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«1 Introduction A habitual noncomplier (HNC, also known as an egregious repeater) is an individual with a history or pattern of noncompliance—a ...»

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Habitual Noncompliers

Michael Duggan, Martyn Knottenbelt, Jason Byrnes, Judi Scheffer, Kevin Green, Phillip Anderson,

and Stewart Donaldson, Inland Revenue New Zealand

1 Introduction


habitual noncomplier (HNC, also known as an egregious repeater) is an individual with a history or

pattern of noncompliance—a person who serially and deliberately does not comply—even after com-

pliance intervention. HNCs are a risk to tax administrations in terms of lost revenue, integrity of the

tax system, and reputational damage. They can also be costly to deal with through compliance interventions.

The purpose of this paper is to outline research that was conducted to understand, quantify, and assess the risk posed by habitual noncompliers and discuss the management of this customer group going forward. The research project was initiated by tax administration investigators, and was a collaboration among researchers, managers, analysts, and investigators within the organisation.

Tax noncompliance is a problem for all jurisdictions and includes all facets of tax administration span- ning registration, filing, paying, reporting, and entitlements. Repeated noncompliant behaviour by a person, a habitual noncomplier, is not unique to the field of tax. However, the study of habitual noncompliance within the tax context and an understanding as to how to effectively treat this behaviour is limited. The identifica- tion of HNCs as a population of interest for New Zealand Inland Revenue began with an internal discussion document that identified the need for a coordinated approach to managing the noncompliant behaviour of recidivist tax offenders. This paper will first briefly cover the literature on HNCs, followed by four interrelated research studies: 1) the creation of a research database of HNCs known by staff; 2) “Voice of the HNC”—quali- tative indepth interviews with HNCs; 3) a profile of habitually late filers and payers; and 4) statistical model- ling to identify key indicators of the “worst” noncompliers and using these indicators to detect other potential HNCs. Lastly, the paper will discuss the implications of the research findings and further research directions.

1.1 Literature Review Habitual noncompliance and recidivism as theoretical constructs span many academic disciplines and re- search foci including criminology, psychology, sociology, white-collar crime, fraud, recidivism or habitual noncompliance, and tax. As the literature on the link between habitual noncompliance and tax is limited, a literature scan was undertaken across the confluence of disciplines and ideas.

Habitual noncompliance is a research topic in itself as well as often being the measure of the success of any treatment. For instance, within the New Zealand prison and correctional context, the recidivism rate is often a primary measure to assess the effectiveness of an intervention over time (e.g., Nadesu, 2008, 2009). However, this is not the case within taxation.

Arguably, the preeminent international source of tax compliance strategies and activities can be found in the reports published by the Organisation for Economic Cooperation and Development (OECD). In recent papers, however, few examples or instances of the habitual noncompliance, repeat offender, or recidivism concepts were published (refer to OECD 2011; 2010a; 2010b; 2009; 2008).1 While recidivism is acknowledged as an issue it has not been widely and consistently considered or addressed. These references include: Her Majesty’s Revenue & Customs (HMRC) managing deliberate defaulters programme; the use of audit revisit programmes to ensure repeat noncompliance does not occur; the need for longitudinal and repeated evaluation measures; and, that for HNCs a deterrence strategy involving recurring audit activity may be required.

Fundamentally, habitual noncompliance is not part of the common lexicon or language that taxation authorities use when they describe taxation in the context of treatment, evaluation, influence, or compliance improvement. Thus a gap exists between the language tax authorities use to describe noncompliance in comparison to the language used in the literature of crime, punishment, and effective treatment.

142 Duggan, Knottenbelt, Byrnes, Scheffer, Green, Anderson, and Donaldson As HNCs span all areas of compliance issues there is an important distinction between areas where the noncompliance reveals itself and is clearly visible, such as filing and paying, compared to where it is largely invisible and requires the revenue authority to identify through enforcement action, such as in the cases of fraud, evasion, and aggressive tax planning. If a taxpayer is registered correctly then filing HNC behaviour is detectable and if the taxpayer files correctly then paying compliance is readily identifiable.

