## _tnm1014

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---

### Overview
- Definition: the “shadow economy” describes businesses operating outside the tax system and registered businesses that conceal transactions to avoid paying taxes or social security charges, or to avoid the costs associated with legislation on safe working conditions or protection of consumers’ rights.
- Forms: Transactions may be partially concealed (reported at lower than true values) or entirely unrecorded (often cash payments).
- Revenue impact: the shadow economy represents a very significant component of the total tax gap (the difference between actual and potential tax revenues).
- Sweden example: at least half of its total tax gap is attributable to the shadow economy, with around two-thirds of the revenue loss centered in the micro business taxpayer segment.
- Measurement caveat: Current measurement methodologies (e.g., MIMIC modeling) are best viewed as indicators of the order of magnitude and are most useful for identifying trends over time rather than as absolute measures.

### Estimated size of the shadow economy (G20 countries)
- Schneider (Shadow Economies All Over the World: New Estimates for 1999-2007) country averages (size of the shadow economy as a percentage of official GDP):
  - USA: 8.8
  - Japan: 11.4
  - UK: 12.9
  - China: 13.5
  - Australia: 14.6
  - France: 15.4
  - Germany: 16.0
  - Canada: 16.3
  - Saudi Arabia: 18.7
  - Indonesia: 19.9
  - India: 24.0
  - Argentina: 25.5
  - Italy: 27.2
  - Korea: 28.2
  - South Africa: 29.5
  - Mexico: 30.2
  - Turkey: 33.0
  - Brazil: 40.5
  - Russia: 48.6
- Aggregate observations:
  - The average size in developing countries and transition countries is around double that of high income OECD countries.
  - Significant variation across G20 countries indicates potential revenue gains if poorer performing countries could reduce the shadow economy toward levels in top performers (USA, Japan, UK).

### Business environment indicators related to shadow economy risk
- World Bank Doing Business 2010: average time required to complete key business processes (regional averages).
- PAYING TAXES
  - Number of payments required per year:
    - East Asia & Pacific: 24.6
    - Eastern Europe & Central Asia: 46.3
    - Latin America & Caribbean: 33.2
    - Middle East & North Africa: 22.9
    - OECD: 12.8
    - South Asia: 31.3
    - Sub-Saharan Africa: 37.7
  - Time required to comply (hours per year):
    - East Asia & Pacific: 227.2
    - Eastern Europe & Central Asia: 336.3
    - Latin America & Caribbean: 385.2
    - Middle East & North Africa: 204.2
    - OECD: 194.1
    - South Asia: 284.5
    - Sub-Saharan Africa: 306.0
- STARTING A BUSINESS
  - Number of procedures required:
    - East Asia & Pacific: 8.1
    - Eastern Europe & Central Asia: 6.3
    - Latin America & Caribbean: 9.5
    - Middle East & North Africa: 7.9
    - OECD: 5.7
    - South Asia: 7.3
    - Sub-Saharan Africa: 9.4
  - Time required to comply (days):
    - East Asia & Pacific: 41.0
    - Eastern Europe & Central Asia: 17.4
    - Latin America & Caribbean: 61.7
    - Middle East & North Africa: 20.7
    - OECD: 13.0
    - South Asia: 28.1
    - Sub-Saharan Africa: 45.6

### Drivers of the shadow economy
- Influencing factors:
  - Overall tax and social security contribution burden.
  - Complexity of the tax system.
  - Cost of formalizing a business (time, procedures, fees).
  - Prevailing social welfare environment.
  - Effectiveness of tax administration.
  - Attitudes to government authority and government spending.
- Correlation: many developing and transition countries have overly complex tax laws and procedures; higher costs and time burdens for business processes correlate with higher shadow economy participation.

### Tax policy responses (recommended)
- Simplify tax laws.
- Reduce taxes on micro and small businesses.
- Reduce barriers to entry into the formal economy such as costs, time, and procedures.
- Allow more flexible hiring and firing of workers (e.g., through temporary contracts).
- Improve and expand coverage of social services and health programs.

