Circles of Trust

Suspicion and Secrecy Among Tax Authorities

Tax authorities are inherently suspicious. They do not understand the idea of a bona fide taxpayer and consider everyone a potential violator. Auditors scrutinize everything and do not trust provided documents. This mistrust is reinforced by a belief widely held among tax officials: “Why pay taxes if you can avoid it?”.

However, tax administrations cannot audit everyone. They do not have enough time and resources for this. That is why the tax risk departments model taxpayer behavior to focus audits on the segments with the highest risk. Tax authorities keep these models under wraps, thinking that taxpayers will adapt to them and escape audits. Contrastingly, conscientious taxpayers want to know and comprehend compliance requirements to avoid breaking them. This paradox creates the preconditions necessary for reducing risks in the tax environment.

A Circle of Trusted Taxpayers as the Method of Reducing Tax Risks

What happens if tax authorities reveal the criteria they used to identify bona fide taxpayers? Respectable taxpayers will strive to comply with them. None of them wants to waste time and resources being involved in a painful audit.

Tax authorities can also provide incentives to work with conscientious suppliers. Since the buyer chooses the supplier, the supplier must comply with these criteria. As a result, conscientious buyers bring conscientious suppliers into their “circle of trust”. When tax authorities provide enough motivation, these circles will grow by themselves. The tax environment becomes cleaner through a natural process, and the number of conscientious taxpayers rises.

Tax authorities rarely use this approach. Creating a “circle of trust” requires them to establish and then disclose a model of a conscientious taxpayer. It also requires taxpayers to perform due diligence and disclose tax data.

Tax authorities should explain to taxpayers how the “circle of trust” will let them reduce the likelihood and consequences of violations. The result will be greater taxpayer compliance as well as increased tax revenues.