ATO audits & investigations
The ATO carried out almost 4 million audits, reviews and other checks in the 2015-16 year. Some of these would have been quick and simple, but others would have taken a long time to sort out. The time it takes to carry out an audit or investigation, and the steps involved, depends on the complexity of the issues and the information that is available to the ATO.
How the ATO carries out an investigation
The ATO can approach investigations in different ways.
Notification of review or audit
Usually, the ATO will send you a letter to tell you that it will conduct a tax review or tax audit. This notice will usually tell you that you have the chance to make voluntary disclosure of any underpayment of tax. If you make this disclosure, you should get a reduced penalty.
Review as a first step
It will often start with a review. This can focus on a single issue or can be a review of your entire operations. The ATO will use this process to assess whether there is a risk that you have not complied with your obligations or paid the right amount of tax.
A review usually involves a questionnaire in which the ATO gathers the information it needs to review your affairs. It may also ask for copies of documents such as trust deeds, invoices, contracts and financial statements. The ATO may also ask for an interview with you and your accountant. At the end of the review, the ATO will decide whether to move onto an audit or close the review.
Straight to audit
A review is not always the first step. If the ATO believes it already has enough evidence that you are not complying with your obligations, then it might skip the review and go straight to a tax audit. This can happen where the ATO has gathered information from third parties, such as through its data matching programs.
When you won’t be notified of a review or audit
You will not always receive notification that the ATO is investigating you. Sometimes the ATO will conduct an investigation entirely without your knowledge. It can do this by collecting information from third parties only. At the end of the internal investigation, the ATO may issue you with a default or amended assessment, without giving you the opportunity to have any input. This should only happen in the most extreme of situations; for example, where there is evidence that you might move your money offshore to avoid paying the tax debt if you know about the investigation.
Getting legal advice
You are entitled to get legal advice during any ATO investigation – whether it is at the review or audit stage. You are also entitled to have a lawyer with you at any ATO interviews.
The kinds of things a tax lawyer can help you with during a tax review or tax audit are:
- advice about disclosure – a tax lawyer can tell you what information you must give the ATO and what information you do not have to provide.
- help fix mistakes – a tax lawyer can tell you what you can do if you find a mistake in your taxes. Generally, the sooner you disclose this to the ATO, the better. Early disclosure should result in lower penalties. Your tax lawyer can also help you to make sure that you don’t continue to make the same mistake with your taxes.
- full information – a tax lawyer will arm you with full information and be able to tell you the likely outcome of the review based on the facts. In my experience, ATO officers will often only tell you the worst case scenario, so it can be valuable to have someone who is on your side look at it for you. You don’t want to settle with the ATO and pay more tax than you should have just because an ATO officer told you that this was a good idea.
- strategy advice – a tax lawyer can give you strategy advice on your options for settling with the ATO, based on their past experiences and knowledge of the law.
How the ATO decides who to audit
The ATO use different sources of information to work out who to investigate or audit. Some of these are very simple. For example:
- public reporting – the ATO receives reports from the public, such as employees who are concerned that their employer is not correctly withholding tax or paying superannuation.
- the news – the ATO keeps up to date with the news – sometimes there can be something in the news that indicates a risk that a person or business may not be reporting their tax correctly.
- social media and the internet – the ATO will use social media and the internet to track you. For example, if you report a low income to the ATO but your facebook or instagram account shows pictures of you on lavish holidays, or Google maps shows an expensive car in your driveway, then this can wave a red flag to the ATO.
- court reports – it tracks what’s going on in court – for example, someone convicted of selling drugs can soon find the ATO asking questions about whether they paid income tax on their drug sales.
Two more complex and involved ways the ATO identifies risks and chooses who to investigate are data matching programs and benchmarking of financial data.
Data matching programs
Data matching programs allow the ATO to access information from third parties about you or your transactions. The ATO sorts through this information to identify situations where tax may have been underpaid.
For example, the ATO has an ongoing data matching program for property transactions. It can access data on the sale of property in any State or Territory. It can also access information about any rental bond lodged with a government authority. The ATO cross-checks this data with tax returns to identify transactions where:
- a person has sold a property but not reported any capital gains tax on that sale
- a person is renting a property to another person, but not paying any tax on the rental income
This is just one example of the ATO’s data matching programs. It runs several programs at any given time and is able to access a huge amount of information in this way. Other data matching programs give the ATO access to seller’s accounts on eBay and insurance records for ‘lifestyle assets’ such as boats, motor vehicles and thoroughbred horses.
The ATO uses benchmarking to compare the financial performance of businesses within the same industry.
The ATO collects information from the tax returns and business activity statements (BAS) of all businesses within an industry, and then compiles this information to give the performance benchmarks for that industry.
A business’s key financial ratios can then be compared against others in its industry. This allows the ATO to do a preliminary assessment of a business. The benchmark helps the ATO to identify if there is a risk that a business is under-reporting its income or over-claiming deductions.
If the ATO identifies a risk, it can lead to an audit of the business. The ATO will ask for evidence in support of the tax return or BAS lodged by the business. If the business cannot produce the evidence, then the auditors can use the benchmarks to recalculate the business income, adjust tax returns and issue amended assessments.
The end of the investigation
There are three ways that an ATO investigation can end.
The investigation is closed
The best case scenario at the end of the audit is that the agrees that you have paid the right amount of tax and closes the investigation.
Usually this can only happen if you have been co-operative with the ATO and made the effort to explain your position. If you ignore the ATO’s letters and requests for information, then it’s very unlikely that the investigation will be decided in your favour.
If both you and the ATO recognise that there are strengths and weaknesses to each of your arguments, you might enter into a Settlement Deed. Under this deed, you will agree to pay a certain amount of tax and the ATO will agree to close the matter.
The negotiation of a settlement with the ATO takes great care and skill. You should consult a tax lawyer before entering into settlement negotiations with the ATO, because you need to know where you stand under the law and what the possible outcomes are. An experienced lawyer can put together a matrix of potential outcomes, and weigh up the likely success of each argument. This information can help you to understand your position and decide how much you should settle for.
You should also get advice on the terms of the Settlement Deed – not just the dollar amount of your settlement.
An amended assessment is issued
If the ATO believes that you have not paid the right amount of tax, it will issue you with an amended assessment. You will be required to pay:
- tax – the amount of tax that the ATO calculates as being correct
- interest – you must pay interest on the difference between what you have already paid and what the ATO says you must pay
- penalties – administrative penalties are applied on the base amount of tax at either 25%, 50% or 75%. The amount will depend on how the ATO views your conduct that led to the incorrect reporting of tax