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Any correlation between tax% and tax compliance?

Is there any study or proof showing any relationship between tax rate and tax compliance?

I work for the Revenue and some years ago, I had issued tax assessments on some gambling operators following a tax audit on all of them.
Under the local gambling law, a monthly gaming tax is payable by the operator on his gross gambling yield for the month from its table games activity. From an audit perspective, one would note that no invoices are issued in these types of operation and there is a need for the keeping of proper books & records. This is emphasised in our Legislation which governs the administration of gambling taxes. The Act does not only specify the keeping of proper books & records but also requires the duration of 5 years that these records should be kept and the production of these records to the Revenue when requested to do so. It also gives the Revenue the power to issue an assessment if such conditions are not met.
All the audits of the different operators were simultaneously carried out by different teams working under me. The audits were carried out in accordance with the Revenue's standard operating procedures. Some additional objectives were added by me, such as the provision of an on the job training of audit staffs and an in-depth appraisal and documentation of the operators' system of keeping books and records with a view to make recommendations for the enhancement of transparency in the sector.

Weaknesses were identified in most of the cases, particularly where the businesses were privately owned and managed, compared to the State-owned companies which had good internal control procedures, sufficient segregation of duties and a better record keeping system. Some of these weaknesses are:

1. Cash counts of money collected by croupiers and dropped inside each gaming table's drop-box are performed by only one or two senior staffs or the owner himself;

2. There is no record against which the correctness of the amount of money counted could be cross-checked. To the auditor, the recorded amount was to be taken as good even though there was the risk that a different amount was recorded compared to what was counted. In the government-owned businesses a senior employee, the pit-boss, normally (during gameplay) records the money being dropped by the croupiers into the respective drop-box and same is entered on the corresponding table's night sheet. Each table has its own recording sheet on which all chip allocations, drop-box feeding and other transactions are recorded and signed by the respective employees.

3. All source documents including the daily table sheets are destroyed within a few days leaving no scope for an audit trail. Only a summary sheet is kept by the operators showing only daily profit/loss. No details are available to allow verification on how these profits/losses have been arrived at with regards to their accuracy or completeness i.e the number of active tables which have contributed to reaching such amounts.

It, therefore, followed that in most cases, our audits were hampered and we only had to believe on the correctness of what were shown on the monthly summary sheets. 

Following the completion of the direct examinations (at least those that could be performed), the audit teams performed a trend analysis of monthly gambling income of their respective taxpayers. It was found that in respect of ALL the privately owned cases, there was a SUDDEN, HIGH (ranging from 200% to over 400%) and SUSTAINED increase in their reported gambling income as from ONLY ONE AND SAME particular month. This pattern WAS NOT observed among the State-owned operators who had a better system of keeping books and records. As supervisor of the different audit teams, I instructed them to investigate the sudden surge and to identify any possible reason, both internal or external. Explanations were also sought from each of the operators. Their explanations ranged from (1) no explanations at all; (2) increase due to the closure of a competitor's business more than a year from the point of the sudden surge there were also other nearby operators; and (3) the organisation of World Poker Tournaments with the first one taking place 5 months after the sudden increase was noted.

The only external factor that we identified was that there was a very large decrease in the gaming tax rate (from 50% to 15%) EXACTLY from the month in which the SUDDEN surge was noted. It is to be noted that the cost of the gaming tax is not borne by players but by the operators.

We performed tests in order to identify whether there was really an increase in activity OR operators under-reporting their turnover when the tax rate was 50% high compared to when it was decreased to just 15%. These tests are:
1. Whether there was a comparative increase in wages and salaries in respect of table game employees - No records were available;

2. Whether there was a comparative increase in the number of gaming tables used - In most cases the usage capacity stayed the same, while in some, this test could not be carried out as the records were not available since consistently being destroyed by the operator.

Given the above, we proceeded with the issue of a claim for additional tax due in respect of the earlier periods where the tax rate was high on the assumption that the operators had been under-reporting their turnover. As a basis, we multiplied those figures by a factor which we derived from the total turnover reported in the 12 months following the decrease in the tax rate by the 12 months total turnover preceding the decrease in the tax rate. We took a period of 12 months to reduce the impact of seasonal fluctuations.

Many of the operators who had been assessed by my teams have reached an agreement with the Objection Department of the Revenue (I do not know their basis for the reduction of their liability).
One of the operators recently won his case by successfully showing to the committee that the sudden increase was due to the Poker tournaments it organised. It produced documentary evidence which was not available to me during our audit but which I could have questioned. These are:
1. Showing that the poker tournaments which were organised as from February 2012 triggered a SUDDEN increase as from October 2011 (month of tax rate reduction). They mentioned that the qualification rounds took that long without producing any supporting documents. All documents they produced were authorisation letter addressed to the Regulatory dated December 2011 (3 months after sudden increase) and advertisements relating to the tournament which also dated months after the sudden increase.

2. They produced  " invoices" showing that they had increased their table capacity. However, they only showed PRO-FORMA INVOICES for only two tables which were dated 11 months! after the sudden increase. Other invoices produce were about tokens and were irrelevant as they were for the period 2008 and 2009.

3. Stating that the number of live game personnel was increased but no supporting documents were produced.

4. Their fully qualified Accountant with years of experience also deponed in their case by justifying the destruction of the supporting documents only a week after the transactions with the reason that they become bulky.