### Tax administration responses (recommended)
- Develop integrated compliance management strategies addressing underlying causes of non-compliance and balancing assistance, encouragement, and enforcement.
- Recognize the shadow economy is largely centred in micro and small business sectors; audits alone are not a feasible sole lever given participant numbers.
- Develop mitigation strategies to:
  - Reduce community tolerance for the shadow economy.
  - Provide targeted assistance to promote voluntary compliance.
  - Encourage self-regulation.
  - Demonstrate a visible and credible detection and enforcement capability.

### A. Reduce community tolerance of the shadow economy (communication strategy)
- Whole-of-government medium-term campaign to raise understanding of the role of taxes in social equity and essential public services.
- School-based education programs to promote voluntary compliance, ranging from basic story-telling to embedding technical tax topics into secondary and tertiary curricula.
- Raise awareness of dangers of dealing with shadow economy operators (poor workmanship, lack of warranties, health and safety risks) in partnership with business, trade and professional associations.
- Educate small business operators about non-tax risks of understating income (reduced insurance pay-outs, compromised ability to sell the business, compromised debt collection).
- Engage the community in identifying and rejecting shadow economy operators and encourage confidential reporting.
- Publicize the tax agency’s detection and enforcement capability and anti-avoidance actions (sanitized case studies where privacy laws restrict detailed publication).

### B. Provide targeted assistance (to small businesses and new businesses)
- Typical assistance activities:
  - High quality taxpayer enquiry services (telephone, email, letters, one-stop-shop service centers).
  - Free seminars with other government agencies explaining obligations and entitlements.
  - Outbound telephone calls to offer help and advice.
  - Optional free advisory visits at taxpayer premises.
  - Targeted advisory visits (non-optional) to premises of small businesses considered high risk.
  - Simple information products explaining key obligations (especially record-keeping) and how to seek help.
  - Provision of on-line self help tools (on-line calculators, decision support systems).
  - Proactive reminders of approaching obligations (letters, emails, text messages, telephone calls).
- Manage new businesses as a discrete group: early identification, ongoing monitoring in early stages, timely proactive assistance.
- Pay attention to businesses becoming employers for the first time to embed compliance around withholding and social security payments.

### C. Encourage self-regulation
- Incentives to recognize and reward good compliance behavior:
  - Remission guidelines for penalties and interest that recognize a good compliance record.
  - Less-onerous reporting requirements and easier access to extended filing periods and payment instalment arrangements for taxpayers with a record of good compliance.
  - On-line self-help tools to promote accurate reporting of complex obligations (e.g., employment status decision support).
  - Pre-filling of tax returns with third-party data (salaries and wages; interest; dividends; social service payments; credits for tax payments withheld; credits or offsets).
- Liaison with intermediaries and stakeholders:
  - Tax agents and practitioners: provide premium services (dedicated telephone teams, direct access to expert officers, tailored seminars) while monitoring compliance by tax agents.
  - Banks and financial institutions: ensure understanding and support for collection enforcement policies (garnishee notices, withholding arrangements, reporting of financial transactions).
  - Industry, business and professional associations: leverage for influencing compliance behavior.

### Cooperative partnerships with industry and business associations
- Cooperative “partnership” arrangements with key industry and business associations are effective conduits for identifying compliance problems (ambiguous law, complex forms, unreasonable time limits, onerous reporting) and developing workable solutions (examples from New Zealand, Australia, and many other countries).
- Open dialogue and co-design demonstrate transparency and promote ownership of solutions within user groups.
- Associations can help eliminate unscrupulous operators and provide intelligence on ground-level practices.

### Industry benchmarks and business-to-consumer trades
- Develop ‘industry benchmarks’ for high risk industries where business-to-consumer transactions are a major proportion of income.
- Benchmarks reflect expected relationships between inputs and outputs based on industry standards and focus on trades with strong correlations between few inputs and total income.
- Jointly developed and endorsed benchmarks gain credibility for self-checks and dispute resolution.
- Publicize benchmarks to enable taxpayer self-comparison and assist voluntary compliance.
- Compliance actions: taxpayers with returns outside benchmark limits should be warned, automatically checked against benchmarks, and outliers reported for further review.

### Leverage points: software and business service providers
- Manufacturers of accounting software and payroll service providers are leverage points for improving small business compliance.
- Close liaison ensures software accurately captures and reports all tax obligations, including new requirements.

