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1989 Report of the Auditor General of Canada

Main Points

19.1 Millions of dollars in additional revenues could be collected if National Revenue - Taxation were to expand its payroll and non-resident audit coverage further. This is demonstrated by the fact that increases in audit coverage since 1984-85 have resulted in substantial increases in source deductions assessed and in the amount of unreported income discovered (paragraphs 19.37 to 19.44).

19.2 Delays in the receipt and deposit of revenues due to National Revenue - Taxation's processing procedures have been reduced following interim changes made by the Department in 1988. These delays were highlighted in a 1986 study commissioned by the Office of the Comptroller General and were estimated by us to cost roughly $24 million annually. Final measures instituted in early 1989 to speed the deposit of cash received through district offices should further reduce or eliminate this cost (19.20 to 19.22).

19.3 Productivity levels differ in taxation centres for similar activities. The differences result from a variety of factors, many of which can be influenced by departmental management alone or in concert with the central agencies. Analysis of these activities would likely reveal opportunities for efficiency enhancement (19.71 to 19.78).

19.4 In the event of a disaster, National Revenue - Taxation does not have an adequate plan for continuing operations on an interim basis while the computer system is being restored (19.32 to 19.34).

19.5 Problems that we have reported on two previous occasions (1985 and 1987) concerning the growth of the Canada Pension Plan unidentified earnings file have not yet been resolved. The value of items in the file has now reached $108 million. If contributors do not receive credit for these contributions, their pensions will be lower than they should be (19.60 to 19.63).

Introduction

19.6 The Department of National Revenue - Taxation collects four main categories of revenues: federal income taxes, provincial and territorial income taxes where determined by agreement, employer and employee contributions to the Canada Pension Plan, and employer and employee Unemployment Insurance premiums. The following table shows the amounts collected in the 1987-88 fiscal year.

19.7 Source deductions. When Canadians file their income tax returns each spring, they have often paid all or part of their taxes, Canada Pension Plan contributions, and Unemployment Insurance premiums through deductions made by their employers from their incomes. Employers remit these funds to the Department of National Revenue - Taxation at least once a month. All such remittances are recorded on computer files. Later they are allocated to the appropriate individual taxpayers' records, which are also maintained on computer files.

19.9 Most individuals are required to make quarterly instalment payments of income tax unless tax is deducted at source from at least three-quarters of their net income, or their net federal tax payable for the current or preceding year does not exceed $1,000. Farmers and fishermen whose tax for each of the current and preceding years is more than $1,000 pay instalments on a different schedule than other individuals.

19.10 Corporations remit income tax in monthly instalments.

19.11 Payments on filing. When individual taxpayers file their income tax returns, many will have a balance owing. They are required to remit the balance by 30 April. Corporate taxpayers are required to remit balances owing two or three months after their fiscal year end, depending on the type of corporation.

19.12 Non-residents. Individuals who are not resident in Canada must pay non-resident tax on certain income from Canadian sources. This tax is required to be withheld at source.

Source Deductions and Revenue Programs Activities

19.14 Inquiries and correspondence. District office staff provide information and answer general questions pertaining to source deductions. Taxation centres are responsible for answering correspondence concerning employers' and taxpayers' accounts.

19.15 Audit and enforcement. The Department monitors amounts received from employers, to identify those who have not deducted or remitted as required. It contacts delinquent employers to request payment and, if necessary, audits their records and issues assessments for the amounts due. It may also audit employers to uncover unreported employment income and taxable benefits given to employees, or to verify deductions of Canada Pension Plan contributions and Unemployment Insurance premiums from pensionable and insurable earnings. The source deductions program also conducts audits of payments made to non-residents to uncover those that are subject to non-resident tax.

19.16 Canada Pension Plan and Unemployment Insurance. The Minister of National Revenue - Taxation is responsible for administering certain aspects of both the Canada Pension Plan (CPP) and the Unemployment Insurance Program (UI). The Department of National Revenue - Taxation collects contributions, premiums and benefit repayments, gathers certain information, and issues rulings on the application of certain provisions of the relevant legislation. Amounts collected and information gathered are transferred to the departments with primary responsibility for CPP and UI administration.

Audit Scope

19.18 Source Deductions and Revenue Programs are supported by certain computer applications operated by the Head Office Information Systems Directorate. We examined these applications.

19.19 Some of the activities included in our scope had been examined by the Department's internal auditors within the last three years. We reviewed the internal audit reports and followed up some of the findings in the course of our audit.

Revenue Programs

Cash Management

The processing of remittances made to district offices is more efficient

19.22 A study dated October 1986 commissioned by the Office of the Comptroller General highlighted this delay. As an interim measure, district offices began in June 1988 to deposit cheques having a large value, thus reducing the financing cost by half. The study also became the impetus for National Revenue - Taxation's "District Office Cash Project". Under procedures implemented in early 1989, district offices themselves make deposits of all amounts they receive. This should greatly reduce or eliminate the former delay.

