risk based audit system for smes ifc
TRANSCRIPT
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Effective Management of SME
Taxpayers:The Role of Risk Based Audit
Kigali, Rwanda
April 23, 2009
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Contents
1. Why Special Treatment to SMEs?2. Principles of Risk Management
- risk based tax audit for SMEs
3. Can we set up a Risk Based AuditSystem in a Non-Computerized TaxEnvironment?
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1. Why Special Treatment to SMEs?
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Special characteristics of SMEs
Largest number of taxpayers (other thanwage earners)
Also, major contributors to informal economyoperating outside tax net
Compliance risk: higher likelihood of taxevasion, operating outside tax net, hiding partof business transactions
Face high costs of compliance relative to theirturnover, profits
Need to overcome hurdles of formalization
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Compliance costs higher for SMEs -
Example South Africa:Compliance Burden for preparation of tax returns as
a percent of turnover (firms registered/not registered
for VAT; mandatory at R300,000)
0.0%1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
0.15 0.3 0.65 3.5 10
Turnover (in R million)
%
ofturnover
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Compliance costs higher for SMEs -
Example Yemen:% of businesses who paid bribes by size
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Strategy: Segment SMEs
SMEs segmented according to size (defined byturnover, number of employees, assets, capitalbase, etc.)
Micro enterprises left out of tax net equivalent to threshold for personal tax
Small businesses in a special Small BusinessTax regime, eg., a turnover tax regime
Vast majority of business taxpayers usuallyabove VAT threshold and under large taxpayerthreshold
These taxpayers are in the regular tax regime and are a management problem
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A different law of large numbers
Large number of SME cases in the taxnet:
Rwanda: Large taxpayers 300Medium sized 1,200
Small sized 15,000Informal Sector (estimated 60,000)
Effective control and deterrence compliance management
tax audit
Good taxpayer service timely refunds
help with compliance
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2. Principles of Risk Management
- risk based audit for SMEs
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Role of Audit
Detect and redress individual cases ofnon-compliance with tax law
Promote voluntary compliance
Focus on high-risk taxpayers
Help tax administration learn aboutshare of non-compliant taxpayers in total
taxpayer baseEstimate tax gap
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Business Industry
Taxpayer
Sociological Economic
Psychological
Factors influencing taxpayer behaviorAttitude to compliance
Have decided not to comply
Dont want to comply, butwill if we pay attention
Try to but dontalways succeed
Willing to do theright thing
Audit strategy aims tocreate pressure down
Compliance strategy
Use full force of the law
Deterrence by detecti
Assist to compl
Make it ea
A model of tax compliance
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Compliance management in SMEs
For those SMEs that are willing to do theright thing and try but dont succeed, make iteasier to comply
For those SMEs that dont want to complybut will if we pay attention provide strongdeterrence through effective audit
But, given large numbers and othercharacteristics, risk based audit is the most
appropriate method
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Methods of Audit
Manual screening by local officersAuditors decide on cases: high risk of corruption
Not a systematic method, hence some non-compliance can bemissed
Only internal data and local knowledge is used for selection
Random selection
Stratified sampling better representation of taxpayer strata
No bias in audit selection
High opportunity cost of auditing go errors
Risk-based selectionIdentify those taxpayers who are most likely to be non-compliant
Use of risk-scoring techniques and taxpayer profiling
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Core Principles of Risk Based Audit
Trust, but verify
Self-assessment of taxes
Equity honest, compliant taxpayers treated with respect, non-compliant taxpayers treated with severity
Taxpayer service orientation
Promote a tax culture of voluntary compliance tax system is based on trust
taxpayers self-assess their taxes
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Objectives of Risk Based Audit
Select the most risky cases for detailed audit get most bangfor the buck
Case selection based on objective criteria, not left to the
discretion of the tax official reduce opportunities for rent seeking behavior
Better use of resources of tax authority few cases audited
most professionally competent officers can be deputed to tax audit cell
Lower cost of tax collection
Reduce interface between tax inspectors and taxpayers
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3. Can we set up a Risk Based AuditSystem for SMEs in a Non-Computerized Environment?
