Digital Desk Audit

Objectives and Methods of the Desk Audit Process

In some countries, a separate desk audit (also known as “cameral control”), follows a collection of tax returns. The tax administration checks the filed tax return, and either informs the taxpayer that there are no questions about it or, during the audit, asks taxpayer questions and receives explanations or clarifications regarding the tax return. Desk audit can be total, covering all tax returns for all tax regimes.

Or it can be selective, e.g., only for tax returns that require payments to the taxpayer from the state budget. The tax code describes the desk and field audit processes, including the rights and obligations of tax authorities and taxpayers, the timing of the audit, and the rules for requesting additional information from taxpayers. In this article, we will discuss methods for organizing and optimizing desk audits with the help of digital tax administration solutions.

The tax authority checks whether the filing of tax return is correct and fully reflects the taxpayer’s tax base and obligations. This process is critical for tax authorities. Detection of unreported liabilities motivates taxpayers to correct inaccuracies (or an intentionally understated tax base), increases tax collections, and reduces the tax gap.

Format and logic control verifies the correctness of the submitted tax returns:

• Does it comply with the tax return format? Are mandatory fields filled in as required, for example, with numbers, letters, dates, phone numbers, the required number of characters?
• Does it comply with logical rules, such as calculation rules, formulas, time periods, and others?

It eliminates errors in returns and provides accurate initial data to ensure full reporting of tax obligations.

If errors still exist, tax authorities need to ask to correct mistakes or get the proof that a taxpayer has deliberately understated tax liabilities. Tax administrations generate claims to correct violations based on identified errors, discrepancies, and understated tax obligations. Without accurate information, tax administrations will struggle to draw meaningful conclusions from the results of the audit.

They can use the following methods for analysis and reconciliation:

• Comparison of the tax return data with the taxpayer’s other tax returns.
• Comparison of the taxpayer’s tax return data to counterparties’ tax returns and information on purchases/sales involving customers and suppliers.
• Comparison of tax return data with other data submitted by the taxpayer to tax authorities, such as data on tax invoices or receipts, as well as data from other government agencies, such as the customs office.
• Reconciliation of tax return data with bank account transactions.
• Comparison of tax return data with information about the taxpayer’s economic activities: utility bills, transportation, advertising activities, customer acquisition activities, licensing, getting permits.

Even though taxpayers and the banking industry may oppose, it is crucial to gather this data. Otherwise, it will not be possible to calculate full taxpayers’ obligations. Even in the United States, the country where they convicted Al Capone only for tax evasion, the tax gap due to understated tax obligations may be as high as $1 trillion per year_[1].

Prerequisites for the Transition to the Digital Desk Audits

Growing number of tax returns affects the tax audit process. The more taxpayers and the shorter the tax period, the more entities that require audits and control decisions. There are hundreds of thousands of them, and sometimes millions of audits yearly. Yet, tax authorities have a limited number of employees available for audits.

As a result, tax authorities must automate analysis and reconciliation of tax returns, and—most importantly—notifying taxpayers of discovered inconsistencies and getting responses that fix noncompliance and disparities.

Decisions that result in payments from the state budget to the taxpayers should be the subject of independent examination since they involve risks of corruption. Taxpayers may attempt to bargain with the tax officers to secure a favorable judgment and receive money from the state budget.

Therefore, it is essential to centralize and automate audit processes, and to distance individual tax agency employees from influencing the outcome of the desk tax audit. We can automate the subsequent procedure without involving tax officials in examinations or judgments.

Time after time legislation requires a tax administration employee to decide based on the results of the audit. Thus, a randomly selected decision-maker from another territory should make an independent decision to mitigate corruption risks.

Tax administrations should change their analysis and reconciliation methods and algorithms frequently. Taxpayers eventually understand how the tax authorities’ “death star” works and adjust. As an amusing example, one country limited the number of corrections for a VAT return to 999. But nobody required taxpayers to use consecutive numbers. For example, they could enter a number much larger than the previous one. When the amendment reached number 999, the system automatically closed the desk audit without sending corrective claims. Taxpayers quickly learned about this feature and exploited it until authorities eliminated the loophole.

Typical Mistakes in Digitalization of Desk Audits

Implementations of automated desk audits sometimes repeat the following standard mistakes:

• Desk audits only apply to taxpayers who filed tax returns. As they say, “if there is no body, there is no case”. They are usually subject to enforcement measures in the form of fines or frozen bank accounts. Many taxpayers do not file tax returns. These taxpayers do not face audits, even though they contribute to a significant part of the tax gap.
• Desk audits should not only cover tax returns or payments, such as insurance premiums but also other data that taxpayers send to tax authorities, such as tax invoices or fiscal receipts.
• Although authorities must close a desk audit after a predefined period, they must reopen it for a taxpayer if a counterparty submits amended tax returns that create discrepancies so they must correct them again.

Automation and digitization of desk audits are critically important for tax administrations as it helps to reduce the tax gap and successfully combat tax optimization, which is a vast business. Criminals have the opportunity and the means to automate interactions with tax authorities’ information systems, including digital desk audits.

Besides attempts to disable the tax system, they automatically create tax returns with tax invoices that resolve discrepancies or transfer them to terminal companies. Therefore, automated desk audits require a constant analysis of the environment and taxpayer behavior to change audit procedures and combat such countermeasures.

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[1] Tax cheats cost the U.S. $1 trillion per year, I.R.S. chief says. Alan Rappeport. Published April 13, 2021. Updated October 13, 2021. URL: https://www.nytimes.com/2021/04/13/business/irs-tax-gap.html