Paragraphs 4.8 to 4.10 of the report of the Comptroller and Auditor General read:
4.8 Repayments of Value Added Tax to Registered Traders
Background
Value Added Tax (VAT) is an indirect tax on consumer expenditure that is charged on the value added at each stage of the production and distribution cycle. VAT is chargeable when a taxable person supplies goods or services within the State in the course or furtherance of business. Effectively, VAT is paid by a customer or consumer who is supplied goods or services for his or her own personal use. The supplier (i.e. the registered trader) is charging and collecting the tax on behalf of the Revenue Commissioners. There are currently over 200,000 traders registered for VAT. The gross amount of VAT collected by Revenue in 2001 was €10.5 billion.
A registered trader is charged VAT on the taxable goods and services it purchases for its business. A registered trader in turn charges VAT on the taxable goods and services it supplies. The trader is entitled to deduct the VAT charged on its purchases from the VAT it has charged on its sales. A trader accounts for VAT on his/her sales and purchases by means of a return to Revenue (normally every two months). In most periods, VAT charged on sales exceeds VAT charged on purchases and the trader pays the difference to Revenue. However, in certain circumstances the VAT on purchases exceeds the VAT on sales and the trader is due a repayment of VAT. For instance, if a trader increases stock or purchases an expensive item of equipment, a repayment can arise. Some businesses (e.g. food businesses) are in a permanent repayment situation because their sales are zero-rated but they are being charged VAT on some or all of their purchases. The total amount of VAT repayments by Revenue in 2001 was €2.6 billion. This includes refunds which arise where a trader has overpaid VAT and the overpayment is repaid by Revenue.
VAT is a self assessed tax and registered traders are required to maintain proper records of all transactions that affect their VAT liability. Revenue carry out a programme of audits which includes audits of traders' VAT records to ensure they are complying with the regulations and to check the accuracy of VAT returns including repayable returns. VAT audit activity may be dedicated or form part of general audit programmes. The VAT yield from audits in 2001 was -61.2m mostly arising from underpayment of tax but would also include an element of overstatement of VAT repayment claims.
In recent years, a number of taxpayers have been convicted and received prison sentences for obtaining payment by making false VAT repayment claims. In addition, a former official of the Revenue Commissioners received a prison sentence for conspiring with others to defraud the Revenue Commissioners of €4.8m by means of a false VAT repayment claim.
Revenue's customer service standards aim to repay 85% of VAT claims within 10 working days of receipt of claim with the balance being repaid within a further 20 working days. In 2001, figures supplied by Revenue showed that 80% were refunded within 10 days and 94% within 30 days.
Objectives and Scope of the Audit
The objectives of the audit were
· To ensure that the system for repayment of VAT to registered traders is such that
- Repayments are only made where properly due
- All repayments are supported by valid and complete documentation
- All payments are correctly made and recorded in the accounting records.
· To establish if appropriate arrangements are in place for setting repayment limits and for the approval of repayment claims which exceed those limits.
· To establish whether appropriate management information relating to repayments is produced and utilised to improve the efficiency and effectiveness of the system and its controls.
The examination of the VAT repayments system was based on a review of documentation and discussions with the Accountant General's Office and the Collector General's Office. The role of the Inspectorate in controlling VAT repayments was established by means of discussions with officials in the Office of the Chief Inspector of Taxes. A random sample of VAT repayments and refunds made in 2001 was selected and checked against the prevailing system validation rules. Where repayments in the sample were referred to the relevant tax district for certification the action taken in the district was reviewed.
System for Repaying VAT
In recent years Revenue has been developing its systems so that each taxpayer will be treated as a single customer for all taxes. The Integrated Taxation Processing System (ITP) is a key element in moving to this approach. ITP is a system for issuing and processing returns, payments, repayments and refunds. VAT was incorporated into ITP in April 2000 and since then all claims for VAT repayments to registered traders are processed through the ITP system and payments are made from that system.
VAT returns when received by Revenue are scanned into electronic format and processed through the ITP returns reception sub-system. When the VAT return has been successfully processed through returns reception it will create an amount due from or to the taxpayer for the period depending on whether the return is payable or repayable. Each day the Debits/Credits sub-system of ITP is run which identifies credits on a taxpayer's record and instigates the processing of a repayment. The system checks each repayment claim against a series of validation rules which includes examining the taxpayer's record for outstanding taxes or returns. If a claim fails a validation rule the processing of the claim by the system ceases and a 'work item' is created which is delivered electronically to an official within Revenue to process. If the taxpayer has outstanding taxes the system will, in certain circumstances, automatically set the repayment claim against those taxes. In other situations where there are outstanding taxes, a work item will be created and the repayment claim may be offset against the outstanding taxes manually. The processing of a claim or 'credit' automatically by the computer or manually by an official can result in
· The full amount of the credit being approved and payment being issued.
· The full amount of the credit being disapproved. The credit will remain on the customer's account but there will be a stop to prevent the credit being processed.
· Issuing payment for part of the credit and disapproving the remainder.
· Offsetting the full amount of the credit to outstanding taxes.
· Offsetting some of the credit to outstanding taxes and payment being issued for the balance.
· Offsetting some of the credit and disapproving the balance.
The Debits/Credits system processes the credit through 3 stages
· Credit validation - confirming that the credit is valid and can be released for offsetting and/or repayment.
· Offset validation - offsetting the credit to outstanding taxes.
· Repayment validation - repaying the credit.
Work items created in relation to VAT repayments are referred to the relevant tax district of the taxpayer, to the VAT Repayments Section of the Accountant General's Office or to the Collector General's Office. The official to whom the work item is referred takes the appropriate action depending on the nature of the work item. For instance, if a work item is created because the taxpayer has outstanding returns, the taxpayer will be contacted and asked to submit the returns and informed that payment will be withheld pending their receipt. If a claim fails a particular validation rule and is referred to an official, it is the responsibility of the official to check the claim against the remaining system validation rules, as the claim does not re-enter the sequence of validation checks at the point it failed. The exception to this is a work item referred to the tax district which if approved re-enters the sequence of validation checks at a pre-defined point in the system. An official to whom a work item is assigned can use the comments box provided to indicate what action is being/was taken. The insertion of such comments is optional. When an official has processed a work item to his satisfaction, he electronically approves it and it is then referred to his supervisor for approval. In certain circumstances, for example high value repayment claims, a third level of approval is required.
Audit Findings
Returns
As part of the examination a sample of 40 repayments and refunds made in 2001 were scrutinised. Each payment was checked against the original VAT return submitted by the taxpayer. Prior to scanning, all returns are reviewed to ensure all information appears to be in order. In certain circumstances, for example, if the taxpayer has not signed the return, it will be returned to the taxpayer. Correctly completed returns which have been damaged or which are considered to be uninterpretible to the scanner, are re-written by Revenue staff prior to scanning. In these cases, the original return is attached to the re-written version. This was the case for two of the claims examined both of which were for amounts in excess of €1m.
