Managing your audit risk – a practical guide for Cairns small business

Tax audits come in a variety of shapes and sizes. They can range from a simple enquiry such as a request for additional information to an in-depth analysis of a complex transaction or arrangement. If you’ve been in business for any period of time then you may have already experienced them in some form or manner.

The Australian Taxation Office (ATO) are quite transparent about who they target and how they target their audit activity. There is extensive information on their website about how they conduct their audit activities and they provide regular updates on new approaches and initiatives through media releases and announcements.

The ATO publish their corporate plan each year which clearly discloses their goals and objectives. Current strategy is centered around the use of data and analytics, creating a better client experience and building trust and confidence.

The ATO refers to taxpayers as clients which provides some insight into their current strategy and mindset. There seems to be a clear focus on providing an improved experience for the taxpayer or ‘client’ aimed at building community confidence and engagement.

However, finding new ways of identifying non-compliance and closing the tax gap is also one of the ATO’s current objectives and for that reason audits will continue to be a key strategy for the ATO. Audit activity generates substantial revenue for the ATO, for the 2020 financial year the ATO raised $13.7 billion from audit and other enforcement activities.

Small businesses will continue to be targeted by the ATO and should not expect any concessional treatment. According to the ATO they audit around 120,000 small business taxpayers each year across all tax types with small business contributing 15% of all income tax and 23% of total GST collections.

Additionally, according to statistics published by the Australian Small Business and Family Enterprise Ombudsman (Small Business Counts, December 2020) small businesses employ over 41% of Australia’s workforce. Together this makes them the largest withholder of income tax from wages paid to employees in Australia.

Given small businesses in Cairns, in fact across Australia are such a significant source of revenue for the ATO, it’s hardly surprising then that they receive their fair share of scrutiny from the ATO. For any type of audit there can be a cost involved due to the disruption to your business, time lost in preparing and retrieving documents, costs paid to professional advisors, penalties and interest in the event there is a shortfall of tax and don’t forget the unwanted stress an audit can impose. Small businesses need to be aware that the risk of an audit is ever present and they can be selected for an audit for any number of reasons.

ATO audit risk management should be part of risk management practices for every Cairns small business. The objective being both to reduce the risk of being selected for an audit and to manage the impact on the business in the event of an audit. So, what can a small business do? Let’s take a closer look.

How’s your record keeping?

For obvious reasons it would be a good idea to have sound procedures in place to manage all aspects of your record keeping and document retention requirements. Information and records that need to be maintained include:

• Sales and purchase invoices
• Records that clearly demonstrate how net income or loss has been determined
• Tax invoices and all other documents relating to GST
• Salary and wage records, including super guarantee
• Records evidencing asset purchases such as land and buildings, plant and equipment
• Records relating to tax returns, activity statements and fringe benefits tax returns

The ATO does allow records to be kept electronically with no need to also keep a paper copy unless a particular law or regulation requires a paper copy. Most accounting software platforms now provide electronic storage options for documents within the accounting software and attach them to the relevant transaction for easy access.

Further, mobile friendly apps that integrate with the accounting software will allow for easy capture and recording of transactions on the go. The technology to assist small businesses with their record keeping is well advanced and readily available and competitively priced to boot.

Don’t forget there are further benefits that come from good record management practices such as being better placed to manage your finances and cash flow leading to more effective decision making.

More information regarding your record keeping requirements can be found at: https://www.ato.gov.au/Business/Record-keeping-for-business/

Use a Trusted Advisor

An essential part in managing audit risk is to seek support from a trusted advisor who has the knowledge and experience to provide the right guidance and support to you and your business regarding your tax compliance obligations.

Bookkeepers play a very important role in managing your record keeping requirements. For this reason, it is imperative your bookkeeper is experienced and has a good understanding of record keeping requirements that relate to income and expenses, payroll including superannuation and single touch payroll reporting requirements and GST reporting.

Your Cairns tax agent should also have a thorough knowledge of record keeping requirements and should be well placed to provide relevant feedback on your record keeping and even your bookkeeper’s abilities.

