How to manage an ATO tax audit

If there is going to be a full-fledged audit, it is important to establish whether it has already commenced or is about to

Ray Cummings of Melbourne-based tax firm Greenoak Advisory shares his tips on dealing with an ATO tax audit.

So, the Australian Taxation Office (ATO) has signalled an intention to audit one of your client’s affairs.

Many accountants have little experience in dealing with ATO disputes and according to Ray Cummings, principal of Greenoak Advisory, it’s not unusual for him to take calls from accountants who are in blind panic over the prospect of an audit.

“After you calm them down, you quite often find they are subject to some sort of investigation or enquiry, but not what I would describe as a ‘full-blown audit’,” he says.

The first step is to determine the nature of the ATO’s action.

“If the client is being investigated by way of standard questionnaire or risk review, it generally means they have been selected at random, rather than because there is some major issue in dispute,” Cummings explains. “Pointing this out can alleviate some of their concern and answering the ATO’s query may be the end of the matter.”

If, however, there is going to be a full-fledged audit, it is important to establish whether it has already commenced or is about to.

“The delineation is critical, particularly in the context of making voluntary disclosures and the ATO practice of partial remittance of culpability penalties,” Cummings says.

The ATO will remit 80 per cent of any penalties for a voluntary disclosure prior to an investigation commencing, but only 20 per cent after. Clearly, this can significantly impact calculation of overall liability.

It is also important to note that the Commissioner of Taxation has discretion in section 284-225 (5), being able to treat a disclosure as having been made prior to notification of the examination, with the consequence of an 80 per cent rather than 20 per cent remission, even though the examination had already commenced.

“Clearly, though, best practice is to make disclosure prior to notification, rather than relying on any discretion,” Cummings says.

Technical issues

He suggests trying to identify the issues in dispute – or likely to be in dispute – and the technical arguments in favour of and against the taxpayer. After that, a determination can be made as to whether the taxpayer has a reasonably arguable position.

A “reasonably arguable position”, commonly referred to as a “RAP”, is defined as follows in Section 284-15 of the Taxation Administration Act:

“A matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.”

MT 2008/2 sets out in detail the ATO’s position in relation to what the Commissioner regards as a reasonably arguable position. It refers to the Explanatory Memorandum section 284-75(2), which states:

“The strength of the taxpayer’s argument should be sufficient to support a reasonable expectation that the taxpayer could win in court. The taxpayer’s argument should be cogent, well-grounded and considerable in its persuasiveness.”

Where the taxpayer does not have a reasonably arguable position, it will be necessary for the advisor to consider whether or not the level of penalties imposed – or being proposed – is appropriate.

There are a number of areas in which the applicable laws are complex and require particular vigilance, if mistakes are to be avoided. For example, advisors frequently err in the areas of small business Capital Gains Tax (CGT) concessions, Division 7A, trust distributions, recoupment of trust losses, and categorisation of amounts as capital gain rather than income.

Is the ATO “in time” to issue amended assessments?

In cases where there has been no fraud or evasion, the normal amendment period is four years from the date an assessment was made. Accordingly, if a matter pertains to a period prior, the ATO cannot amend.

However, if there has been fraud or evasion, the time frame within which the Commissioner can issue amended assessments is open-ended.

The ATO’s position in relation to both fraud and evasion is set out in PS LA 2008/6. Paragraph 15 states that fraud involves:

“Making false statements knowingly, recklessly or without belief in the truth, to deceive the Commissioner.”

Paragraph 17 refers to a case involving Denver Chemical Manufacturing, and describes evasion as:

“A blameworthy act or omission on the part of the taxpayer.”

Of note is the fact that the ATO may well allege evasion in order to issue an amended assessment which would otherwise be “out of time”.

Quantify potential tax and penalties

Calculate primary tax, penalties and interest (shortfall interest charge [SIC] and general interest charge [GIC]) to ascertain how much the dispute is likely to cost. These should be quantified for each disputed item.

From here, best and worst case scenarios can be evaluated. Rank the schedules in order of hopeful, likely and worst case outcomes.

Cummings emphasises the importance of only giving the ATO information it has specifically requested.

“This framework helps communicate the broad issues to clients in a tangible, non-technical way, and helps them decide whether or not they should continue the dispute or agree to settle,” Cummings says. It also provides a useful platform from which to negotiate with the ATO.

Making disclosures

Before making any disclosures to the ATO, Cummings recommends establishing clear guidelines for the conduct of the audit, both with the ATO and client.

“My preference is that all communications be through the tax agent,” he says. “The ATO communicates only with the tax agent and the client communicates only with the tax agent.

“I’ve seen too many circumstances where a taxpayer, either trying to be helpful or trying to save on costs, communicates directly to the ATO. They inadvertently give too much information, incorrect technical responses or fall for leading questions. It is then virtually impossible to retract statements or information that did not need to be provided.”

Cummings emphasises the importance of only giving the ATO information it has specifically requested.

“For instance, if they ask for financials for a particular year, don’t give them a set of accounts showing comparative figures for the previous financial year. Likewise, it is sometimes better to give short answers to questions rather than elaborating,” However, he acknowledges that in certain circumstances, a lengthy response may lead to a better outcome.

Whatever the case, all matters need to be fully disclosed, and without misstatements.

Decide when to settle or litigate

It’s also imperative that clients are fully advised as to the costs of continuing a dispute. These can be significant in complex or protracted cases, and it is often better to settle rather than continue disputing a matter because of principle.

In addition, costs need to be weighed against the uncertainty and stress of a protracted dispute.

“Some people are happy to continue with a dispute until they are happy with the outcome,” Cummings says. “Others don’t want to end up in court and will seek the earliest opportunity to resolve a matter. As an advisor, it’s important to be conscious of your client’s profile.”

Other considerations

As a matter progresses, there are a number of other issues to keep in mind. Among them: paying tax while in dispute; objecting to or appealing against an ATO decision; the settlement process; and remission of penalties and interest.

“Regardless of the situation, don’t assume the ATO doesn’t know what they’re talking about,” Cummings warns.

“Don’t assume you can achieve a favourable outcome. Don’t assume you are the world’s best negotiator. Don’t assume your client is on your side.”

October 2021
October 2021

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