The Australian Tax Office has been using small business benchmarks for a number of years. This approach has not been without controversy, with claims that benchmarks unfairly produce a one-size-fits-all approach and don’t take into account unique circumstances of a business, resulting in added tax compliance costs to businesses.
Activity statements lodged by businesses provide the Tax Office with up-to-date trading information. The Tax Office then uses this information to establish industry benchmarks for a variety of business ratios. The benchmarks are financial ratios developed to provide guidance to the ATO on what figures it would normally expect a business in a particular industry to report. Ratios include salary and wage expenses as a proportion of turnover, the ratio of cost of goods sold to reported business income, and the ratio of input tax credits to turnover.
These benchmarks are used to compare a taxpayer’s performance as reported on its Business Activity Statements against the industry benchmark, thereby identifying potential audit targets. This is particularly useful for the Tax Office in targeting what it regards as high-risk industries, such as building and construction, cleaning, beauty salons, restaurants, cafes and takeaway food, road freight, smash repairs and taxis.
A recent Administrative Appeals Tribunal decision saw the ATO successfully apply the ratios to a florist business, resulting in a higher tax bill for the business. The income tax shortfall was $57,389 and the GST shortfall was $16,745.
The taxpayer conducted a GST-registered florist business in Western Australia and lodged BASs for the monthly tax periods from July 1, 2007 to June 30, 2008. In her 2008 tax return, she reported “Cost of sales” for the business of $259,982 and a “Total business income” of $313,971.
The ATO selected the business for audit because she had reported Cost Of Goods Sold (COGS) representing 83% of her reported business income and this was outside the COGS industry benchmark percentage range of between 44% and 54%. The ATO requested the taxpayer provide evidence that she was correctly recording and reporting her business income. In response, her tax agent forwarded certain documentation to the ATO e.g. EFTPOS statements, a spread sheet summary of cash register rolls, cash register roll receipts, bank account statements, and several bank deposit slips. The documentation generally covered the period from April to July 2008.
Following the audit, the ATO advised the taxpayer that in its opinion, she had not kept adequate records, and as a result, issued default amended assessments for income tax and GST (including penalties) totalling just over $130,000 based on the COGS small business industry benchmarks. Her objection was partially allowed on the penalty issue (by reducing the administrative penalty for the income tax and GST shortfalls from 75% to 50%, and a partial remission of the general interest charge), but disallowed regarding the income tax and GST assessments, and she appealed to the AAT.
The AAT said there was no evidence before it to support the taxpayer’s contentions. Based on the evidence before it, the tribunal considered that the taxpayer had failed to prove positively, on the balance of probabilities, that the relevant assessments were excessive. The tribunal said the evidence did not prove how the taxpayer calculated the gross income of her florist business for the year ended June 30, 2008 and, in particular, the cash component.
The AAT said the taxpayer’s problems in this regard appeared to arise as a result of the following:
- a defective cash register – the taxpayer said the cash register never worked properly and the roll would never follow through correctly and constantly jammed;
- missing till (cash register) tapes for June 2008; and
- the fact that no reconciliations had ever been produced.
The spread sheet summary of till (cash register) rolls for April and May 2008 was unreliable in that:
- days were missing from the summary and other evidence before the tribunal indicated that the taxpayer did, in fact, trade on the those days; and
- there was a difference between the total sales recorded on the spread sheet summary and the reported label G1 “Total sales” amount in the BASs for the florist business for April and May 2008.
The tribunal considered that in the circumstances, it was open to the commissioner to exercise his discretion and apply the COGS small industry benchmark range.
The tribunal considered it was appropriate for the commissioner to apply a base penalty amount of 50% on the income tax and GST shortfall amounts on the basis that those shortfall amounts were caused by her “recklessness” and that no part of those penalties should be remitted.
More particularly, the tribunal considered “that a reasonable person in [the taxpayer’s] position would have foreseen that there was a real … risk that by not reconciling the Z-tapes (i.e. cash register tapes) with the BASs and bank accounts with the florist business for the relevant period and, instead, by relying solely on the deposited cash in bank to identify the sales of the florist business for the relevant period, her income tax returns and BASs may well be incorrect.
“Further, a reasonable person in [the taxpayer’s] shoes would have foreseen the risks of operating a business with a faulty cash register which is unlikely to record all sales and/or damage the Z-tapes such that the true sales for a particular day may be unascertainable.”
The lessons from this case are obvious, given the tribunal’s comments. Although the taxpayer said her business was struggling because of increased competition from a supermarket in the shopping centre where the business operated, the lack of adequate records meant she could not prove the tax assessments were excessive.
Terry Hayes is the Editor-in-Chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.