In Australia, the Australian Taxation Office (ATO) is usually auditing businesses every 3 years or how often they “feel like it”. If the tax returns contain false information or the ATO found wrong tax figures that don’t meet the GST obligations, the ATO is allowed to audit businesses as often as they like.
Presently in Australia, business tax audits are at a record high, with the Australian Tax Office (ATO) very eager to crack down on businesses not paying their fair share of tax. And as any business that’s undergone a tax audit would tell you, it is a stressful and time-consuming process that’s best avoided.
Table of Content
- What is a Tax Audit?
- Have Financial Performance that is out of Kilter with your Industry
- Don’t Pay the Right Amount of Superannuation to your Employees
- Variances Between Tax Returns and Business Activity Statements
- Get the Disclosure Items Wrong in Your Tax Return
- Show Big Fluctuations Between Years
- Have International Transactions
- Be in the Papers
- Have a Poor Record of Lodging Returns on time
- Consistently Show Operating Losses
- Own Motor Vehicles, but don’t Lodge an FBT Return
- Acquire Tax Audit Insurance
- Know How ATO Meetings Work
- Understand Industry Targets
- Implement Good Business Record Keeping
- Separate Your Finances
What is a Tax Audit?
In simple terms, a tax audit happens when the ATO chooses to review an individual’s or business’s tax affairs to ascertain all the information they provided on their tax return. This includes checking whether all income was declared, deductions were accurate, and tax-related obligations were calculated and reported correctly.
The ATO audit process commences with them first deciding that they will investigate businesses considered high risk. The Australian tax office has published over 100 industry benchmarks. These benchmarks are by industry and show what the Australian tax office expects. For instance, the ATO will expect a profit of 11% ($55,000) for a discount store with turnover (sales) of $500,000. Anything less may have the ATO knocking on doors.
Tax inspectors have also told taxation agents that they intend to focus on cash businesses. Inspectors have been known to eat at restaurants, pay in cash and then, at a later date, come back to check if that sale was recorded in the books. They will visit a retail store and buy items over a few weeks and pay at different tills and then return to check their sale has been recorded.
The Australian tax office is also concentrating more on lifestyle. If declared income is low but one has a large home, expensive cars and children in private schools, the Australian tax office may start asking how this lifestyle is being maintained. Note that part of the ATO audit procedures is that they can ask for passports so that they can check holidays and ask how those holidays were paid for.
Nonetheless, it is not all bad news. Unfortunately or fortunately, depending on which side of the fence you are on, the Australian tax office is severely underfunded. You have to be quite unlikely to get picked for an ATO audit. However, it tends to happen and you never can tell.
Common Ways Businesses Trigger an ATO Audit
What these triggers show is that tax compliance – in particular annual income tax returns – are much more than a routine compliance process. It is the main way they interact with the ATO and manage their risk of being selected for audit.
Note that those businesses, who demonstrate best practice, will have an active tax risk management process in place involving both senior management of the business and their key external advisors. You can add significant value by being proactive in looking for (and addressing) likely audit triggers. Below are few ways businesses trigger an ATO audit.
Have Financial Performance that is out of Kilter with your Industry
Have it in mind that the ATO will normally and statistically analyse tax returns. For business clients, one of the parts analysed is their performance compared to industry peers (based on the industry disclosed on the front page of the return). Note that if you’re inconsistent with the industry, this can be an indicator of tax issues such as unreported (cash) income, transfer pricing and other issues.
Whether you think they are accurate or not, statistics such as the small business benchmarks published by the ATO can provide a guide as to how (in the ATO’s eyes) your performing compared to industry peers. When preparing a small business client’s tax return, take five minutes to see whether the ATO publish a benchmark for their industry.
Don’t Pay the Right Amount of Superannuation to your Employees
If employees complain to the ATO that their employer has not paid them the right amount of superannuation, or not paid it on time, this is a well known way to get a review or audit from the ATO. Most times, these types of audits can begin as a review of superannuation guarantee obligations, but quickly escalate to include income tax, GST and fringe benefits tax audits if the process isn’t appropriately managed.
Variances Between Tax Returns and Business Activity Statements
Aligning the information reported on your business activity statements and tax returns is a major part of tax risk management. Large variances between the information reported in a tax return compared to the activity statements for the corresponding period is likely to trigger an ATO review or audit.
Get the Disclosure Items Wrong in Your Tax Return
Note that the tax return is the major way that ATO gets information on your business. Making mistakes in the disclosure items can more or less cause that client to be flagged for a review. There are internal checks in the returns (superannuation, cost of goods and withholding tax are examples) and disclosures which are easily verifiable against publicly available or other information collated by the ATO (such as the existence of international transactions). Get these disclosures wrong and the ATO is likely to call.
Show Big Fluctuations Between Years
The ATO will compare your tax returns year on year. Big fluctuations in financial position or particular line items in the tax return can trigger an inquiry from the ATO.
Have International Transactions
International transactions are a major area of focus for the ATO. Transactions with international related parties, transactions with tax havens, material funds transfers in and out of Australia are all instances of factors that can raise a red flag at the ATO. Defensive strategies, such as transfer pricing documentation, can often be the best way to manage this risk.
