The ATO has been using benchmarking for some time in its compliance activities. However, a report by the Inspector-General of Taxation, Ali Noroozi, into the ATO's use of benchmarking to target the cash economy has flagged business concerns about the ATO's use of benchmarks.
Under its benchmarking strategy, the ATO uses a business' financial performance variance from their industry benchmark as the main basis for determining the administrative treatment to which the business will be subjected. The treatments vary from a help and educate letter, to a phone review, or a correspondence audit (see further below).
The Inspector-General conducted his review in response to concerns raised by small businesses and tax practitioners about the ATO's use of small business benchmarks.
Overall, the review found that stakeholders were supportive of the use of benchmarks as a risk identification tool. They were, however, concerned with the benchmarks themselves in addition to the way the ATO was using them for compliance activities.
In particular, concerns were expressed that the benchmarks did not account for business differences in an industry or for geographic differences. Where this was the case, resultant ATO action could impose time and cost pressures on small businesses that later proved to be unwarranted and unnecessary. There were also concerns about the data integrity of the inputs the ATO was using to develop its benchmarks.
The Inspector-General said he found that many of these concerns related to the transparency of the process and could be addressed by publishing the data inputs and methodology the ATO uses to develop the benchmarks, as well as seeking and publishing independent third party assurance on the methodology.
The Inspector-General also noted there was some confusion during ATO audits about the types of evidence the ATO would take into account in determining whether taxpayers had omitted income.
The IGT found that the ATO could address this confusion by clarifying in its staff instructions and communication with businesses the evidence it is seeking during audits. In particular, the Inspector-General recommended that the ATO publish information regarding how it takes into account business records during an audit and the evidence which a business may adduce should its records not meet the ATO’s requirements.
Noroozi said taxpayers and their advisors also suggested that a greater understanding by the ATO of the pressures experienced by small businesses was needed in designing relevant compliance activities. Although these pressures were not purported to justify non-compliance with the reporting obligations under tax and other laws, they were seen as impacting on the ability of businesses to ensure compliance.
The pressures won't surprise SMEs and include:
- Regulatory costs, including tax compliance costs, are significant and generally borne regressively by micro and small businesses. Whilst many businesses may use the services of a bookkeeper and tax agent, certain taxpayers could consider the cost prohibitive and seek to manage their own record keeping and return preparation. This has the result of taking the business operator away from carrying on more productive activities.
- Micro and small businesses operate in a more marginal or highly competitive environment that increases pressure to find cost savings. These savings, for some, may include attempts to reduce the overall tax compliance burden. This may be particularly so if they perceive an uneven playing field whereby their competitors are gaining an unfair advantage from tax non-compliance.
- Tax "competency" in the micro and small business market segment is highly variable. Research commissioned by the ATO in 2008 also indicated that 13% of micro businesses had neither engaged an accountant nor a bookkeeper. Of that population, 31% reported not using an electronic record keeping system. In terms of knowledge, 21% of micro businesses rated themselves as knowing only a little about their tax obligations and entitlements. However, the report noted that 93% of micro enterprises use registered tax agents to lodge their tax returns and 50% to lodge their activity statements.
Correspondence audits are a desk-based activity where the ATO officer does not visit the business premises during the course of the audit.
Where the ATO officer is satisfied that the ATO has applied the correct benchmark, he or she will send an "audit confirmation letter" to the business or its representative, notifying them of the commencement of the correspondence audit. This letter requires the business to send sales records to the ATO for a sample quarter, usually April to June. The expected records include cash register reports, bank statements, daily sales summaries and reconciliations.
Seven to 10 days after the letter has been sent the ATO auditor calls the taxpayer or their representative to discuss the audit. Once the ATO receives the records, the auditor assesses their quality and completeness to determine whether the sales figures reported in the BAS and income tax returns are supported.
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