In seven of the 40 cases examined, the taxpayer submitted a second return for the same period after the original repayment claim had been processed. Each of these cases was a designated 'repayment only case' where the taxpayer is permitted to submit two claims for a period. For other cases, the system will accept a second repayable return for a period and will automatically treat it as supplementary to the first return and not as a replacement for it unless the second return is greater than the original in which case a work item will be created and customer confirmation sought. Revenue should consider introducing procedures to extend the confirmation process to all instances where second repayable returns are received. Alternatively, the VAT return could be revised to allow the taxpayer signify the nature of second returns. The exception to this is where the taxpayer clearly marks the second return as a replacement and this fact is noted by the Collector General's staff prior to scanning. In these cases, the system will substitute the amounts on the second return for those on the first and adjust the taxpayer's record accordingly. This can be problematic if the second return is for less than the first and repayment has already issued based on the first. The taxpayer's record will show an amount due from the taxpayer for the relevant period but this fact is not flagged by the system and recoupment of the amount already repaid will have to await normal collection activities. Revenue has indicated that the possible enhancement of ITP to facilitate the confirmation of all second repayable returns is being examined.
System Validation Checks
The validation checks carried out by the system involve checking against the information held on the taxpayer's record in the Revenue computer. In the main the checks relate to whether the amount of the claim exceeds monetary limits which are set for each taxpayer by the Inspector, whether the taxpayer has outstanding taxes, whether his returns are up to date and whether there are any stops or other markers on the taxpayer's record which would prevent repayment. For the sample of 40 repayments examined, it was found that the system was carrying out all the checks specified.
While staff did receive training and introductory training manuals when VAT was first introduced into ITP, there is a lack of user documentation to inform officials how to deal with work items that arise when claims fail validation checks. However, VAT Repayments Section are currently drafting a user manual. It should be borne in mind that with each new release of ITP, changes can be made to the system that affect the VAT repayments element of the system so that user documentation could become outdated. Nevertheless, it should be possible to maintain an up to date user manual to which staff could refer. Revenue has confirmed that the manual is expected to be completed in October 2002, following which it will be updated regularly.
The VAT Repayments Section is established in such a way that the each taxpayer deals with the same staff member and Revenue's view was that the advantage of this in terms of staff members becoming familiar with the case outweighed the obvious control weakness. Following the audit, Revenue decided to change this policy and will shortly implement the conventional control device of regular rotation of team members. For the sample examined, work items which were referred to officials in the VAT Repayments Section, were dealt with in an appropriate manner. Repayment claims which fail validation rules do not re-enter the sequence of checks at the point which they failed and the onus is on the user to check the claim against the remaining validation rules. Revenue should assess the risk that this gives rise to against the delay in repayment that would occur by subjecting approved work items to re-checking by the system. Revenue has stated that claims which fail validation rules are subject to at least two levels of approval before repayment and that the rechecking of such claims by the system would duplicate work already done and delay the repayment. They are also of the view that even in the unlikely event that the user releases the payment in circumstances where it would fail system checks, the risk is negligible as normal compliance activity would be initiated in due course.
Offsetting Repayments against Outstanding Taxes
The Finance Act, 2000 gave Revenue the power to introduce regulations to allow them to offset repayments due to a taxpayer under one taxhead against outstanding taxes in other taxheads. Previously, this was not possible without the permission of the taxpayer. Revenue introduced these regulations in August 2001. These regulations and the extension of ITP in September 2001 to incorporate almost all taxes with the exception of Relevant Contracts Tax (RCT) and some capital taxes will allow automatic offsetting of repayments due in most instances. The random sample examined showed that repayments and refunds were made in five cases where the taxpayer's record showed amounts outstanding in respect of RCT ranging from €1,825 to €108,146. Two cases were also noted where the taxpayer's record showed Capital Gains Tax outstanding of €14,349 and €21,527. While each of these cases pre-dated the regulations allowing automatic offsetting of repayment against unpaid taxes, they underline the need for the taxpayer's position as a whole to be examined prior to repayment being issued. These cases also highlight the need for Revenue to complete the introduction of all taxes into ITP to allow the system to automatically offset repayments against unpaid taxes. Until this is done, offsetting of unpaid taxes which have not yet been incorporated into ITP can only be done manually and there is the possibility that outstanding non-ITP taxes will be overlooked when repayment is being issued. Repayment claims which do not fail system validation checks and therefore are automatically approved by the system are by definition not brought to the attention of an official. Therefore, it is not possible to carry out manual checks for outstanding non-ITP taxes. It is understood that RCT will be incorporated into ITP before the end of 2002 which will allow greater use to be made of the offset provisions. Capital Gains Tax is now incorporated into ITP and subject to the full offset provisions.
Referrals to Inspectors
The main risk based control of VAT repayments is the system of monetary limits set by the Inspector for each taxpayer. If a repayment claim is received which exceeds these limits the claim requires the approval of the Inspector before payment is made. The main objectives of this system of referral to Inspectors are
· To provide an improved service to compliant taxpayers.
· To assist in the detection of fraudulent or incorrect claims.
In addition, a small proportion of all claims are randomly selected and referred to the relevant Inspector for review prior to repayment.
The setting of these monetary limits is at the discretion of the relevant Inspector. Minimum levels have been prescribed centrally and criteria are set to identify high risk cases in this context, including
· 'Phoenix' type operations or cases with poor Revenue history.
· Traders registering with no fixed place of business.
· Non-resident companies.
· Liquidator/receiver cases.
· Cases where trading records are poorly maintained.
While these criteria are good indicators of potential risks it is essential that cases are constantly reviewed to ensure that all such high-risk cases are promptly identified and the limits adjusted accordingly as necessary.
When a claim is referred to the Inspector it is at the discretion of the Inspector what action should be taken. In essence, the decision has to be taken as to whether the claim can be certified with or without an audit. Instructions to inspectors require that in general all first claims in excess of a specified amount require an audit but that the Inspector has discretion in deciding the degree of checking required. The Inspector may decide that there is sufficient information available to certify the claim otherwise than by way of audit. Factors which the Inspector takes into account in making this judgment include
· 3Whether the case had previously been audited and what is the compliance history.
· What is the nature of the trade and whether it involves highly technical business transactions.
· The degree of understanding by the trader of his/her VAT obligations.
· The agent and his/her level of involvement.
· Are there exempt transactions involved?
· Is there a large volume or value of trade in goods in which the trader does not normally trade or is there a trade in high value goods to registered traders in other EU countries?
Revenue are currently examining the feasibility of establishing VAT Verification Units to deal with the checking of repayment claims. Planning is under way to establish one such unit on a pilot basis. The intention is to review the operation of this unit to establish whether similar units should be set up in all regions.
Of the 40 claims examined during this audit, 17 had been referred to the relevant Inspector for certification because the monetary limits had been exceeded. These claims were certified by the districts on the basis of one or more of the following
· Requesting from the taxpayer supporting invoices, explanation for the claim or other information deemed necessary.
· Knowledge of the taxpayer and their tax history (including knowledge from any on-going audit).
· For single large transactions, checking that the vendor had paid to Revenue the VAT that the taxpayer is seeking repayment of.
· Carry out an audit of the taxpayer.
· Examination of latest accounts.
· Consideration of nature of the business.
