By Gaute Solheim, Senior Tax Advisor, Norwegian Tax Administration
(Mr. Solheim writes in his individual capacity and does not purport to represent the views of the Norwegian Tax Administration.)
The Norwegian Tax Administration (NTA) has succeeded in leading most of the taxpayers away from the temptation of tax evasion over the last two decades. Not all, but most. It was not by carefully guiding them down a narrow path. The NTA constructed a wide avenue built on large quantities of third-party information pushed into prepopulated tax filings. Norway tweaked details in the rules for the most used deductions, linking them to easy observable facts and standard rates instead of using actual cost. Feedback from audits were used to evaluate possible changes in rules, eliminating or reducing the temptations facing the taxpayer in the filing process.
After all this work, we still had a problem with taxpayers being formally non-compliant by not logging into the digital portal and clicking the button for submitting their prepopulated tax filing. The easy fix was to change the law. A taxpayer receiving the digital and prepopulated tax report would be deemed to accept it as his filing if he stayed passive. Presto, even more compliant taxpayers.
But, at least for internal use, the NTA retained the old division of taxpayers into those who want to comply and those who want to evade. The faithful and the sinners. What people want is hard to observe, and it is hard to design measures to influence what people want. The NTA kept it despite its actions being focused very much on making it irrelevant whether the taxpayer wanted this or that. Spending all my time auditing MNEs, I found it really hard to figure out the wants of a corporation.
I was very pleased when in March I came across Leandra Lederman’s paper on applying the perspective of the fraud triangle to tax compliance. After playing a bit with the ideas from that paper, I decided to invert it into a compliance triangle with the taxpayer in the centre. I later learned that Matt Kelly had written something similar to my ideas. After some more drawing and thinking, I decided to take three sides of the fraud diamond and use them to shape my compliance triangle. My prototype compliance triangle at this stage looks as in this figure:
The taxpayer is in the centre, and the job of the tax authorities is to make sure that she has the room needed for staying compliant. It focus on what tax authority and government may control. It illustrates that we need to focus on what measures establish a comfortable space for compliance. A space so large that we do not lead the taxpayer into the temptation of walking dangerously close to the edges of the compliance triangle. We do not want her inches from stepping across the line.
Comparing what the NTA had done over the last two decades and how that influenced the room for compliance, it was check, check, check. All the main changes we had made could easily be translated into a larger compliance triangle around the taxpayer. Very little of our actions was focused directly on the hearts and minds of the taxpayer (see Army Field manual 3-24). We targeted the realities shaping the environment and the taxpayer’s room to manoeuver, and this had a big influence on compliance.
The deduction for work travel costs is a very illustrative example of how you may alter the compliance triangle. We had a compliance nightmare based on actual costs, limited to the cost of public transport if you did not qualify for the cost of using your own car. The rules carving out this exception were based on facts hard to observe. The auditor actually had to make the trip with a stopwatch using public transportation on different days of the week in order to establish facts for a challenge to the filing. And the intricacies from the possibility of carpooling are best left untouched.
We probably eliminated 99% of that problem with a tweak to the rules. We changed it to a deduction based on the distance between work and residence and a standard cost per kilometer. A lot of auditing resources freed up by establishing a compliance triangle so wide that few end up even close to temptation.
A perfect example of a compliance triangle so narrow that the Norwegian taxpayer must stay balanced on one toe is foreign financial income. I will use financial income from Sweden in my example. A lot of Swedes have immigrated to Norway over the last decades and are Norwegian tax residents. Some of them inherited from their Swedish parents after a while, and the inheritance may have been a Swedish fund. The title of the investment fund is typically transferred to the now Norwegian tax resident from the estate.
The Swedish fund must subtract a 25% withholding tax on all gains in the fund, and the taxpayer gets a very lengthy report listing each taxable transaction in the fund. The tax on financial income in Norway is 25%, but you may claim credit for taxes paid, so there is in theory a net of zero taxes to pay in Norway. But you will only get your credit if you claim it, which encourages the taxpayer to file. (It is a lot more complicated than this, but the details of all the elements of taxation in different jurisdictions are beyond the scope of this post.)
I helped out an old lady with this some years ago. The value of the shares in three Swedish funds were approximately USD 200,000 and the income from those funds around 15,000. I spent many hours completing the work of reading the documents and filing the forms needed to reach the correct, easily observable result of a tax liability averaging out to zero. Some years produced an unused credit of USD 100 to bring forward, which then cancelled out the next year. I did some quick informal research among tax lawyer friends on how much they would charge for this job. No one would do it for less than USD 2,000.
So, her choices were compliant with zero paid taxes and USD 2,000 in compliance expenses (leaving out of the equation that I helped her for no charge) or “non-compliant” with zero paid taxes and no compliance expenses. The old lady was really balancing on the tip of one toe to stay compliant, in terms of reporting all taxable income.
At that time, there was no reporting between Sweden and Norway on cross-border financial income. It comes as no surprise that when Sweden and Norway started automatic exchange of information on financial assets and income, the NTA discovered a huge number of non-compliant taxpayers. Unfortunately, this problem was at the start lumped into the existing box of risk issues labelled “Taxpayers hiding money in foreign jurisdictions.” Taxpayers hiding money in foreign jurisdictions is the prime example of those who do not want to pay taxes. The chosen approach was targeted audits and notices to thousands of taxpayers. My guess is that a mental anchoring in our compliance methodology influenced this.
Using a compliance triangle instead could have resulted in a quite different approach. We knew that financial income from jurisdictions with a withholding tax approximately similar to the Norwegian tax rate would result in no net revenue. Using this as the starting point, we could have pondered how to create a large compliance triangle for taxpayers with foreign financial income from jurisdictions with no significant net effect on Norwegian revenue. We could have made small tweaks to the rules ensuring that the taxpayers with close to zero net tax liability on foreign financial income could become compliant by simply reporting the value of the funds, the source country, and checking the box for withholding tax paid.
But we did not, and I believe our chosen approach was very much a product of a methodology using “taxpayers not wanting to pay their taxes” as a defined group. We did not have the mental picture of a taxpayer balancing on one toe in the smallest compliance triangle one can imagine.
I am not arguing that using the perspective of the compliance triangle will lead us to the utopia of 100% compliance. I just have a hunch that using the compliance triangle will give us a better return on resources employed than dividing our taxpayers into two groups based on whether they want to comply or not. One advantage is that it fits better with what most advanced tax authorities actually try to do. And if used properly it could free up a lot of resources to use on those remaining on the outside of the triangle.
If you know about any paper or article that has debated or analysed a similar approach, I would be very grateful for a link or reference.