The ATO make it clear in their compliance program for 2013-14 that they will be active in their review and audit practices. For example, they expect to data match over 640 million transactions to tax returns this year.
Below are 10 common ways that private businesses trigger an ATO audit. What these triggers show is that your clients’ tax compliance – in particular their annual income tax return – is much more than a routine compliance process. It is the key way that they interact with the ATO and manage their risk of being selected for audit.
Businesses demonstrating best practice will have an active tax risk management process in place involving both senior management of the business and their key external advisors. As an accountant and advisor, you can add significant value by being proactive in looking for (and addressing) likely audit triggers, such as those discussed below.
1. Have financial performance that is out of kilter with your industry
As a matter of course the ATO will statistically analyse your clients’ tax returns. For business clients one of the aspects analysed is their performance compared to industry peers (based on the industry disclosed on the front page of the return). If your client is inconsistent with the industry, this can be an indicator of tax issues such as unreported (cash) income, transfer pricing and other issues.
Whether you consider 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 client is performing compared to industry peers. When preparing a small business client’s tax return, take 5 minutes to see whether the ATO publish a benchmark for their industry. If they do, see how your client compares. If they are underperforming relative to the industry, it will increase their risk of an ATO audit, especially if they operate in a ‘cash industry’.
2. 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 sure fire way to get a review or audit from the ATO. Often 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.
3. Variances between tax returns and business activity statements
Reconciling the information reported on a client’s business activity statements and their tax returns is a crucial 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.
In a recent case1 , an accountant’s client was selected for an ATO audit primarily because the disclosures of capital and non-capital items at G10 and G11 on the BAS were different to the expenses and depreciable assets reported in the income tax return for that year (even though the correct amounts of GST and income tax had been paid to the ATO).
4. Have a poor record of lodging returns on time
It’s not just 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.
5. Consistently show operating losses
The ATO regards 3 loss years out of 5 as indicative of problems. There may be genuine reasons, but the ATO is likely to want to investigate these.
6. 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 purchases 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.
If an audit is triggered because of the business owning a motor vehicle, the audit will generally cover income tax, GST and fringe benefits tax.
7. Get the disclosure items wrong in your tax return
The tax return is the main way that ATO gathers information on your client’s business. Making mistakes in the disclosure items can inadvertently 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 publically 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.
8. Show big fluctuations between years
The ATO will compare your client’s 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.
9. Have international transactions
International transactions are a key 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 examples of things 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.
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.
10. 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 easily bring your client to the attention of the ATO. A major transaction or dispute that is reported in the media will undoubtedly 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.
Conclusion on audit triggers
As an accountant and advisor, you can proactively assist your client in reducing the risk of them triggering an audit. Often the value you add won’t involve significant extra work – things which can easily be put in place such as reconciling the BAS and tax return, or comparing the client’s outcomes to those of industry peers are invaluable ways of reducing audit risk.
If a client is selected for an ATO audit, having audit insurance in place can take the pressure off the client having to worry not only about the ATO questions, but also the professional fees which will be incurred in dealing with the ATO. The cost of many audit insurance policies is minor relative to the likely professional fees incurred in handling an ATO audit.
William Buck assists many accountants in dealing with ATO, OSR or other tax related audits that their clients may have. As a result of the many years of experience we have in handling these matters, we have developed numerous systems and processes to ensure the best outcomes are achieved with a minimum of time, fuss and costs.
Should you require assistance in dealing with a tax audit or review, or would like further information about audit triggers, please contact your William Buck advisor.
1 Thalia Corporation Pty Ltd v Bentleys (SA) Pty Ltd  SASC 172