In one case where a claim for €1.21m was certified by the Inspector, the comments box on the ITP system in relation to the work item notes that the claim was not checked due to lack of resources. Revenue has since stated that the basis for the decision to approve the claim also included knowledge of the company including a recent audit and the compliance record of the company.
Risk Assessment
In recent years, due to the growth in the economy, the number of claims being referred to Inspectors increased to such a level as to be unmanageable and it became necessary to universally increase the monetary limits for all but the most high-risk traders. In fact, two such general increases have been made in recent years in the level of these monetary limits. These increases were deemed necessary because the level of resources available in tax districts could not deal with the number of claims being referred to them for approval. Nevertheless, the identification of particular risk type cases and the setting of appropriate limits based on the identified risk would be more appropriate than general increases designed principally to reduce the number of claims being referred. The monetary limits are trader specific and therefore are only reviewed if the case is re-examined by the Inspector either because it is the subject of some type of audit or because the Inspector is required to certify a repayment claim. More research and information is required to identify the type of cases that may give rise to the risk of fraudulent or incorrect repayment claims and to apply this knowledge in setting appropriate monetary limits for particular types of cases.
Revenue has recently appointed contractors to develop a computerised risk analysis and risk scoring system to identify customers who are most likely to fail to meet their obligations in respect of the various taxes and duties. The intention is that an automated process of applying rules to available data such as audit results, third party information, accounts, data from tax returns, intelligence information and trade classification (NACE) codes will be implemented to assist Revenue in its audit and investigation activities. This will allow the degree of risk to be determined by the calculation of a risk score. The opportunity should be taken when this system is being introduced to incorporate risk factors in relation to VAT repayments and adjust the system of repaying VAT accordingly. Revenue has stated that the new system will be effective for all taxes and all areas of Revenue business including VAT repayments.
Revenue has estimated that approximately 50% of repayments and refunds are automatically approved by the system for payment. In many cases, a number of years can elapse between audits of traders and therefore it may be some time before the validity of repayments which have not been referred to the Inspector can be checked. Also, when an audit is carried out it does not examine all periods since the previous audit so some repayments may never be examined. In 2001, repayments and refunds of almost €63m were made to traders who registered for VAT in that year. Over €51m of these payments were to companies who according to data on the ITP system have not been audited. Repayments and refunds of over €571m were made in 2001 to traders who have not been audited since before 1990.
Revenue has stated that total reliance cannot be placed on the audit data on ITP as not all districts record audit details on that system. The Active Intervention Management System (AIM) provides a more comprehensive record of audit activity. However, the interface between AIM and ITP systems does not update the record of audit activity. The AIM system is currently under review and the issue of consistent and comprehensive recording of audit activity will be addressed as part of the review. Revenue has also pointed out that some of the companies who received repayments in 2001 with no apparent recent audit were in a group relationship with other companies. While no audit details were recorded in respect of the company that received the repayment, audit activity did in fact take place and was recorded on the computer record of another company within the group. In relation to new registrations, Revenue has stated that they are aware of the risks involved and have procedures in place to minimise that risk. These procedures include checking the PPS numbers of the principals involved in the business, examining that compliance record of associated businesses and in certain cases conducting pre-registration visits.
In relation to VAT risk analysis, Revenue stated that
· The increase in the referral limits followed a review in 2000 by a working group in the Chief Inspector's Office. It was a necessary stop gap measure to alleviate an unacceptably high level of non-productive referrals and to provide a breathing space in which to develop a real risk based selection model.
· Various options for the development of a more scientific method of case selection had been examined in recent years including
- Flexible risk ratings based on industry sector, case size, compliance record, etc.
- Differentiating between 'payment' and 'repayment' traders so that different targeting rules could be applied to each category
- The use of audit dates so that traders who had been satisfactorily audited could be given higher referral limits.
· In the absence of an overriding risk analysis system, the Chief Inspector's Office has centrally identified and issued to selected tax districts lists of VAT cases which posed a possible revenue risk. These were based on factors such as repayment only cases, cases in an overall repayment position and cases that had received two repayments in excess of the monetary limits in a calendar year.
Revenue has also stated that risk, in the context of Revenue operations, focuses on the potential loss of revenue arising from non-compliance with obligations under legislation with the purpose of identifying those who pose the greatest risk of tax default. In this context risk is not confined to repayments only.
Management Information
Possible risk based checking of claims is of course limited by the amount of information that is available. As the VAT return shows the amount of VAT on sales and purchases for the period but not the amount of sales and purchases themselves, it would not be possible to review ratios. Registered traders are required to submit each year a return of trading details showing the total of their sales and purchases for the year broken down by VAT rate. These returns are required to be submitted to the Collector General's Office but due to a lack of resources the information on returns submitted is not being captured on the taxpayer's record. This limits the ability to check the credibility of repayment claims against known trading levels. It is understood that proposals to resolve the matter are currently under consideration.
Each taxpayer registered with Revenue is given a trade classification code known as a NACE code. Proper classification of traders by type of business would help in assessing the validity of repayment claims. However, the current system of NACE codes is apparently not suitable for this due to a lack of definition in the code. A project is under way to review and revise the NACE codes.
Other than information in relation to the number and value of repayments made and performance in relation to customer service standards, very little management information is routinely produced in relation to VAT repayments. The production and review of relevant management information would provide a valuable tool in monitoring and controlling VAT repayments. Examples of the type of management information that could be obtained include
· Analysis of claims disapproved or partially approved by Inspectors. This could provide indicators of possible fraudulent claims and inform checks on future claims. Further analysis could be conducted by trade class to identify types of traders whose claims are adjusted most often.
· The random selection of claims for review by the relevant Inspector is capable of providing a valuable indicator as to whether the system is operating satisfactorily. However, unless the results of the Inspectors' reviews of these claims are collated and analysed, an assessment of the system based on this test can not be made.
· Details of claims from recently registered traders.
· The yield in terms of payment or offsetting of outstanding taxes from checking claims should be recorded.
Revenue has stated that the review of the NACE codes and the new computerised risk analysis system will allow greater analysis of available information for management information purposes.
Conclusions
The administration of VAT differs significantly from that of other tax heads by virtue of the fact that almost one quarter of the gross amount collected is subsequently repaid. This is innate to the nature of the tax but it requires Revenue to continually reassess its strategies for striking the correct balance between legitimate demands for improved customer service in making VAT repayments with the equally important objectives of only making correct repayments and minimisation of the likelihood of fraud.
The consolidation of VAT, including repayments, with the integrated taxation processing system in April 2000 provided the opportunity for significant benefits both in the areas of customer service and internal control. However, the relative newness of these arrangements requires ongoing strategic and operational review to ensure that the full possibilities of the system are achieved and that where necessary it is modified to address any weaknesses detected.
The system now in operation puts a premium on the implementation and regular review of a comprehensive risk control strategy, together with full operation of the procedures designed to achieve the desired level of control. The findings of my examination indicate that there is scope for improving both the strategy and the application of controls. Revenue is now at an advanced stage in obtaining a comprehensive computerised risk management system for all taxes and all areas of Revenue business including VAT repayments.
