Taxing the Tax Man – how the ATO use of industry benchmarks will be investigated

As part of its compliance armoury, the ATO uses industry benchmarks to detect cases where businesses may not be properly complying with their tax obligations.

The kinds of benchmarks used include cash sales benchmarks, performance benchmarks (which provide key business ratios for different industries) and input benchmarks (which show an expected range of income for tradespeople based on the labour and materials they use).

Using these benchmarks, the ATO can determine the average proportion of cash sales a business should be making and which businesses are not reporting as much cash income as others in the same industry. They also provide a pointer to a possible future audit by the ATO. Businesses whose performance falls significantly outside one or more of the benchmarks are more likely to be selected for a review or audit.

To calculate the cash sales benchmarks, for example, the total value of card sales is subtracted from total sales reported on activity statements for the same period and then divided by total sales. Total cash sales include all sales by cash, cheque, bank transfer or direct deposit.

The ATO says the benchmarks provide guidance on what figures it would normally expect a business in a particular industry to report.

However, the use of the benchmarks has come in for criticism from taxpayers and their tax agents. So, the Inspector-General of Taxation has decided to review the ATO’s use of its benchmarks.

The Inspector-General said his review would look at the concerns raised by taxpayers and tax agents over how the benchmarks are developed and applied. The review will also consider whether record keeping requirements expected of small businesses are too onerous and whether it is fair to use benchmarks as the basis for default assessments.

It has been suggested that the ATO’s overall approach in using the benchmarks can be “heavy handed” with too much faith being placed in benchmarks. Some of the concerns relate to:

• Whether large numbers of compliant taxpayers are unnecessarily being targeted and thereby being subjected to unnecessary compliance costs – this is a major concern for SMEs;
• Whether the benchmarks adequately account for variations among businesses in the same industry, with some taxpayers expressing the view that no two businesses are alike;
• Whether it is appropriate for the ATO to use the benchmarks as a basis to issue amended or default assessments; and
• Whether the ATO’s expectations in relation to small business record keeping are reasonable and clearly communicated.

To address the concerns raised by taxpayers, the Inspector-General will specifically focus on the following areas of the benchmarking process:

• The ATO’s risk identification process: its ability to correctly identify under-reporting of income by taxpayers, including:
  o Are compliant taxpayers being wrongly targeted?
  o Are the compliance costs imposed proportionate to the risks involved?
  o Is the ATO’s underlying benchmark methodology, related data inputs and identification process sufficiently transparent?
  o  Does the ATO take into consideration any resulting taxpayer concerns?
• The ability of the ATO’s benchmarking process to take into account material differences between taxpayers in a given industry category – including: (i) differences in locality; (ii) businesses providing multiple goods or services being inappropriately categorised in a single industry identification process; (iii) business owner specific factors; and (iv) different business measures that govern the handling and recording of cash.
• The fairness and reasonableness of the ATO using the benchmarking process as a basis for determining and issuing amended or default assessments, including:
  o Circumstances in which the ATO issues assessments based on benchmarking data;
  o Where business records are considered inadequate, whether the ATO uses other information or evidence to assess the profits of the business, eg unexplained assets accumulation or personal expenditure records;
  o Difficulties that taxpayers and tax agents face in seeking to challenge these assessments (such as proving they did not earn the alleged additional income).
• ATO’s approach, processes and practices in conducting compliance action – including whether adequate time is given to taxpayers to respond; and whether the ATO seeks to understand the taxpayer’s business and consider the facts and reasons for a variance from the benchmark.

For the review, the Inspector-General is specifically seeking submissions from micro and small businesses that have been subject to compliance activities (including audits) involving the ATO’s use of small business benchmarks.

It has been suggested that the ATO’s benchmark system fails to consider a number of things, for example:

The demographic of the client base;

• Changing trends towards using electronic payment methods over cash;
• The region the business operates in;
• The payment policies of the business itself; and
• What happens to the business when the operator takes extended leave.

SMEs should watch for the report of the Inspector-General on this issue. It could make some interesting and important recommendations.

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

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