### Demonstrating visible and credible detection and enforcement capability
- Enforcement must complement education and assistance with effective intelligence gathering, risk identification and analysis, case selection, and a skilled compliance workforce.
- Detection methods include:
  - Regular unannounced on-site visits to industrial estates, shopping districts, markets and fairs, restaurant precincts, taxi ranks, etc. to check registration.
  - Matching active taxpayer registers against third party databases for trades and professional associations to find unregistered operators.
  - Test-checking tax invoice validity to ensure suppliers are registered.
  - Reporting arrangements for business-to-business transactions requiring reporting of purchases from suppliers who do not quote valid tax identification numbers; can be complemented by a withholding requirement.
- Australia note: purchaser must withhold an amount equal to the highest marginal PIT rate and remit it to the tax office, or pay an administrative penalty equal to that amount.

### Monitor compliance by new registrations
- Registrations are a critical control point for shadow economy and fraud prevention.
- Implement a registrations risk engine to match new registration data against:
  - known operators with a poor compliance record;
  - known addresses from which such people have operated;
  - known contact numbers connected to such people;
  - known high risk advisors.
- Risk engine features: check for common names, addresses, contact numbers across multiple registrations; use enhanced fuzzy search for spelling variations.
- Actions for high-risk/new registrations:
  - Physically verify bona fides of highest risk cases and refuse/cancel registrations where appropriate.
  - Closely monitor suspect registrations where refusal/cancellation is not possible.
  - Telephone all genuine first-time business operators to assess understanding of obligations and entitlements and advise where to get assistance.
  - Follow-up on-site advisory visits for first-time businesses failing to demonstrate reasonable grasp of obligations through telephone interview.
  - Contact by telephone or make on-site visits to selected new businesses that fail to meet filing and/or payment obligations.

### Improve record keeping practices
- Regular program of short on-site verification visits to micro and small businesses to ensure appropriate records are maintained.
- Where gaps are identified, give guidance and a reasonable time to self-correct; failure to self-correct should result in an audit and/or an administrative penalty.
- Australia: on-the-spot administrative penalties for failure to keep adequate records; quantum proportionate to the size of the business and penalties escalate for each period the taxpayer fails to self-correct. Penalty imposed under a stand-alone provision and does not require separate assessment of liability to tax.

### Identify businesses declaring losses or unrealistically low income
- Detect operators who understate income using data matching and data mining.
- In benchmarked industries, select taxpayers outside benchmark limits for review.
- Differentiated response by assessed risk:
  - High risk: selected for audit verification.
  - Medium risk: issue customized letters explaining suspected tax gap and directing review/amendment; follow up on non-responses.
  - Low risk: issue warning letters explaining contact reason and warning of possible future audit.
- Ensure auditors have authority and training to apply indirect audit methods for reconstructing income.

### Focused industry projects (sample approach)
- Engage associations to explain risk and ensure accurate understanding of industry operations.
- Publicize verification intent and seek association support.
- Identify tax practitioners with significant client base in targeted industry and alert them.
- Conduct sample audits to confirm non-compliance areas and quantify tax at risk.
- Work with associations and practitioners to prepare advice to participants on identified non-compliance.
- Communicate and request review and self-correction; highlight lenient penalties for voluntary disclosures and planned further audits.
- Offer free seminars and advisory visits, ideally jointly with associations.
- Ensure enquiry staff have scripted answers on voluntary disclosure procedures.
- Apply reduced penalties and flexible payment arrangements for voluntary self-correctors.
- Follow-up audits and prosecutions for worst offenders; publicize representative case studies.
- Measure effectiveness by tracking voluntary disclosures, overall change in tax paid, and surveying industry/practitioners for observed compliance behavior changes.

### Detecting benefit fraud and conspicuous consumption
- Match government benefit payment data with third party and tax return data to identify unjustified benefit claims; resolve by cessation of benefits, restitution letters, and prosecution in most serious cases.
- Match motor vehicle, boat, aircraft, and property registers against income tax returns to identify asset/income mismatches; apply risk-based differentiated verification.

### Recent initiatives and cash transaction considerations
- Observation: even high income OECD countries acknowledge the shadow economy remains a major revenue threat and that the global economic crisis has almost certainly increased participation.
- Need for innovation: further enhancements to existing programs may have only marginal impact; agencies must develop more innovative mitigation strategies.
- Reduce cash transactions:
  - Australia central bank study: cash still accounted for 70 percent of all payments.
  - The study showed these payments represented 38 percent of the total value of transactions, indicating cash remains the primary instrument for low-value purchases.
- Recommendation: revenue agencies should work with banks and financial institutions to develop and promote alternative payment mechanisms and reduce demand for cash.