There is an increased level of risk associated with the issue of substantial repayments to newly formed companies and to older companies which have not been audited for some time. Revenue has confirmed that with 25,000 new VAT registrations annually, risk analysis and risk management must be central to the control process. The tax history of the individuals behind each new business are checked in detail and further action such as new business visits and later audits are based on the on going assessment of risk. However, my examination noted low utilisation of management information for control purposes in an area where the volume of transactions would suggest that it could be a valuable control tool.
Potential weaknesses at the point where manual intervention necessarily allows for system checks to be overridden should be carefully managed, for example where there is a break in the sequence of validation tests. Clarity in the handling of second returns for a period, the better use of comments fields, improved user documentation, a more refined use of business codes together with the implementation of the staff rotation policy should help to further improve the control environment.
4.2 Dividend Withholding Tax
Background
The scheme of Dividend Withholding Tax (DWT) was introduced in the Finance Act, 1999, and requires companies resident in the State to make a deduction at the standard rate of income tax from dividends paid or other profit distributions made after 6 April 1999, subject to certain exemptions. Recipients such as companies resident in Ireland, investment funds, charities and pension funds are specifically excluded. Others, including most non-resident individuals and companies, may qualify for an exemption by making the appropriate declaration and supplying adequate supporting documentation either directly to Revenue or to approved dividend paying companies or agents acting for the company (Authorised Withholding Agents). A financial institution or stockbroker which has registered with Revenue as a Qualifying Intermediary may receive distributions without deduction of DWT in respect of clients who have provided the intermediary with appropriate declarations of exemption. The Qualifying Intermediary takes responsibility for administering the DWT, must retain declarations and other relevant documentation for inspection for six years, and provide an auditors report of compliance with the scheme in its first year of operation and subsequently on request.
A company or Authorised Withholding Agent which makes a distribution is required to submit a return containing details of distributions made and DWT deducted to the DWT Section of the Customs and Residence Division of Revenue by the 14th day of the following month, together with payment of the full DWT liability. A return is required even where no DWT deduction is made from the distribution. An Inspector of Taxes may make an assessment for any unremitted tax or in cases where s/he considers that the return understates the full amount due. While the recipient of the distribution is required to declare the gross amount received for income tax purposes, credit may be claimed in respect of the DWT deducted at the standard rate. Where the DWT amount exceeds final tax liability, or where a valid exemption entitlement had not been sought, a refund of DWT may be claimed.
DWT receipts for 1999-2001 are shown in Table 1.
Table 1 - DWT Receipts and Returns 1999-2001
|
Gross Receipts
|
Refunds*
|
Net Receipts
|
Total No. of Returns
|
No. of ’Nil’ Returns
|
|
1999
|
€46m
|
€8m
|
€38m
|
1,003
|
378
|
|
2000
|
€203m
|
€18m
|
€185m
|
3,301
|
1,429
|
|
2001
|
€189m
|
€46m
|
€143m
|
4,010
|
1,628
|
[* The table shows the overall DWT position, taking account of direct refunds by DWT Section and tax districts, and subsequent refunds on the basis of approved claims from non-residents etc.]
The low figures for 1999 reflect the nine month period, and special transitional arrangements for some non-resident persons. It was also likely that some distribution dates may have been brought forward to avoid the necessity for a DWT deduction. Revenue expectation was that DWT would yield in the region of -100m in a full year.
Objectives and Scope of the Audit
The objective of the audit was to examine the extent to which procedures currently operated by Revenue provide adequate assurance as to the assessment and collection of revenues due in respect of DWT. Audit work mainly focused on the operation of the DWT Section. Information and papers were also received from the Office of the Chief Inspector of Taxes. From an examination of records, a sample of recipients of distributions were selected and cross-checked to their IT returns. A sample of companies was selected from those which had previously made distributions for Advanced Corporation Tax purposes and failed to submit a DWT return. The sampled cases were cross-checked to Corporation Tax returns and company accounts for evidence of distributions. Procedures for granting exemption status from the payment of DWT, and for the issue of refund payments, were also examined.
This report also includes reference to a number of findings from a 2001 report by Revenue's Internal Audit Division on the procedures governing the administration of DWT.
Audit Findings
Declaration of Distributions by Companies
DWT operates on the basis of self-declaration by companies. Companies are not required to register for DWT, and the Revenue returns compliance programme is not applied to company distributions. There were no comprehensive procedures operated to ensure that all liable companies submitted returns for DWT. Corporation Tax returns and supporting annual financial statements were not systematically monitored for distributions which would indicate a liability for DWT returns and possibly deductions. Revenue has however stated that an enhancement is in the process of being developed whereby the response to the panel on the Corporation Tax return indicating whether a distribution had been paid will be captured by the Tax Districts and made available electronically to the DWT Section.
The level of returns received in 2000 and 2001 of 3,301 and 4,010 respectively (relating to some 2,300 companies) represents under 4% of companies classified as live for Corporation Tax purposes. For the same periods, DWT returns were submitted by only 50% of those companies which had returned Advanced Corporation Tax in 1997/98. Revenue have pointed out that the corresponding figure for 1998/99 rose to 57%. While it considers that these statistics in themselves do not indicate a DWT compliance problem, Revenue accepts the need to crosscheck former Advanced Corporation Tax filers against DWT filers and the DWT compliance programme now provides for this.
A review by my staff of 21 companies which had filed returns in respect of Advanced Corporation Tax but which appeared not to have submitted DWT returns revealed that
· 13 companies had not made distributions; however in five cases, distributions may have been made by other companies in the group
· 5 of the companies had, in fact, made returns in respect of the distributions identified. One of the companies filed a return in 2000 but had omitted to file a return in 1999. The liability was €7,807 and the return has since been received
· 3 companies had made distributions totalling €1.4m without completing a DWT return. Two of the companies had no liability and are now in the process of preparing 'nil' returns. In the other case, confirmation is awaited as to whether a proposed distribution was made.
Internal Audit noted that 439 or 25% of companies which had made a DWT return in 1999/2000 did not submit a return in 2000/01. Revenue stated that there may not be a compliance problem as a company which makes a distribution in one year may not do so in the following year. However, in June 2002, 79 companies which had previously filed a return in 1999 and 2000 showing a DWT liability in excess of €1,000 but did not file a return in 2001 or early 2002 were contacted. To date, 38 companies had responded and only 2 had a DWT liability which amounted to €11,000 in total.
Internal Audit found that 25 of a sample of 79 companies which had made Corporation Tax payments greater than €125,000 had failed to submit DWT returns. The formal response to Internal Audit stated that, of the 25 cases,
- 16 companies should have submitted 'Nil' returns
- 1 company had a DWT liability and subsequently filed a return
- 1 company had made the distribution prior to the introduction of DWT
- 2 companies which had provided for distribution in their accounts did not make the distributions
- Investigations were under way into othe remaining 5 companies.
Revenue has pointed out that 92% of DWT yield comes from stock exchange quoted companies plus a handful of others (111 companies in all) - and these are very tightly controlled. In the case of companies quoted on the Dublin Stock Exchange, a weekly list of companies, who are due to make distribution is provided by the Dublin Stock Exchange to DWT Section. These companies are monitored to ensure that returns and payments are received on time. The compliance level has been excellent and ensures that the bulk of DWT is collected in full.
