The poachers have been put in charge of the game park.
Incredibly, the Australian Taxation Office is running a pilot scheme whereby it outsources the duty of tax compliance for Australia’s largest companies to none other than company auditor.
In a scheme euphemistically labelled the External Compliance Assurance Program (ECAP), large taxpayers are to pay their own external audit firms – read the “Big Four”: PwC, Deloitte, Ernst & Young and KPMG – to conduct their tax compliance work as well as doing the audit.
The tax office claims the scheme is designed not only to cut costs and reduce red tape but improve tax compliance. Others, however, are not convinced.
According to one source, ECAP is akin to the Sheriff on Nottingham making his soldiers redundant and accepting Friar Tuck’s proposition that, for a small fee paid by Robin Hood’s merry men, Friar Tuck could verify the merry men’s tax obligations.
The big audit firms rake in hundreds of millions in fees for advising their corporate clients on the best ways to avoid tax, including prolific use of tax havens to avoid paying tax in Australia. Former ATO officer Martin Locke says the latest shift to self-regulation throws up serious conflicts of interest.
“A taxpayer faced with a choice of an ATO-internal review or ECAP faces a choice between a reviewer who acts under the direction, supervision and control of the commissioner of taxation and one who doesn’t; a reviewer bound by public service code of conduct and one who isn’t; a reviewer expected to report unusual or suspicious though incidental findings, and one who isn’t; and a reviewer who gets no fee from the taxpayer and one who does.
“This creates a serious problem for the commissioner: he must be seen to avoid actual or perceived bias in his decision-making, bias that can arise from applying different standards of treatment to different taxpayers of the same ‘class’,” Locke said. “He’s also expected to make his own findings of fact when a power of his depends on the existence or non-existence of those facts.”
Further, the ATO claims one of the benefits of ECAP is that it reduces compliance costs. Seeing, however, as this large taxpayer (or perhaps like Apple, a large company tha is an exceedingly small taxpayer) now has to pay its high-charging audit firm for a service the ATO used to provide for free, the only way it could reduce costs could be by cutting the tax burden of the corporation and lumping the costs straight into the lap of ordinary taxpayers.
The concept of self-regulation is not new, media standards being one example, and it seems to work reasonably well, if not perfectly, for non-monetary arrangements. Self-regulation of the money trail, though, is a recipe for corruption.
The Commissioner defines high-turnover companies eligible for ECAP as “medium to low risk”, a definition that seems, against all evidence, to assume that big corporations are better behaved than smaller taxpayers. In reality, some of Australia’s largest corporations are also some of its most prolific tax dodgers.
He is also assuming that the local companies should be taxed as Australian resident “body corporates”, when in fact most now fail the “mind and management test” and are in reality non-resident companies running branch operations in Australia.
According to one expert on multinational financing, ECAP betrays a lack of understanding of how the audit process actually works, particularly for multinationals. “The audit engagement for local subsidiaries of multinationals requires Australian auditors to firstly sign off on the subsidiary’s compliance with group policy and materiality levels in financial returns sent to the parent for purposes of preparing the group consolidated financial statements,” he told Fairfax. “These reports from the local companies are financial returns, not financial statements. The group process takes precedence over local statutory accounts, but income tax obligations are generally determined and audited with both reporting requirements in mind”.
Part of the problem with most modern multinationals is that they organise their management and financing reporting, and therefore their accounting policies and materiality requirements, along global business segment lines rather than legal entity lines.
“Local legal entity boundaries, which may require a different interpretation of accounting standards and materiality from those laid down by the group and business segment leadership, are often overlooked or even ignored,” said the source. “Group returns, once submitted, effectively become locked in. If an error is subsequently detected or the local interpretation or materiality level is different, and it is material, in a statutory financial statements or tax return sense, local directors can find themselves in a Catch 22.
“Their senior management will not entertain changes in the group returns and will generally not tolerate the preparation of local documents that conflict with group returns. Both local directors and subsidiary auditors are often at risk of being conflicted when it comes to preparing local financial statements which includes the local tax provision.”
Local directors are more like to toe the line with head office than invite conflict or be seen not to be a team player. The same thing happens on the audit side. The Big Four are global firms and are reluctant to place themselves in a position of having firstly signed off on an audit and then be forced to approve a different number for local reporting.
Under ECAP, the commissioner’s proposal is to have the same potentially conflicted auditors perform tasks that are in the first place the responsibility of the same potentially conflicted directors.
“The pressure will be on both groups to sell the review report to the ATO in support of a situation they know to be erroneous. The ATO is proposing compliance reviews of the auditors’ work, but this becomes a case of punishing the messenger, when the problem and responsibility is actually with the directors (both formally appointed and shadow directors).”
“The only way this sort of program can be relied upon is to guarantee reviewer independence. To achieve that, the reviewer’s firm should not have participated in the audit and should not previously have provided tax advice to the company. The probability that there will be an inadequate supply of qualified resources seems too high for self-regulation, based on adequate independence of the reviewer, to be workable. Perhaps the answer is in having these reviews of tax returns done by ATO assessors.
The above assumes no transfer pricing. The trial program is presumably designed to avoid such inconvenient truths. Whether there is any requirement to make the reports public either is doubtful. The way things are moving, sadly for ordinary taxpayers who carry the burden for the big avoiders, is towards less transparency and less disclosure, and consequently less tax paid, by increasingly large organisations.