Processing of payments included with tax returns has improved substantially in 1989

(Photos not available)

19.24 In 1988, it took until 27 May for the Department to deposit all these payments. It estimated the financing cost of the delay in depositing to be about $3.4 million.

19.25 In October 1988, the Department set out to develop strategies that would enable it to clear the backlog of payments on filing more quickly. The target for 1989 was to clear the backlog by 19 May at the latest. This was expected to reduce the financing cost to $2.3 million, an improvement of $1.1 million. All taxation centres met the target, and one taxation centre was able to clear the backlog by 9 May 1989. The Department plans to review and evaluate the methods used to achieve this performance.

Delays in depositing certain receipts result in failure to comply with legislative requirements

The Department does not have the information necessary to determine whether the processing of remittances through "indirect clearers" is cost-effective

19.28 Indirect clearers typically use the mail to transfer to National Revenue - Taxation the amounts they have collected. Statistics developed by National Revenue - Taxation for the period from September 1988 to March 1989 show that the average difference between the date remittances were received by a financial institution and the date they were received by the Department varied from 7.59 to 8.98 days. The overall average was 8.16.

19.29 The average daily amount of remittances transferred by indirect clearers through the mail during this period was approximately $1.3 million. The annual financing cost of carrying a float equal to eight days' remittances is $1.0 million at an assumed interest rate of 10 percent. The Department does not know the value of service charges that would be required to pay indirect clearers on the same basis as direct clearers. Consequently it is unable to assess the cost-effectiveness of processing through indirect clearers. Late in 1988 information to perform the analysis started to become available and when sufficient data are available the Department of Supply and Services will proceed with a cost-benefit analysis.

Cash Receipts and Accounting Systems

19.31 In view of the amounts of revenue that the Department handles, it is essential that there be a sound system of internal controls over cash receipts to protect against loss through fraud or error. We reviewed documentation and made inquiries concerning certain key internal controls and found no evidence of significant deficiencies. However, we did not test the controls to determine whether they were functioning as intended. The Department's internal auditors periodically test the procedures performed at each taxation centre.

The Department has not made adequate arrangements for recovery of its cash receipts accounting systems in the event of a disaster

19.33 The disaster recovery plan assumes that the data available in off-site storage will be adequate as a basis for recovery. At the time of our audit, we found that there were not adequate data available off-site. However, the Department has informed us that it has now corrected the situation. We also noted that, except for procedures for manual preparation of deposits, the Department has no plan for operating during the period that it would take to get the back-up site operating.

19.34 The Department should include in its disaster recovery plan a strategy for operating from the time a disaster occurs until the back-up computer site is ready for use. It should also periodically conduct tests to ensure that data maintained in off-site storage are adequate to effect a recovery.

Department's response: We agree and our EDP Systems and Technology Branch will be convening a Disaster Recovery Steering Committee and a Disaster Recovery Working Committee to address elements of the Disaster Recovery Plan such as the capability to operate following a major shutdown of the main system.

The Department's systems for performing interest calculations need revision

19.36 Calculation of interest can be very complex. For individual taxpayers, calculations are performed chiefly through the computer software system that maintains individual taxpayer accounts. This system, known as CINDAC, was developed about 25 years ago and has since undergone continuous amendment. As a result, it has become increasingly inefficient and expensive to maintain and modify. The difficulty with interest calculations is simply one consequence of using the software system in its present form. The Department has begun a process of completely rewriting the CINDAC system software over a period of five years with a view to improving its efficiency and capabilities. It plans to complete the segments of the system for performing interest calculations by 1991.

Source Deductions

Audit

19.38 One of the payroll audits is known as an enforcement audit. It is initiated, for example, when National Revenue -Taxation's computer system identifies a potential problem with an employer such as an overdue payment. A second type, known as a service audit, is done after a receivership or bankruptcy where a proof of claim must be filed. The third type of payroll audit deals with unreported employment income or taxable benefits. This is known as a benefit and employment income audit (BEIA). In the fourth category, the non-resident audit, auditors look for taxable payments to non-residents.

The performance of the Source Deductions audit function has improved over the last five years

19.40 This expanded audit coverage has translated into an increase in the additional source deductions assessed of from about $145 million in 1984-85 to $319 million in 1988-89, and in the amount of unreported income discovered of from $35 million in 1984-85 to $82 million in 1988-89. Auditors are also managing to collect a higher proportion of the assessments at the time of their field visits.

19.41 Despite this generally improved performance, the Department has not met its own targets for "percentage coverage" of employer accounts (the proportion audited as a percentage of all accounts) or average age of audit inventory (accounts selected for audit but which have not yet been done). The BEIA and non-resident audits, while increasing in number, have still fallen short of the planned number of audits.