Revenue stated that the introduction of a comprehensive compliance programme for smaller companies was postponed until 2002 as it was considered that any loss of revenue would be very small, and that the initial focus had to be on customer service and on establishing a system to administer the tax. Revenue also stated that DWT Section has commenced a compliance programme to gauge the level of compliance of the smaller private companies, and that the only evidence of a compliance problem to date related to companies which did not have a DWT liability but which failed to file the required 'nil' return.
Claims for Exemption Status
A sample of exemption cases was examined by my staff and all appeared to be in order and were supported by appropriate declarations from the beneficiary. Variations were noted in the level of assurance provided in the audit certificates supplied by Qualifying Intermediaries. In this regard, it is noted that, following a consultation process with the accountancy profession, DWT Section had agreed a standard certificate with the objective of achieving a consistency in the audit work to be performed and the extent of the assurance to be provided. In addition, the Section has drawn up a set of audit checks for the examination of Qualifying Intermediary records, and a programme of Revenue visits to these agents commenced recently.
Regular Distribution Patterns
There are strong indications that salary payments and other remuneration are being made by companies in the form of distributions which initially only attract deductions at the standard rate of tax, and which also avoid the requirement for payment of PRSI contributions. The Internal Audit report noted 32 companies which had made monthly distributions of similar amounts to the same beneficiaries. The DWT Section has since identified 139 companies making regular distributions. The matter was initially referred to Special Enquiry Branch for investigation but Revenue has since referred the cases in question to its Anti-Avoidance Unit which will handle such cases in future.
Declaration of Dividend Income on Income Tax Returns
While DWT is deducted at the standard rate from the proceeds of distributions received, a taxpayer has an Income Tax liability at the marginal rate. However, while the name and address of recipients must be shown, there is no requirement to record the Personal Public Service (PPS) No. of dividend recipients on DWT returns. Even in the absence of this common reference, it is still possible to perform a manual matching between DWT and Income Tax returns for individual cases but an overall systematic check on the return of dividends for Income Tax, possibly through the selection and sampling of high value cases, is not feasible.
Revenue stated that, at the time the DWT legislation was enacted, it was considered that imposing a requirement on registrars of quoted companies and qualifying intermediaries to obtain the PPS numbers was a disproportionate compliance burden which could interfere with the efficient workings of the stock market. Revenue said that a recent report recommended undertaking a study to establish the benefits accruing and costs associated with the quoting of third party reference numbers on all forms, including the DWT form. The results of this study will inform the debate prior to requesting any legislative changes to implement the quoting of such PPS Nos. Revenue also stated that a prototype system for better matching and risk profiling of dividend recipients has been developed and will be made available shortly to Tax Districts.
A sample of 50 recipients of dividend income to the value of -1.6m was extracted by my staff from DWT returns and matched with individual Income Tax returns with the following results:
· 33 returned the dividend
· 5 returned an amount less than the dividend paid on DWT return
· a PPS No. could not be traced in 4 cases
· 2 did not submit an Income Tax return
· in 6 cases the submitted Income Tax returns were not traced by Revenue; a computer check has established that the relevant Income Tax returns have been processed in 5 cases, assessments have issued and that each has returned dividend income. The remaining case is under enquire by the tax district.
Internal Audit found that, of 17 Income Tax returns examined, 5 individuals had not returned their dividend. Revised returns and tax payments were subsequently received from 3 individuals. A further case, while not returned by a minors' trustee, was returned on the minors' returns. The final case was resolved by a repayment of the DWT.
Conclusions
One of the lessons from the DIRT investigations was that, even in a self-assessment system, it would be inadvisable to rely totally on self-declarations by companies, or any other clients of the tax system. There are clear indications both from the findings of this audit and from the Internal Audit report that compliance by companies with the DWT scheme is not being monitored by Revenue in a systematic way.
The DWT Section is now becoming more proactive, for example by launching a programme of checking of recipients' agents. It is likely that this process will be accelerated by the Internal Audit report. Nevertheless, up to recently, DWT was less than fully established in the tax system, with the level of compliance unclear. It is considered that further improvement in this situation would be achieved with actions on two fronts:
· setting DWT compliance targets and implementing a clear strategy to achieve them, and
· putting structures in place to facilitate full exchange of data with other areas of Revenue.
Part of the administration of DWT is delegated to companies, to Authorised Withholding Agents and to Qualifying Intermediaries. While this makes a substantial contribution to the efficient operation of the scheme, Revenue should formally consider the risks inherent in a delegated approach. An appropriate programme of monitoring of this aspect of the scheme should then be implemented which is commensurate with the level of risk and the efficient utilisation of resources.
In response to the report, Revenue has stated that since the introduction of the scheme, much of the emphasis was on legislative, customer and information technology development issues. As priority was now switching away from those issues, greater emphasis and resources were being assigned to scheme compliance issues. Revenue has indicated that actions now under way or proposed include:
· 14 reviews are currently in progress under a programme for reviewing and checking the activities of paying companies and intermediaries. It is envisaged that there will be a significant expansion in this aspect of work in the future
· since September 2001, DWT is in the Integrated Taxation Processing system and, since May 2002, returns and payments can be filed through the Revenue On-line System. A comprehensive DWT database containing details of DWT payments and related shareholder information has been developed and is available to DWT section and is being rolled out to tax districts
· DWT Section intend to compile, on an ongoing basis, a register of companies with a potential DWT liability. Previous filers will be recorded and any who have not made a return in the previous 18 months will be contacted
· as part of the compilation of a DWT register, former Advanced Corporation Tax filers will be cross checked against DWT filers, and the position of all companies who have not made DWT returns will be checked
· electronic transfer of data from the Corporation Tax returns to DWT Section
· Corporation Tax filers who had a tax liability greater than €125,000 and who did not make a DWT return will be identified, and the accounts submitted to tax districts in these cases will be inspected.
4.2 Forecasting of Tax Receipts
Under Article 28 of Bunreacht na hÉireann, a White Paper setting out Estimates of Receipts and Expenditure for the coming year is presented to Dáil Éireann prior to the annual Budget statement of the Minister for Finance. The estimated tax receipts in this statement are subsequently adjusted to take account of Budget changes, and the resulting 'Post-Budget Estimate' becomes the tax collection target for the coming year, and the main funding basis for the expenditure side of the Budget statement. While the final estimates of tax receipts are decided and formally presented by the Department of Finance, and while the estimates at all stages are prepared on the basis of economic forecasts from the Department, Revenue plays a major advisory role through the preparation of estimates of tax receipts and costing of options and proposals. Tax receipts are reported through the monthly Exchequer Statement, the annual Finance Accounts and my Annual Report (which differs from the other sources in showing the actual net receipts as opposed to the amounts paid into the Exchequer).
