Chapter 4.7 of the report of the Comptroller and Auditor General reads:
In Depth Examination of Tax Written Off
Introduction
In 2000, Revenue wrote off outstanding taxes to a total amount of €104 million under the care and management provisions of the Taxes Acts. It was considered by Revenue that the taxes due in each case had become uncollectable for various reasons. The write offs were subject to internal control procedures, and some 4% of cases were examined by Internal Audit to ensure that procedures were followed and that tax was not improperly written off. My staff also reviewed a sample of cases which indicated that procedures had been followed. However, as a separate exercise, they commenced a more in depth examination of a sample of cases in some write off categories in order to establish the extent and adequacy of Revenue activity over the years prior to write off and whether the relevant lessons had been learned from such cases. This report sets out the findings of that examination.
Background
An analysis by Revenue of outstanding taxes at the end of 1996 concluded that there was no realistic chance of recovering much of the book debt of €1,817m for tax years up to 1994-95 due to a number of factors:
€745m of the arrears related to periods prior to self assessment, was more than 10 years old and remained uncollected at the end of the collection and enforcement cycle
the overall debt included estimated assessments of €620 million, many of which were regarded as speculative and overestimated
€509m was due from cases cancelled by the Inspector of Taxes, usually on the basis of having ceased trading, and
the rate of recovery of the €312m arrears amassed in the early years of self assessment was extremely low; even the very favourable terms of the 1993 tax amnesty had made little impression.
Revenue write-off procedures were revised in early 1997 so that much of the old uncollectable debt would be deleted from the records through the use of automation to write off small amounts, an enhanced effort to review doubtful debt, and the write off of cases involving company liquidations at the beginning rather than the end of the company liquidation process. It was hoped that the measures would result in a significant reduction in the level of old book arrears and a greater focus on the collection of current taxes and collectable arrears, and lead to a more planned approach to debt management. Write off remained an internal management matter and decisions to write off are not notified to taxpayers or other interested parties. Revenue considers that the strategy has been successful on the basis of a fall of 11% in the level of recorded tax debt between 1997 and 2001, as against increases of 64% in the gross tax collection and 50% in the number of taxpayers in the same period.
At that time, the Revenue Commissioners sought my views on their proposals and I stated that I was in broad agreement but pointed out that
control procedures needed to be designed to minimize the risk of writing-off collectable debt
the Revenue policy of reinstituting collection action on written off arrears should continue where circumstances change to an extent that the debt can be satisfied
the revised write-off procedures should not be seen as giving the message that if Revenue demands are ignored for long enough they will go away.
Table 11 details the overall amounts of tax written off in the five years 1997-2001, and the amounts for two of the main categories - 'liquidation-receivership-bankruptcy', and 'ceased trading - no assets' which account for 40% and 20% respectively of the total.
Table 11 - Tax Written Off
|
Year
|
Overall Total Written Off
|
|
Liquidations etc.
|
|
Ceased Trading - No Assets
|
|
|
No. of Cases
|
€m
|
No.
|
€m
|
No.
|
€m
|
|
1997
|
-*
|
357
|
-
|
193
|
-
|
27
|
|
1998
|
-*
|
274
|
-
|
118
|
-
|
67
|
|
1999
|
4,501
|
112
|
475
|
36
|
2,347
|
42
|
|
2000
|
3,975
|
104
|
397
|
25
|
1,432
|
42
|
|
2001
|
36,654**
|
140
|
382
|
27
|
578
|
17
|
|
Total
|
|
987
|
|
399
|
|
195
|
*Number of cases written off in 1997 and 1998 are not available.
** Includes automatic write off of small amounts totalling €67m.
Objectives and Scope of the Audit
The objective of the audit was to go beyond the standard write off papers, and to examine the role of the relevant divisions and processes within Revenue in managing and pursuing a sample of significant write off cases in the years prior to reaching write off stage in order to fully assess the appropriateness of the write off decision and to identify any lessons which might be learned from the loss, and whether Revenue had actually made the necessary adjustments to procedures and practice.
The expectation was that only the selected write-off cases would require to be examined. It was anticipated that the entity/person/business had ceased and was no longer involved in any economic activity. However, it became apparent from an early stage in the examination of a number of cases that the people and their businesses had not ceased but often had multiple ongoing business involvements which gave every indication of deliberate abuse of the tax system. In the light of this preliminary finding, the examination was reoriented towards identifying the extent of these activities, the relationships between various business entities, the methods used to escape the tax system and the overall lessons for the tax collection system.
The original sample on which the audit was based was a selection of 50 cases in which an amount greater than €125,000 was written off during 2000. It comprised 34 companies, 14 individuals and two other institutions. The cases were selected to cover the various write off categories e.g. 'liquidations' and 'ceased trading - no assets', and the different units in Revenue which had been involved in the authorisation of the write offs. However, due to the extent of the work involved and the approximately 300 related cases which were also fully examined, the number of cases from the original sample on which a full review was possible was reduced to 25 with only a brief review of the remainder.
In each full review, the liquidation and write off files were examined. Case histories were reviewed on the Revenue computer systems i.e. Central Registration System, Integrated Taxation Processing and Active Intervention Management, in some cases. Additional data from other sources was also examined in certain cases as follows:
tax assessment files
Revenue property database
excise licence databases
Companies Registration Office system (available on Revenue computer systems from Sept. 2000).
The CRO system was particularly useful for identifying directorships, relationships and the status and activities of businesses. The various information sources were utilized to build up a comprehensive tax history of cases, which gave a more complete picture than that provided by any of the stand alone Revenue systems, or by the write off summary and backing papers. While all of these information sources were available to Revenue staff at the time of write off, some e.g. access to the new Companies Registration Office system and Revenues Integrated Taxation Processing are relatively recent developments and were not available to Revenue staff when the sample cases were originally worked.
In addition to this report and analysis of the audit findings, with its focus on the performance of the overall system, detailed reports were forwarded to Revenue on an ongoing basis outlining all information which came to light in each case in order that any tax implications could be established and investigated.