Mandatory workloads divert resources away from audit activities that could produce high returns

19.43 We noted a few recent instances where resources were temporarily withdrawn from the audit activity and moved elsewhere. Without suggesting that such cases are widespread, we raise the concern that this kind of choice could involve foregoing revenues, particularly where government-wide constraints on person-year resources combine with the Department's current priority of providing service to its clients.

19.44 Statistics show that an additional dollar spent on audit can provide a return of many times that amount. During 1988-89, enforcement and service audits generated revenue in the order of $765,000 and $395,000 per auditor respectively. A typical payroll auditor earned approximately $35,000 annually. It follows, therefore, that millions of dollars in additional revenue could be collected if the Department were to expand its payroll audit and non-resident audit coverage beyond the current level.

19.45 The Department indicated to us that it has recently set up a committee to consider the competing objectives of compliance and service to the public, both of which play a part in its designation of activities as mandatory or non-mandatory.

Enforcement

(Exhibit 19.1 not available)

The decision to change a tolerance level was made without the aid of a formal cost-benefit analysis

19.48 The Department recently raised one of its tolerance levels to decrease the workload by 20 percent in that activity; labour hours are also expected to decline. This affects the same activity from which most of the staff resources were taken to handle the rapidly expanding public inquiries function. This is another example of resources being moved from a non-mandatory activity to a mandatory activity.

19.49 In deciding to raise the tolerance level, the Department estimated the amount of resources that would be freed, and reasoned that no significant monetary loss would occur. No formal cost-benefit analysis was done to support the decision. While we do not question the Department's decision, we believe it would be preferable to support such changes with a formal cost-benefit analysis.

The Department's desired levels of voluntary compliance have not been achieved

Inquiries

The Department did not accurately estimate the resources required to implement its decision to relocate the Source Deductions inquiries function

19.53 The Department believes that the quality of responses to inquiries concerning source deductions has improved. However, this cannot be verified because it did not collect the data before and after the transfer which would be necessary to measure improvement. It samples the types of inquiries being handled and plans to do a comprehensive survey of responses to monitor their quality.

The Department cannot in all locations monitor achievement of its level of service targets for Source Deductions inquiries

19.55 The Department should ensure that district offices have adequate data sources available to permit monitoring of performance standards for the Source Deductions inquiries function.

Department's response: We agree and have taken steps to acquire the necessary equipment beginning in this fiscal year.

Accelerated Remittances

The Department has successfully implemented the government policy decision to accelerate source deduction remittances

19.57 Cut-off points at which employers would be subject to the new requirement were chosen to minimize the compliance burden on small employers and the administrative burden on National Revenue - Taxation.

19.58 The impetus for the change came from the Department of Finance; National Revenue - Taxation's role was one of implementation. The Department set up a task force to plan and manage the implementation of the change, including a communication program, design of forms, changes to internal systems, and training. It also prepared a contingency plan to cover possible problems or delays.

19.59 Information about the change was sent to all employers in June 1987, more than six months before it was to go into effect. In August 1987 the Source Deductions function sent out a questionnaire to identify the pay period frequency of large employers to enable the Department to adjust its own records to prepare for the more frequent payments. The communication program was generally effective, and minor problems that did occur were promptly recognized and corrected.

Canada Pension Plan

The Department has not worked out an adequate memorandum of understanding with the Department of National Health and Welfare covering its role in administering the Canada Pension Plan

19.61 The Department of National Revenue - Taxation should enter into a memorandum of understanding with the Department of National Health and Welfare that outlines their respective roles in the administration of the Canada Pension Plan.

Department's response: A Memorandum of Agreement was prepared by Health and Welfare and subsequently reviewed by officials of Revenue Canada - Taxation. A meeting was held on 2 and 3 August, 1989 to clarify and revise the proposed agreement to the satisfaction of both Departments. Most of the issues have now been resolved and the final Agreement will be ready in the very near future.

The CPP unidentified earnings file continues to grow

19.63 A study conducted by the Department in 1987 and a report by the CPP Advisory Board in 1988 have recommended various measures to limit the future growth of suspense accounts. Nevertheless, to date there has been no evident success in checking the steady growth of the file. The Department has told us that it is currently devising a plan of action, developing and devising projects, and preparing, for September 1989, a report to senior management of both departments.

(Exhibit 19.2 not available)

The Department has not amended its formula for recovery of costs in respect of CPP in accordance with the Treasury Board's instructions

19.65 These are recovered on the basis of a formula approved by the Treasury Board in 1974. Less than two years after the formula was established it became the subject of criticism in an internal audit of CPP operations by National Health and Welfare. The formula, which called for National Revenue - Taxation to allocate costs in proportion to the categories of revenue that it collected, was said to overcharge the CPP. A study by an independent consulting firm was commissioned in 1985; in its 1987 report, it recommended an alternative basis for recovery and showed that, had this method been used, the amount recovered from the CPP for 1984-85 (the base year for the study) would have been roughly $10 million lower than the $45 million actually charged.