### Key points for tax administration design
- The shadow economy is an endemic tax compliance risk requiring long-term targeted compliance risk management strategies addressing underlying causes with a mix of education, assistance, encouragement, and enforcement.
- Pursue close cooperation with other government agencies (e.g., Social Security and Immigration) and with non-government intermediaries (tax agents and banks).
- Objective: limit the shadow economy over time to a level tolerable to the government and community; eliminating it entirely is unlikely cost-effective and may increase unemployment, particularly in developing countries.
- Scale responses proportionately to the magnitude of the problem and consider other issues that may represent equal or greater revenue risks.

### Box 2. Recent initiatives in the fight against the shadow economy
- Increased application of withholding/reporting arrangements in high risk industries (Canada, Sweden, United Kingdom and United States, and strongly supported by the OECD).
- Extensive use of third party data matching to detect instances of ‘conspicuous consumption’ (Australia).
- Publication of the names of serious tax evaders—“naming and shaming” (Korea, United Kingdom).
- Development of “industry benchmarks” for high risk industries reflecting expected input-output relationships (Australia).
- Increased reporting requirements for identified tax evaders (United Kingdom).
- Mandatory use of certified cash registers in high risk industries with high incidence of small value cash sales (e.g., restaurants). Certified cash registers connect to a tamper proof control unit (‘black box’) and it is mandatory to provide receipts to customers (Sweden, Canada, Greece).
- Mandatory staff registers for industries with high incidence of informal employees (e.g., restaurants and hairdressers) — operators must maintain up to date registers showing business name, employees’ names and birthdates and their working hours (Sweden).

### Enforcement and penalties; post-audit engagement; measurement
- Enforcement and penalties:
  - New ‘failure to notify’ penalties for taxpayers with a history of operating in the shadow economy who fail to notify the revenue agency that they:
    - are liable to register for and pay a particular tax;
    - intend to carry out taxable activities; or
    - that their circumstances in relation to a particular tax have changed (United Kingdom).
- Post-audit engagement:
  - Re-contact programs for previously audited taxpayers to check progress and provide assistance if needed (Australia).
- Measurement and statistical collaboration:
  - Continue work with statistical authorities to refine measurement over time.
  - Benefits: enhance government revenue forecast accuracy and ensure appropriate policy and administrative responses to shadow economy revenue risks.

*Source: TNM/10/14, Revenue Administration: Managing the Shadow Economy, Barrie Russell, Fiscal Affairs Department, International Monetary Fund, June 2010.*

### Section 1

### _tnm1014 - Section 1

### Overview
- The “shadow economy” describes businesses operating outside the tax system and registered businesses that conceal transactions to avoid paying taxes or social security charges, or to avoid the costs associated with legislation on safe working conditions or protection of consumers’ rights.
- Transactions in the shadow economy may be partially concealed (reported at lower than true values) or entirely unrecorded (often cash payments).
- The shadow economy represents a very significant component of the total tax gap (the difference between actual and potential tax revenues).
- Sweden estimates that at least half of its total tax gap is attributable to the shadow economy, with around two-thirds of the revenue loss centered in the micro business taxpayer segment.
- Current measurement methodologies (e.g., MIMIC modeling) are best viewed as indicators of the order of magnitude and are most useful for identifying trends over time rather than as absolute measures.

### Estimated size of the shadow economy (G20 countries)
- Schneider (Shadow Economies All Over the World: New Estimates for 1999-2007) estimates the size of the shadow economy as a percentage of official GDP. Country averages (as presented) are:
  - USA: 8.8
  - Japan: 11.4
  - UK: 12.9
  - China: 13.5
  - Australia: 14.6
  - France: 15.4
  - Germany: 16.0
  - Canada: 16.3
  - Saudi Arabia: 18.7
  - Indonesia: 19.9
  - India: 24.0
  - Argentina: 25.5
  - Italy: 27.2
  - Korea: 28.2
  - South Africa: 29.5
  - Mexico: 30.2
  - Turkey: 33.0
  - Brazil: 40.5
  - Russia: 48.6
- The study shows the average size of the shadow economy (as a percent of ‘official’ GDP) in developing countries and transition countries is around double that of high income OECD countries.
- There is very significant variation across G20 countries, indicating potential revenue gains if poorer performing countries could reduce the size of the shadow economy in line with top performing countries (USA, Japan and the UK).

