Will your business expenses trigger a personal audit?
1st January, 2015
Some of us went crazy with the Game of Thrones grand finale, with the show becoming the most pirated program in history. Australians were the worst offenders. Digital piracy is illegal; so too is tax evasion.
If you have cheated the tax system, it may not impact you now as a struggling entrepreneur or business owner, but perhaps years later when you are held to account for your actions. Long after the moment of greed, or seeming need, you may have a partner, child and a thriving business by then.
That is when you may get caught up in a personal audit and tarred at the height of your brilliant career. There goes that promotion, partnership or opportunity: you have just been charged with a crime or are subject to an extended tax investigation.
Do you participate in the cash or hidden economy?
If you receive cash and don’t declare income, your expenses will look abnormally high. To detect potential illegal activity, the Australian Taxation Office (ATO) uses risk indicators such as unusually high expenses to target businesses for further investigation.
Apart from being a bad business decision — posing considerable reputational risk to the value of your business — you can easily get caught out. The ATO uses data matching, benchmarking and reports from the community (probably disgruntled former employees or customers) to flag potential issues.
READ: Why a move to a cashless society could quash the black economy
Using benchmark data
The ATO has at its disposable perhaps the most comprehensive records of business activities in the country. They know average income and key expense ratios for each industry and trade — from bakeries and hot bread shops to takeaway food services and tyre retailing — and both you and the ATO can use this information to benchmark your business expenses.
These figures are very useful for benchmarking your business, but troublesome if you fall outside of the benchmarks in an audit. For example, the ATO website publishes these benchmarks for bakeries and hot bread shops (extracted 20 June 2014):
| Key benchmark ratio |
Annual turnover range |
||
|
$65,000 – $400,000 |
$400,000 – $750,000 |
More than $750,000 |
|
| Income tax return | |||
| Cost of sales/turnover |
34% – 40% |
31% – 38% |
28% – 34% |
| Average cost of sales |
37% |
34% |
31% |
| Total expenses/ turnover |
76% – 84% |
83% – 90% |
86% – 92% |
| Average total expenses |
80% |
87% |
89% |
| Activity statement | |||
| Non-capital purchases/ total sales |
59% – 70% |
51% – 60% |
48% – 55% |
| GST-free sales/total sales |
35% – 50% |
36% – 50% |
31% – 57% |
| Benchmark ratio |
Annual turnover range |
||
| Income tax return |
$65,000 – $400,000 |
$400,000 – $750,000 |
More than $750,000 |
| Labour/turnover |
13% – 21% |
21% – 30% |
28% – 34% |
| Rent/turnover |
11% – 17% |
7% – 11% |
5% – 8% |
| Motor vehicle expenses/turnover |
1% – 2% |
1% – 2% |
1% |
Sourced from the ATO.
Don’t over claim expenses or under report income in the first place. This is called refund fraud if it is “deliberate and dishonest” and is considered a crime. If all else fails during an audit, the ATO may use the benchmark data to estimate your income and determine your true taxable income.
The ATO will also look closely at trust arrangements for the 2013/14 financial year and focus on the use of motor vehicle claims. Abnormally low income will be under the microscope. Also expect the typical focus areas like travel and entertainment to be examined and unusually large or small transactions to attract some attention.
What happens if you get audited?
- Don’t panic – Most accountants and tax agents will have a program, some free, to assist you in times of an audit. Sometimes it’s an honest mistake or you decide to mend your ways: come forward, amend your return or ask the ATO for help. Taxpayers who cooperate and work with the ATO to correct any issues receive favourable treatment.
- Know reviews are different to audits –There are two types of “tax audits”. One is called a “review” and the other an “audit”:
- Reviews: These are conducted by phone, the simplest being termed a “phone review” where you clarify a few matters. The second “office review” is by telephone but involves greater substantiation and review of your record keeping and other procedures. These are usually 30 minutes to 60 minutes.
-
- Audits: These occur when if the ATO believes you may not be complying with your tax obligations or a review will not be sufficient. There are a variety of different categories or audits, ranging from record keeping audits to cash and hidden economy audits.
- Time to complete an audit – If nothing else persuades you to fully meet your taxation obligations, it is this: estimated times to complete an audit range from 90 days to 120 days of you providing details, evidence, attending meetings and more.
- Possible outcomes – You may spend 120 days of valuable business time and energy for there to be no further action. You may need to amend your return or face penalties, or then face prosecution for serious or blatant breaches of the law.
- Honesty and good record keeping – If selected for an audit, be open, honest and forthright from beginning. To do this you need good record keeping. Bad records will make things worse, much worse. Ensure you have a good accounting or book keeping system with supporting documentation.
On a final note, as a small business owner, even if your business is separate legal entity, you should expect your personal income tax returns to be drawn into the audit. If in doubt about business expenses, call the ATO or your tax agent.