Part 5: Resources

Inland Revenue Department: Performance of Taxpayer Audit.

Introduction

5.1
In this part we examine the human resources available for taxpayer audit under the following headings:

5.2
We also discuss sharing best practice, information and intelligence, and use of technology in taxpayer audits. Finally, we consider the implications of the IRD’s strategic direction and compliance model for enhancing the future capability of taxpayer audit.

Staff Numbers, Recruitment, and Retention

Staff Numbers

5.3
In recent years, the IRD has been increasing the numbers of staff allocated to taxpayer audit. At February 2003, there were 853 field delivery staff in total, comprising 699 in the service centres (615 investigators and 84 team leaders) and 154 in the Corporates Division. This represented an 8% increase on the annual average level of staff (788) in 1999-2000.

Recruitment and Retention

5.4
Figure 6 on page 58 shows that, in 2001-02, 106 staff were recruited to taxpayer audit and 46 people left. This level of turnover (approximately 5%) is very low compared with turnover experienced by the large private accounting firms. The low turnover is likely to be caused by a wide range of factors – one important factor we noted was the IRD’s relatively flexible employment conditions, which staff view positively and are likely to act as a competitive advantage.

Figure 6
Audit Staff Recruited and Departed 2001-02

Figure 6.

5.5
However, much of the turnover represents the IRD losing some of its most capable audit staff, who are highly desirable to private sector employers.

5.6
The problem is particularly acute in Wellington, where external competition for good staff is compounded by Wellington’s service centre also losing them to the IRD’s National Office and the Corporates Division. The service centre’s relatively higher turnover inevitably results in a higher proportion of its staff having low levels of experience in undertaking long-term, complex audits.

Qualifications and Competence

Numbers of Qualified Audit Staff and Staff Undertaking Study

5.7
In terms of qualifications, the profiles of staff working in the Corporates Division and those in the service centres are different. At 30 June 2002, 75% of audit staff in the Corporates Division were tertiary qualified – this included more than 60% of audit staff having or also studying for professional accountancy qualifications. In contrast, in the service centres only 39% of the audit staff were qualified. However, over a third of the unqualified audit staff are studying for an accountancy or other tertiary qualification.

5.8
Figure 7 below shows that the number of audit staff studying for a tertiary qualification has been steadily increasing over recent years, both absolutely and as a percentage of all audit staff. These numbers represent an important investment in capability. Audit staff told us that the availability of opportunities to undertake training and study is an important factor in enabling the IRD to recruit and retain staff.

Figure 7
Staff Undertaking Tertiary Study10


 1999-2000 2000-01 2001-02
Total Audit Staff 788 798 866
Number Studying 109 137 155
Percentage Studying 13.8% 17.2% 17.9%

Measures of Core and Technical Competence

5.9
Investigators, through the IRD’s performance measurement system, have their core and technical (audit and tax) competence checked regularly. We wanted to include in this report aggregated data about the levels of competence, but were unable to do so because of the following shortcomings in the data:

  • The database from which the tax technical figures are drawn is not linked to the overall performance rating of individual staff. Some parts of the IRD have therefore not paid sufficient attention to the technical competence database or kept their records up to date.
  • The assessment of technical competence is against a common standard, rather than one that takes account of the level of experience and qualification of a member of staff and the work they actually do. So, a relatively new and inexperienced member of staff in training will be assessed as not being technically competent, even though their actual performance (i.e. work done on an audit) may be technically competent where they are allocated work appropriate to their level of experience and appropriately supervised.

5.10
In any organisation, staff who are allocated work beyond their technical competence represent a business risk. We consider that the IRD would obtain a better understanding of its risk in this area than it currently does if it:

  • Measured competence relative to the work that staff actually undertake. Thus, if staff are being allocated work beyond their competence, the measure would indicate business risk, but if relatively inexperienced staff are being given appropriate work and properly supervised, a lower (or no) risk would be indicated.
  • Linked the results to technical competence assessments of individual staff. Each assessment could then be used to validate the other, and staff could see the relevance of the measure and be encouraged to ensure that it is reliable.

External Perspectives on Competence

5.11
The IRD identified enhancing the capability of its staff as a major theme in The Way Forward 2001 Onwards. From our interviews and file reviews, we also identified the need for the IRD to improve the capability of taxpayer audit staff. Some external people we consulted, including some who had worked in the IRD in the recent past, confirmed this view.

