeting these requirements, some

banks may seek to raise capital through the issuance of hybrid securities, which contain both

equity and debt features.

For banks, some hybrids offer the advantage that they may be

classified as equity for regulatory purposes and as debt (with tax deductibility of interest) for

tax purposes. The misclassification of these securities, when combined with large numbers of

issues, could substantially reduce the corporate income tax base. It may be that the crisis

experience will dampen markets’ interest in hybrids. Nevertheless, tax agencies should

clearly communicate to taxpayers how hybrid securities are to be treated for tax purposes.

74. Large financial losses incurred by many financial institutions have major

revenue implications. As mentioned in Section IV, the tax laws in many countries permit

loss-sustaining firms, with limitation, to carry forward and/or carry back their losses. Tax

agencies will need to carefully evaluate the losses reported by financial institutions.

75. Mergers and acquisitions in the financial sector also raise significant issues. In a

number of countries, the financial sector is undergoing major restructuring, with some

distressed firms being acquired by healthier ones. These reorganizations raise a broad range

of complex tax issues, including whether the merger should be treated as taxable or tax-

deferred, whether the cost basis of an acquired firm’s assets can be increased, and the extent

to which an acquiring firm can benefit from the tax losses (and other tax attributes) from an

acquired company. Tax agencies should carefully scrutinize large-value mergers to ensure

that the correct tax treatment has been applied.

76. Valuing the financial assets reported under mark-to-market accounting presents

additional complexities for tax administration. In the wake of the financial crisis,

questions have arisen on how banks should value assets in inactive markets or where the

market prices reflect distressed sales. In April 2009, the U.S. Financial Accounting Standards

Board issued new guidance on the conditions under which banks may value illiquid assets

using “best judgment” instead of quoted market prices (FASB, 2009). This widened scope

for best judgment may boost revenues now, but could create risks when normal economic

conditions return. The International Accounting Standards Board announced in April 2009

that over the next six months it will conduct a comprehensive review of the accounting

standards relating to financial instruments. In light of these changing rules, tax agencies in

some countries will need to pay particular attention to the methods banks use to value

For example, a convertible bond pays interest in its early years (like debt) and at a designated time is

converted into shares of stock (like equity) in the issuing company at a preannounced ratio.

financial assets. Greater cooperation between tax agencies and bank regulatory agencies may

help in this regard.

77. Gains or losses on foreclosed property may also have substantial revenue

implications. Many banks are foreclosing on large amounts of property, either through a

formal foreclosure process or by voluntary conveyance of the property by the borrower. In

some countries, banks are required to recognize a tax gain or loss on receipt of foreclosed

property. In such cases, the gain or loss is often measured as the difference between the basis

of the loan and the fair market value of the property. To guard against revenue leakage, tax

agencies will need to allocate greater audit resources in validating the valuation of foreclosed

property, confirming the deductible expenses taken by banks while the repossessed property

is held for sale and ensuring that banks take no additional tax write-downs for bad debt on

the loan after the foreclosure.

78. Tax agencies need to provide guidance on the tax treatment of fraudulent

investment schemes. The financial crisis has also uncovered a number of fraudulent

investment schemes (including so-called Ponzi schemes), some of which are reported to have

resulted in huge losses for investors. Under such schemes, the perpetrator typically promises

high returns—and even sometimes provides official-looking earnings statements—some or

all of which are fictitious. Tax agencies need to provide guidance to the victims of these

schemes by explaining (1) the treatment of taxes that were paid on fictitious income; (2)

whether, how, and to what extent losses from fraud schemes are tax deductible; and (3) the

supporting documentation that taxpayers must present to substantiate a claim for tax

deduction. Where the losses are tax deductible, tax agencies may need to invest considerable

resources reviewing the claimed deductions investor by investor.

79. Tax agencies may use the financial crisis as an opportunity to enter into a more

cooperative relationship with financial institutions based on (1) a unilateral statement by

the tax agency of how it intends to work with financial institutions, (2) a charter adopted

jointly by the tax agency and all stakeholders setting out how they intend to work together, or

(3) a formal agreement between the tax agency and specific bank associations (OECD

2008b). For example, the South African Revenue Service has recently entered into a

cooperative arrangement with the country’s banking association aimed at improving tax

compliance, discouraging illicit tax avoidance schemes, and enhancing service (Appendix 5).