Table 2 - Variation between Forecast Tax Receipts and Exchequer Outturn 2001
|
Tax Head
|
2001 Post-Budget Estimate €m
|
2001 Outturn €m
|
Actual Shortfall €m
|
Shortfall As Percentage of Estimate %
|
|
Customs
|
230
|
165
|
-65
|
-28
|
|
Excise
|
4,774
|
4,050
|
-724
|
-15
|
|
Capital Taxes
|
1,196
|
1,051
|
-145
|
-12
|
|
Stamp Duty
|
1,276
|
1,227
|
-49
|
-4
|
|
Income Tax
|
9,879
|
9,347
|
-532*
|
-5
|
|
Corporation Tax
|
4,302
|
4,156
|
-146
|
-3
|
|
VAT
|
8,792
|
7,920
|
-872
|
-10
|
|
Other
|
12
|
9
|
-3
|
|
|
Total
|
30,461
|
27,925
|
-2,536
|
-8
|
*includes PAYE shortfall of €762m.
The considerable variances which occurred in 2001 between the final forecast of tax receipts for that year and the actual amounts collected for each tax head and paid into the Exchequer are detailed in Table 2. The overall outturn for 2001 was 8% less than predicted, and there were notable shortfalls in VAT, Income Tax and Excise. The outturn for Excise for 2001 was €213m lower than the 2000 total in a year when the preliminary estimate for GDP economic growth was just under 6%.
In the current year, the end-March 2002 Exchequer returns noted that year on year tax receipts were 2.8% lower in the first quarter of 2002 than for the equivalent period in 2001, as compared with a predicted increase of 8.6% for all of 2002 over 2001. Internal Revenue statistics for 2002 Income Tax for the period from 1 January to 31 May 2002, which are analysed in Table 3, indicate a shortfall of €295m (7.7%) over expected receipts in the period. The cumulative shortfall in PAYE, which is the major component of the Income Tax total, was €182m (5.8%).
Table 3 - Income Tax: Projected and Actual Receipts to end May 2002
|
Projected*to end May 2002 €m
|
Actual Receipts**To end May 2002 €m
|
Shortfall €m
|
|
Income Tax (PAYE)
|
3,126
|
2,944
|
182
|
|
Income Tax (Non-PAYE)
|
695
|
582
|
113
|
|
Income Tax (Total)
|
3,821
|
3,526
|
295
|
*For management information purposes, the Post-Budget Estimate for each tax head for the year is apportioned by Revenue over each of the months on the basis of the established payment patterns for that tax head.
**Internal Revenue collection figures are not directly comparable with Exchequer lodgments.
Having regard to the serious implications for the economy of inaccurate revenue forecasting, I asked the Accounting Officer
· whether specific analysis has been undertaken with a view to establishing the factors which have given rise to the 2001 shortfalls in VAT (€872m), Capital Taxes (€145m) and Excise (€724m) and, if so, the results of such analysis
· the reasons for the continuing trend of shortfalls in the PAYE take, and if these shortfalls are mirrored in the PRSI take for 2001 and 2002 to date.
In addition, I sought the observations of the Accounting Officer as to the extent to which the recent variances in revenue collected as against that forecast, and in particular those outlined above, are indicative of
· a weakness in Revenue forecast data, calculations or methodology
· a weakness in Department of Finance forecast data, calculations or methodology, or
· a reduction in the efficiency and effectiveness of revenue collection.
I also invited the observations of the Accounting Officer at the Department of Finance.
Since I received the observations of the Accounting Officers the shortfall between projected and actual income tax receipts has grown further as shown in Table 4.
Table 4 - Income Tax: Projected and Actual Receipt to end August 2002
|
Projected to end August 2002 €m
|
Actual Receipts To end August €m
|
Shortfall €m
|
|
Income Tax (PAYE)
|
4,929
|
4,566
|
363
|
|
Income Tax (Non-PAYE)
|
863
|
729
|
134
|
|
Income Tax (Total)
|
5,792
|
5,295
|
497
|
Revenue Response
In response the Accounting Officer of Revenue pointed out that the role of Revenue in forecasting tax revenue receipts was a supporting one to the work of the Department of Finance. He stated that each year Revenue was formally asked by the Department of Finance for preliminary forecasts of tax revenue. The forecasts for some taxes such as PAYE, VAT, Capital Gains Tax, Customs, and the VRT element of Excise Duties were normally derived by Revenue from applying the percentage growth rate projected by the Department for certain macro-economic indicators to the expected tax outturn of the preceding year. Appropriate specific macro-economic indicators were not available for other taxes such as Corporation Tax, Income Tax (non-PAYE) and Excise (other than VRT) and forecasts for these were based on alternative growth indicators derived from local or other sources. While the specific macro-economic indicator used for VAT, namely Personal Consumer expenditure, could also be used as a basis for forecasting Excise, other than VRT, it was considered much less appropriate because the Excise base was significantly narrower than VAT. Accordingly the prevailing method for forecasting Excise was by way of a trend-based analysis of the yields from the various dutiable commodities over a number of years. The forecast figures thus provided by Revenue were taken into account by the Department of Finance in their deliberative process leading up to publication of the Pre-Budget forecasts (the "White Paper" Estimates) and the Post-Budget forecasts. The latter reflected the projected impact of Budget changes on the economy as well as on tax revenues.
Specific Analysis
As regards specific analysis, the Accounting Officer informed me that in 2001 the collection performances of all taxes were monitored as usual on a monthly basis and that the forecasts were continually revised where appropriate until year end. A number of special enquiries were also undertaken during the year into the collection performances of VAT, Excise and PAYE which were significantly under-performing against Budget forecast.
With regard to the factors giving rise to the shortfalls in VAT, Capital Taxes and Excise the Accounting Officer stated that, of the total shortfall of €872m for VAT against Budget target, VAT on Imports accounted for €233m with the main causes of the undershoot being a significant drop-off in imports of motor vehicles, fuels and computer parts from outside the EU. While falling significantly short of Budget forecast, the yield in 2001 from VAT Internal grew by over 8% compared with the outturn for 2000. That was a marked fall in the growth rate of 18% achieved in the year 2000 over 1999. Revenue was satisfied that the reasons for the fall in the rate of growth in 2001 was directly related to the level of activity in the economy reflecting a general slowdown in consumption, exacerbated by the Foot and Mouth crisis and influenced in the last quarter by the attacks in the USA on 11 September. Because of the general fall in growth rate throughout 2001, it was not possible to place monetary values on each of these effects.
The Accounting Officer said that Capital Taxes were more difficult to forecast than other taxes generally because of their nature. Capital Gains Tax and Capital Acquisitions Tax were driven by events (mainly disposals of assets), and were not as closely related to general economic activity as VAT or Excise. Of the total shortfall of €145m for all Capital Taxes against Budget target, Capital Gains Tax accounted for €113m. He said that firm reasons for that shortfall were not available but that, while an element of it could have been attributed to some slowdown in the economy in early 2001, it may also have been an indication that the release of pent up investment funds which generated the acquisition of further capital assets in the years following the reduction of the Capital Gains Tax rate to 20% in the 1998 Budget had slowed down. The shortfall of €32m in yield from Capital Acquisitions Tax was accounted for principally by a reduction in the yield from Inheritance Tax.
The Accounting Officer also stated that receipts from Excise were down on target for all excisible commodities. An examination of the net receipt in 2001 indicated the following breakdown of the €724m shortfall as identified at commodity level in Table 5:
Table 5 - Excise: Analysis of 2001 Shortfall by Commodity
|
Commodity
|
Shortfall (€m)
|
Commodity
|
Shortfall (€m)
|
|
Beer
|
63
|
Tobacco
|
188
|
|
Spirits
|
57
|
Light Oils
|
66
|
|
Wine
|
14
|
Other Oils
|
56
|
|
Cider & Perry
|
3
|
VRT
|
276
|
The total of these figures emerges at €1m less than the total shown in Table 3 because of rounding in the constituent items.