### Business environment indicators related to shadow economy risk
- World Bank Doing Business 2010: average time required to complete key business processes (regional averages):
  - PAYING TAXES
    - Number of payments required per year:
      - East Asia & Pacific: 24.6
      - Eastern Europe & Central Asia: 46.3
      - Latin America & Caribbean: 33.2
      - Middle East & North Africa: 22.9
      - OECD: 12.8
      - South Asia: 31.3
      - Sub-Saharan Africa: 37.7
    - Time required to comply (hours per year):
      - East Asia & Pacific: 227.2
      - Eastern Europe & Central Asia: 336.3
      - Latin America & Caribbean: 385.2
      - Middle East & North Africa: 204.2
      - OECD: 194.1
      - South Asia: 284.5
      - Sub-Saharan Africa: 306.0
  - STARTING A BUSINESS
    - Number of procedures required:
      - East Asia & Pacific: 8.1
      - Eastern Europe & Central Asia: 6.3
      - Latin America & Caribbean: 9.5
      - Middle East & North Africa: 7.9
      - OECD: 5.7
      - South Asia: 7.3
      - Sub-Saharan Africa: 9.4
    - Time required to comply (days):
      - East Asia & Pacific: 41.0
      - Eastern Europe & Central Asia: 17.4
      - Latin America & Caribbean: 61.7
      - Middle East & North Africa: 20.7
      - OECD: 13.0
      - South Asia: 28.1
      - Sub-Saharan Africa: 45.6

### Drivers of the shadow economy
- Influencing factors include:
  - Overall tax and social security contribution burden.
  - Complexity of the tax system.
  - Cost of formalizing a business (time, procedures, fees).
  - Prevailing social welfare environment.
  - Effectiveness of tax administration.
  - Attitudes to government authority and government spending.
- Many developing and transition countries have overly complex tax laws and procedures; the higher costs and time burdens for business processes correlate with higher shadow economy participation.

### Tax policy responses (recommended)
- Simplify tax laws.
- Reduce taxes on micro and small businesses.
- Reduce barriers to entry into the formal economy such as costs, time, and procedures.
- Allow more flexible hiring and firing of workers (e.g., through temporary contracts).
- Improve and expand coverage of social services and health programs.

### Tax administration responses (recommended)
- Develop integrated compliance management strategies addressing underlying causes of non-compliance and balancing assistance, encouragement, and enforcement.
- Recognize the shadow economy is largely centred in micro and small business sectors; audits alone are not a feasible sole lever given participant numbers.
- Develop mitigation strategies to:
  - Reduce community tolerance for the shadow economy.
  - Provide targeted assistance to promote voluntary compliance.
  - Encourage self-regulation.
  - Demonstrate a visible and credible detection and enforcement capability.

### A. Reduce community tolerance of the shadow economy (communication strategy)
- Raise community understanding of the role played by taxes in achieving social equity objectives and providing essential public services and infrastructure; this should be a whole-of-government medium-term campaign explaining the overall program of taxes and transfers.
- Promote a voluntary compliance culture through school-based education programs that range from basic story-telling to embedding technical tax topics into secondary and tertiary curricula.
- Raise awareness of the dangers of dealing with shadow economy operators (poor workmanship, lack of warranties, health and safety risks); deliver in partnership with reputable business, trade and professional associations.
- Educate small business operators about non-tax risks of understating income (reduced insurance pay-outs, compromised ability to sell the business, compromised debt collection).
- Engage the community in identifying and rejecting shadow economy operators; encourage reporting with guarantees of confidentiality.
- Inform the community of the tax agency’s increasing capability to detect and deal with shadow economy activities; publicize anti-avoidance actions and report results (sanitized case studies where privacy laws restrict detailed publication).