Appendix 1. Singapore: Managing Tax Arrears in a Financial Crisis

The financial crisis that hit east Asia in 1997 raised concerns within the Inland Revenue Authority of

Singapore (IRAS) that severe liquidity problems associated with the crisis could lead many

companies and individuals—even those with good tax compliance histories—to accumulate large

amounts of tax arrears. To head off this problem, IRAS established a special program to give eligible

taxpayers extra time to pay their tax liabilities. This program included the following measures:

x Individuals who lost their jobs were allowed to defer their tax payments for up to six months

or until they found a new job, whichever came first.

x Individuals facing severe cash-flow difficulties were permitted to pay their taxes in interest-

free installments, with the extension period determined on a case-by-case basis.

x Companies facing severe cash-flow problems were allowed to apply for “extended”

installment plans—with or without penalty, depending on the circumstances—that could be

for a period of up to 50 percent longer than that under the standard installment plan.

x Based on their cash flow, companies could pay off their tax arrears in a flexible manner,

subject to late payment penalties and interest charges.

Eligibility for any of these special measures was restricted to taxpayers with good compliance

histories who could produce documentary evidence that full and immediate payment of taxes would

cause a genuine hardship. Importantly, enforcement officers reviewed each request for assistance on a

case-by-case basis based on documentation provided by taxpayers on their financial position.

As it turned out, a relatively small number of individuals and businesses sought relief under the IRAS

program, and the proportion of total tax arrears to current tax collections increased only temporarily,

from 6.3 percent in 1997 to 8.2 percent in 1998, before declining to 7.1 percent in 1999. Similarly, the

ratio of new flows of tax arrears to current tax collection increased by 2.1 percent, 3.0 percent, and

2.0 percent, respectively, for 1997, 1998, and 1999.

IRAS officials believe that the special debt program helped improve taxpayers’ perception of the

fairness of the tax system, which, in turn, helped preserve the generally high level of compliance

among taxpayers during a very difficult period.

The agency has adopted similar approaches for the

current global economic crisis. IRAS officials believe that being sympathetic, understanding, and

flexible toward taxpayers who are experiencing real hardship would help preserve the generally high

level of compliance among taxpayers during a very difficult period.

Appendix 2. Main Elements of a VAT Refund Verification Program

An effective refund verification program should provide for (1) an initial risk assessment of new VAT

applicants, (2) a front-end data validation system, (3) risk-based audit selection, and (4) differentiated

verification methods.

Initial risk assessment. Refund management systems should include an initial risk assessment to

identify potentially fraudulent registrants. When the taxpayer first registers with the tax

administration, the registration application should be compared with standardized risk profiles.

Suspect applications should be referred for a preregistration visit by a tax officer to determine whether

the location and nature of the business are consistent with the declared business activities, sources of

supplies, and financing. Applications that remain suspect after the visit should be denied registration

or conditions should be established for registration (e.g., posting of a security).

Front-end data validation. Refund claims should first be subjected to a front-end check of

completeness (including supporting documentation), arithmetic correctness, and consistency of

information before being screened for audit selection. The tax agency should have the authority to

override minor arithmetic errors; more serious errors should lead to a rejection of the claim and

require its resubmission by the taxpayer.

Risk-based audit selection. Once validated, refund claims should be classified into different risk-

based categories ( e.g., high, moderate, low) for audit selection. The criteria for establishing the

rankings could include such factors as the claim’s deviation from amounts claimed previously, the

claimant’s compliance history, whether the refund represents a first-time claim, and the date of the

most recent audit. The amount of audit resources allocated to refund verifications should be consistent

with the degree of revenue risk posed by refund claims relative to other compliance risks faced by the

tax agency. From this perspective, an effective audit program would devote, for example, 30 percent

of its audit resources to verifying refund claims and 70 percent of resources to other types of audits.

Differentiated verification methods. Different types of verifications should be applied, depending

on a claim’s degree of risk. High-risk claims should be audited prior to issuing the refund, usually at

the taxpayer’s premises. Moderate-risk claims would be assigned an upper-refund limit. Claims not

exceeding the upper limit and accompanied by supporting documents would be subject to a brief desk

review before the refund is issued and a post-approval audit at periodic intervals. Claims exceeding

the limit would be subject to a pre-approval audit. Low-risk refund claims would typically be

approved within 72 hours without the pre-approval audit requirement. For these claims, a post-

approval audit may be arranged on a random basis from time to time.

When an audit is to be conducted, the scope of the examination should be limited to the refund claim

(and not cover other tax types) and focus on issues material to the refund. Statistical sampling

methods should be used to determine the number of transactions that need to be checked. Importantly,

the audit should not rely excessively on export documents from Customs, since such documents are

not really evidence that the goods in question were in fact exported. Instead, a sample number of

export shipments should be selected and traced through purchase invoices, sales records, inventory

records, shipping receipts, and payment and bank records. This would be better proof of the validity

of the exports. And, if these records still leave doubt, the auditor may confirm with Customs of the

importing country that the goods were properly entered for consumption.