Any good accountant in Cairns should also be savvy in completing your income tax return taking care to answer questions carefully, without mistakes and with a good understanding of what circumstances would trigger an ATO audit or enquiry.

They should also be able to highlight areas of risk and provide suitable recommendations to manage and eliminate that risk going forward.

Know your industry benchmarks

The ATO through their benchmarking program maintains a record of key data reported by small businesses in their income tax returns. Such information as cost of sales, gross profit percentage, net profit percentage and total expenses are collected from income tax returns for varying turnover ranges and across all industry types.

This information is highly valued by the ATO as it used to identify non-compliance where information is reported on tax returns that fall outside these benchmarks. There are often genuine reasons for the difference but any variance could result in an enquiry and further investigation from the ATO.

The ATO regularly publish the latest benchmark data and it would be a good risk management practice to know and understand the benchmark data that is relevant for your local business. Your Cairns tax accountant can provide you with this information that is relevant for your business or you can find the benchmarking data on the ATO website at https://www.ato.gov.au/business/small-business-benchmarks/ .

The ATO benchmarking data can also be a key source of information from a business management perspective as it will enable you to compare your business results to other businesses of similar size in the same industry. This sort of information about your competitors and potential competitors is highly valuable and sort after by all astute business owners.

Know what they know

The ATO carry out extensive data collection and matching programs and are becoming very sophisticated in how they use the data and analytics that these programs generate. They state that “together with the insights they provide it underpins their culture of service, early intervention activities and their goal of prevention rather than correction”.

The ATO through legislation or through other powers collect data from a wide range of sources. Examples include banks and financial institutions, employers through single touch payroll (STP) and SuperStream reporting, other government agencies, stock exchanges and share registries, health insurers and on-line selling platforms. The data is then validated before forming part of their data matching programs.

The ATO are also becoming increasingly innovative in how they use the data they collect. One of their strategic initiatives is to unlock their data potential (ATO Corporate Plan 2021-22), again as a means to building greater community confidence.

To illustrate, data collected from motor vehicle registries is used to assess compliance in reporting luxury car tax, fringe benefits and fuel schemes. From the data collected, private companies that are registered owners of non-commercial vehicles can easily be identified and targeted to check compliance with fringe benefits tax provisions. This is just one example of many in how the data collected can be used.

The ATO also continue to broaden their reach in sourcing new data that can be used to enforce compliance. New initiatives are continually being developed. One such recent initiative will allow the ATO to verify the identity and tax residency status of individuals.

Announced in April this year the Department of Home Affairs will now provide passenger movement records for the 2016-17 to 2022-23 financial years. The data, comprising such things as names, date of births, arrival and departure dates, passport information and visa status types will allow the ATO to verify and identify residency status for Australian tax and superannuation purposes.

In managing your risk be aware of the powers of the ATO and keep abreast of the sources of data collected by them. Take care in ensuring the data and information you report to the ATO corelates with the data and information provided to these third-party sources.

A sound risk management plan would include a good document retention system to ensure information provided to the ATO is correct and easily substantiated. The ATO also share some of the information they collect.

For example, what are known as pre-filled reports are available for individual taxpayers each financial year and will include all tax related data they have collected for that particular individual. Part of their strategic initiatives is to improve the way they share data so expect your Cairns tax agent to be across these developments as they become available.

Are you in the firing line?

The ATO will regularly develop new strategies to target what they believe are high risk areas of non-compliance. They can be targeted at specific industries that have a track record of non-compliance, tax agents that have a poor record and particular transactions and types of deductions claimed.

Each year the ATO will make it clear what areas will be targeted. They provide every opportunity for taxpayers to manage their tax affairs accordingly, part of their strategy of prevention rather than correction. For 2021 the ATO have revealed amongst others the following areas will be targeted:

• Cryptocurrency, due to its growing popularity and use and the lack of understanding around reporting gains and losses, will be targeted through education programs and sophisticated data matching programs
• Investment properties are in the spotlight again due to the disruptions to rentals received as a result of Covid-19 and new rental restrictions put in place
• Home office deductions due to the expected increase in claims again due to the impacts of Covid-19

The cash economy is one that is continually on the ATO’s radar. If your business is in a known ‘cash’ industry then you would be well advised to ensure your record keeping practices are adequate and show a clear trail of receipts being recorded from the source to amounts declared on business activity statements and income tax returns.

