SME tax compliance: What will the taxman look at?

This year the tax office plans to undertake hundreds of reviews and audits of SMEs, and will check up on thousands more. Here is a guide to help you prepare. By TERRY HAYES

By Terry Hayes

This year the tax office plans to undertake hundreds of reviews and audits of SMEs, and will check up on thousands more. Here is a guide to help you prepare.

The recent release by the tax office of its 2008-09 compliance program provides a valuable pointer for small and medium businesses as to what tax issues it will examine in the coming year.

With around 130,000 SMEs in Australia contributing about 15% of total tax collections by the tax office, it’s no wonder tax compliance features prominently on the taxman’s radar.

So what will he look at in the year ahead? Here’s a preview.

This year, the tax office plans to undertake 595 reviews and 370 audits of SMEs. These will focus on income tax and FBT compliance issues, including:

• Lodgement issues such as tax returns, BAS, etc. The tax office notes that industries and sectors with higher rates of late lodgement include financial and insurance services, property, building and construction, and self-managed super funds.
• Capital management (see below).
• International transactions, including transfer pricing and tax havens.
• Capital gains (see below).
• Tax planning around business exits (see below).
• Trusts and service trusts.
• Fringe benefits tax (see below).
• Losses – in 2007-08, the tax office disallowed current year and carried forward losses of $740 million.
• Phoenix arrangements – see my earlier column on Taxman takes aim at phoenix tactics.

The tax office will also contact 1300 SMEs by letter or phone to verify specific income tax and FBT issues.

Sale of a business

With baby boomers approaching retirement age, many SME owners might be considering selling (or already have sold) their business. This always gives rise to tax issues and the taxman is concerned SMEs may be making mistakes. This year, the tax office says it will look more closely at issues surrounding the sale of businesses, such as CGT rollovers, eligibility for the small business CGT concessions.

Capital management

The tax office says it will also be continuing its focus on business owners who try to extract value from their private companies without paying the correct tax, such as by:

• Using loans, payments and debt forgiveness by private companies to, in effect, distribute company profits to shareholders or their associates in a form other than dividends.
• Using mechanisms such as share buy-backs, capital reductions and the sale of shares to exit from businesses – particularly in relation to disposing of nominally pre-CGT assets (where a capital gain may still arise) and tax issues arising out of actions to enable the business to be sold, such as writing off or forgiving shareholder loans.

Capital gains tax issues

Capital gains tax issues are endemic in many transactions undertaken by SMEs, so it’s important they get these issues right. The kinds of issues the tax office will focus on this year include:

• Misclassifying ordinary income as capital gains to obtain a more advantageous tax position.
• Incorrectly retaining or claiming carry-forward capital losses, where the continuity of ownership or same business test is not met.
• Claiming small business concessions when not eligible, or incorrectly calculating the claim.
• Failing to report capital gains tax events, including by non-residents.
• Failing to correctly report capital gains on property and share disposals.
• Incorrectly re-setting the cost base of assets, particularly under consolidation.
• Arranging to reduce the capital gain when a business is sold.
• Arranging to avoid capital gains tax on offshore transactions.
• Failing to account for capital gains where assets are transferred into a superannuation fund, or where proceeds from the sale of assets have been transferred into the fund.

Fringe benefits tax issues

The taxman has continuing concerns about the correct FBT treatment of business-owned motor vehicles, particularly in relation to the private use of vehicles and the provision of luxury vehicles to business principals. Checks will also be made that SMEs use the correct accounting treatment of any employee contributions that may reduce the taxable value of benefits provided.

The tax office intends to use data-matching to help identify high-risk employers for further compliance action.

GST issues

The tax office considers that SMEs represent a “significant [GST] refund integrity risk”. This is evidenced by the fact that, in 2006-07, it made GST refund adjustments totalling $171 million across 1149 cases.

This year, the tax office says it will continue to undertake pre-issue and post-issue checks to ensure that refund claims are correct. If it is concerned about a refund, it will contact the businesses or third-party supplier to substantiate claims.

Property transactions also feature prominently for GST compliance reviews. Issues to watch out for include:

• Unreported property sales.
• The correct application of the margin scheme.
• Incorrect reporting of adjustment events.
• SMEs that avoid their obligations by not lodging activity statements or not registering in the GST system.

Also this year, the tax office will further develop matching data, such as property registries, with return information.

SMEs should not underestimate the scale of the taxman’s approach. Last year, the tax office conducted 30,000 reviews and audits, with 700 of those related to property risks (which raised tax liabilities of $47.9 million).

Fuel tax credits

The expansion of the fuel tax credits scheme on 1 July 2008 has resulted in a significant increase in the number of businesses eligible to claim fuel tax credits. As a result, the tax office will focus on understanding the compliance behaviours of new categories of claimants. Read more in my earlier column about how to save tax on fuel used in a business.

The tax office will also continue to focus on the recurring risk of fuel tax credits fraud that is often facilitated by identity fraud.

Where to from here?

SMEs need to be aware of the tax issues being targeted this year. Its compliance program flags those issues clearly for all to see. If any of those issues are of concern, see your accountant or adviser before the taxman comes calling.

Read more on data matching, tax compliance and tax audits

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.