### B. Provide targeted assistance (to small businesses and new businesses)
- Typical assistance activities:
  - High quality taxpayer enquiry services (telephone, email, letters, one-stop-shop service centers).
  - Free seminars in conjunction with other government agencies to explain obligations and entitlements.
  - Outbound telephone calls to offer help and advice.
  - Optional free advisory visits at taxpayer premises.
  - Targeted advisory visits (non-optional) to premises of small businesses considered high risk.
  - Simple information products explaining key obligations (especially record-keeping) and how to seek help.
  - Provision of on-line self help tools (on-line calculators, decision support systems).
  - Proactive reminders of approaching obligations (letters, emails, text messages, telephone calls).
- Manage genuine new businesses as a discrete group: early identification of first-time operators, ongoing monitoring in early stages, and timely proactive assistance.
- Pay particular attention to businesses becoming employers for the first time to embed compliance around withholding and social security payments.

### C. Encourage self-regulation
- Use incentives to recognize and reward good compliance behavior:
  - Remission guidelines for penalties and interest that recognize a good compliance record.
  - Less-onerous reporting requirements and easier access to extended filing periods and payment instalment arrangements for taxpayers with a record of good compliance.
  - On-line self-help tools to promote accurate reporting of complex obligations (e.g., employment status decision support).
  - Pre-filling of tax returns with third-party data (salaries and wages; interest; dividends; social service payments; credits for tax payments withheld; credits or offsets).
- Promote self-regulation through effective liaison with intermediaries and stakeholders:
  - Tax agents and practitioners: provide premium services (dedicated telephone teams, direct access to expert officers, tailored seminars) while monitoring compliance by tax agents.
  - Banks and financial institutions: ensure understanding and support for collection enforcement policies (garnishee notices, withholding arrangements, reporting of financial transactions).
  - Industry, business and professional associations: leverage for influencing compliance behavior.

*Source: TNM/10/14, Revenue Administration: Managing the Shadow Economy, Barrie Russell, Fiscal Affairs Department, International Monetary Fund, June 2010.*

### Section 2

### _tnm1014 - Section 2

### Cooperative partnerships with industry and business associations
- Formation of cooperative “partnership” arrangements with key industry and business associations has proven very effective in New Zealand, Australia, and many other countries as a conduit for identifying compliance problems (e.g., ambiguous or impractical law, overly complex forms and procedures, unreasonable time limits, onerous reporting requirements etc.) and for the development of workable solutions.
- Open dialogue, and co-design of approaches with broadly-based representative associations demonstrates transparency in tax administration and promotes ownership of the solutions within the user groups.
- Associations share the revenue agency’s objective of eliminating unscrupulous operators and can represent a valuable source of intelligence on what is happening on the ground within an industry, trade, or profession.

### Industry benchmarks and business-to-consumer trades
- Revenue agencies should work cooperatively with associations to develop ‘industry benchmarks’ for high risk industries in which “business-to-consumer” transactions represent a major proportion of total business income.
- Benchmarks reflect the expected relationship between inputs and outputs for a particular business activity based on industry standards; focus is on trades with a strong correlation between only a few inputs and total business income.
- Where benchmarks are developed in partnership and jointly endorsed they gain strong credibility in the marketplace and in dispute resolution processes.
- Benchmarks should be publicized (in partnership with associations) as a self-checking mechanism to:
  - enable taxpayers to compare their own business performance with industry standards;
  - assist trade participants to voluntarily comply.
- Taxpayers filing returns outside benchmark limits should be warned they will be closely examined; all returns from those industries should be automatically checked against benchmarks and outliers reported to the risk assessment area for further review.

### Leverage points: software and business service providers
- Business service providers such as manufacturers of accounting software packages and payroll service providers are important leverage points for improving compliance by small business.
- Close liaison can ensure software marketed or used accurately captures and reports all tax obligations, including new requirements introduced from time to time.

### Demonstrating visible and credible detection and enforcement capability
- Complement education, assistance and encouragement with a highly visible and credible program to detect and deal with non-compliance. This requires effective intelligence gathering, risk identification and analysis, case selection capabilities, and a skilled compliance workforce.
- The enforcement program should aim to identify people operating outside the system through:
  - conducting regular unannounced on-site visits to locations such as industrial estates, shopping districts, markets and fairs, restaurant precincts, taxi ranks, etc. to check that operators are registered in the system;
  - matching the revenue agency’s active taxpayer register against third party databases for trades and professional associations to identify unregistered operators;
  - test-checking the validity of tax invoices to ensure the supplier is registered;
  - introducing reporting arrangements for business-to-business transactions under which a business must report any purchases from a supplier who does not quote a valid tax identification number; this arrangement can be complemented by a withholding requirement.
- Note: In Australia, the purchaser must also withhold an amount equal to the highest marginal PIT rate and remit this amount to the tax office, or pay an administrative penalty equal to that amount.

