ATO to take a closer look at SME assets

The ATO is planning to run a pilot program on asset betterment reviews in the SME market. These reviews are generally done to ascertain if income has not been disclosed by the business.

Planning for the pilot is under way and there is no indication yet from the ATO when it might be conducted (or completed).

Under asset betterment reviews, the net worth of a business at the end of each relevant year is compared with its net worth at the beginning of each of those years, and an estimate of annual asset growth is obtained. Non-deductible expenditure (often estimated) is added to this estimate, and liabilities and exemptions are subtracted. A figure is then computed for total taxable income. Taxable income previously declared is then subtracted to leave a balance which is the outstanding taxable income.

A key to the project is for the ATO to identify what taxpayers to review. The ATO has an automated system to identify what it calls high wealth individuals (HWIs) classed as those having net assets greater than $30 million. This same system is also used to define so-called wealthy Australians, ie. those with net assets between $5 million and $30 million.

There is some concern that a net asset position calculated by the ATO can be quite misleading. It doesn’t necessarily mean an individual has a strong cashflow position – some people are asset rich but cash poor, eg. someone who has lived in a house in an expensive suburb for 40 or 50 years may have an expensive asset, but not much cash to spend.

There are three major steps in the ATO’s taxpayer identification process:
1. Calculate the net wealth of individual entities.
2. Link the relationships between entities within economic groups including individuals, trusts, partnerships and beneficiaries.
3. Attribute an estimate of net wealth to individual(s) controlling an economic group.

The ATO’s automated system draws on information both inside and outside the ATO to develop an estimate of net wealth. Within the automated system, there are assumptions made regarding the value of assets and liabilities. Once the wealth of the group has been determined, the ATO considers it is better able to understand the HWI and wealthy Australian populations.

To help the ATO with its reviews, it will be developing an asset betterment methodology and the feedback and lessons from the initial cases will be fed back to improve its system.

The ATO says its estimates of wealth will not be based on balance sheet items, but wealth information will be drawn from Australian Bureau of Statistics information on property data and transactional data. The ATO says this is a transactional tool and would detect inflationary increases in values.

As noted above, the ATO asset betterment tool will measure wealth at two points in time to determine the increase in wealth and then compare that increase with income disclosed in the relevant income tax return. Letters will be sent out by the ATO and a pilot of 10 cases will be conducted in Melbourne. The ATO says the cases will be selected to test ATO data and to examine some of the bigger discrepancies.

While the asset betterment methodology is to be developed, the ATO said it will initially conduct reviews which will give taxpayers the chance to review their records.

The ATO has been trialling its asset betterment tool although the outcome of the trials is not yet known. However, SMEs should be aware that this tool is being developed and be prepared if it is implemented at a later stage.

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