5.12
Tax practitioners’ views are relevant to taxpayer audit performance, especially since they are likely to be able to comment on changes in performance over time. Taxpayer auditors tend to get a mixed review. While there is always a risk that practitioners will generalise from a few examples, the following consistent points of criticism came from the tax practitioners we spoke with:

  • Investigators tend to focus on the areas in which they have competence and experience. Therefore, some significant risks are missed.
  • Inexperienced staff are expected to do audits beyond their capability.
  • New staff are not adequately supervised.

5.13
Despite these comments, many of the practitioners (including large accounting firms) we spoke to, particularly those in Auckland, considered that the IRD’s taxpayer audit function was moving in the right direction and that standards, competence, and approach were all improving. Practitioners also held the view that managers were aware of many of the current weaknesses and were working hard to address them.

5.14
Tax practitioners also consistently expressed an opinion that Corporates Division staff are better qualified and more able than staff in the service centres. As noted in paragraph 5.7, the Corporates Division and the service centres have a different profile of qualified staff. The higher proportion of qualified staff in the Corporates Division may explain why external stakeholders perceive the two groups so differently.

Staff Training

5.15
Basic formal training of investigators is part of the IRD’s ASPIRE11 training modules, which also provide training in mainstream tax areas such as tax law, disputes procedures, rights and powers, and what constitutes income and deductions. ASPIRE also provides training on some specialist topics (such as evasion and aggressive tax issues) and on non-tax skills (such as business writing).

5.16
Two ASPIRE modules specifically address auditing. In the three years to 30 June 2002, 71 and 18 staff respectively completed the applied and advanced audit modules. Over the same period, the IRD appointed 280 new audit staff. While not all of these staff would necessarily need to complete these modules, we consider that take-up has been surprisingly low given the modules’ content.

5.17
The focus group and interview evidence we collected suggested that, in practice, most investigators receive most of their training from their team leader. There is no standard audit induction programme for new investigators. In addition, the performance management system is not being systematically used to:

  • identify the training and development needs of audit staff;
  • tailor courses and opportunities to meet the identified needs; and
  • follow up to check that the training is done.

5.18
The IRD has a project under way to increase the capability of team leaders. One objective of the project is to clarify the team leader’s role in training and mentoring staff.

5.19
In our view, the current relatively unsystematic approach to training reinforces the variations in investigators’ practices that we describe in other parts of this report. As part of tackling the inconsistency of approach, a planned programme of training needs to be prepared and applied to new staff, together with systematic training of all auditors in the application of important new developments – such as the revision of the manual that we outline in paragraphs 4.28-4.29 on page 52.

5.20
At all levels within taxpayer audit we came across talented people committed to the IRD’s objectives, notwithstanding the opportunities available elsewhere. We feel that the IRD could make more and better use of some of the investigators we met (and, no doubt, many we did not meet) by making them mentors for less experienced staff. The aim would be to promote good practice and help new recruits to gain experience and improve their competence.

Sharing Best Practice

5.21
We saw examples of good ideas being disseminated among different teams within the same service centre. However, there is little evidence of good practice sharing between service centres. Audit area managers meet periodically, but their meeting minutes indicated that best practice initiatives are not usually discussed.

5.22
Historically, there has been a high level of competition between service centres. While this has provided an incentive to meet targets, it is likely also to have impeded good transfer of new practices and ideas. In our view, changing existing practices is likely to be a considerable challenge.

5.23
Tax practitioners commented to us on the importance of the information contained in the Adjudication and Rulings database, but this database has not been readily accessible to investigators. We understand that the IRD is reviewing access, and that the Technical Standards Group is sending a monthly summary of the latest Adjudication reports to the Technical Legal Support Group managers, who are based in the service centres, and to the Corporates Division.

5.24
The Technical Standards Group also has access to all Public Rulings and can get copies of specific Private Rulings as required. The challenge for the IRD is how to make this large volume of technical information available to investigators when they need it and in a form that is easy to access and use.

5.25
The changes required in communicating best practice reinforce our view that some form of management for change is necessary. A number of useful forums have been and are being established – including regular meetings of audit area managers, IRD’s National Compliance and Penalties Consistency Committee, and the National Quality Review Committee. We would expect these forums to be monitored to ensure that they are successfully communicating, reinforcing, and monitoring best practice.

