The Australian Taxation Office (ATO) has recently updated its “small-to-medium enterprises and wealthy individuals” compliance booklet to include a detailed list of tax risks.

This “what attracts our attention” analysis sets out the behavioural and inherent tax risk factors that the ATO use to identify small-to-medium entity (SME) and wealthy taxpayers[1] for ATO review and audit activity, and forms the basis of such compliance activity when commenced.  As stated by the ATO, in addition to the ATO’s ongoing analysis of internal and external data and intelligence, the detailed list will be used by ATO audit teams to “prioritise … and identify new and emerging [tax] risks.

In the absence of the ATO publishing their Annual Compliance Program, this “what attracts our attention” analysis should be critically reviewed by taxpayers seeking to manage their tax risk and achieve certainty in their tax affairs. The list should be used as part of SME and wealthy taxpayers’ periodic internal ‘tax due diligence reviews’ (and that of their controlled groups) for any potential tax risks or exposure in advance of any ATO compliance activity.

Specifically, as relevant to the tax affairs of SME and wealthy individuals, the “what attracts our attention” analysis confirms the ATO’s focus on:Magnifying glass isolated on white background1.  Behavioural risk factors

Behavioural characteristics that may attract the attention of the ATO include:

  • Large, one-off or unusual transactions
  • A history of aggressive tax planning
  • Tax outcomes inconsistent with the intent of tax law
  • Lifestyle not supported by after-tax income
  • Accessing business assets for tax-free private use
  • Poor governance and risk-management systems.

For example

  • Deloitte recently resolved a matter on behalf of a taxpayer in receipt of large sums of cash from previously undisclosed offshore investments – these receipts being identified and notified to the ATO by AUSTRAC. With the enhanced ability of the ATO to automatically obtain and match data, the likelihood of transactions resulting in ATO compliance activity has increased dramatically.

2.  Specific tax risk factors

Specific risk indicators, upon which the ATO will focus in examining the tax affairs of SME and wealthy individuals, include:

2.1   Tax Consolidation risks including:

  • Application (and calculation) of the available fraction loss utilisation rules
  • Consolidation entries and exits, including uplifts in cost base and reporting of capital gains on exits
  • Trusts with revenue losses being moved into tax consolidated groups
  • Potentially incorrect inclusion or exclusion of entities as members of a consolidated group – including the movement of entities between tax consolidated groups that are within privately held economic groups. 

For example

  • Recent ATO compliance activity indicates a focus on uplifts in the cost base of assets on tax consolidation.

2.2   Capital Gains Tax (CGT) risks including:

  • Application of the CGT discount and the small business CGT concessions
  • Potential anomalies regarding the disposal of large assets, with small capital gains or losses
  • Scrip for scrip rollovers (including cash receipts on partial scrip for scrip rollovers).

For example

  • Deloitte is aware that the ATO is reviewing taxpayer small business CGT concession claims, with a focus on eligibility and calculation of the concession.

2.3   Capital and Revenue tax losses including:

  • Tax loss generation and utilisation
  • The ‘transfer in’ of losses, including the application of the transfer pricing rules and available fraction provisions
  • Loss classification.

For example

  • Deloitte recently concluded a matter with the ATO involving the question of whether a disposal was on revenue and capital account (and therefore eligible for the CGT discount).

2.4   International tax risks including:

  • Transfer Pricing and non-arm’s length related party dealings
  • Relationships or dealings with entities in secrecy and low tax jurisdictions
  • Application of the foreign branch income and non-portfolio dividend rules
  • Application of the Thin Capitalisation provisions
  • Dividend, interest and royalty withholding, reporting and payment.

For example

  • Following the amendments to the Thin Capitalisation safe harbour, debt deductions denied are estimated to rise from $0.8 billion to $8.7 billion – in view of these changes, there is likely to be an  increase in ATO Thin Capitalisation review activity.

2.5   Division 7A risks including:

  • Private use of company assets
  • Non-compliance with the ‘deemed dividend’ rules, including director/shareholder loans and non-compliant loan agreements
  • Unpaid present entitlement where private company is beneficiary of a trust.

2.6   Trust risks including:

  • Distributions to tax preferred entities and tax concessional beneficiaries (including Superfunds, loss-making and tax exempt entities, new companies and limited resource beneficiaries)
  • Differences between distributable and taxable income
  • Classification of income and gains on revenue or capital account
  • Value extraction – including by valuable asset expense deductions and corpus distributions.

For example

  • The ATO’s Trust Taskforce has been allocated $68 million and is targeting an additional $380 million tax from trust related activities. 

2.7   Demerger activity specifically targeting:

  • Application of the CGT rollover and dividend concessions.

2.8   Fringe Benefit Tax (FBT) risks including:

  • Application of the FBT rules – including in relation to motor vehicles, employer rebate and the new LAFHA provisions.

For example

  • Companies failing disclose a motor vehicle fringe benefit on the employer’s FBT return
  • Companies failing to report contributions in their income tax return or incorrectly claiming employee contributions to reduce the taxable value of the benefits provided.

2.9   Other risk areas include:

  • Application of the Research & Development (R&D) Tax Incentive provisions – including the interaction with income tax provisions
  • Claiming of franking credits – noting the ATO’s ‘dividend washing amnesty’ in late 2014
  • Application of the Taxation of Financial Arrangements (TOFA) and Commercial Debt Forgiveness provisions.

Deloitte Recommendations

The risk indicators listed above provide a useful starting point for taxpayers in considering their potential exposure to ATO review, and the potential impact of that review when commenced.

Specifically, it is recommended that SME and wealthy taxpayers conduct internal ‘due diligence reviews’ of their historic and current tax positions (and that of their controlled groups) for any potential tax risks or exposure in advance of ATO compliance activity.

Deloitte is happy to provide further detail on the risk indicators generally, and taxpayer’s circumstances specifically, on a fully confidential no obligation basis.

[1] The ATO defines SME taxpayers as economic groups with an annual turnover between $2 million and $250 million, and wealthy individuals as taxpayers controlling net wealth over $5 million – including highly wealthy individuals controlling $30 million or more in wealth.