In contrast, issues of registration, reporting, and entitlements are far more hidden. For a taxpayer to be identified as noncompliant, enforcement actions generally need to have been undertaken, and for HNCs multiple actions. Known HNCs are identifiable through staff awareness of the behaviour and through analysis of instances of multiple compliance actions against a taxpayer and their related entities. Detection of this type of harm is therefore dependent on prevalence of HNC activity, and our ability to detect it and have it confirmed through enforcement (Sparrow, 2008).

1.2 General Causes of Habitual Noncompliance Noncompliance is undoubtedly caused by the interactions of a wide variety of factors. In basic terms, and from a tax administration perspective, these causes can be split into three broad categories (see Appendix 1 for

further description):

• Individual—personality, tax thinking (including motives, drivers, and rationalisations), and circumstances (such as addictions, financial situation, and business performance).

• Administration—the interaction between the individual and tax administration including tax knowledge, legislation, opportunities for noncompliance, rewards, and real and perceived consequences.

• Social Influences—other people, groups, and societal factors that directly and indirectly influence the HNC compliance behaviour.

Noncompliance occurs when there are sufficient underlying causes present and insufficient inhibitors to prevent it from occurring (Andrews and Bonta, 2010). From a tax authority perspective, the central difference between HNC behaviour and other forms of noncompliant behaviour is our inability to restrict, monitor, identify and treat the noncompliance successfully. Habitual noncompliant behaviour continues serially and deliberately. HNCs are more likely to be: people with personality issues or who have strong rationalisations and attitudes against tax; have repeated easy opportunities to not comply, with limited or no consequences applied; and where there is strong social pressure for noncompliance—such as from trusted advisors or where noncompliance within a population segment is the norm. HNCs highlight a gap between a tax administration’s ability to restrict, monitor, detect, and treat noncompliance in a manner that changes an individual’s tax behaviour to sustained compliance.

1.3 Treatment of Habitual Noncompliance Within Revenue Authorities Although recidivism within tax administrations may not have a large body of published research, a number of agencies are focusing on taxpayers who repeatedly choose to not comply with their tax obligations—particularly filing and paying compliance.

Where identified, tax authorities’ treatment of HNCs has been attempted through:

• Use of automated letters

• Issuing of arbitrary assessments

• Escalation of the case to a more advanced stage of the collection process (using fines and liens earlier in the collection process)

• Requiring increased disclosure

• Deterrence of phoenix activities

• Public Naming

• Prosecutions 143 Habitual Noncompliers Canadian Revenue Authority (CRA) For example, the Canadian Revenue Authority (CRA, 2005; 2007) researched various treatment options for those who have not filed tax returns including the use of arbitrary assessments. The results suggest that initial treatments effected behaviour change, but that this change was not sustained over time, and that the arbitrary assessment process did not appear to be a major deterrent for committed noncompliers.

Internal Revenue Service (IRS) The IRS has focused on identifying balance due2 taxpayers who were likely to repeat noncompliant behaviour (i.e., filing and paying), and in particular, “hard core” (“egregious”) noncompliers (Scott, Plueger, and Mendelson, 2010). Using filing and payment data, the IRS differentiated their egregious customers from other repeat nonfilers using administrative data variables. Once an egregious noncomplier is identified, the IRS accelerates the higher risk cases into a more appropriate stage of the collection process and tests alternative compliance treatments. The targeted approach increases overall efficiencies by initiating collection action in a more appropriate manner and potentially by eliminating unnecessary steps.

Her Majesty’s Revenue and Customs (HMRC) HMRC initiated a Managing Deliberate Defaulters (MDD) programme in February 2011 (HRMC 2010; 2011).3 The programme aims to deter defaulters from returning to noncompliant behaviour, encourages a permanent shift to compliant behaviour, and deters potential evaders. The HMRC monitors and manages the compliance behaviour of deliberate evaders across all their compliance responsibilities with HMRC (registration, filing, reporting and payment). A key theme behind the approach is that evasive behaviour in one tax area highlights a wider risk across the whole of the evader’s trading activities, and their relationship with HMRC.