While collection performance in general reflected a fall in consumer spending on excisable items, he added that some specific factors were also identifiable such as:
· the provision in the 2001 Finance Act to abolish the end-year payment catch-up for alcohols was not included in the Budget arithmetic - the cash flow cost of this factor at end 2001 was estimated at €39m for Beer, €33m for Spirits and €16m for Wine
· the negative effects on yields arising from the Foot and Mouth crisis, particularly in the tobacco and oils sectors (these were down on target by €188 million and €122 million respectively)
· the yield from VRT was affected by a drop of more than 66,000 new car registrations in 2001 compared with 2000 and with a 2001 Budget forecast which was based on an assumed "no change" year-on-year in the volume of car registrations (this was down on target by €276m).
The Accounting Officer informed me that the shortfalls in PAYE in 2001 and in 2002 to date were the subject of ongoing research. Various aspects of Income Tax forecasting and collection, particularly in regard to PAYE, were analysed on an ongoing basis by a technical group chaired by the Department of Finance and involving personnel from Finance, Revenue, Social and Family Affairs and the Central Bank. He indicated that some specific contributory factors towards the €762m shortfall in 2001 PAYE collection as against Budget forecast had been identified, such as an over-estimate of €67m in the 2000 outturn base when compiling the 2001 forecast, an underestimate by €203m in the cost of the 2001 Budget package in 2001 and the cost of the Special Savings Incentive Scheme, which was introduced in the 2001 Finance Act and not factored into the Budget arithmetic. The cost of the Savings Scheme in terms of PAYE tax forgone in 2001 was €55m but when that was offset by a reduction in the expected cost of Medical Insurance relief under the new Tax Relief at Source system the net cost was reduced to €27m. In the wider economy, the lower than expected growth in GDP in 2001 allied to a reduced growth in employment numbers (lower at 49,000 than the 60,000 estimated at Budget time) would also have affected income tax.
The Accounting Officer considered that most taxes were performing reasonably well in 2002 apart from Income Tax. As regards the negative collection performance by PAYE in 2002 to date, Revenue was confident that part of the variation was explained by issues of timing which could not be accurately predicted because of changing the tax year to the calendar year, and the difficulty of predicting exactly when budget changes would take effect. Also, the monthly targets for PAYE collection in 2002 were broadly based on the monthly collection pattern over the 12 months of 2001. PAYE collection in 2001 was at its strongest in the first half of the year and using this as a basis for the corresponding target in 2002 may have had the effect of front-loading the target for the first half of 2002 to an unrealistic level. The 2002 forecast for PAYE was based on a projected growth over 2001 allied to an expected recovery in the economy. If this recovery takes place, PAYE receipts should recover over the remainder of the year in line with the general pattern in the economy.
While Revenue did not monitor PRSI collection against monthly targets, the Accounting Officer understood that PRSI outturn had come in ahead of targets set by the Department of Social and Family Affairs in 2001 and to date in 2002. As regards the comparison between PRSI and PAYE collection performance there were certain systemic differences in the way PAYE and PRSI operate which can account for different effects in the respective outturns. For example, if earnings were reduced (short-time working, less overtime or job loss) there was no refund of PRSI contributions already paid but there could be tax repayments due. Furthermore, any reduction in earned income for individuals who had already exceeded the PRSI ceiling (€35,870 in 2001 and €38,740 in 2002) had no effect on the individual's contribution to PRSI but it would reduce the tax yield.
Quality of Revenue Forecast Data, Calculations and Methodology
The Accounting Officer informed me that the forecasting of tax revenue could not be an exact science as it was necessarily based on a number of key factors which were themselves forecasts. Tax revenue forecasts were usually based on a combination of forecast yield figures for the outgoing year (or for a future year, where forecasts for more than one year were being prepared) and on projected annual trends in economic growth. Frequently it was also necessary to factor in an estimated carryover cost or yield impact of significant budgetary changes, which impact had itself been compiled on the basis of historical data projected forward using extensions of the same projected trends in economic growth. In summary, forecasts of tax revenue would be as sound or as weak as the variables on which the process depended and that while every effort was made to have reliable basic data there would also be scope for some margin of error. Tax receipts performance in 2002 was being kept under review by the technical group.
Possibility of Reduction in Efficiency and Effectiveness of Revenue Collection
The Accounting Officer assured me that Revenue had examined in considerable detail the question of whether the extensive shortfalls were indicative of a reduction in the efficiency and effectiveness of collection, and was fully satisfied that there was no such reduction. The pattern of return and payment compliance for PAYE is shown in Table 6. Similar patterns pertained to VAT and other taxes.
Table 6 - PAYE Compliance: Number of Employers paying PAYE on time
|
Year
|
Number of monthly returns issued to employers
|
Number of monthly returns/payments on time
|
Percentage compliance*
|
|
1999
|
1,373,321
|
702,069
|
51.12%
|
|
2000
|
1,534,609
|
805,224
|
52.47%
|
|
2001
|
1,676,013
|
896,963
|
53.52%
|
|
2002 (to end-May)
|
718,785
|
404,992
|
56.34%**
|
*The figures shown related to returns received within the due month. For example in 2002 by the end of the following month, 74% of all cases which had a known liability had made returns.
**Although percentage compliance appeared to be low (56% in 2002 to end May) the proportion of monthly liability represented was much higher as it included the big cases and most medium sized payers.
Another measure of compliance was the level of arrears outstanding. He stated that there had been no exceptional rise in the level of arrears at December 2001. Arrears of €351m at that date represented a rise of 1.4% over December 2000, while collection rose by 2.7%. The final possible area in which there might have been a reduction in compliance would be the area of underdeclaration and, in particular, whether the extent of undeclared employment increased in 2001. Any significant rise would be visible as a divergence in trend between the number of employees and employments reported to Revenue, and the general employment statistics. The Quarterly Labour Force Estimates for 2001 showed a year-on-year rise in the number of persons in full-time employment of 3.6% at the start of 2001, falling to 2.5% in the final Quarter. Returns received by Revenue in 2002 (in respect of 2001) showed an increase of 7% in the number of employments. While the significance of the larger increase in the number of employments was under investigation, Revenue was satisfied that there had been no widespread failure to declare employment. In conclusion, the Accounting Officer indicated that Revenue was fully satisfied that taxpayer compliance and Revenue efficiency had been maintained or enhanced since the beginning of 2001, and had made no contribution to the relatively poor performance of that year.
Response of Department of Finance
Economic Growth Lower than Anticipated
In response to my request for observations, the Accounting Officer at the Department of Finance informed me that the shortfall in tax receipts was mainly due to overall economic growth being lower than expected on Budget day. Budget 2001 was predicated on a forecast of 8.8% for real GDP growth for the year 2001. That economic forecast was based on the latest national and international data available to the Department at that time and was broadly in line with what was widely believed as the likely growth scenario for the economy. The EU Commission Autumn 2000 forecasts expected real GDP growth of the order of 8.25%, the OECD and the Central Bank about 8% and market commentators' forecasts did not differ substantially from that level.