Audit Findings
The audit findings fall into two main categories i.e. audit concern relating to the appropriateness of each write off, and the weaknesses in the Revenue collection system which might be indicated by the details of the cases. The weaknesses and possible lessons are considered in areas such as registration, compliance, enforcement and audit. In addition, the implications of particular aspects of abuse noted in two business sectors - property development and the licensed trade - and the difficult area of the abuse of limited liability for tax evasion are also considered. At times, there may be some overlap between points which is unavoidable as many occur together and are closely related e.g.
inadequate pursuit earlier in the case
a narrow 'case-based' approach
inadequate information on and understanding of the overall business and tax context of the case
lack of awareness of previous write off record
strong evidence of extended tax abuse.
However, it is necessary to attempt to isolate and categorise each issue in so far as that is possible in order that it may receive full consideration within the context of the overall tax collection system. While much of this report's content relates to systems and procedures, the write offs were processed on an individual case by case basis. Therefore, for illustration purposes, outlines are included of some details in relation to a sample of three cases which came to light during the audit as a result of following the information trail back from the write off of amounts of €442,000, €146,000 and €170,000. In my opinion, these serve to underline the main points made in the report, and also show the extent of Revenue's task when such activities are concealed within the millions of transactions of the taxes systems.
Appropriateness of Write Off
Reports on the write off cases examined were forwarded to Revenue including comments on the issues coming to audit attention which raised questions on aspects of the write off decision in 2000. Essentially these can be summarised into two main issues - the inadequately informed 'case-based' approach, and the policy of minimising the write off amount.
Write Off Decision based on Inadequate Information
Write off decisions were made on the very narrow basis of the recent collection history of a case treated in isolation, and without an examination of all of the information which was available to Revenue. It is clear from cases reviewed that such an examination would have revealed a far more complex tax history and, in particular, relationships to other tax cases and write-offs involving the same principals. Given the depth of information revealed in some cases, the Revenue write off review could only be considered to be superficial in nature. A comprehensive record of an individual and his/her businesses is vital to a decision on the appropriateness of write-off. A more comprehensive tax history could have resulted in a different conclusion and decision on the collectability of outstanding taxes in a number of cases reviewed.
There is still every possibility that a write off will ultimately be the only option in many cases due to the very limited options available to enforce the recovery of tax owed by a company with no remaining business or assets. However, in cases where a pattern of behaviour encompassing aspects of chronic non-compliance or even deliberate tax evasion activity is identified, a lesson will have been learned either regarding an individual taxpayer, or a system weakness. Appropriate action either through the close monitoring of all of an individual's future activities, or by addressing the weakness, should minimise future losses.
Full Extent of Loss Understated
When a write off is reported, the reasonable expectation is that the amount recorded faithfully represented the substance of the transaction i.e. in this context the extent of the loss to the Exchequer. Obviously, the amount of the recorded loss should not be distorted by inflated estimates but, equally, the extent of the actual loss should not be misrepresented by the exclusion of reasonable estimates likely to be acceptable for legal action in other circumstances e.g. estimates made under Section 23 of VAT Act. It was noted in many cases examined that the extent of the recorded loss may have been understated as
there was no assessment of the extent of non-compliance or the likely size of the full tax debt
the write off was based purely on charges on record, even where these only equated to some payments from a failed fixed payment arrangement
a number of undercharges identified on tax audits were excluded; and all interest and penalty charges were excluded.
Revenue has stated that it would be unproductive to apply scarce resources to the task of establishing the full liability in circumstances where such tax would, in any event, most likely be uncollectable. Such activity would add nothing to the Exchequer and would operate to the detriment of more productive work.
While the Revenue position is understandable, in the context of resource allocation, I believe that some effort should be made to present a complete and accurate picture with regard to write offs bearing in mind that the real scale of a write off is likely to have an impact on the decision taken
it would be expected that efforts to establish the full extent of a tax liability should arise earlier in the collection process
accounting and transparency requirements cannot be totally put aside.
Further Write Off Issues
Irrespective of how the write off process is carried out, there is a further issue relating to its timing. It is, or should be, the final in depth review of all aspects of a case in order to establish whether it should be 'written off' or excluded from all of the live stages of the tax collection system. However it is usually carried out at a stage, e.g. six years or more after tax due, when the conclusion will be that it is too late to take any meaningful action and the difficulty of tracing persons and records too great. In order to maximise the value of such a review, consideration should be given to performing this process, say as a third party review, at a much earlier stage e.g after 12 months/24 months without meaningful collection activity in order to get to the bottom of what has occurred in a case at a time where the chances of tax recovery may be much greater. Following the completion of this process cases could be moved to a 'pending write off' account for a further period, but would not be subject to routine collection activity unless new information of relationship comes to light. The current principle would not be affected whereby the debt does not totally disappear at any stage, but remains on taxpayer record for recovery should the opportunity arise, and any lessons for Revenue would be learned earlier. Revenue consider that a decision on whether to write-off or not should be taken at the time of review, as placing a case in a pending category to be re-examined again later would be wasteful of resources.
The weakness of the basis of the write off decisions in a number of the small sample of cases reviewed out of the €104m total written off in 2000 also raises the issue of the extent to which the 2000 write offs in total, and even earlier years, contain cases where the decision should be reviewed. Obviously, at this remove, any look back would require to be focused both with regard to size and type of cases. A further issue, and possibly of greater importance at this stage, may be the extent to which those write offs hide the successful efforts of tax evaders, allowing them the opportunity to repeat their undiscovered practices as instanced by the three sample outlinedcases.
CASE No. 1 - Property Developer
Developer entered the tax system through the 1988 tax amnesty with a payment of €79,000 for years 1970/71 - 1988/89; while that was considered inadequate by Revenue, no further payment was ultimately demanded;
Write off of €442,000 CT from 1988 included in sample reviewed; demand returned undelivered 1990; no further collection action until write off in 2000 on basis that neither of the two directors could be contacted; Co. had failed to register issued share capital, directors, business address or any annual returns; no connection was made with the individual, the amnesty payment, or his other companies;
Developer and his family were involved in at least 35 active million pound plus property development companies during 1990s including several major industrial estates, office blocks, apartment blocks, townhouse schemes and a shopping centre, with recent developments valued at over €125m.
