Choosing a business name


30th September, 2021

8 common ways to trigger an IRD audit

There are many things to avoid in business, and one of the most unpleasant is triggering an IRD audit. Here’s how it commonly happens.

Having been involved in many tax investigations (on behalf of clients of course), I can confirm they are not very pleasant and can result in stress and serious financial difficulties, often leading to relationship breakups and bankruptcy.

What is an IRD audit?

According to the department, an Inland Revenue audit is an ‘examination of your financial affairs to check that you’ve paid the correct amount of tax, and your complying with tax laws’.

As a result, an audit process can be as simple or as exhaustive as the department requires in order to confirm the status of things like GST registration, taxes paid and even your personal finances.

If you’re found to be in the wrong, you may face fines or even criminal charges depending on the severity of the offence.

What triggers an IRD audit?

Any evidence of inconsistencies in tax and financial affairs may trigger an IRD audit, and that’s a big reason to work with a tax advisor on your business financials right from the start.

Over the many years I’ve spent working with tax helping clients and Inland Revenue, I’ve seen many ways that business owners have invited the IRD to investigate them for tax evasion. Below are the eight most common (and therefore the best ones to watch out for).

1. Spending far outpaces income

As we all know, living day-to-day is expensive, so if your drawings (money in) are consistently low and you have no other sources of income, it’s like a red rag to a bull, especially if you have high outgoings like a mortgage, child support (which of course the IRD know all about) or finance on vehicles or toys.

I’ve had a couple of calls out of the blue recently from the IRD wanting to know how the clients involved pay their bills and luckily for both, they have working spouses so the IRD went away.

2. Paying undeclared earnings into the bank

It doesn’t matter whether the bank accounts are in your name, that of your other half, your kids or your parent; if you can’t explain where the cash came from it’s like an own goal.

As with anything in life, if your finances are by-the-book and you can evidence that fact, there’s little to worry about. But even honest people can find themselves attracting scrutiny when their financial reporting and recordkeeping processes are poor.

3. Involving others in evasion behaviour

Business owners sometimes fall into the trap of paying employees undeclared takings or tell others they’re doing cash jobs, without suspecting someone might report this activity to IRD.

In some cases, we’ve even recently heard of business owners offering cash deals to IRD staff without realising they work for the government.

Undercover government staff aside, guess what happens when employees receiving undeclared cash payments get disgruntled, or the business owners fall out with friends, family or their partners?

4. Using diverted or undisclosed cash to live off

Similar to the first example, living off undisclosed or diverted amounts of cash is a big red flag for the IRD.

Take the example of the small business owner who drew no cash from any of his bank accounts for five years, plus they officially had no drawings in cash from their business.

The IRD was thrilled to see that they hadn’t paid for any petrol or shopping via their bank accounts or credit card over this entire period. Unfortunately, all these things add up to an invitation to investigate further.

5. Using credit cards in unexpected locations

Some think they can get away with heading overseas with undeclared cash to avoid the eye of the IRD, but all it takes is a small slip up for this game to completely fall apart.

That’s because the IRD will notice if no transaction records for flights or accommodation appears in bank accounts or on credit cards, contrasted against unexpected, discretionary spending in foreign locations popping up.

This happens more often than you might expect for one simple reason: physical cash is finite and much harder to transport, meaning tax evasion travellers often find themselves out-of-pocket while overseas.

6. Diverting cash to buy assets

Using diverted cash to buy expensive cars, and other assets is also big no-no as well as being very conspicuous.

Extravagant purchases tend to get noticed, and if there’s no apparent means of paying for those assets, it won’t take the IRD long to realise they might have a fruitful enquiry on their hands.

7. Paying for materials via credit when the job is for cash

Never pay for materials through your bank account and then use these in a cash job. It’s a surefire way to get attention. After all, all the IRD have to do is trace through a selection of materials to sales invoices, which doesn’t take long.

Tradies are at particular risk here, because many wholesalers maintain a record of over-the-counter sales as well as sales by credit. Restaurants too have been caught out by the IRD buying food and booze using cash, so just don’t take the chance.

8. Maintaining a suspiciously low gross profit margin

Taking too much cash out of the business is going to significantly reduce your gross profit margin.

What that means is you are going to stick out like a sore thumb when the IRD run your figures through their new benchmarking system, and if it looks like you’ve been trying to fudge the books, that’s exactly when they’ll leap into action.

Get your tax accounting done right from the start

Unless you like living dangerously, step back and think things through.

Take advice from a good, practical accountant with plenty of experience in the world of small business and if you’re struggling to keep up with business admin and keeping good records, perhaps it’s time to consider a good bookkeeper.

After all, is saving some time or cutting corners with taxes worth risk an audit (and the fines and charges that follow) from the IRD?

The information provided here is of a general nature and only applies in New Zealand. You should not act upon this information without obtaining appropriate professional advice and only after a thorough examination of your particular circumstances by an experienced tax advisor.

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