During the hearing, my attempt to show that the justification items produced were not relevant to show the sudden increase in October 2011 was turned down as I was OVER FOCUSING the October 2011. The negative correlation between tax rate and tax compliance was rejected by the Tribunal on the basis that there is not proof of it. In my Department, I am treated as the bad guy as I went for the kill without adopting a neutral approach (?). Most of my colleagues run away from the audit of the gambling sector and even AVOID seeing the logic (such as the invoice dates). While most of the documents were produced by the taxpayer at objection level and the objection Unit determined the case by maintaining the assessment, they FAILED to support their determination in their Statment of Facts to the Tribunal. Perhaps, had they done so, the Revenue could have made an appeal to the Supreme Court. 
I need to better prepare for a few other similar cases. that's why I need to know of any studies or reports on any correlation between tax rate and tax compliance.

PS
I did err in the computation of the upliftment factor. By trying to negate the impact of seasonal fluctuation and extending the basis period to 12 months I overlapped the periods in which the International Tournaments took place. Had I made the appropriate allowance, the multiplier would have been 1.9 rather than 1.90.

 

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By SXGuy
02nd Nov 2018 08:04

Sadly I can't help with real evidence. However I do know its a common belief (rightly or wrongly) that when tax is low revenue goes up.

Could be many reasons for this, but the most common I guess would be the risk of compliance against the cost in tax. Less tax to pay the more chance the tax payer is willing to declare more income.

Thanks (1)
02nd Nov 2018 10:46

There are a number of reasons businesses benefit from showing a high turnover, higher than what is in fact their actual turnover, such as securing funding or investment. If the cost of tax drops suddenly then there is more scope for business owners to artificially inflate turnover for these reasons.

Or, as SXGuy says, there will be more of an incentive to err on the side of caution when reporting turnover and if there's any gaps in the records, business owners may estimate turnover higher in circumstances where there's less of a tax impact in doing so.

While you may identify a rise in reported turnover with a drop in tax rates, you can't say with any certainty that the turnover before or after the change is correct and that would be my argument against your otherwise well reasoned points.

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to Duggimon
02nd Nov 2018 11:30

Thanks for your response. I did not mention that the table game activities represent less than 15% of the operators' gross income. Their other and main source of income is from gaming machines (also found to have been significantly understated - I will write another post on this area).
The argument for reporting a higher turnover with a view of raising finance does not hold here as the company was not planning for any large capital investment. Gaming machines, which are the main capital expenses were already at full capacity.
The fact that the increases were noted at the same point in time and in almost all of the privately owned gaming houses points more in the direction of suppressed turnover. My failure to use circumstantial evidence to convince the Tribunal despite the fact that the company has failed to comply with the different provisions of the law makes me wonder whether it is worth it to carry on with any future audit in the sector.

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02nd Nov 2018 11:55

As you work in an entirely different jurisdiction from the UK, you might find more useful input from resources local to you.

https://www.accountingweb.co.uk/any-answers/tax-fraud-0

“I am a tax investigator (country = NOT UK) working on a case where I suspect evasion of VAT.”

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to Accountant A
02nd Nov 2018 12:07

That would be great indeed. Mauritius is aiming towards having a world-class revenue department and since our appeal system ultimately lands to the Privy Council, I like getting ideas from the UK. Of course, I do understand that the legislations might be different but I would keep your suggestion in mind and thank you for your views.

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05th Nov 2018 10:08

I don't think you should be discouraged from doing your job to the best of your knowledge and ability. You had a setback in the Tribunal and the taxpayer's evidence was preferred, but the integrity of the tax system depends on Revenue employees carrying out investigations into anomalies, and these being properly tested in court. You never will (and probably shouldn't) 'win them all', but your post notes that you want to see improvements in your jurisdiction's record of compliance, and that is a worthy goal.

Having said that, the wording of your post is neither neutral nor unbiased (though I can understand the frustration!). I understand that the Mauritian constitution contains the presumption of innocence (tax evasion being a criminal offence, the taxpayer should receive the benefit of this presumption), and - in your role of Revenue protection it is vital to remember that just as anomalies can mean that a taxpayer is doing something incorrectly, so too can they have innocent (or at least non-tax related) explanations.

I am not aware of any 'hard' data looking at the correlation of receipts to tax rates in the avoidance/evasion context, although there is some data which shows an optimum tax rate beyond which receipts drop because people arrange to receive capital rather than income receipts.

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By DJKL
05th Nov 2018 11:23

Re academic studies regarding tax rates and evasion, searches about the Laffer Curve and Evasion might bring up some sources, e.g.

http://www.southampton.ac.uk/~sg1f06/papers/tax_evasion_laffer_curves.pd...

The catch with journal articles like the above is that whilst you might , in a court, be able to cite them to make an in the round , "academic research suggests ......." type statement, imho few have sufficient empirical data to withstand the rigour of cross examination so introducing them could possibly damage a case akin to;

1. Never ask a question where you do not know what the answer will be type approach

2. No evidence is better than savaged/discredited evidence etc.

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07th Nov 2018 15:06

This is a bit off topic but the level of tax does have an impact on behaviour.
This is a quote from a paper I found on the internet: "In 1979, Australia abolished federal inheritance taxes. Using daily deaths data, we show that approximately 50 deaths were shifted from the week before the abolition to the week after (amounting to over half of those who would have been eligible to pay the tax)."

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