Dealings with Revenue:
35 Co.s registered for CT, 25 for VAT, and none for PAYE/PRSI
while the core business was always property development, cases were spread over various tax districts due to a wide variation of declared activities
CT returns rarely filed for post-completion i.e. disposal periods; Co.s typically informally dissolved without formal wind-up of final statement of affairs providing information on the sale of property or disposal of cash and other assets which would allow assessment of tax liabilities
CT paid totalled €0.25m, while VAT Repayments exceeded VAT payments by €6m (however, portion of that difference is due to 'Section 4A' exemptions arising from sales to VAT registered purchasers)
An agent for one of the Co.s informed Revenue that Co. had always been dormant, and the certified accounts filed with CRO reflected this position; Co. had constructed two townhouse developments and an apartment block in early 1990s which sold for €10m
In response to a returned demand for €34,000 VAT arrears arising from four tax audits, a Revenue field officer called to the registered address of one of the Co.s and was informed that the Co. had transferred to another address, and that the whereabouts of the directors were unknown; at the second address it was stated that Co. no longer existed; both locations were owned by the developers Co.s. The VAT arrears were written off. The Co. developed 36 houses to the value of €2.5m but no CT was paid.
In all, our examination noted four write offs of taxes totalling €0.6m.
While the developer was registered for Residential Property Tax, he was not considered to have a liability when his residence was sold for €3.9m because his declared income was below the income threshold.
Revenue Response
Having examined the write off cases referred by my staff, Revenue is satisfied that the cases were worked in accordance with the instructions, guidelines and work practices prevailing at the time the write off was recommended. The write off decision, taking each case on its specific merits, was fully justified. The write off procedure requires each staff member to make a judgment bearing the following factors in mind - the size and age of the debt, previous collection history, whether the debt is well founded i.e. based on returns filed not estimates, feasibility of further collection or enforcement action. Each recommendation is submitted for approval by the Assistant Principal or Compliance Manager, or where the total write off exceeds €320,000, by the Principal Officer or Senior Inspector.
Having reviewed write off procedures in light of cases highlighted by my audit, Revenue has introduced additional checks, called 'commonality checks' which seek to identify and check on the principals behind companies with significant tax payment problems and is amending Write Off Guidelines to provide for:
checks for linkages to be carried out where tax is being considered for write off
a specific question for caseworkers to confirm that they have checked the Companies Registration Office for links to other companies in which directors may be involved
a check on the write off position in respect of the director's personal tax together with the recording of a brief summary of those enquiries.
Revenue has stated that while an old Revenue system which collapsed in 1997 did allow for interrogation of Companies Registration Office records, it was not easy to use and the information was not up to date. The current system which was installed in September 2000 allows staff to create the links used by my staff during the course of this audit. In relation to use of information on the Revenue property file, property searches usually occur after a decision is made to pursue a debt, for example, in considering a judgment mortgage or forced sale. The property search is carried out using the more comprehensive and up to date on-line Land Registry database. The type of use to which the Special Enquiry Branch property file was put during our examination is usually reserved for audit cases. However, Revenue will give consideration to what further use can be made of that system in the context of write off operations. When the structured management system for Revenues data being developed under the LINKS project is fully operational, it should be possible to obtain all information held by Revenue relevant to a particular taxpayer through one enquiry. This will greatly assist the working of audit and compliance cases by increasing efficiency and focusing on the risk in a particular case. The first part of this system will become operational towards the end of 2002.
With regard to the question of reviewing other write off cases, Revenue considered that the audit sample which was drawn from the larger write off decisions in 2000 would not be fully representative of all write off cases. The larger cases sampled would be more likely to involve cases where enforcement action had never been successful and where evasion would therefore be more likely than in the generality of cases. Revenue has indicated that the recently introduced 'commonality checks' should pick up evaders who attempt to repeat the stratagem and that all of the previous write offs would be reviewed and, where possible, overturned in such cases. That approach would provide the most efficient use of available resources.
In conclusion, Revenue is satisfied that while the write off decisions on each individual case were correct in accordance with the procedures and information systems available at the time, deficiencies in the systems identified in my examination have now been addressed. Revised structures and procedures have been put in place to ensure detection and follow through where case linkages of the type revealed by my examination are identified. An investigation has commenced as to how a comprehensive examination of the cases noted can be put in train. The write off of uncollectable tax will play an important role in the challenging programme of debt reduction set out in Revenue's Statement of Strategy 2001-2003, and Revenue is satisfied that the procedures and systems in place will ensure the appropriateness of its actions, taking all factors into account.
Weakness in Revenue Activity
This section of the report sets out a number of weaknesses in Revenue activity which were noted from the in depth examination of the sample of write off cases, and also from the many related cases which were sourced and reviewed in the course of that examination. The objective was to establish the extent to which such weaknesses, which had, in all likelihood, contributed to the failure of collection and to reaching the stage of write off, had been identified and rectified by Revenue. The items in this section are grouped under registration, compliance, enforcement, audit and other controls.
Registration
Points noted in this area included:
individuals with multiple tax
the incorporation of companies was not linked to tax registration; many other companies owned by directors involved in write off cases were not registered for tax purposes
companies registered for one tax but not for the obviously appropriate tax: pubs registered for Corporation Tax but not for VAT, similarly services sector businesses not registered for PAYE
discrepancies as between the registration details in Revenue and Companies Registration Office different directors or business addresses
formal documentation in Companies Registration Office e.g. annual returns and registered charges, indicated that the companies traded before being registered for tax.
There would appear to be a need to synchronise the incorporation of companies and their registration for tax. The tax registration process should be tightened to ensure that all relevant tax heads are included, and that complete and accurate details regarding beneficial ownership and business address are provided. Consideration could be given to including the PPS No. of each director as the objective of limited liability is to facilitate the conduct of business investment as opposed to concealment from the tax system.
Compliance
The lack of monitoring and review of a number of cases which came to attention was indicative of weaknesses in the compliance area:
companies found to be active had a 'dormant' status on the tax database
Companies Registration Office indications of business activity e.g. annual returns, registration of charges, changes of business address, were not used to check compliance
There was a pattern of registration for Corporation Tax and no other tax head, and of submitting no returns; from the check of several hundred companies registered for Corporation Tax, some with evidence of extensive trading activity, only a handful returned a liability, or any returns, for Corporation Tax
Returned mail was a basis for a number of write off decisions; this should be seen as an early indicator of compliance or more serious problems - signalling the need for early action; in two cases, there were delays of many years before attempting to re-establish contact
VAT returns are a valuable measure of business activity; this source did not appear to be used as a useful indicator of liability for other taxes; and the monitoring of Corporation Tax compliance appeared to have a low priority in the cases examined, particularly in comparison with the high yielding VAT and PAYE.
