Taxman’s cash economy review catches the unwary

No-one can say the cash economy has been beaten. It’s just that the taxman now has more tools then ever to track it down. By TERRY HAYES

By Terry Hayes

No-one can say the cash economy has been beaten. It’s just that the taxman now has more tools then ever to track it down.

The cash economy has been around for a long time. It’s still there, but the tax office is paying more attention to it than ever before. And that attention is paying off.

The tax office has more data than it’s ever had and its use of sophisticated data-matching, data-mining and other practices like benchmarking means it has a greater ability to detect tax fraud.

In addition to benchmarks, the tax office is also using information from Centrelink, the Child Support Agency, state fair trading agencies, insurance providers, shopping centre operators, product suppliers and the community to help identify unreported income.

It is reviewing records of so-called “luxury” goods purchases – like cars and boats – to identify people with lifestyles not readily supported by their reported income.

In other words, the scope of what the taxoffice is looking at is huge.

For instance, the tax office considers that evidence of involvement in the cash economy may be when taxpayers report unrealistic business income, or have lifestyles that appear to be out of step with reported income.

Think about it – in many ways, this is no trocket science but is merely observing what taxpayers and businesses are doing.

As part of its strategy to address the cash economy, the tax office is increasing its direct contact with businesses that have high volumes of cash transactions. So if this is you, don’t be surprisedif you get a letter from the taxman.

The letters give advice about the obligations of such businesses and about proper record-keeping. In 2008-09, the tax office expects to contact around 50,000 taxpayers in this way.

Tax office auditors often review personal living expenses to test for proper accounting of business income. To help businesses and their advisers with this, the tax office says it is working on a personal living-expenses guide.

The plumber

The tax office audited a plumber after he lodged income tax returns with net business losses of $84,000 over a two year period. He also declared net losses on two rental properties during the same two years.

Separated from his wife, the plumber remained in the family home while his wife and three of their five children moved into a second property that he also owned.

During an audit interview, the plumber admitted to overstating expenses by including personal amounts of $245,000.

The tax office also found he was inflating purchases then claiming input tax credits and business deductions on the higher amount. Overstated expenses totalled $284,000 over two years.

Further analysis showed the plumber had not recorded and reported all cash transactions, and was reporting income based only on his records of invoices paid. The tax office reviewed the plumber’s bank account and found that deposits were $71,500 more than the total income he had reported in his activity statements.

After analysing the plumber’s private living expenses, the tax office concluded that his lifestyle could not be supported by his declared income. However, when the bank account deposits were added back as income and the inflated expenses were excluded, the tax office found his net business income was sufficient to cover personal living expenses.

The auditors also discovered a number of invoices listed as unpaid. After contacting several of his customers, the auditors found that some of these payments had been made in cash.

The plumber then admitted to another $44,000 in unreported cash over the two year period.

At the completion of the audit, the tax office found that the plumber had understated his net business income by $394,000 over two years.

This had the following consequences:

• A GST adjustment of $46,000 was made.
• An income tax adjustment of $102,000 was made.
• A 75% administrative penalty was imposed.

The tax office says it is considering this case for prosecution before the court.

Proper record keeping and complying with the tax laws go hand-in-hand. The taxman now has a vast array of tools at his disposal to check compliance.

The power of this should not be underestimated.

Read more on the cash economy, benchmarking and data-matching

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