SMEs feel the heat from the ATO

Reports of banks and the ATO chasing SMEs for debts owing is a concern. As if running a small business is not difficult enough in these times, having the money men and the tax man after you is not a pleasant prospect.

Of course, this is not to say that the banks and the ATO are not perfectly entitled (legally and otherwise) to chase debts owing to them. They are. It’s just that as small business is the often quoted “engine room” of the country, a reducing (or under threat) small business sector could spell trouble for the economy.

Perhaps it’s an exaggeration to say SMEs are an endangered species (although some will certainly be in that category), but they are definitely facing some tough challenges.

Look, the tax man is certainly entitled to his due, and SMEs have no choice but to acknowledge that. But, they also:

Need to be aware of tax flashpoints – as often highlighted by the ATO (see below);
Keep good records – a perennial issue raised by the ATO;
Get good professional advice;
Don’t be afraid to contact the ATO if they strike problems with paying their tax.

While others may not baulk at the prospect, the ATO really is loathe to put an SME to the wall for outstanding tax debts. That’s not to say it won’t do that, but it really is a last resort. While that is meant to provide some comfort, SMEs must be careful of pushing their luck – the ATO, as it so often reminds us, is not a bank.

Notwithstanding this, the Tax Commissioner has again recently acknowledged that the economic downturn had been “a very tough time” for small business. Reflecting that, he said that, from July 1, 2009 to March 2010, the ATO received 2,433 applications for release of tax debts, and granted 1,159 of these.

D’Ascenzo said the ATO continues to make contact with struggling businesses to offer help, usually by phone in the first instance. He said that in the ATO’s experience, a struggling business may show early signs of trouble by lodging tax returns or activity statements late, or by increasing its debt. Where the ATO sees this, it contacts the business to offer assistance, eg. help with better record keeping, tailored payment arrangements, and remission of penalties and interest.

And don’t forget that the ATO has in place some quite specific assistance measures for small businesses as it announced in June 2009, including 12-month interest-free payment arrangements and deferral of activity statement payment due dates.

As at March 5, 2010, the ATO said it had granted nearly 200,000 payment arrangements worth $4.52 billion and nearly 5,000 deferrals of activity statement due dates. These concessions help.

So, what else do SMEs need to look out for?

The ATO’s increasing sophistication in its compliance activities means it can identify individuals or businesses operating in ways it considers need further explanation or scrutiny. The following areas are just some of the things the ATO looks closely at:

Unexplained losses;
Tax payments that don’t match economic indicators – the ATO’s use of its benchmarks for various industries plays an important role here (and it plans to have published over 100 such benchmarks by June 30 this year, and covering sectors such as building and construction trades, retail and hospitality);
Big variations between tax performance and business performance, eg. a business disclosing large gross revenue, but very small profit;
Unrealistic market valuations for various assets – valuations for assets are needed for all sorts of reasons, not the least of which is to set a cost base of an asset for capital gains tax purposes;
Tax benefits that are greater than real expenditure;
Non-disclosure of capital gains – a large and ongoing issue for the ATO;
Lifestyles that don’t match after-tax income eg an individual acquiring expensive assets (like a car, holiday house, boat, etc) or even taking an extensive and expensive holiday, where the tax return shows only modest income;
Private assets treated as business assets; and
Tax outcomes that don’t match the intent of newer tax laws.

Where businesses have consistently made losses over a number of years, the ATO says it will seek explanations of those losses. It would simply question why an entity would remain in existence if it was perpetually making losses.

Benchmarks

As noted above, the ATO is continuing to expand its use of benchmarks to help it track tax compliance.

To this end, the ATO has been contacting businesses who it considers are running “well outside of the benchmarks” and seeking explanations for the variations.

While failure of a business to meet the benchmarks is not an automatic ticket to paying more tax and/or penalties, the ATO says that where it is not satisfied with the explanation a business offers, and in the absence of records and other evidence to back up the explanation, it will use the benchmarks to help calculate revised tax assessments. There is, therefore, a clear sting in the tail here.

Similarly, businesses who do not respond to ATO requests to lodge tax returns may have default assessments raised using the benchmarks and any other relevant information available to the ATO.

Data-matching expands (again)

The use by the ATO of data-matching is also becoming increasingly sophisticated and SMEs need to be aware of this. The ATO’s data matching program complements its benchmarks and now includes bank data identifying credit card and EFTPOS transactions for around 220,000 merchants, significant sales through online auction houses, AUSTRAC data, motor vehicle purchases and property purchases. Soon, the ATO expects to have information that highlights the income and expenditure of the majority of businesses that could participate in the cash economy.

Running a small business is tough. The laws provide for tax to be paid in the appropriate circumstances. Tax issues shouldn’t rule a business, but don’t ignore them either.

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