Enforcement
An aspect which stood out from the review was the necessity for prompt and decisive action when matters reach enforcement stage. The opportunities for effective enforcement of tax debt can be limited when dealing with private companies, and collection procedures should have the flexibility to respond appropriately in such cases. Particular weaknesses in write off cases included:
allowing token action by the taxpayer to revert the whole enforcement process back to the beginning as opposed to picking up where it was suspended
excessive caution and inordinate delays, sometimes over minor matters, in proceeding to enforcement.
CASE No. 2 - Publican A & Publican B
From the early 1990s Publican A has, through Co.s, been involved at different stages in the operation of three pubs owned by Publican B; each of the newly-formed Co.s registered for tax, obtained Tax Clearance Certificates (TCCs) and renewed the pub licence;
Each then followed a behaviour pattern which outsmarted and rendered useless the normal Revenue procedures in this area:
Co.s were partly tax compliant (for VAT) during the first year
At the end of the year an instalment arrangement for a small amount i.e. €1,000 per month was agreed with Revenue for Year 1 arrears, and TCC was issued enabling licence renewal
The instalment arrangement was immediately abandoned and, by the third year, Co.s had large VAT arrears. These were mainly estimated because of failure to make returns.
At this point, Co.s ceased to trade and were dissolved (no annual returns were sent to the RO). Licence was transferred to the owner, Publican B, who successfully obtains a TCC and renewal of the licence
An interim period follows during which the business is totally non-compliant: in one case VAT returns were not filed for an unbroken three years, and a return under any tax head for one year
The dissolved Co. is then replaced by another with Publican A as a director, and which has a 'clean' tax record to allow the cycle to recommence.
In addition to the write off of €146,000 in the audit sample, a total of €100,000 was written off in two further cases relating to Publican A.
Publican A's companies have not made any Corporation Tax returns to date.
Publican B has declared only one of his ten directorships to Revenue; one of his Co.s acquired eight properties, mainly pubs and hotels, in the period 1987 to 1997 while deregistered for tax. On licence renewal application, three of the pubs declared annual turnover of between €1mand €2.5m.
Twenty two Co.s which operated pubs owned by Publican B were dissolved without a formal wind up or statement of affairs; no Co. returns were made to the Companies Registration Office during the period of incorporation.
Revenue Response
In relation to the areas of registration, compliance and enforcement, Revenue has stated that procedures regarding registration have been significantly tightened up over the years, and that it should not now be possible to register more than once. Individuals wishing to register must use the PPS No. and provide information on date of birth and mother's maiden name. To the extent to which they could be identified, existing registrations were merged and consolidated with the advent of the Central Registration System, Integrated Taxation Processing and Active Intervention Management. Revenue also advised that a review of all aspects of registration is under way and will be completed in Autumn 2002, with proposed implementation of recommendations by early 2003. The findings and implications of the audit report would be incorporated in the review.
The bringing together of the various registrations within the Central Registration System has enabled caseworkers to get a better overall perspective, and thus ensure that more effective action can be taken against non-compliance. Another example is the recent legislation on offsetting that now allows Integrated Taxation Processing to automatically offset where a tax liability is due or to withhold a repayment until outstanding returns are submitted. The Companies Registration Office system installed in September 2000 is also relevant in this context. The Active Intervention Management system and cross taxhead caseworking approach to non-compliance has been in place for a number of years and the approach had been a significant success in ensuring that debt problems, whether highlighted through current compliance or arrears difficulties, were pursued promptly and efficiently.
A number of legislative changes introduced in recent years have resulted in closer co-operation between Revenue and the Companies Registration Office in policing newly incorporated companies and companies which have just commenced business. Revenue has also issued a form for completion by all dormant companies in order to ascertain their current business status. A company which does not reply may be struck off. Where the response indicated that business activity had not commenced, the matter would be followed up on a regular basis.
Some of the cases identified by the audit predated the caseworking era and Revenue was satisfied that pursuit of the cases would be radically different today. Expertise in pursuing tax debt had been steadily enhanced. Lessons had been learned and remedial changes had been introduced. For example, where the original caseworking guidelines had provided for a graduated customer service type approach to default, that had since given way to a more direct approach with early decision-making and a clear strategy in each case to ensure that default was effectively dealt with at the earliest possible date. Revenue stated that a more critical view was taken of instalment arrangements, especially repeat arrangements, with the taxpayer having to justify an instalment in all cases. Those aspects had been emphasised by training. There had also been considerable enhancement of Revenues enforcement capability with the employment of six firms of solicitors to ensure the effectiveness of Revenues enforcement capability through the Courts.
Because of those developments, Revenue was confident that many of the collection shortcomings identified by my examination could no longer arise. However, Revenue also accepted that the cases brought to attention from the examination demonstrated that some further developments would improve effectiveness and that a number of new measures are in the course of introduction to try and ensure that the problems highlighted can be overcome. Some of the changes were procedural and had been introduced straightaway. Others (referred to under later sections) required more detailed consideration, including possible legal changes, and would take a little longer to introduce.
Revenue Audit
Points in relation to Revenue audit which arose from the examination of selected write off cases were as follows:
there was no facility for input to the audit selection process by anybody outside of the inspectorate e.g. cases being caseworked due to poor payment record were not referred for audit consideration despite the risk to the correctness of returns
information sources which were critical to our examination viz. CRO, Revenue property file and excise licence database, did not appear to be used by Revenue to identify possible tax abuse
there was little evidence of audits in the cases examined, apart from regular VAT audits up the early 1990s. These audits did result in the detection of a high incidence of under-declared liabilities and some instances categorised as evasion. However all cases were not assessed or pursued for the shortfall, action did not appear to be taken against those categorised as evaders, and there was no evidence of specific monitoring of risk cases identified from audit
an audit was initiated in one case when returns were considered too low; the audit revealed substantial underdeclaration of tax due.