5.26
An area where effective communication of best practice is assisting the investigators in their work is the good access they have to support on difficult technical issues. A range of support is provided by other team members, team leaders, Litigation Management, the Technical Legal Support Group based in the service centres, and the central Technical Standards area.

5.27
Currently, a less effective area is mandatory reporting – which is the mandatory referral of certain technical matters to a more senior level, as a means of ensuring the integrity of decision-making. This new initiative is being well used by some audit staff but is poorly understood by others, who are not clear on what matters need to be reported on a mandatory basis. Better communication of best practice about the initiative would help make the process routine and reduce the risk of important decisions being taken by insufficiently experienced and/or qualified staff.

Information and Intelligence

5.28
In order to do their work effectively under the compliance model, investigators need to have access to and make full use of good information and intelligence on the circumstances of taxpayers to enable investigators to:

  • respond to taxpayers in a way that is appropriate to their circumstances; and
  • use the information to make risk analysis and case selection as effective as possible.

5.29
Intelligence is central to all the IRD’s activities involving managing and improving compliance, including taxpayer audit. Improving intelligence and information is a key IRD priority, with fundamental work required to:

  • identify and clarify requirements;
  • establish ways to gather intelligence and information that is not currently being gathered; and
  • set up systems to make better use of the intelligence.

5.30
Taxpayer audit’s most advanced tool for case selection is the Taxpayer Audit Selection System (see paragraphs 4.12-4.14 on page 49). Other information resources that investigators can draw upon are examined below.

The Data Warehouse

5.31
The IRD’s Data Warehouse stores a wide range of taxpayer information. It is being enhanced as part of a long-term project that is being implemented in a number of phases.

5.32
One development of the Data Warehouse that is crucial to improving the efficiency and effectiveness of taxpayer audit is the bringing together in one place of a wide range of information and intelligence that investigators currently receive from many sources. Examples include information referred from:

(i) other parts of the IRD,
(ii) other investigators,
(iii) analysis of previous audit activity,
(iv) industry,
(v) the media, and
(vi) the general public.

5.33
If successful, this development of the Data Warehouse will enable the IRD to understand the tax base better, and audit staff will be able to use this knowledge to improve the targeting of audit effort.

5.34
In the meantime, the IRD needs to make best use of the information generated in the conduct of audits. The IRD’s 1999 Health Report12 stated that –

… there is still significant potential to make further improvements to the risk assessment process. In particular, the Department needs to make greater use of information on completed audits collected by its audit systems, which can be broken down by up to 420 industry types …

5.35
An analysis of completed audit cases by industry sector for the 1997-98 and 1998-99 years was then under way. The analysis was completed in early 2000, and the results were used to inform work on industry profiles (see paragraphs 5.40-5.45) and at the start of the Industry Partnership initiative in 2001 (see paragraphs 5.46-5.50).

5.36
Part of the Data Warehouse project involves enabling the IRD to gain access to sources of third-party information that will assist in targeting audits. Examples include the Births, Deaths, and Marriages Register; the Building Consent Application Lists held by District Councils; and, from the Registrar of Companies, particulars of newly formed companies. However, the issues around access are complex.

5.37
The IRD is conscious of privacy issues with respect to accessing certain third-party information, but believes that this type of information can be appropriately obtained within the existing legislation. It is investigating the legal, policy, and public relations consequences before it proceeds further with this important work that is necessary for taxpayer audit to be improved in line with the Taxpayer Compliance Model.

5.38
The Data Warehouse development has plans approved through to July 2003. Plans for a further phase are being prepared, and the work under way includes ensuring that the plans will take full account of the outcomes of the current phase and progress on other elements of the IRD’s technology strategy.

5.39
The elements of the Data Warehouse project that are essential to the development of taxpayer audit should be given a priority that enables them to be effectively co-ordinated with the taxpayer audit strategy.

Industry Profiles

5.40
Companies that fall within the responsibility of Corporates Division pay 50% of all revenue collected by the IRD each year. It is therefore important that the Division has good information on these companies.

5.41
Corporates Division has account managers responsible for the largest companies in each of its six sectors, enabling them to concentrate their efforts on gaining a good level of understanding of the companies and the sectors they operate in. They routinely produce industry specific tax risk analysis reports that are used to help select the audits to be conducted and to decide the focus of the audits.

