ATO compliance targets for SMEs… and some help too

Much has already been written (much is always written) about the latest ATO compliance program for 2010-11. The public release of these programs is important if for no other reason than they provide a window into the issues and areas the ATO will target in the coming year (but be careful not to overlook the fact that the issues outlined are not the only issues the ATO will look at in the year ahead).

The ATO compliance programs are, however, a double-edged sword. Yes, they provide a transparency about the ATO and perform an educative function for taxpayers, but they also serve as a warning – ignore what the ATO is saying at your peril.

Cash economy

The cash economy continues to be a major ATO focus for SMEs and it plans to review and audit more than 26,000 so-called micro businesses (turnover under $2 million). ATO concerns include the use of cash transactions to hide income and evade tax obligations. This includes businesses:

paying cash-in-hand wages or treating employees as contractors – there is a growing list of court cases dealing with the employee versus contractor issue. The ATO has released what it calls a “decision tool” designed to help businesses understand whether their individual workers are employees or contractors in order to comply with Commonwealth tax and superannuation laws. It is a guide and SMEs should take advice on the matter if they are unsure of their situation;
skimming some or all of the cash takings;
running part of their normal business activities off the books;
not reporting the exchange of goods and services for other goods and services (barter);
operating underground, avoiding tax obligations by not registering or not lodging tax returns.

Benchmarks

The ATO also plans to expand its range of small business benchmarks. There are currently 106 of these for small business. The ATO has benchmarked the key business ratios for high, medium and low turnover businesses. Information on the benchmarks, including the industries they cover, is on the ATO website.

In the coming year, the ATO expects to contact around 100,000 micro businesses because their reported income is outside the published benchmark ranges. And, recently, the ATO sent letters to around 1,000 businesses that it said reported income “significantly” outside the benchmarks.

So, these benchmarks are important indicators for the ATO, and SMEs and their advisers should be sure they are familiar with them. Typically, they give benchmarks for things like the ratio of cost of goods sold to turnover, the ratio of labour to turnover, and the ratio of rent to turnover. When the benchmarks show up a potential problem, the ATO contacts the business and asks it to explain why they are reporting outside of the benchmarks. When the discrepancy cannot be explained, the ATO may audit the business or raise default assessments. This only serves to illustrate how important it is for SMEs to know what the benchmarks are and to be able to explain if the ATO queries why a business is outside the benchmarks.

In an actual case, the ATO looked at a plasterer who had reported low income for a number of years.

Using data from its data matching activities, the ATO found he had purchased a car, placed a deposit on a property and sent money overseas. The total value of these outgoings exceeded his declared income.

The ATO also contacted the plasterer’s main suppliers and used the small business benchmarks to indicate his expected range of income based on labour and materials. During the audit, the ATO identified a significant amount of unreported cash income and expenses, and determined that his record keeping was inadequate.

After adjusting his BAS and income tax return to include the additional sales, the ATO found the plasterer had understated his income, resulting in over $49,000 of additional tax liabilities and over $24,000 in penalties for evasive behaviour. The audit raised liabilities totalling more than $74,000 over a five-year period.

Other issues for ATO attention

Other ATO target areas for micro businesses include:

Lodgment of correct Business Activity Statements (BASs) – the ATO says it will focus on omitted or incorrectly reported property sales and acquisitions, and incorrectly applied margin scheme rules under the GST laws. It expects to verify over 48,200 refund claims from micro enterprises this year.
Employer obligations, eg. super guarantee, FBT – this year, the ATO says it expects to take action on over 17,500 employee complaints about unpaid superannuation. The ATO will also undertake 800 compliance reviews targeted at industries and employers showing a pattern of non-compliance, including the road freight transport, automotive repair and electrical services industries.
Property assets – issues here include: CGT and GST implications from the sale of assets; application of the CGT small business concession rules.
Losses – Where micro enterprises incurred a loss for the first time in 2009, the ATO will contact them and provide information about incurring and using losses. It will also review the tax affairs of businesses using losses to ensure that tax payable is not incorrectly reduced in current or future years.
Contractors – the ATO is concerned that some contractors might seek to alienate their personal services income through entities such as companies, partnerships and trusts. The ATO says it will continue its test case program to clarify the law and provide further information to contractors and their tax agents.
Specifically, the ATO will: match data from labour hire firms and the mining industry to identify and target contractors, particularly engineers and computer technology specialists; and also review the tax affairs of contractors identifying themselves as a personal services business and businesses in receipt of government stimulus payments.
Superannuation – This year, the ATO will audit or review around 10,800 self-managed super funds and will focus on loans to related parties and follow up on undertakings given in previous years to rectify breaches.

ATO extends small business relief measures

In announcing the 2010-11 ATO Compliance Program, the Tax Commissioner revealed that the ATO would extend the measures to assist small businesses announced last year. He said the ATO understood that some businesses were still experiencing financial hardship as a result of the economic downturn and that businesses having difficulty paying their tax debts should contact the ATO early for help, eg. with flexible payment arrangements or interest-free payment deferrals.

The package of measures was originally intended to expire on June 30, 2010, but will now run until June, 30 2011. The extension of the Small Business Assistance Package will mean that eligible businesses with a turnover of $2 million or less will continue to have access to:

a 12-month interest-free payment arrangement with the Tax Office; and
a deferral of activity statement payment due dates.

The Commissioner said that, during this further extension of the assistance measures, businesses must be willing to enter into direct debit arrangements with the ATO. He said the ATO continues to expect these businesses to reciprocate by seeking to put their tax affairs in order as soon as possible and “by exhibiting good compliance behaviour into the future”.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.