Revenue Response
Revenue stated that the compliance and collection programmes are designed to address the failure to comply with payment and filing requirements with direct action, and that an approach to poor payment record cases that involved considering them for audit would not be the most productive use of resources. However, Revenue will consider the inclusion of poor payment compliance as one of the risk factors in the planned computerised risk analysis and risk scoring system which will be used to identify suitable cases for audit. It is intended that an automated process will calculate a risk score by applying rules and weighting to available data such as audit results, third party information, accounts, data from tax returns, intelligence information and trade classification codes. This process will be helped by the current links to the Companies Registration Office database and future linking of all Revenue databases under the LINKS project.
As regards the VAT audits of the sample which were carried out in the early 1990s, Revenue stated that in most cases the undercharges had been dealt with either by restricting repayment or by subsequent submission of the return. Assessments to recover the VAT were not required.
There has been continuous development in the area of monitoring of risk for audit since the 1990s. After 1993, VAT audit programmes were subsumed into the Revenue Audit Programme, and the selection of cases for audit has been based on tax at risk under all tax heads. The computerised risk management system previously described is at contract stage. Other developments in the audit area since the cases dealt with in this report included the AIM case-tracking mechanism and a Code of Practice for Revenue auditors under which all audits go through a set procedure to finality.
As regards cases which were brought to Revenue's attention in the course of my examination, detailed profiling of the principals behind the companies had been undertaken and arrangements were under way to have audits carried out.
Direct Debit
The direct debit facility for payment of taxes allows taxpayers to pay a fixed amount each month by direct debit followed by a single annual return together with any balance due. When operated correctly, the system benefits both the taxpayer and the Revenue compliance workload. However, cases of abuse of this system were noted where traders deliberately underpaid the direct debit amounts giving rise to significant liabilities at annual return stage.
Revenue Response
Revenue is satisfied that measures introduced in the last two years provide an effective mechanism for tackling the problem of deliberate abuse of the direct debit facility viz.
legal provisions to establish a minimum amount of direct debit payment, with back dated interest payments for breaches
the facility is withdrawn from cases with compliance problems, including 'phoenix' cases
a dedicated unit has been established to systematically pursue annual returns in direct debit cases, and apply interest where appropriate.
'No Case Size'
It was noted in a number of instances that a tax debt had accumulated from the early stages after registration without collection activity by Revenue. This arose because in the absence of tax returns or payments, the collection system was not able to determine an appropriate level of estimate, and a case was classified as 'no case size' and remained peripheral to the pursuit/enforcement process.
CASE 3. - Leisure Sector Operator
Operator and family had interests over 12 years in 18 companies which ran 11 bars, nightclubs and hotels; 3 companies are currently 'live', while the others were dissolved or liquidated; Companies Registration Office registration or filing requirements were not fully met for any company.
All of operators companies were partly or totally non-compliant for taxes; some submitted tax returns but did not make payments; companies were registered for Corporation Tax but did not submit returns; a receiver of one of operators companies generated and paid over substantial amounts of tax while running a business which had made no returns while controlled by the operator.
VAT audits of a number of the operators companies identified underpayments and evasion; each was treated on a single case basis, and not linked to the operator.
Current nightclub business is run by a 'fourth generation' company, which received a Tax Clearance Certificate even though it is not registered for VAT or PAYE; previous owner was registered for these taxes.
Excise licences have been issued to this operator up to one year after due date; companies conducting some of the businesses did not have any excise licence, but 'sheltered' under a licence held by unrelated operators of other bars in a complex.
In addition to the write off of €170,000 which was included in the audit sample, there have been 5 other write offs totalling €520,000 in relation to this operator.
Revenue Response
Revenue indicated that the risks of the 'no case' size classification had been under review, and pointed out the complication that a new registration may not start trading immediately and that the issue of estimates could lead to unfounded debt. A solution is currently being implemented with the objective of ensuring that registrations will not remain in the 'no case size' category for longer than six months. All nil return and permanent VAT repayment cases have been moved from 'no case size' to a new category. A computer program development will schedule a series of contacts with new registrations to encourage submission of returns. In the event that this step does not get a response, a visit to the premises will provide the basis for the issue of an informed estimate which will bring the case into the regular pursuit/enforcement process. Where it is established that no trading occurred, the registration will be cancelled.
Tax Issues arising in Particular Sectors
It was noted that a pattern of difficulties arose across a number of cases in two particular business sectors - property development and pubs - and some indication of the issues can be seen from the outline sketches presented in this report from each of the sectors. However it was considered that, side by side with the particular tax risks in each sector, Revenue also had particular risk control advantages in each of these areas through the requirement for formal legal transfers in all property transactions, and the requirement for an annual Excise licence and tax clearance in the licensed trade. General issues arising from limited liability and the corporate veil are considered elsewhere in this report.
Property Development
In the area of property development, there may be a complexity of company and financial arrangements and relationships. A separate legal entity may be established for each property development and, in some cases, a number of separate companies may be formed to deal with aspects of a development including property development, property holding, investment, and management of the completed building. During the course of the development a company can legitimately make VAT repayment claims, and no liability to Corporation Tax arises at that stage. The tax liability invariably arises when the development is complete and properties are being leased or sold. This creates a large VAT and Corporation Tax liability and Revenue is particularly vulnerable to the situation where the development company ceases to trade immediately after the properties are leased or sold without making tax returns or payment. Even if Revenue were monitoring the situation and reacted quickly to raise VAT assessments, it is likely that collection and enforcement activity would be fruitless where legal liability rested with a company which has ceased, leaving only the option of liquidation which is unlikely to recover any of the outstanding tax. With any delay recovery becomes virtually impossible.
Revenue Response
Revenue accepts that more needed to be done to combat the type of abuse of VAT and Corporation Tax identified in the write off cases examined, and a Working Group to recommend proposals in this regard has been established. It seemed clear that legislative changes would be needed to counteract the problem, and Revenue indicated that appropriate proposals would be developed in time for the next Finance Bill.
Pubs, Excise Licences and Tax Clearance
The issue of Tax Clearance Certificates (TCC) by Revenue only to persons who are tax compliant is a strong control. TCCs are required for many areas of business e.g. for public sector contracts, obtaining various licences, and state grants. The audit found that:
companies had obtained TCCs without registering for any tax head
companies obtained TCCs by registering for one tax e.g. Corporation Tax, but not for the taxes which would give rise to their main tax liabilities i.e. VAT and PAYE. In many instances, pubs had obtained TCCs without registering for those taxes
chronic arrears cases subverted the regulations and obtained TCCs simply by changing the name of the business usually by the creation of another company. The tax histories of the company owners were not considered in the vetting of applications for tax clearance
TCCs were issued in serious arrears cases on the foot of a pledge or arrangement to pay off arrears, leaving Revenue at a loss when the arrangement collapsed
A known 'phoenix' case with over 60 employees filed a nil return for PAYE but received a TCC.