### Monitor compliance by new registrations
- New registrations are a critical control point for shadow economy and fraud prevention.
- Implement a registrations risk engine capable of matching data from all new registration applications against:
  - known operators with a poor compliance record;
  - known addresses from which such people have operated;
  - known contact numbers connected to such people;
  - known high risk advisors.
- Risk engine should check for common names, addresses, and contact numbers across multiple registrations and use enhanced fuzzy search capabilities to compensate for spelling variations.
- Actions for high-risk/new registrations:
  - Physically verify the bona fides of the highest risk cases and refuse/cancel registrations where appropriate;
  - Closely monitor compliance of suspect registrations where refusal/cancellation is not possible;
  - Telephone all genuine first-time business operators to determine through interview their understanding of obligations and entitlements and advise where to get assistance from the tax agency;
  - Conduct follow-up on-site advisory visits to first-time businesses failing to demonstrate a reasonable grasp of obligations through telephone interview;
  - Contact by telephone, or make on-site visits to, selected new businesses that fail to meet filing and/or payment obligations.

### Improve record keeping practices
- Regular program of record keeping reviews: short on-site verification visits to micro and small businesses to ensure appropriate records are maintained.
- Where gaps are identified the taxpayer should be given guidance and a reasonable time to self-correct; failure to self-correct should result in an audit and/or an administrative penalty.
- Australia has introduced on-the-spot administrative penalties for failure to keep adequate records; the quantum is proportionate to the size of the business and penalties escalate for each period the taxpayer fails to self-correct. The penalty is imposed under a stand-alone provision and does not require any separate assessment of liability to tax.

### Identify businesses declaring losses or unrealistically low income
- Detect operators who understate income and contribute little or nothing in taxes; use data matching and data mining capabilities.
- In industries with performance benchmarks, taxpayers outside benchmark limits should be selected for review.
- Adopt a differentiated response depending on assessed risk to “touch” as many taxpayers in the risk pool as possible:
  - Select the high risk cases for audit verification;
  - Issue customized letters to the medium risk cases explaining how the suspected tax gap has been identified, directing review and either amended return or explanation; follow up on non-responses;
  - Issue warning letters to the low risk cases explaining contact reason and warning of possible future audit.
- It is critical that auditors are vested with authority to apply indirect audit methods for reconstructing income and are trained in these methods.

### Focused industry projects (Box 1: Sample shadow economy industry project approach)
- Engage relevant industry or business associations to explain risk and ensure accurate understanding of industry operations.
- Publicize intention to conduct a verification program and seek association support in informing members.
- Identify tax practitioners with a significant client base in the targeted industry and alert them to the verification program.
- Conduct a sample audit program to confirm serious areas of non-compliance and quantify tax at risk across the industry.
- Engage with industry association and practitioners to prepare advice to participants on areas of non-compliance identified.
- Send letters and/or communicate through associations and practitioners advising specific areas of non-compliance and request review and self-correction; highlight lenient penalties for voluntary disclosures and planned further audits.
- Offer free seminars and advisory visits, ideally jointly with the industry association.
- Ensure enquiry staff have scripted answers on how to make voluntary disclosures, attend seminars, or request advisory visits.
- Ensure collection enforcement staff apply reduced penalties and flexible payment arrangements to taxpayers who voluntarily self-correct.
- Conduct follow-up audit program targeting taxpayers who failed to self-correct and prosecute worst offenders.
- Publicize audit and prosecution results using representative case studies to show detection methods.
- Measure project effectiveness by tracking voluntary disclosures, overall change in tax paid, and surveying industry and practitioners for observed compliance behavior changes.

### Detecting benefit fraud and conspicuous consumption
- Match data on government benefit payments with third party data and tax return data to identify people who have claimed benefits to which they are not entitled; resolve by cessation of benefits and restitution letters, with prosecution considered in the most serious cases.
- Match motor vehicle, boat, aircraft, and property registers against income tax returns to identify persons whose declared income does not match assets owned; apply a risk-based differentiated verification approach.

