As we head into tax time, a small but significant proportion of Australian businesses will find themselves subject to some unwelcome scrutiny from the Australian Taxation Office (ATO) because they have got their tax return wrong. Falling foul of the ATO can be stressful and potentially expensive in terms of extra tax payable, interest and penalties, and the key to avoiding that situation is to stay out of trouble in the first place.
So, what are the most common causes for unwanted ATO attention?
Failing to declare income
If you run a retail business and don’t declare all your sales, expect the ATO to take an interest. The ATO is looking particularly closely at cash-only businesses. Their perception is that in this day and age, the only reason for a business to be run on a cash-only basis is to avoid tax. Even where the business isn’t only cash only, the ATO will keep a close eye on your business margins to ensure all sales are being properly recorded through the books.
One of the ‘tricks of the trade’ the ATO uses are the small business benchmarks, which group together the financial results of numerous businesses across a particular industry to produce a band of results representing a typical business within that sector. Businesses that fall outside the benchmark percentages will often find themselves being looked at more closely by the taxman. This can be a controversial approach, with many business owners who have fought off the ATO complaining that the one size fits all approach fails to take into account unusual but very real factors (such as seasonal trade, demographics or even personal factors like relationship breakdowns) which can cause some businesses to perform differently to their peers.
In addition, the ATO now has access to multiple sources of external information which it uses to data-match against the figures businesses themselves report. If they don’t match, the business can expect a visit from the tax man. Among the data sources available to the Tax Office are transaction details from banks, share registries, employers, merchants, states and territories and government departments.
As an example of how this can be used, the ATO acquired data from coffee merchants detailing coffee purchases by coffee shops across Australia. From that data, the ATO was able to extrapolate roughly how many cups of coffee each shop should have sold and, using average coffee prices, what the value of turnover would be for each shop. Comparing this to the turnover declared by each coffee outlet highlights those where there is the possibility of undeclared sales.
The ATO is also highly dependent on good old fashioned whistle-blowers. For example, recent compliance visits by the ATO to 159 businesses in Sydney’s Haymarket area came about after a high number of community referrals, presumably either from customers who saw their cash going into the back pocket of the proprietor rather than the cash register or possibly from disgruntled staff, who are often a good source of information, particularly when there are outstanding wages or superannuation contributions. It recovered $18.3 million in taxes and $4 million in penalties.
Claiming deductions you’re not entitled to
We all know you've got to spend money to make money and if you spend it to produce 'assessable' income, then your business will usually be entitled to a tax deduction. Many businesses trip up by inflating their deductions or claiming for something they shouldn’t, but a surprising number also miss out on deductions they could have claimed.
The basic rule is that you need to show you are actually 'out of pocket' and that the expense has been incurred to run your business. You also need to keep sufficient records to substantiate the expense.
Income out of line with lifestyle
If you’re riding around in the latest Rolls Royce and enjoying harbour side living in one of the ritzier Sydney suburbs, but only declaring business income of $10,000 on your tax return, the ATO will be looking very closely indeed at you.
The ATO is able to assess the assets you own—cars, properties, boats, etc.—and calculate the approximate amount of income you would need to support your lifestyle. If the amount of income you’re declaring is significantly less, you’ll trigger alarm bells.
As well as traditional sources of third party data like records of property purchases and sales, the ATO even scrutinises social media, so those Instagram pictures of you enjoying the high life in the Caribbean might not sit too comfortably if your declared income is less than the tax-free threshold!
And finally…take advice
Given the complexity of tax law, and the potentially stringent penalties that can arise if you make a mistake, relying on your own bookkeeping and accounting skills can prove to be a costly mistake in the long run. It’s better by far to lower your stress levels and free up more time to run your business by calling in an expert.
Mark Chapman is the director of Tax Communications at H&R Block.