Over generous operation of the TCC system undermines the purpose and effectiveness of this control, and misses an opportunity to ensure tax compliance.
Case No. 2 demonstrates how the controls based on the requirement for a Tax Clearance Certificate before obtaining or renewing an Excise Licence can be circumvented.
Revenue Response
Revenue has stated that the requirement for a Tax Clearance Certificate in this area makes a significant contribution to the tax collection effort but acknowledges that it is not foolproof. Efforts have been made over the years to tighten requirements, but difficulties had arisen because the type of action ideally required would conflict with limited liability. However, in light of the cases identified in this report, Revenue has set up a Working Group to prepare proposals which would link the tax clearance requirement with the actual operation of the pub. As the types of remedy envisaged would require legislative change, definite Revenue proposals would be formulated in sufficient time for the next Finance Bill.
Abuse of Limited Liability for Tax Evasion
The findings in this area are considered under the headings of abuse of limited liability, directorships, and 'phoenix' syndrome.
Abuse of Limited Liability
The concept of limited liability allows the formation of a legal entity for the purpose of stated business activities, and limits the possible loss of owners to the amounts which have been invested in the company. The purpose of limited liability is to facilitate the growth of business and investment. However the degree of redress available to any third party is also limited to the net assets of the company. The requirements for setting up and operating a company are set out in company law and policed by the Companies Registration Office, the Department of Enterprise Trade and Employment and, more recently, by the Office of the Director of Corporate Enforcement. Certain details relating to each company are in the Companies Registration Office including details of directors, company address, and annual returns relating to the operation and financial position as certified by a public auditor.
It is generally understood that the key to successful business dealings with limited companies is accurate information and a close understanding of its business and relationships. As companies can cease trading and wind up with the same ease with which they are formed, and given the limitation of pursuit, it would be considered imprudent to place full reliance on the items of information in the Companies Registration Office, or to await the filing of the minimalist annual returns. Those engaged in major business transactions with companies e.g. banks and main suppliers also ensure that their interests are protected by such facilities as liens and charges, personal guarantees, and the absolute insistence on meeting tight payment deadlines. When dealing with companies, whether with regard to Corporation Tax and Capital Gains Tax or PAYE and VAT, Revenue is operating in exactly the same business sphere, and is effectively competing with the other interests for the cash available to each company. Therefore it has little option but to operate at a similar level. Anything less will lead to a frequent experience of dealing with the remains of a business which has closed and moved on. There will be little left as many companies on the tax system are of the 'close' company type with an issued share capital of €2.50.
In the course of our examination of the tax records of the cases in the sample, related companies and other business interests of principals revealed substantial abuses of the tax system by individuals through abuse of the principle of limited liability or the 'corporate veil'. These individuals did not receive any particular interest from Revenue - even at write off stage. Clear patterns of abuse were identified as follows:
there was extensive use of companies bought 'off-the-shelf' which were activated to operate a business activity for a short period, for example, one to five years, and which then ceased trading, either having not registered for tax, or not made returns, or having run up substantial tax arrears
individuals concealed their business interests under cover of the company veil. Directorships were not declared. Other family members and employees were registered as directors to conceal principal ownership. Concealment was aided by the declaration and registration of a plethora of home and business addresses
in addition to such registration offences, all of the required Companies Registration Office registration information was not supplied. These were also accepted as companies by Revenue.
While there were few instances where Revenue cross checked information with the Companies Registration Office records, information at that source was less than complete for a number of cases reviewed:
there were major information gaps with regard to directorships. A new number is allocated to each newly registered director, but the extent of individual's directorships are concealed by inconsistent declarations of details such as name, address, and date of birth; this makes it impossible to police the limit of 25 directorships per individual
instances were noted where no directors were listed, or less than the number legally required; there was no issued share capital, and the address of the formation office was listed as the address of the new company
there was a low level of annual returns compliance among the companies reviewed; most have been dissolved without provision of the required special motion of dissolution or of a statement of affairs showing the distribution of the company assets.
The Companies Registration Office will only be effective as a general information source and protection for the general public and Revenue when it ensures that complete and correct information is registered in accordance with company law.
However there are further risks for Revenue should the Companies Registration Office embark on a strike-off programme in order to enforce annual returns compliance. This could seriously hinder tax collection as the directors can then walk away from the tax debts of the struck off company, or even choose to bring about such a situation by failing to file annual company returns.
In summary, it was clear that the requirements of incorporation were treated with disdain by the companies reviewed, and that limited liability was merely a device to be used to escape tax obligations. The registration deficiencies must raise questions as to whether the companies created have the legal status to allow them to avail of limited liability. In view of the extent of lost tax revenues, there may also be an onus on Revenue to challenge such status, and to attempt to look beyond the companies and seek out and pursue beneficial owners. However, in a few cases, Revenue has recently pursued a course of action with the objective of obtaining the disqualification of an individual to serve as a director.
Directorships
Points noted were as follows:
individuals had extensive directorships which were not on the tax record
individuals with directorships on the tax records were not monitored as directors
there was little evidence of usage of this information for establishing relationships with other cases; there was no evidence that the directors of companies which dissolved while solvent were pursued for drawings, where there was no indication of any other accountability for the company assets
there was evidence of inter-company asset transfers without the establishment of final tax liability or ultimate beneficiary.
The narrow 'case-based' approach in these instances may have resulted in considerable tax loss.
Phoenix Syndrome
Phoenix syndrome describes a particular area of tax evasion where directors attempt to use the protection of limited liability for the deliberate avoidance of tax liabilities, essentially by ceasing activity under the guise of one company and transferring the assets and business to a 'new' company with a clean tax record. To counter this activity, Revenue monitors a list of approximately 300 companies. It was noted that:
'phoenix' monitoring was focused on companies and not on the individuals behind the companies. Companies created for separate projects by the same principal, and subsequently dissolved leaving substantial assessed and unassessed tax liabilities were not included in the Revenue monitoring programme
the 'phoenix' programme monitored the 'new' company but no action appeared to be taken in relation to the past activities of companies and directors
instances were noted where it appeared that Revenue identified and investigated classic cases of 'phoenix' activity but did not add them to the programme.