Australian Taxation Office (ATO) In treating phoenixing, a form of habitual noncompliant behaviour, the ATO favours an early intervention approach to discourage directors from becoming repeat offenders (Roach, 2010). The ATO’s early intervention (and prevention) programme involves contacting phoenix operators sooner via targeted letter and phone campaigns. This is designed to deter fraudulent phoenix behaviour at inception before it becomes business as usual. The ATO also seeks out the worst offenders, subjects them to comprehensive audits and, where appropriate, refers them for prosecution.

1.4 General Treatment of HNCs The literature has shown that a decision to not comply is influenced by a variety of factors both internal and external to the individual. In order to treat the root cause of HNC behaviour more effectively it is useful to consider how recidivist criminal behaviour in general is treated. Although there is a wide body of research on different aspects of treatment, two broad classes are important to the initial discussion of HNCs within tax— sanctions and behavioural approaches.

1.4.1 Sanctions and HNCs At present, the main options for managing HNCs by tax authorities are generally education, penalties, and prosecutions. In criminal contexts, traditional mechanisms of greater penalties and sanctions such as imprisonment, although possibly effective as deterrents, have not been found to greatly impact recidivism rates. In fact, studies on the length and severity of punishment have found that increased severity leads to slight increases in recidivism compared to lesser punishments (Andrews and Bonta, 2010).

Ideally, for a sanction to be maximally effective there is a need for the early identification of offending, full discovery of all breaches, and prompt application of sanctions to fit the level of the offending. Obviously no enforcement system can deliver sanctions with such certainty. If detection of offending is less than certain, there is a strong likelihood that the extent and level of offending will remain unidentified, and punishments and sanctions not delivered, then recidivism becomes a more likely consequence.

144 Duggan, Knottenbelt, Byrnes, Scheffer, Green, Anderson, and Donaldson 1.4.2 Individual HNC Behaviour and Interventions In terms of effecting behaviour change in HNCs most tax authorities face an obvious constraint in that they have no mandate to engage in individual behavioural interventions to treat underlying causes of noncompliance. One set of methodologies that have found wide success in reducing recidivism is the classes of treatment referred to as cognitive behaviour therapy (CBT). A number of meta-analytic studies have found CBT to be the most effective or one of the most effective treatment strategies for juvenile and adult offenders (i.e., Pearson, Lipton, Cleland, and Yee, 2002; Wilson, Bouffard, and MacKenzie, 2005). CBT looks to change how people think (‘cognitive’) as well as what people do (‘behaviour’). However, tax authorities generally have no mandate or expertise to undertake this class of treatments.

HNCs or recidivists are an important segment to research and discuss. Within the tax literature HNCs are an area that has not been well researched and integrated in the compliance activities of tax authorities.

Although there are initiatives in certain jurisdictions, tax authorities appear to be behind other agencies in their approach to reduce habitual noncompliance. Given the literature suggests sanctions may not be the best method to treat HNCs, and that the most effective class of treatments is beyond the mandate of most tax authorities, it is important to research the topic to identify more effective means of identifying, classifying, and intervening to maintain the integrity of the tax system.

2 Habitual Noncompliers Research Project The HNCs research project was initiated following an internal discussion document written by a group of investigators in 2009. They identified HNCs as a segment requiring special attention and the need for a coordinated approach to managing the noncompliant behaviour of recidivist tax offenders.

The document noted that the behaviour of these types of people is costly and unlikely to change unless they were specifically targeted for intervention. As a result, a research project was set up to investigate HNCs as part of the wider compliance programmes and as outlined in Inland Revenue’s compliance focus document.4

The project deliverables were:

• Study 1: A database of Tier 1 HNCs (the most serious offenders).

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