Setting a standard from which to judge outcomes is not just instructive, it can be almost forensic in the taxman’s hands. By TERRY HAYES of Thomson Legal & Regulatory
By Terry Hayes
In seeking to maximise its approach to ensuring tax compliance among SMEs, the tax office is keen that SMEs have the information and support they need to comply with their tax obligations.
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When the tax office identifies a new or common compliance issue, such as practices that it considers are at high risk of being non-compliant, it alerts other SMEs that are at high risk of not complying or not accessing an entitlement – so the problem can be avoided before it becomes a major issue.
For example, the tax office might release a ruling or a guide that outlines what practices will attract particular scrutiny and why, or better explain the availability of an entitlement.
In looking at SME tax compliance, the tax office considers factors such as whether a business is making a loss, or is engaged in international transactions or transactions with related entities (as these all have tax consequences that can be checked).
The tax office also plots the tax outcomes of businesses against reasonable expectations of profitability based on industry norms or benchmarks (that is, it effectively tries to check whether their tax performance is in line with economic performance).
In today’s business environment, to obtain repeat business and to drive new business, SMEs are keen to ensure the prices they charge for the goods and services they provide are competitive. They are keen to know how they are travelling in relation to their competitors.
The tax office too knows and understands that many SMEs regularly evaluate their performance against their competitors and their industry in general. It gives them a pointer or a barometer of how successful they are.
This is where industry benchmarks are useful, and the tax office also uses them as a pointer that may indicate that a business is significantly outside a norm, and to seek an explanation of why that is the case.
The benchmarks can cover a type of business (for example, manufacturing, retail trade) or a type of business activity. These benchmarks are not used in isolation, but are one of a number of indicators.
The sorts of benchmark financial ratios the tax office uses include:
Gross profit ratio
Total business income – cost of sales
Total business income
Net profit ratio
Total business income – total expenses
Total business income
Wages to turnover ratio
Salary and wages paid
Total business income
Activity statements, including the BAS, have provided the tax office with more information than it has ever had before. And it uses that information via the following activity statement ratios:
- Wages to sales ratio
Total salary, wages and other payments (label W1)
Total sales (label G1)
- Expenses to sales ratio
Non-capital purchases (label G11) + total salary,
wages and other payments (label W1)
- Net GST to sales ratio
GST on sales or GST instalment
(label 1A) – GST on purchases (label 1B)
Where the tax office finds an entity engaging in what it considers high-risk tax practices, it will write, telephone or visit them to obtain more information.
Related entities are also brought into the investigation net and the tax office then profiles the tax performance of the group as a whole, including the controlling individuals. So, it’s an integrated approach by the tax office for many businesses – one letter or phone call can lead to the investigation of many.
Hand in hand with the use of benchmark ratios, the tax office also has a special interest in employers because they withhold and pay tax, and report information on behalf of their employees.
In fact, the tax office says that, in 2005-06, employers collectively administered about 45% of its net collections (that is, pay-as-you-go, or PAYG amounts) withheld on behalf of their employees.
Although the tax office acknowledges that most employers fully comply with their tax obligations, it notes that non-compliance occurs where:
- Tax management and record keeping practices and systems are inadequate – an oft repeated message in many tax scenarios.
- Cash flow is not well managed, which can lead to distortions and artificial means to manage the problem.
- Tax obligations are not well understood.
To improve compliance by employers, the tax office is in the process of:
- Reviewing situations where reporting appears inconsistent, such as where PAYG withholding reported by an employer does not match the credits claimed by employees in their tax returns.
- Telephoning or writing to employers to seek clarification where their reporting under one obligation indicates they have not adequately reported under another obligation. For example, PAYG reporting may mean FBT or superannuation reporting is also required.
- Auditing businesses with deliberate or persistent inconsistencies or omissions to ensure they are complying with their obligations.
The tax office has become highly sophisticated in its use of techniques to monitor tax compliance. All businesses, including SMEs, need to be aware of this.
Terry Hayes is the senior tax writer at Thomson Legal & Regulatory, a leading Australian provider of tax, accounting and legal information solutions; www.thomson.com.au
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