Also, take an interest in the benchmarking data available for your industry as these are often used by the ATO to target those businesses not declaring all of their income. In the event you find your data falls outside these benchmarks you should document at the time the reasons why in preparation for any enquiry from the ATO.

The ATO is also known to target their activities on those taxpayers that they feel receive an unfair tax advantage over other taxpayers or have a history of exploiting parts of the legislation for their own benefit. For example, family discretionary trusts, which are a common structure used by small business owners, have received a lot of attention from the ATO in recent years due to their well-known tax advantages.

Legislation has been tightened to make it harder for trusts to receive these tax advantages. An example is making it mandatory for all discretionary trusts to have made a trustee distribution resolution for a financial year prior to 30 June of that year. This presents difficulties and costs in determining the most tax effective distribution due to having to prepare and rely on estimates of income for the trust and that of its beneficiaries. I should note most trust deeds require the resolution for a financial year to be done prior to the 30th of that year, however the ATO have in the past provided a concession and allowed further time post June 30.

Legislation has also been introduced which has made it harder to gain access to the small business company tax rate by increasing compliance around distributions to corporate beneficiaries. Although these changes have been in place for a number of years now those businesses with a family trust structure should ensure they receive the correct professional advice and guidance in relation to any future legislation changes. Additionally, they need to ensure they are complying with current laws that impact family discretionary trusts.

Stay under the ATO radar with a good lodgement and payment history

Another trigger for an ATO audit is outstanding lodgments or a poor lodgment history. As a means of enforcing compliance, those with outstanding lodgments can be selected for an audit. Also be aware other means of enforcing compliance include issuing penalty notices and even default assessments which can attract a 75% penalty component.

Also make sure you keep on top of your superannuation guarantee obligations. Employers that are behind in making the payments by the required dates are at risk of being selected for a super guarantee audit. Single Touch Payroll (STP) reporting now provides the ATO with information on wages and super for employees each time they are paid. Combined with the SuperStream reporting requirements the ATO can now keep track of all late payments and outstanding amounts.

Making your super guarantee payments on time and keeping up to date with business activity statement and income tax return lodgments would obviously be the most effective way of mitigating this risk. If there is a valid reason for a lodgment delay make sure your tax agent communicates this with the ATO before the lodgment is due. Extensions of time to lodge can also be arranged through your accountant or tax agent.

There is insurance

Most accounting firms these days have an audit insurance policy which can be offered to clients. The insurance will cover professional fees incurred by an accountant, tax agent or tax expert or lawyer in providing a defense to an audit, investigation or enquiry by the ATO.

The insurance won’t reduce the risk of an ATO audit or enquiry but it can assist greatly in reducing the impact to your business in the event of an audit.

In Summary

As you can now see there is a lot that can be done to reduce the risk of an audit and manage and reduce the impact on your business that can result from an ATO audit.

Even if you do the right thing and have good record keeping practices, a good lodgment history and are receiving the right professional advice you need to be aware you could still be in the firing line due to the various ways the ATO matches data and identifies areas of potential non-compliance.

Through no fault of your own you could find yourself selected for an audit due to a particular legitimate transaction you undertook, the industry you were in or how your accountant or tax agent answered a question on your income tax return.

Being mindful of the strategies and objectives of the ATO in determining its audit activity and adopting a number of practical strategies as part of your overall risk management policy will help in negating the risk an audit can present to your business. They can not only considerably reduce the risk of being selected for an audit but help you survive an ATO audit and ensure you come out the other side only stronger and wiser for the experience.

For further information and tax advice, contact Adcock Accounting, your specialist tax accountant in Cairns.

This advice is general in nature and has been prepared without taking into account your particular financial circumstances, needs and objectives. Before making any decision, you should assess your own circumstances and seek professional advice from your financial and/or taxation advisor.