19.66 In January 1988 the Treasury Board instructed National Health and Welfare and other participating departments to enter into memoranda of understanding for the 1988-89 fiscal year. These were to ensure that costing criteria and principles for recovering costs were applied as recommended by the consultants. At the time of our audit, the memorandum of understanding between the Departments of National Health and Welfare and National Revenue - Taxation had not been finalized.

19.67 The Department of National Revenue - Taxation should come to an agreement with National Health and Welfare on the appropriate basis for calculating amounts to be recovered by National Revenue - Taxation from the Canada Pension Plan Account.

Department's response: As a result of a joint submission to Treasury Board, approved on 21 January 1988, Revenue Canada, Taxation and National Health and Welfare agreed to implement a revised methodology for charging C.P.P. administration costs for 1988-89. Indications are that the revised methodology would result in a lower charge of approximately $10 million mainly because the majority of costs of Quebec operations were excluded from the base in the new method.

Management Systems and Practices

Local Management Information Systems

Efficiency gains may be possible through the standardization of aspects of local management information systems

19.69 Local systems also provide data for the Head Office functional group to incorporate into its quarterly or semi-annual "report cards". Because the local systems are not standardized, this must be manually entered into the Head Office system. There is an opportunity for efficiency gains by standardizing local systems reports so that entry can be done automatically.

19.70 The Department should review local management information requirements and systems so that it can determine which local systems can be standardized for all district offices or taxation centres.

Department's response: This is an ongoing process and we agree to continue this effort.

Resource Allocation and Operational Planning

19.72 Standards for the next year are derived from past results recorded in the Department's Time Production System (TPS). As a starting point, each location, for a given activity, is asked to at least keep pace with the better of its prior year or current year-to- date results. Those whose results were poorer than the national average will be asked to achieve the national average in the next year. This requirement can be modified in the negotiations to give recognition to a variety of factors that combine to create differences in levels of results. In a taxation centre, for example, these are: the nature, complexity and mix of the workload; the type of workforce; and facilities and equipment. The agreed-upon per-unit standard is applied to the estimated total volume of work for the next year to allocate resources.

19.73 We used 1988-89 TPS data to compare results between taxation centres for an extensive sample of activities, which covered about 1,400 person-years worth of work. We looked at the spread between the results of each taxation centre and the most productive taxation centre for each activity. Adding all activities in the sample, the spread was equal to a usage of 439 person-years. Exhibit 19.3 breaks down the total by taxation centre. However, this figure does not entirely represent potential productivity gains.

(Exhibit 19.3 not available)

19.74 In reviewing our results with the Department, we were told that in some cases the taxation centres were not comparable because units of production, although similar in nature, differed in mix and complexity across taxation centres. Although the Department can't readily quantify the amount, it told us that these reasons explain many of the differences.

19.75 The Department, where it believes it is appropriate, redefines time production codes and prescribes uniform accounting procedures to give more accurate and comparable data.

Rigorous analysis of operations may identify opportunities for productivity gains

19.77 Except perhaps for the nature, mix and complexity of the workload, all the factors that cause variations in productivity are controllable over time by departmental management alone or in concert with the central agencies. We are not suggesting that person-year savings from improved efficiency could be achieved overnight, nor do we know what the actual savings would be. But we believe the approach outlined above would be a valuable complement to existing mechanisms that promote greater efficiency.

19.78 The Department should, on an ongoing basis, analyze its operations to identify the reasons for variations in productivity, and make changes that will remove revealed inefficiencies.

Department's response: We spend significant resources on an ongoing basis and will continue to do so reviewing our activities in search of opportunities for improved efficiency. For instance, there are regular departmental meetings, such as the Regional Operations Committees, as well as ad hoc exchanges of information among the various taxation centres, one purpose of which is to foster improved productivity. As well, significant effort is expended in monitoring functional activities at the taxation centres, which can involve reviews by teams of experts (comprised of Head Office and experienced field personnel) looking into opportunities for enhanced efficiency. These processes are complemented by annual report cards prepared by Head Office, which analyze results in the taxation centres, and the more independent internal audits which are conducted by the Department; this information, and any resultant recommendations for changes, are reviewed by the Deputy Minister and the Committee of Revenue Executives (CORE).

We do not share your view that your study indicates a vast potential for productivity gains since, as was indicated on several occasions, the methodology does not take account of many significant differences in the tax centres themselves and in the specific activities looked at. Nevertheless, the Department agrees with the idea that comparisons should be made amongst the various tax centres, and will continue to review all possible means of making valid comparisons in order to identify potential for productivity improvement.