Revenue activity in this area can be frustrated where the owner of a business, through careful leasing arrangements, ensures that the former companies do not own any assets against which action can be taken.
Revenue Response
Revenue has indicated its awareness of the dangers that limited liability poses to tax collection, in particular where the principal of a company abuses limited liability by deliberately leaving tax debts unpaid and 'walking away' from insolvent companies. Revenue has stated that, because of the requirements of company law and limited liability, there were essentially only two remedies open to it in dealing with such individuals. Firstly, where such a practice is identified, to closely manage new cases associated with such persons from the start so that early and decisive action is taken where compliance problems develop. The phoenix monitoring programme demonstrated the success of that approach. Secondly, where such a practice was identified through a ceased business, to seek to have directors restricted or disqualified for fraudulent or reckless trading through the liquidation process.
It was also pointed out that the dangers posed by limited liability were not confined to Revenue and reference was made in that regard to the McDowell Report, the subsequent enactment of the Company Law Enforcement Act, 2001, and the establishment of the Office of the Director of Corporate Enforcement, ODCE. It was considered that the ODCE now had real teeth to take action against rogue directors using a 'scorched earth' policy to defraud creditors including Revenue. The ODCE and Revenue can exchange information, and the two agencies are cooperating closely with liaison procedures in place. The Company Law Review Group has also reported on ongoing issues in this area, such as mitigating the effects of strike off for Revenue and other creditors.
In recent years, Revenue had introduced a specific programme for phoenix companies aimed at stopping any build up of arrears in the current trading entity, and had been successful in minimising tax losses. Where the taxpayers co-operation was not forthcoming, enforcement action was taken without delay, and where necessary the company was liquidated. The approach was constantly monitored, and further refinements introduced, for example, seeking earlier identification, and the use of bonding. However, as the modus operandi of the cases identified from our examination did not conform to the classic phoenix outline, revised operational guidelines have been issued to broaden the scope of operations by changing the emphasis from company succeeding company to business succeeding business whether company, partnership or sole trader. At end 2001, 400 companies were intensively monitored under the scheme.
Revenue has stated that the use of the liquidation process was primarily to deal with a situation where 'ordinary' enforcement was not successful and the debts of a company continued to rise. Apart from preventing the rise of debt, Revenue also pursued the possibility of directors being restricted or disqualified and made personally liable for the debts of the company in so far as it was appropriate and possible. However, decisions in those areas were outside of Revenues control and the difficulty arose from the necessity for convincing evidence to be presented to the Court. Liquidators could be reluctant to pursue such possibilities in view of the legal costs involved, although where appropriate Revenue can guarantee funding for liquidators in that regard. A further problem arose in instances where the principal of a company 'resists' turning over the books and records of the company to the liquidator. While recent changes in company law made it more likely that errant directors would be restricted or disqualified, evidence of the impact of the change in practice was awaited.
Many of the companies identified by our examination had long since ceased trading, and the only course of action for Revenue to pursue the companies at this stage would be to apply to the High Court for the appointment of a liquidator on a just and equitable basis. The liquidator would then pursue the directors on the basis that there was a probable debt outstanding from the directors of the company. It was doubtful whether such a course of action would be successful or cost effective based on the age of the debt, the limited and circumstantial information available and the costs involved. Revenues experience would suggest that such a course would not be successful.
Notwithstanding the success of Revenue actions whether in relation to phoenix monitoring or caseworking generally, Revenue considered that it was clear from the cases emanating from our examination that further measures were needed to tackle the problem of people using limited liability as a vehicle for deliberate and sustained non-payment of tax liabilities. The effective elements of the measures which have now been introduced provide for
mandatory checks to identify related cases where there was a history of non-compliance. These checks would be carried out at (a) registration stage (b) where the company had a significant tax debt problem and (c) prior to a write off decision of any significant level of debt
systematic and vigorous pursuit of related cases by a Dedicated Pursuit Unit in the Collector Generals Office. Such pursuit will include the principal plus all related companies, and will be supported where necessary by a co-ordinated cross-Revenue approach ensuring audits in appropriate cases.
The arrangements have already been introduced and the Unit has commenced work in pursuing the cases identified by our examination. Further cases would be brought into the programme as they are identified by caseworkers. Revenue is confident that the particular measures now being implemented provided an appropriate and effective remedy in the identification and subsequent pursuit of people using limited liability for the deliberate non-payment of tax liabilities.
Response of the Department of Enterprise, Trade and Employment
With regard to the role of the CRO the Department of Enterprise, Trade and Employment accepted that there had been abuses of company law, and indicated that the recognition of such abuses had led to the establishment of the McDowell Group with a mandate to review the compliance and enforcement regimes for company law and to make recommendations to address those issues. The goup's recommendations which sought to strengthen registration-type compliance, to properly enforce company law generally and to provide for the updating of company law on an ongoing basis were given effect by the Company Law Enforcement Act 2001 following which the ODCE was established and resourced to fully and effectively ensure the enforcement of the Companies Acts.
The Department also adverted to combined provisions enacted in company and tax law in 1999 to counter tax abuse in the area of Irish registered non-resident companies. The provisions strengthened Revenues hand by introducing a requirement for newly formed companies to give details of proposed activity, and the ability for a company to be struck off the register for failure to provide information to the Revenue Commissioners. These provisions were specifically designed to enable the Revenue to immediately interact with newly incorporated companies and obtain any necessary information. A failure to supply the information requested can result in the company in question being struck off.
Particular areas covered by the Department's response included the concealment of directorships through the provision of inconsistent information to the Companies Registration Office, the low compliance rate in filing annual returns with the Companies Registration Office and the impact of the strike-off process on Revenues ability to collect outstanding tax liabilities.
The Department stated that the question of the identification of directors had been considered in the First Report of the Company Law Review Group in December 2001. The group concluded that while a formal identification procedure such as is found in certain civil law countries ought not be initiated, consideration should be given to requiring the pre-registration of directors who would at all times subsequently identify themselves on CRO filings by reference to their PPS number with parallel provisions for non Irish-resident directors. The Government had accepted that recommendation and the legislation to give it effect was currently being drafted.
