Is the ATO’s ability to retain tax refunds too great?

Our self-assessment system of taxation has conditioned taxpayers, including SMEs, to expect refunds of income tax or GST to be issued promptly by the ATO.

The ATO has always had the power to withhold or delay tax refunds in certain circumstances, for example where tax evasion or fraud may be involved.

That is not unreasonable, but a recent court case has prompted the government to release draft amendments that would seek to give the Commissioner of Taxation new and arguably much wider powers to withhold refunds. As many SMEs, rightly or wrongly, rely on refunds (especially GST refunds) to provide cash flow for their businesses, any delay in receiving them is cause for concern. It is therefore important that SMEs are aware of what is being proposed.

The draft legislation proposes to amend the tax law to allow the Commissioner to hold refunds for verification prior to payment. Sounds somewhat innocuous and reasonable enough in principle, but the breadth of what is being proposed is of major concern.

The draft legislation came about as a result of the Full Federal Court’s decision in November 2011 in FCT v Multiflex v FCT [2011] FCA 1112. The company was in the business of purchasing mobile phones and similar goods from suppliers and making GST-free exports of goods to customers overseas, resulting in an excess of input tax credits. It lodged monthly Business Activity Statements for the periods January to May 2011, and claimed it was entitled to an immediate payment of refunds. At first instance, the ATO contended that the input tax credits claimed were unsubstantiated and allegedly fraudulent and it therefore refused to pay the refunds until it had concluded its audit. The matter came before the full Federal Court and it held that the refunds should be immediately paid.

In that decision, the court dismissed the Commissioner’s appeal against paying the GST refunds and upheld the Federal Court’s earlier order that a writ of mandamus issue directing the Commissioner to comply with various provisions of the tax law by immediately paying the company the net amount notified in its GST return. The High Court subsequently refused to grant the Commissioner special leave to appeal against the decision.

So the government has stepped in to change the law.

Broadly, the proposed changes seek to insert new provisions in the tax law to provide the Commissioner with discretion to retain refunds for the period required to undertake checks to verify the correctness of the amount claimed. If they go ahead, the changes would apply to all refunds and payments arising under taxation laws that the Commissioner administers, so that includes income tax, GST, etc.

Commissioner’s new wider power

The proposed new laws would allow the Commissioner to retain an amount pending “refund integrity checks” of a taxpayer’s claim, if the Commissioner is satisfied that it would be reasonable to require verification of information. They would apply where the taxpayer has given the Commissioner a notification (such as a GST return) that affects, or may affect, the amount the Commissioner is required to refund to the taxpayer.

If the Commissioner retains a refund, he would be required to notify the taxpayer within 30 days of the taxpayer giving the Commissioner a notice containing the amount claimed.

The draft legislation indicates that the Commissioner could retain a refund until the earlier of the following:

• when the Commissioner becomes satisfied that it would no longer be reasonable to require verification of information;
• when the Commissioner amends the taxpayer’s assessment relating to the amount and the amendment changes the amount that the Commissioner would otherwise have to refund;
• when the Commissioner makes an assessment which relates to the amount, and the assessment changes the amount the Commissioner would otherwise have to refund; or
• 60 days after the day on which the Commissioner is required to notify the taxpayer of his decision to retain the refund.

Under the proposed changes, the 60-day period would be extended by the number of days in that period in which the Commissioner has requested information and that information has not been provided by the taxpayer to the Commissioner. The onus is on the taxpayer/business to supply the information quickly.

Retaining the refund after 60 days

In addition, the draft legislation proposes to allow the Commissioner to retain the refund beyond the 60-day period if it would be reasonable to require further verification of the information. However, the Commissioner would be required to inform the entity within 14 days after the end of the period that he has retained the amount. It is the Commissioner who would decide if it’s reasonable to require further verification.

The draft legislation sets out the factors the Commissioner would need to consider in deciding whether it would be reasonable to continue to hold back a refund – some of these factors will surprise many:

• The likelihood that the information provided by the taxpayer is inaccurate, and the likely extent of the inaccuracy. It is proposed that it would generally be reasonable for the ATO to retain a refund when the Commissioner considers it highly likely that the information provided by the taxpayer is inaccurate to a significant extent. In assessing the likelihood of the inaccuracy, the Commissioner could consider factors such as the amount of refund claimed compared to refund amounts previously (or usually) claimed.
• The likelihood that the information was affected by fraud or evasion, intentional disregard of a taxation law or recklessness as to the operation of a taxation law. In assessing this likelihood, the compliance history of the entity or business may be relevant (a good compliance history would be an indicator that fraud or recklessness is unlikely).
• Whether retaining the amount is necessary for the protection of revenue, including whether the Commissioner would be able to recover a refunded amount if the information was subsequently found to be incorrect. This factor would be applied where the Commissioner suspects the taxpayer may be involved in fraudulent activity.
• The complexity that would be involved in verifying the information. Complex arrangements such as those involving multiple supply chains and entities will generally require more time and resources. Therefore, in complex cases, the government proposes that it would generally be reasonable for the Commissioner to retain a refund beyond the 60-day period.
• The impact of retaining the amount on the financial position of the business. In the absence of one of the other factors such as likelihood of information being affected by fraud, evasion, intentional disregard, or recklessness, it would be likely that the amount should be refunded. However, if another factor such as risk to revenue outweighed the considerations, the draft legislation provides that it would be reasonable for the Commissioner to retain the amount beyond the 60-day period, even if it causes serious financial hardship or is detrimental to the viability of the business. Ouch!
• Any other matters the Commissioner considers relevant. This really is about as wide a discretion as it gets.

Concern at discretions

The draft legislation places considerable discretion in the Commissioner’s hands. While there will of course be occasions when the withholding of a refund is justifiable, the concern is that the changes would give the Commissioner too much power and discretion to hold back a refund.

There is concern that the discretions that would be given to the Commissioner are too subjective and that they should in fact be more objective and that the proposed legislation should reflect that objectivity.

The changes are only in draft form at the moment and it is highly likely that Treasury will receive some strong comments.

SMEs would do well to watch this space. The legislation as finally introduced to parliament could be different, but in any case, will require close scrutiny by all businesses. Tax refunds are often a lifeline for a cash-strapped business, so any delay could be terminal.

I guess the Commissioner might say that if a taxpayer’s affairs are in order, and they have a good tax compliance record, there should not be any problem in promptly issuing refunds. However, the proposed new discretions arguably suggest some pause in respect of any such assurance.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.