However, the outturn for economic growth was much lower than anticipated, with the preliminary estimate for GDP growth for 2001 at 5.9%. That lower growth was due to the outbreak of Foot and Mouth disease and related restrictions which also affected the pattern of growth (depressing cross-border and domestic spending on petrol, for example), as well as to the effect of the slowdown in the United States economy, exacerbated by the events of 11 September. That lower economic growth and changed patterns of personal consumption generated less tax receipts than expected, especially in the areas of Income Tax, Value Added Tax and Excise. In the case of excise receipts €88 million of the shortfall was due to an oversight, as the cost of deferment of the payment of excise duty on alcohol was not included in the Budget arithmetic.
Tax Forecasting Methodology
The Accounting Officer stated that the tax forecasting methodology used by the Department was set out in a report published by the Department in 1999. Basically, the process of forecasting involves collaboration between the Revenue Commissioners and the Department. In the run up to the Budget, the Revenue Commissioners provide estimates of likely tax revenue for the Budget year in question and the subsequent years. In doing so, the Revenue Commissioners rely in certain cases (e.g. income tax) on macroeconomic forecasts supplied by the Department of Finance on earnings, employment and consumption growth. In assessing the overall tax revenue forecast the methodology involves relating that forecast to expected economic growth in nominal terms. The relationship is of the order of 1:1 with variation to be expected, depending on whether growth is mainly domestic or externally driven, and on whether budget tax measures are less or more generous. If growth is mainly externally driven or tax concessions are more substantial then when nominal GDP increased by 1%, taxes would be expected to increase by less than that.
In the period 1996 to 2000 the ratio (or elasticity) of the increase in taxes compared to nominal GDP averaged close to 1:1 i.e. every 1% increase in actual GDP resulted in an increase in taxes of 1%. The 2001 Budget elasticity based on the 2000 forecast out-turn for taxes was 0.84 and 0.91 based on the actual 2000 outturn. The forecast for the increase in tax revenue in the Budget for 2001 was 11.6%, which became 12.5% as the tax out-turn for 2000 came in €216m below the Budget forecast.
Factors which Impacted on Income Tax Yield in 2001
The Accounting Officer considered that at the time of the Budget for 2001 the forecast increase in tax revenue appeared reasonable and consistent with previous experience. He said, however, that the experience in 2001 had turned out much differently. One relevant factor had been the decrease in average hours worked in the economy in 2001, which in the industrial and construction sector amounted to one hour or more. That in itself could have been expected to have a significant effect on the rate of growth in income tax receipts.
In the case of income tax, the forecast tax yield was further affected by an upward revision in the cost of the Income Tax reductions in the Budget for 2001 on the basis of subsequently available data. The annual update of the tax base completed in summer 2001 led to an upward revision in the cost of the tax package which had been announced in the Budget. The revised tax base reflected the fact that economic growth in 2000 was higher than expected in late 1999, leading to higher employment and incomes in 2000. For example, the Department of Finance forecast for GDP and GNP in the 2000 Economic Review and Outlook was 10.3% and 8.3% respectively. The eventual figures published by the CSO for the year 2000 were 11.5% and 10.4%. The revised tax base reflected the fact that the estimated number of PAYE income earners on Revenue's books in 2001 increased by 76,000 compared with the corresponding figure used in the Budget for 2001. The tax base revised on the basis of these figures caused the cost of the 2001 tax package to be revised upwards by €300 million in a full year (€200 million in 2001, i.e. April to December tax year).
A further consideration was that tax system changes (e.g. the widening of the spouse tax band, broadening of tax relief on pension contributions) could affect behavioural patterns, with the potential to affect tax yield in ways in which there was no "history" on which to ground estimates of impact. He said that substantial changes in the tax regime of recent years may have generated effects of that kind, the impact of which would only be determinable as later years' tax data became available for analysis.
Factors Impacting on Tax Yield in 2002
In relation to 2002, the Accounting Officer reported that tax receipts to end-June were down 7.1% compared with receipts during the same period last year. However, he pointed out that the due date for June Corporation Tax had fallen on Friday 28 June, and that payments of the order of €1 billion had been received on 1 July in relation to the June period. An adjustment for that timing factor left tax revenue at roughly the same level as 2001.
He indicated that tax receipts for the first half of 2002 had been affected by a number of factors:
· The tax reductions in the budget for 2001 came into effect on 6 April 2001 and there was a carry over cost of the full year effect of those reductions in the first four months of 2002. That cost was estimated at €540m in the first four months of 2001.
· The start of the income tax year had been brought back from 6 April to 1 January. As a result, the tax reductions announced in the Budget for 2002 were payable with effect from 1 January 2002, and not from 6 April as was the case in 2001. The additional cost of that was approximately €120m.
· Refunds of income tax of €170m were made in respect of Special Savings Investment Accounts (SSIAs) in the first six months of 2002 compared with €2m in the same period in 2001. SSIAs were introduced with effect from 1 May 2001.
Income tax receipts at the end of June 2002 were €630m below receipts at the end of June 2001, whereas the total of the foregoing measures was €830 million. He pointed out that this year's yield was also affected by increases in income over the levels obtaining in 2001 ^ the size of which was conjectural at this point.
He also noted that the economy was growing at a much faster rate in the first half of 2001 compared to what was expected for the first half of 2002. That was a result of the sharp slowdown in growth in the economy in the second half of 2001. The Central Statistics Office provisional estimates showed that the economy grew on an annual basis by 12% in the first quarter of 2001 but had slowed to zero by the fourth quarter of 2001. As a result, income tax receipts in the first six months of 2001 grew at a rate of almost 9% but fell by over 3% in the second half of 2001 compared to the year 2000. It would have been expected on that basis alone that income tax receipts in the first half of 2002 would have performed poorly in comparison to the first six months of 2001.
Looking forward to the second half of the year, the Department of Finance expected revenue to improve in response to a stronger economy. Nevertheless, it was expected that tax revenue for the year as a whole would be of the order of €500 million less than the Budget estimate, due for the most part to lower than expected economic growth and higher than expected SSIA costs given the unexpectedly large number of accounts opened as the "window" came to a close in April 2002.
In Depth Examination of the Income Tax Base
The Accounting Officer informed me that the Department, in consultation with Revenue, is examining the income tax base in more depth based on the up-dating of the income tax file to 1999-2000, supplemented by estimates based on latest PAYE returns to end-2001 and an examination of trends in PAYE payments by a sample of larger employers. That examination was ongoing. It was considered that the major changes made to the tax system in the 1999 and 2000 Budgets in relation to tax credits and widening of the standard rate band may have affected the income tax base and the projections that could be made on that basis. Furthermore, the elasticity of tax receipts at a time when GDP was increasing was likely to differ significantly from that experienced when economic growth slowed sharply, especially if overtime, bonuses or commissions were being cut as growth slows. Such income was more likely to be taxed at the higher rate. He stated that the issue was one of concern to the Department and was being carefully examined and monitored closely in preparation for the next Budget in December.