5.42
The investigators based in the service centres have a much more numerous and diffuse client base. Historically, their understanding of this client base was assisted by information contained in an Industry Profile manual. We understand that most of the material in the manual was written in the early 1980s. It described in detail how different industries operated – e.g. Milk Vendors, Public Houses, Farmers, Chemists, Corner Dairies – and contained useful sections on common business ratios and tax legislation relating to each particular industry.

5.43
We understand that the manual has only once been subject to a major update – in 1986 when the profiles were amended to reflect the new GST regime. The IRD told us that the nature of business had not changed substantially and, therefore, that in many cases these original profiles were still relevant.

5.44
During 1998, the IRD decided to create a new series of industry profiles containing information such as a description of the industry, industry associations, business and accounting practices, specific legislation, case law, and the number, type and outcome of audits conducted.

5.45
Work on these new profiles has so far been limited. In June 2000, work was done in relation to 11 industries – not to produce profiles along the lines envisaged, but to provide statistics on the number of businesses within an industry, and details of the audit work conducted, i.e. number of completed cases, coverage, average hours per case, average discrepancy per case. Further work was planned for early 2002, but has been deferred in favour of other work assessed to be a higher priority.

Industry Partnerships

5.46
In the past, some industry specific projects have been undertaken in particular locations. The IRD has also previously undertaken a number of industry-wide initiatives – e.g. in the taxi and real estate industries.

5.47
The IRD has established a new project – Industry Partnerships – that involves a concerted and co-ordinated IRD focus on particular industries. The project is being undertaken by a multi-disciplinary team attached to Service Delivery – comprising audit, debt collection, and service staff.

5.48
In the short term, this project cannot replace the industry profiles, because what is envisaged is much more involved and will be carried out over an extended period. The goals of the project are to make it easier for businesses to meet their obligations and for the IRD to target non-compliance, particularly around cash transactions. A key difference is that the products of Industry Partnerships are intended to assist the relevant industries to comply, as well as to provide information that is useful to IRD staff.

5.49
Industry Partnerships is creating a process to evaluate taxpayer behaviour with reference to the compliance model (see Figure 5 on page 40). So far, four criteria have been identified and will be used to group taxpayers who behave in a similar way and place them on the compliance model in one of the four categories – for example, “have decided not to comply”. This intelligence will then be used to better target audit work.

5.50
The first industries selected in 2002 for the Industry Partnerships project were painters and decorators and electricians. The IRD has established working relationships with groups representing these industries, and detailed industry profiles for internal use have been prepared and will be updated as necessary. Since March 2003, the IRD has expanded the project to include hairdressers, collision repairers, entrepreneurs (home businesses), and fruit growers. Over time, the IRD aims to create profiles for a large number of other industries.

5.51
The IRD still has some way to go to extend its risk profiling more generally. However, from July 2003, service centres are selecting more audits based on compliance risk factors. The IRD also has areas of expertise in which risks are especially well understood, and audits are effectively targeted. For example, the IRD knows a great deal about the practice of transfer pricing, and about some particular types of tax avoidance and evasion.

Use of Technology

5.52
In December 2002, the IRD launched its technology strategy that aimed to identify:

  • the current status of the IRD’s technology environment;
  • the future technology requirements to support its strategic direction; and
  • the activities required to reach the desired future state, as set out in the strategic direction.

Computer Tax Audit Group

5.53
The Computer Tax Audit Group assists investigators by downloading and analysing general ledgers, reviewing computer systems, and providing computer forensic expertise. The group has concentrated primarily on the Corporates Division’s audits, but is increasingly involved in assisting with audits in the service centres.

5.54
Computer tax audit is a complex and continually developing activity. The head of the Computer Tax Audit Group is leading a project to establish a strategic plan for the group, and resourcing will be an important topic for this project to consider.

Use of Technology by Investigators

5.55
While the IRD has provided support to investigators through the Computer Tax Audit Group and through tools such as TACTICS (see paragraph 4.35 on page 53), in our view it has historically under-invested in technology directly for individual use by investigators. For example, it has only recently reached the position of all investigators having a desktop computer. In the meantime, equipping audit staff with laptop computers has lagged behind what we would expect to see even in a medium-sized accountancy firm.

5.56
In our view, there is no doubt that this resource constraint will have affected past effectiveness and efficiency of taxpayer audit. It will inevitably have inhibited the establishment of a range of computer-based practices – such as the documentation of material and on-line access to manuals, announcements of policy changes, and other guidance.