The Department indicated that while there had, historically, been a low level of compliance with annual filing requirements, that had been one of the issues which the McDowell group had sought to address. By 2001 the compliance rate of 85% showed a considerable improvement over the 1997 level of 36%, and further improvement is needed. The initial improvement in compliance followed an extensive strike-off campaign carried out by the CRO. With effect from October 2001, a severe late filing penalty provided for in the Company Law Enforcement Act, 2001, was introduced and the strike off campaign was rolled back. The CRO is keeping under review the success of the late filing penalty in bringing about a satisfactory level of compliance and will use other enforcement processes as necessary.
The Act also provides for on-the-spot fines as an additional instrument for encouraging compliance and as an alternative to the more resource demanding court prosecutions. While it is open to the Registrar of Companies to prosecute companies and their directors (and that is regularly done), it is difficult to deal with the large numbers involved through that mechanism.
The Department also stated that the strike-off process, which had now been relegated to use as an instrument of last resort for dealing with non-compliant companies, had no effect on Revenue's ability to collect outstanding tax liabilities. Where there were sufficient assets to recover, the company could be easily restored to the register at the time of the appointment of a liquidator. If directors had deliberately disposed of their assets to avoid taxation (or other debts) the continuing existence or non-existence of the company was not the material issue. The Company Law Enforcement Act, 2001, established for the first time a real distinction in law between "Voluntary" and "Involuntary" strike off of a company. Where a company is struck off the register as part of the enforcement process, it is now open to the Director of Corporate Enforcement to seek the disqualification of the directors pursuant to the Companies Act 1990. Where a company itself requests strike off, the registrar will only agree to the request provided that the company files all outstanding returns and accounts, places an advertisement in a newspaper and secures the agreement of the Revenue Commissioners. No companies have been struck off compulsorily since these changes have come into effect but the registrar reserves the right to use this process as provided for by law where absolutely necessary.
Conclusions
The task of Revenue is to collect due taxes from the assessed activities of more than two million taxpaying entities. By and large this is achieved through the acceptance of key procedures e.g. PAYE, tax returns, and the co-operation of the taxpaying public with the minimum contact. The process could hardly operate in any other way given the scale of the numbers involved. However, there is an ongoing risk that persons will attempt to evade tax liabilities through a recognition of the pressure under which the system operates, and by either attempting to hide within the great number of taxpayers and taxpayer activity or, should the attention of the system fall on them, by maximising the extent of Revenue action necessary thereby making the cost to the system so high that Revenue will 'go away'.
In undertaking this in depth examination of some of the largest write off cases in 2000, one might have expected to find one or two 'bad eggs' among a selection of cases which just ended up as write offs for a variety of mundane reasons, for example, genuine business collapse, unfortunate change in personal circumstances. However, there must be considerable concern regarding the number of cases in the sample, involving the use of private limited companies that confirm at least elements of the 'hide or frustrate' approach. This raises questions not only about the adequacy of write off procedures but also, more importantly, about the extent to which Revenue is geared to deal with those attempting extensive tax evasion under cover of limited liability.
Revenue's debt reduction policy incorporating the write-off strategy has proved to be an efficient and effective means of tackling the problem of long outstanding tax arrears as well as allowing resources to be diverted to the prevention of new debt arising. Notwithstanding the success of that policy Revenue's response to the findings of this report recognises that improvements have to be made to its procedures in order to ensure that the risk of tax being inappropriately written off is minimised.
There is a strong message from the findings of this report that write offs, or at least certain categories of write off, must be subjected to a sharper review in the knowledge of what might have transpired in each case. Consideration must also be given to the issue of what may have been included in other significant write offs in recent years. A more time-consuming review of proposed write off cases over a predetermined monetary value, including cross checking with related registrations and principals and other information sources, should pay dividends in the management and control of future cases. Pursuit, even through the legal system, cannot only be on the basis of rate of return, and Revenue's recent use of liquidations to seek restriction and disqualification of directors are valuable steps along this road. There must be possibilities also of using the failure of companies to meet many Companies Registration Office and Revenue requirements to persuade the Courts to withdraw the protection of limited liability and render the directors liable for outstanding taxes.
A considerable portion of the report is devoted to the tax evasion issues arising from limited liability as this would appear to provide serious problems for Revenue. This is hardly surprising given the reality of the figures for 2001 - about 146,000 live companies and 1,200 being formed and 600 struck off each month - together with the possibility of a lack of complete or accurate information and time lags before a problem would become known to Revenue. The evader pays lip service to the requirements of Companies Registration Office and Revenue registration and returns but uses the concept of limited liability to avoid pursuit. Revenue's weapons are time-consuming liquidation and future monitoring where the connections have been identified.
In the business world, the institutions financing such private companies and their main suppliers prevent the possibility of similar losses by successfully penetrating the company veil by way of such facilities as liens and charges in advance, personal guarantees, and the absolute insistence on meeting tight payment deadlines, backed up by the threat of refusing future facility. Revenue in contrast cannot as easily choose its customers, although this is partially countered by the ability to propose amendments to rules and legislation when such a requirement is identified. The message from the practices of the business world is that the focus must be on prevention.
On the basis of the findings of the report, consideration should be given to implementing whatever changes are required to bring about closer co-operation between the Revenue and the Companies Registration Office to prevent a prospective tax evader from playing one institution against the other, and from using the facility of the limited liability of a private company to hide the identity and ultimately the tax liability of the directors from Revenue. The improved enforcement of company law, and the general application of the proposed identification of all directors by PPS Number will be of major benefit.
Revenue has already addressed some of the shortcomings identified by my examination by changing certain procedures and through the development and implementation of new technologies to enable it to adopt a more integrated approach to the collection of tax arrears. Increased application of sophisticated technology tools by Revenue should gradually improve performance in identifying and collecting outstanding tax. But these developments on their own will not have optimum effect without changes in the law to strengthen Revenue's hand in a number of specific areas highlighted in this report. In this regard, Revenue has reacted positively to the report by implementing administrative changes and preparing legislative proposals to give effect to the necessary countermeasures.
