Acceptable standards and procedures for tax audits

Pahala Nainggolan, Jakarta

The most serious complaint from the Indonesian Chamber of Commerce and Industry (KADIN) about the proposed tax law amendments is one of inequality. They feel there is a lack of equality between tax authorities and taxpayers. This conclusion comes from their daily experience in dealing with tax auditors.

Actually, this inequality problem could be solved by improving the way audits are conducted and the handling of taxpayers' complaints.

The process could start with the basics. The purpose of a tax audit is to promote the voluntary compliance of taxpayers in reporting and settling their tax obligations and to deter tax evasion. A tax audit is supposed to be conducted when tax officials find indications of a taxpayer's failure to comply.

In reality this is not the case. Tax auditors come whenever they want -- whether they have indications of non-compliance or not. Tax audits are treated as additional tools to achieve the tax revenue target. This causes tax auditors to focus on how to increase payments rather than to check compliance.

Tax audits are clearly a tax transaction cost. A company must assign its staff time to prepare documents, answer auditors' questions, analyze the findings and so on. In addition to time spent, there are also documents to be copied, reconciled etc.

After the tax auditor's findings are communicated some money must be paid as mentioned in the report. In the case of unfair tax treatment, taxpayers can object to the auditor's findings by going into the regional tax office or to the tax court.

The current mechanism for objection against the tax assessment letter is where the inequality happens.

First, a taxpayer must pay that amount even though they object to the amount. The notice of objection will be processed, but the amount must be deposited first. This can really cause a cash flow problem for taxpayers.

Smart tax auditors know that time is money.They could exaggerate their reports, forcing taxpayers to pay the amount even though they are quite sure the assessment is incorrect.

Second, the objection process takes more than one year. The objection will be processed by the local tax office within a minimum of 12 months after a notice of objection is received.

But usually the taxpayer is asked to respond only as the deadline approaches. If the taxpayer objects to the decision, an appeal could be filed with the tax court, which would take another year to process. So, a final resolution would be reached after two years.

Again, smart tax auditors understand this situation. The objection process will only add to the taxpayer's costs as they need to provide additional documents etc.

Hence, the temptation is great for collusion between taxpayers and tax auditors to reduce the costs at the expense of state revenues.

The third issue at stake is the independency of the people who process the notice of objection. At first, the objection will be processed by different units of an organization, though still under the Directorate General of Taxation. At this stage there are numerous problems. Esprit de corps, their solidarity with their colleagues (tax auditors), of course will be maintained. Then, they have to achieve the tax revenue target. Accepting a taxpayer's objection means they may not reach the target.

Appeals to the tax court more or less follow the same course. Most of the judges are former tax officials or employees of the ministry of finance. Theoretically, the interests of the two parties are rarely voiced equally.

Realizing that the objection process is a long and winding road, it is no wonder that some businesspeople or taxpayers choose the easiest and probably the cheapest way in dealing with tax audits, thus leading to corruption in the taxation system.

Those who are patient, have the finances at their disposal and are certain of winning the case will go to the tax court. But the remainder who have a limited cash flow, will choose the easiest way out.

Tax audits are a must. This is one way to ensure the compliance of taxpayers. But this does not mean taxpayers' burden should be increased. Moreover, tax corruption must be avoided.

To achieve these objectives, there are several alternative solutions.

First, while the objection is being processed, the tax amount due should not be settled in cash but be guaranteed with collateral using the assets of the taxpayer. This ensures that the tax office will be able to get the payment immediately in case the final decision is in favor of the tax auditors. By allowing non-cash payment, taxpayers will face no cash flow problems.

Second, from the outset, the processing of taxpayers' objections must involve independent parties who would voice and act on taxpayer's interests. A model such as the Taxpayer Advocate Service of the IRS could be used.

Third, the processing of notices of objection must be shortened to three months. This would show a commitment from the tax office to serve taxpayers as their main customers. Why is it that a tax audit takes only about two months to complete, while an objection to its findings takes 12 months to process, with no fieldwork needed? As the process requires only the collection of additional data and some further analysis, it should not be longer than the auditing work itself.

The writer, formerly a tax auditor, is a doctoral student of management science at the University of Indonesia's school of economics. He can be reached at pahala@tifafoundation.org.