Appendix 3. Australia: Cash Economy Strategy

The Australian Tax Office (ATO) cash economy strategy provides for a balanced set of measures to

improve compliance in the cash economy, including communication measures, incentives to

encourage self-service, targeted assistance, strategic alliances, and focused enforcement.

Communication measures

x targeting national and local publicity campaigns at specific high-risk sectors—for example,

construction, to make potential taxpayers aware of their obligations and the potential

penalties for noncompliance;

x establishing connections between business and professional associations in high-risk

industries and tax practitioners to alert them to the problems caused by cash economy firms,

explaining the risks and eliciting their support in combating the cash economy; and

x encouraging the community to report instances of tax evasion via a special tax evasion

hotline, fax, website, and mail as well as through other government agencies.

Incentives to encourage self-regulation

x Remission guidelines for penalties and interest differentiate between taxpayers who have a

good compliance record and miss an obligation on an isolated basis and those who regularly

transgress.

x Less-onerous reporting requirements and extended filing periods are available for those with

a record of good compliance.

x Industry benchmarks have been established for high-risk industries. These benchmarks reflect

the expected relationship between inputs and outputs for a particular business activity based

on industry standards. The focus is on trades where there is a strong correlation between only

a few inputs and total business income.

The benchmarks are developed in partnership with the relevant industry or business association,

which enhances their credibility. They are well-publicized throughout the target industry (again, in

partnership with the relevant industry association). Although the benchmarks are marketed primarily

as a self-checking mechanism to enable taxpayers to compare their own business performance with

industry standards and to assist trade participants with voluntarily compliance by using the

benchmarks as a reference point, this is complemented with a strong message that any taxpayer filing

a return that varies significantly from the benchmark will be closely examined by the ATO. All

returns filed by taxpayers in these industries are automatically checked against the benchmarks, and

outliers are subject to risk assessment.

Targeted assistance measures

x simple information products that explain key tax obligations and inform taxpayers of how

they can seek help from the tax office;

x free seminars conducted in conjunction with other key government agencies (e.g., social

insurance) to help new businesses understand their obligations and entitlements;

x telephone calls to check whether a new business operator is experiencing any difficulties and

to offer advice;

x optional free advisory visits to the taxpayer’s premises to resolve any problems that may have

arisen;

x targeted advisory visits (obligatory) to the premises of new businesses that are considered

high risk;

x modern and easily navigable websites that replicate the range of help and assistance products

and services available to new businesses;

x provision of free electronic record-keeping software to all new businesses;

x provision of online self-help tools—for example, an online decision support system for

determination of the employment status of workers (i.e., employee or contractor); and

x reminder letters, text messages, and telephone calls.

Strategic alliances

Tax practitioners. Tax practitioners are provided with a premium service that includes dedicated

telephone inquiry teams, direct access to expert tax interpretation officers, and tailored seminars.

Industry and business associations. Partnership arrangements with key industry and business

associations are used to identify compliance problems (e.g., ambiguous or impractical law, overly

complex forms and procedures, unreasonable time limits, onerous reporting requirements, etc.) and

develop workable solutions.

Experience has shown that paper-based products need to be limited to a few pages at most and should be

written in simple nontechnical language that the taxpayer will understand.

These seminars usually comprise a mix of general presentations dealing with obligations and entitlements

(including record keeping) common to most businesses and more tailored workshops aimed at specific high-risk

industries. Industry-based seminars have been shown to achieve higher penetration when they are conducted in

partnership with the relevant industry and business associations.

Business service providers. Manufacturers of accounting software packages are another leverage

point for small business. Close liaison with the developers of such packages can ensure that the

packages comply with all tax obligations.

Focused enforcement measures

x cross-matching tax agency information with information held by other agencies, companies,

and industry bodies to identify enterprises that are not registered. For example, data from

insurance, shopping center operators, and regulatory authorities have been used to identify

nonreporting of cash income in various industries;

x data matching to identify individuals who appear to be living beyond their reported income.

For example, ATO matches tax return data against information from government licensing

bodies on luxury cars and boats;

x vesting auditors with the authority to apply indirect audit methods for reconstructing income

and training staff in these methods;

x unannounced visits to the premises of high-risk taxpayers for the purpose of confirming their

registration details and reviewing their record-keeping practices;

x telephoning or making personal visits to selected new businesses that fail to meet their filing

obligations to ensure they understand their requirements;

x letters to businesses that report figures outside the norm, asking them to review their reported

figures and ensure they are correct;

x targeted reviews and audits of taxpayers in high-risk industries resulting in the assessment of

additional taxes, penalties, and, in some cases, prosecutions; and

x publicizing the results of enforcement measures to discourage others from noncompliance.