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A sophisticated IT based risk-based audit system needs -
High level of data and IT systems capabilities
Data requirements
Hardware and information technology infrastructure
Data management software
Human resource capabilities and training
Skills needed to design and operate objective risk based auditsystem
Appropriate legal provisions in tax code
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The tax administration may be operating in a rudimentary ITenvironment
The regional offices operate on Local Area Networks, thatmay or may not be linked to the headquarters
Tax returns are not processed online; office audit is done
manually for all tax returns to checkprima facie errors andomissions
The database may only have basic taxpayer information, and
can not be used for developing software based applications
State of computerization of tax administration
in developing economies
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Core objectives of RBA
Select the most risky cases for detailed audit
Case selection based on objective criteria
Better use of resources of tax authority
Lower cost of tax collection
Promote a tax culture of voluntary compliance
- Can all be met in a Risk Based Audit system operating in anenvironment without a sophisticated IT infrastructure in place
Remember: RBA was invented before computerizationbecame common!
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A simple risk based audit system for SMEs in a
non-computerized environment
Steps:
Set up appropriate organization arrangements
Lay down objective criteria for case selection
Develop audit capacities in tax inspectors
Outreach programs for taxpayers
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1. Organizational Arrangements
Set up a Central Audit Committee at the top managementlevel in the tax authority which will lay down objective selection
criteria
Set up an Audit Cell at each tax office mandated to analyzereturns and select those that need to be audited based on objectivecriteria
Audit Cell to prepare a list of cases by business category; list tobe approved by the head of the tax office
Make publicly known the cases finally approved for audit by
prominently displaying the list on a notice board in the tax office
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2. Lay down objective criteria for case selection (tobe done by Central Audit Committee)
Two options -Criteria can be based on:
Compliance characteristics of taxpayer
- behavior of taxpayer in terms of complying withthe tax law
Business characteristics of taxpayer
- indicators of true declaration of profits / income
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Option 1: Compliance characteristics
Irregularity / delays in filing returns
Irregularity / delays in making tax payments
Cases with these characteristics to be taken up for audit
Detailed methodology for categorizing a taxpayer asrisky based on compliance characteristics to be laiddown
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Option 2: Business characteristics
A. Identify businesses that are considered most risky, i.e.,prone to tax evasion
Businesses most prone tend to vary from economy to economy,but some common examples are:
businesses that have most sales in cash, e.g., restaurants, taxis
businesses that involve underreporting of transaction values to evade othertaxes/duties, e.g., real estate (in some countries), imports (where customs
duties are high) professions where individuals control all receipts, e.g., doctors, lawyers,carpenters
=>Identification of tax evasion prone businesses
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Option 2: contd
B. For each risky business category, select two or three keybenchmarksof non risky tax behavior
Benchmarks would vary across countries, but some examples are Gross profit margin of a typical non-risky taxpayer
Sales turnover relative to size
Particular Financial Ratios, e.g., production related to key raw materialconsumption, sales receipts related to fuel consumption,
Amount of tax refund claim
=>Determining benchmarks specific to the country
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3. Develop Audit Capacities in Tax Inspectors
Ability to analyze accounts and taxable transactions to determinetrue taxable income
Analysis of financial statements
Financial ratio interpretation and application
Knowledge and awareness of complexity and loopholes of tax law
Ability to obtain and use external information sources
Knowledge of other relevant laws, e.g., corporate law, customsand VAT regulations, civil and criminal law
=>Training and capacity building of tax inspectors
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4. Outreach programs for taxpayers and privatesector
Publicize tax law and regulations relating to risk based audit
system
Conduct workshops and seminars illustrating provisions of thesystem
Involve private sector and tax authority in jointly disseminatinginformation
=>Knowledge is power: taxpayers must know they can
only be audited if they do not comply with the tax law