Have it in mind that it is not just large businesses which are the focus in this area. Small and medium sized businesses with any international transactions should seek appropriate advice given the recent legislative changes which increase the personal risk Directors bear when their company conducts international transactions.
Be in the Papers
The old adage may be that all publicity is good publicity but when it comes to tax risk, being in the papers for the wrong things can attract the ATO to your business. A major transaction or dispute that is reported in the media will indeed be seen by the ATO. Many business owners are selected for an ATO review after the sale of a high value asset (often the family home) is reported in the paper.
Have a Poor Record of Lodging Returns on time
Remember, it is not just about lodging annual income tax returns by the due date, but all compliance obligations (including activity statements, employee related reporting, fringe benefits tax, etc.) and the on-time payment of any tax liabilities. A good compliance history can be invaluable due to the way it improves the ATO’s perception of a business.
Consistently Show Operating Losses
The ATO regards three loss years out of five as indicative of problems. There may be genuine reasons, but the ATO is likely to want to investigate these.
Own Motor Vehicles, but don’t Lodge an FBT Return
The ATO receive data from the state and territory motor vehicle registries (in NSW this is the Roads and Maritime Services) regarding individuals or businesses that have purchased vehicles (generally those with a value of $10,000 or more).
For businesses, the ATO then match these acquisitions with information reported in tax returns, activity statements and fringe benefits tax returns, with an expectation that there will be at least some private use. If the company or trust fails to lodge an FBT return showing private usage or doesn’t include a ‘fringe benefit employee contribution’ in the income section of the tax return, an ATO review or audit is likely to be just around the corner.
What Should You Do If You Are Chosen For An ATO Tax Audit?
There are several things you can do to help you if you have to do an ATO tax audit.
Acquire Tax Audit Insurance
It is advisable you get a Tax Agent to do the work and communicate with the Australian tax office. It will be expensive but they are experts and should know what to do. Also, it is usually a good idea to take out tax audit insurance so that your Agent’s fees are covered. Seek professional advice from your Tax Agent who should be able to help you.
Know How ATO Meetings Work
The ATO can request for a meeting. Try and avoid this if possible (although you may not have an option). The Australian tax office may ask for this meeting to be at your home. But make sure this never happens as they want to see what is in your home.
Consider arranging a meeting at your Tax Agent’s office as a meeting at an ATO office is likely to intimidate you and you may say things you would not normally. During the meeting, if you feel uncomfortable at any stage, end the meeting.
Also strive to ensure the meeting does not go beyond forty-five minutes to an hour and a quarter because after this time limit you are likely to let your guard down. The Australian tax office will send you notes or minutes of meetings asking it be signed and returned. You are not legally required to sign and our policy is to never sign them.
- Avoid Vague Answers
Finally, do not forget that an ATO audit is not the end of the world. Keep in mind that they have a lot more information about you than you think. We live in a digital age of Google Maps and data matching. The Australian tax office can see what a taxpayer’s home looks like by pressing a few buttons on a computer at their desk. Try to avoid giving vague answers. Tell the truth, stick to the point and only answer the questions asked and nothing more.
How Do You Avoid an ATO Audit?
Howbeit, you should be considering ways to avoid triggering an ATO audit. Here are few options to try:
Understand Industry Targets
Have it in mind that every year the Australian tax office targets a different range of industries to focus their attention on. It has been announced that the ATO audit targets for 2014 are small tradesmen (electricians, builders, carpenters, etc) and multinational corporations who attempt to move company profits to offshore tax haven countries.
Right before making decisions check to see if your industry is one of the benchmarks published by the Australian tax office, ensure you are within the ranges expected by the ATO. If you are outside the ranges you may need to come up with a good reason why.
Implement Good Business Record Keeping
They are good business record keeping tips and strategies you can try out. They include;
- Ensure you have maintained your books and records properly. The Australian tax office has really emphasised this.
- Make sure your records are up to date and that you have all till receipts (not just ‘Z’ readings), sales invoices, supplier invoices and how and when payments and receipts occurred.
- Third, make sure you file and pay all your Tax returns (BAS, FBT etc) on time. If you are late or cannot make payment, get in touch with the Australian tax office and explain what is happening. They will be more responsive and less likely to investigate.
Separate Your Finances
Also remember to keep your private financial affairs separate from your business affairs. Only use a business bank account and business credit cards for business expenses. If you do use a personal credit card, use it solely for business purposes and not personal.
This is because you do not want to give any indication to the Australian tax office what kind of lifestyle you have. There is also less chance of personal items accidentally being claimed as business expenses especially if you have a bookkeeper or Tax Agent preparing your books. Remember a small mistake found by a tax inspector can lead to more questions.
Nobody wants to be audited by the ATO. The Australian Taxation Office (ATO) and the ATO audit are usually two of the most dreaded phrases for Australian SMEs. However, these are a few tips and tricks and some insightful, accurate and consistent advice we want to share with you to make any interaction with the ATO less stressful for you.