Avoiding the tax traps

When you are new to business it is easy to overlook some of the traps that more experienced business owners watch out for.

Many small firms are in the process of completing or organising their 2010 income tax return. Like most business owners you want to stay out of the Tax Office firing line.

Time and cost in managing compliance and reporting are high enough without increasing the load through unnecessary tax audits or reviews. The reality is that there is always the possibility that you will be subject to an audit.

Every year the ATO will select a certain number of businesses at random simply to test their compliance. If you are one of the ‘lucky’ ones there is nothing you can do about that.

Increasingly, however, the ATO approach to selection of audit candidates is much more driven from benchmarking and data matching. They have one of the largest databases in the country with a wealth of financial information.

Not only can they compare you with other similar businesses but they can also compare the information that you send to them throughout the year to ensure that it all matches up. Benchmarking and data matching are powerful tools.

Through data matching, the tax office can compare the information that you have provided in your Business Activity Statements with your final accounts that are represented in your income tax return.

Things like gross income, payroll expenses and total expenses can be readily compared. Where differences exist between the total of your BAS for the years and that which is disclosed in your income tax return, this can invite an enquiry.

It makes good sense at year end to reconcile your business activity statements lodged, with your final accounts. This may be something that your accountant does for you, but equally it is something you can do if you are preparing your accounts to provide to the accountant to complete your tax return. The important thing is not who does the reconciliation – rather that it is done.

Where you are in a popular industry it is likely that the ATO will have some business benchmarks for your industry. This is simply where they have gathered information on a lot of businesses in the one field and through their access to financial information have been able to create a range of information about the normal financial performance for that industry.

Things like what gross profit margin should be expected, what is the likely cost of wages to revenue, what other overheads are likely to be and how much net profit does this type of business normally make.

With this information the ATO compares your business with your industry. If your numbers are well outside the normal range then this can trigger an enquiry.

The ATO provides their business benchmarks on their website. You or your accountant can check to see if your industry is one that they publish information on and if it is how you compare to the industry norms.

There is nothing wrong with being outside of the normal range. You may still be in start-up phase or your business could be outperforming the market. Either of these will cause a variance.

The key is to know where you stand. If this is likely to increase the likelihood of a tax enquiry then be prepared so that you can explain the reasons for the difference. Having a plausible and ready explanation may save some time. It also helps you to identify how your business in progressing.

There’s lots of information out there. You should take advantage of it.

Greg Hayes is a director of accountancy firm Hayes Knight. He is a regular commentator on business and taxation issues and is former national chairman of the Small Business Centre of Excellence, CPA Australia. www.hayesknight.com.au