5.57
In October 2002, the IRD launched an audit technology project to facilitate the increased use of technology in assisting the audit process. The project envisages the need for substantial changes to the type of technology used by investigators and the skills required to use technology in the audit process, and aims to ensure that all investigators that need to use audit technology tools are able to do so effectively by June 2004.

5.58
The audit technology project forms part of the IRD’s wider technology strategy that was launched in December 2002. The inter-relationships between the technology strategy, audit strategy, and the audit technology project need to be clearly identified. The implementation and monitoring of these strategies, in relation to the needs of taxpayer audit, need to be done in a co-ordinated way.

Implications of the IRD’s Strategic Direction and Compliance Model for Future Capability

5.59
Figure 8 below depicts the relationship between the Taxpayer Compliance Model, the focus of audit, and the desired outcome. The first triangle shows the current situation in terms of taxpayer compliance. The desired outcome is the flattened triangle on the right-hand side, whereby even more taxpayers have been moved into the lower sections to join the majority of taxpayers who are fairly or very compliant.

Figure 8
Intended Effect of Audit Focus on the Compliance Model

Figure 8.

5.60
The middle (inverted) triangle represents the required focus of audit to achieve the desired outcome. Taxpayers at all levels of the model need to be subject to some audit attention to ensure that taxpayer compliance is not eroded. However, there is a heavy emphasis on identifying and auditing the taxpayers at the top of the triangle who have “decided not to comply”.

5.61
As the IRD learns more about the behaviour of those at the top of the compliance model, it will be able to re-evaluate the audit coverage for different types of taxpayers and of tax types. By linking coverage with the changing levels of tax compliance, the IRD can achieve more targeted audits.

5.62
The skills necessary to audit taxpayers at the top of the compliance model are very different from those required to perform the routine GST checks or to audit large companies. In the 2002-03 year, the IRD budgeted to spend a little more than 20% of audit staff hours on aggressive tax issues and evasion-related work. Of this:

  • 11% of hours were targeted at aggressive tax issue work, which is largely concerned with mass-marketed tax schemes; and
  • 10.5% of hours were targeted at tax evasion.

5.63
The IRD has been gradually increasing the allocation of audit hours to these activities in recent years.

5.64
The Way Forward 2001 Onwards envisages a human resource strategy that will set out specific initiatives to increase capabilities to enable its staff to more effectively achieve its strategic direction. Work undertaken in 2002 towards preparing this strategy led to observations that mirror, directly or indirectly, the findings and conclusions of our audit:

  • There needs to be a much better understanding of future capability requirements, the gap between them and current capabilities, and the speed with which changes in capability need to take place. This will be a major challenge for the IRD.
  • The compliance model requires strong knowledge-based decisionmaking skills. A key transition will be from transactional to knowledge-based work, and from clerical and process skills to more analytical and relationship management skills. E(electronic)-business calls for a further set of skill requirements that will continuously increase.
  • Competition for people with specialist tax audit training is likely to increase. This makes it particularly important that the work of such specialist staff is well targeted – for example, by risk-based selection of audits using good intelligence.
  • Management skills need to be improved, and to become more consistent with greater transparency and accountability for management decisions. The important team leader role needs to be continuously reviewed – particularly in relation to its contribution to managing staff.
  • There needs to be more focus on achievement and results – and on finishing tasks – and on high-quality analysis that contributes to achieving results without hindering the process.

5.65
From our perspective, these observations provide a comprehensive diagnosis of future skill requirements. Further work is required to define in detail the gap between these requirements and current capability, and to specify what needs to be done to bring capability up to the required level.

10: Includes professional accountancy and other qualifications such as PCE/PAS (the Professional Competence Examination and Professional Accounting School qualifications) required before becoming a member of the Institute of Chartered Accountants of New Zealand.

11: ASPIRE is the ‘Acquisition of Skills Programme for Inland Revenue Employees’. It includes a range of training products and modules, and an assessment framework which is designed to meet the knowledge and skill requirements of technical competence.

12: The Organisational Review of the IRD in 1994 recommended that the IRD should prepare a ‘health report’ for the Minister of Revenue, identifying major issues confronting the Department. Between 1994 and 1999 the IRD prepared four such reports, but none have been completed since 1999. They have been replaced by reports against the IRD’s Customer Charter, the first of which was completed in June 2002.

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