For example, ATO highlights how data matching and other new approaches facilitated the

detection of taxpayers operating in the cash economy and publicizes how these businesses

were dealt with.

Appendix 4. New Zealand: Industry Partnership Program

New Zealand’s Inland Revenue Department (IRD) launched an industry partnership program in

February 2002.

The purpose of the program was to develop, test, and implement a relationship-

based approach to tax administration that would help small and medium-size enterprises in selected

cash economy industries to comply with their tax obligations. Industries were selected on the basis of

the following criteria: average tax returns outstanding, average tax debt outstanding, and likelihood of

tax discrepancies. On this basis, partnerships were formed with some 15 industries, including painting

and decorating, hairdressing, plumbing, and taxi services.

The program comprised a national office team and five field teams. The national office team was

responsible for overseeing the program and providing field teams with a range of support services,

including design advice, research and issues gathering, relationship management with partner

industries, and communication support. The headquarters team remained the primary point of contact

with industry associations, facilitating the provision of guidance and advice to industry members.

The field teams consisted of an encouragement team and an assurance team, which were generally

located at the same field office. Encouragement teams provided education and services about all types

of taxes to taxpayers in industries covered by the program and also looked at minor tax debt and

returns issues. The teams delivered a range of advisory services that included instruction on how to

records and invoices. These services were delivered through one-on-one consultations with business

operators (frequently at their place of business), seminars, and presentations at business events. The

headquarters team provided the encouragement team with various supporting materials such as

simplified tax brochures and booklets, information guides tailored to specific industries, templates for

use at industry events, and articles for publication in industry newsletters and on websites.

The assurance teams managed compliance issues for taxpayers who failed to comply or were

delinquent in their obligations. The teams included debt collection staff, intelligence officers (to

identify persons operating outside the tax system), and auditors.

An IRD evaluation for five partnership industries showed the program had raised tax return filing

rates and lowered tax debt in the industry groups. The study compared the trends in the five industries

with trends in other (nonpartnership) industries. An external review estimated that the program

achieved a 6.7 benefit-cost ratio in the five industries. A taxpayer survey indicated that the program

had been well received by industry groups and had made a positive contribution toward taxpayers’

compliance patterns and their attitude toward IRD.

In July 2005, the partnership program was incorporated into IRD’s mainstream operations. Some of

the industry partnerships were then taken over by IRD’s Customer Insight Group, a new initiative

designed to help improve compliance in light of the factors that influence different taxpayer groups

and those outside the tax system.

For further details, see New Zealand Controller and Auditor General (2008).

Appendix 5. South Africa: Tax Agency–Banking Association Accord

On January 29, 2009, the South African Revenue Service (SARS) and the Banking Association of

South Africa signed an accord that establishes a framework for cooperation between the parties in

order to improve levels of tax compliance, discourage unlawful tax avoidance arrangements, and

enhance service.

By signing the accord the two parties effectively concluded an eight-year process of engagement that

stemmed from serious concern on the part of the minister of finance concerning the effective tax rates

of the banking industry in South Africa.

Although the long-standing informal engagement resulted in closer cooperation and improved levels

of compliance, the accord seeks to further enhance the relationship between SARS and banks and

provide greater clarity on the interpretation and application of tax and customs laws and the

identification of tax risks.

A key feature of the enhanced relationship is the establishment of a banking-SARS forum to promote

tax clarity for banks. These matters have the potential to be translated into industry standards once

accepted by SARS and the Banking Association Board.

Among other things, the accord will

x Establish a guiding framework for future engagement. This framework will promote

better service offerings to the banking industry while pursuing a climate of higher tax

integrity.

x Strive to protect the South African tax base and level the playing field in the industry

by discouraging abusive tax avoidance arrangements. This will translate into ongoing

monitoring of banks’ effective tax rates while providing greater tax clarity and

resolution of common concerns.

In addition, the parties committed themselves to the following:

x Banking Association

o regularly determining, scrutinizing, and monitoring the effective tax rate of individual

banks and across the banking industry

o raising awareness of tax governance processes to the board level within banks

o enhancing risk management and governance processes to ensure optimal tax compliance

o improving the quality and timeliness of information flows to SARS

o cooperation on issues of mutual concern

x SARS

o offering dedicated services to the banking industry through the Large Business Centre,

which will include the appointment of a taxpayer relationship manager to focus

exclusively on the banking industry. Service delivery will be measured against the

standards prescribed in the SARS Taxpayer Service Charter:

 deepening its understanding of the banking industry by building technical and

professional skills

 offering an advance ruling system that is responsive and facilitates tax certainty

for banks and the industry as a whole

 promoting the highest standards of tax compliance and discouraging practices

that are inconsistent with the law

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