### Recent initiatives and cash transaction considerations
- Even high income OECD countries acknowledge the shadow economy remains a major revenue threat and that the global economic crisis has almost certainly increased participation.
- Further enhancements to existing programs may have only marginal impact; agencies must develop more innovative mitigation strategies.
- Efforts might be made to reduce the incidence of cash transactions in the marketplace.
  - A recent central bank study in Australia revealed that cash still accounted for 70 percent of all payments.
  - The study also showed that these payments represented 38 percent of the total value of transactions, indicating that cash remains the primary instrument for low-value purchases.
- Revenue agencies should consider working closely with banks and other financial institutions to develop and promote alternative payment mechanisms and reduce the community’s demand for cash.

### Key points for tax administration design
- The shadow economy is an endemic tax compliance risk in all countries and requires long-term targeted compliance risk management strategies targeting underlying causes of non-compliance with an appropriate mix of education, assistance, encouragement, and enforcement activities.
- Close cooperation with other government agencies (e.g., Social Security and Immigration), and with non-government intermediaries (such as tax agents and banks) should be pursued.
- The objective cannot be to eliminate the shadow economy entirely but to limit it over time to a level tolerable to the government and community; attempting to go further is unlikely to be cost-effective and may increase unemployment, particularly in developing countries.
- The scale of response should be proportionate to the magnitude of the problem and revenue agencies should consider other issues that may represent equal or greater revenue risks.

### Box 2. Recent initiatives in the fight against the shadow economy
- Increased application of withholding/reporting arrangements in high risk industries (Canada, Sweden, United Kingdom and United States, and strongly supported by the OECD).
- Extensive use of third party data matching to detect instances of ‘conspicuous consumption’ (Australia).
- Publication of the names of serious tax evaders—“naming and shaming” (Korea, United Kingdom).
- Development of “industry benchmarks” for high risk industries which reflect the expected relationship between inputs and outputs for a particular business activity based on industry standards (Australia).
- Increased reporting requirements for identified tax evaders (United Kingdom).
- Mandatory use of certified cash registers in high risk industries with a high incidence of relatively small value cash sales (e.g., restaurants). Business operators are required to use cash registers certified by the manufacturer that they are connected to a tamper proof control unit (or ‘black box’) and it is mandatory for the business operator to provide receipts to customers for all purchases (Sweden, Canada, Greece).
- Mandatory staff registers for industries with a high incidence of informal employees (e.g., restaurants and hairdressers) — business operators are required to maintain an up to date register showing the name of the business, the employees’ names and birthdates and their working hours (Sweden).

*Source: _tnm1014 - Section 2*

### Section 3

### _tnm1014 - Section 3

### Enforcement and penalties
- New ‘failure to notify’ penalties for taxpayers who have a history of operating in the shadow economy and fail to notify the revenue agency that they:
  - are liable to register for and pay a particular tax;
  - intend to carry out taxable activities; or
  - that their circumstances in relation to a particular tax have changed (United Kingdom).

### Post-audit engagement
- Re-contact programs for previously audited taxpayers to check how things are going and to provide assistance if needed (Australia).

### Measurement and statistical collaboration
- While measurement of the shadow economy is inherently difficult, revenue agencies should continue to work with statistical authorities to refine the measures over time.
- Benefits of improved measurement:
  - enhance the ability of the government to make accurate revenue forecasts; and
  - help ensure that the most appropriate policy and administrative responses are developed to manage the revenue risks posed by the shadow economy.

### Publication and contact information
- Technical Notes and Manuals 10/14  |  2010  15
- TNM/10/14
- International Monetary Fund
- Fiscal Affairs Department
- 700 19th Street NW
- Washington, DC 20431
- USA
- Tel: 1-202-623-8554
- Fax: 1-202-623-6073
- Revenue Administration: Managing the Shadow Economy
- Barrie Russell
- Fiscal Affairs Department
- INTerNATIoNAl MoNeTAry FUND
- Technical noTes and Manuals

*TNM/10/14 International Monetary Fund Fiscal Affairs Department*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/tnm/2010/_tnm1014.pdf_