The right strategies to manage tax risk are vital if practitioners are to minimise the possibility of clients being audited.
To reduce the risk of your clients being selected for scrutiny by the Australian Taxation Office (ATO) or any other government agencies involves a number of steps including using engagement letters and implementing an appropriate risk management framework.
For practitioners, best practice in managing tax risks for themselves and their clients includes a strict adherence to APES 305, which mandates that practitioners document and communicate terms of engagement with clients, and APES 325, which sets out mandatory requirements and guidance for members in public practice to establish and maintain a risk management framework in their firms with regards to the provision of quality and ethical professional services.
Regardless of the steps taken, there will always remain a chance that a client will be selected for scrutiny. Tax audit insurance can reduce any adverse consequences in the event of an audit and the added costs it could mean for clients, and therefore should be considered as part of a practices overall approach to tax risk management.
The ATO’s approach to risk
The ATO currently takes a number of approaches to improving tax compliance, including pre-emptive and pre-lodgment checks. Through these approaches, it is seeking to address potential issues as soon as practically possible and be more proactive with apparent anomalies.
The process results in cost efficiencies for the ATO and accountants and CPA Australia encourages practitioners to engage with the ATO early when potential risks are identified.
It is also advisable to share with larger clients the ATO’s tax risk management and governance review guide and assist them to implement their own tax governance framework. For more information, refer to the ATO’s approach to compliance.
Detection by data matching
The ATO can and does use data matching from information provided to it by third parties against the information practitioners include in a tax return to detect possible issues. Notably, it conducts a program of verification checks – both before and after refunds are issued – to identify incorrect or fraudulent payments.
The agency also uses robust analytical models to compare income and deduction claims to individuals or businesses in similar circumstances and may seek clarification if income and claim patterns are outside expected parameters.
Mitigating the consequences of an audit
The cost of responding to an ATO audit or a review by another government agency can be a contentious issue between accounting firms and clients. Tax audit insurance can give clients some peace of mind by providing a simple and cost effective way to cover expenses if they face an unexpected audit.
Practitioners can also benefit as tax audit insurance can enable you to access professional expertise and resources to assist you and your client respond to an audit.
Tax audit insurance claims examples
Tax audit insurance caps a client’s liability; usually at between $10,000 and $20,000.
In one business activity statement (BAS) claim the client was a retailer with around $2 million turnover and had been asked to provide details substantiating BAS returns over a two-year period. This audit resulted in a $3400 claim, which covered the cost of the investigation and subsequent preparation by the accountant.
In another example, the client was a large orchard business with some $45 million in turnover. It was alleged the entity under-declared income over three years. This audit resulted in a claim for $15,900, which covered the accountant’s cost of undertaking a full review of the client’s income.
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Broader risk management strategies
As a general rule, practitioners should follow the APES 325 Risk Management Framework and stay abreast of tax updates, rulings, cases and legislation. It is also important to engage staff in the process to keep them informed of emerging risks.
Practitioners should certainly steer clear of being drawn into giving advice on matters for which they have no qualifications or experience. In such circumstances, seek advice from an expert or refer the client to one.
CPA Australia also recommends practitioners consider how they select clients and regularly review their client list and, when deemed necessary, terminate a relationship.
No one is obligated to take on every potential client. Determine the likely risks associated with different clients and always try to understand why they left their previous accountant.
“There is a strong link between clients who move regularly and risk,” warns director of Absolute Accounting Services Gavin Swan FCPA.
“The same applies if they change bookkeepers, as does a history of setting up and then winding up businesses. Always check ATO portals for a history of compliance, lodgment, payment, amendments and previous claims.
“Consider why a client might drive a late-model Mercedes if their taxable income is only $20,000. How can they often go overseas if their income is modest?”
Equally, ensure clients fully understand and then sign the engagement letter, Swan says. Seek substantiation to verify that what clients say is accurate, ask to be informed of any large transactions before they occur and, where appropriate, seek a private binding ruling.
Be sure to document all interactions with clients and instruct staff to report if they are fielding questions from banks/creditors/regulators regarding certain clients.
“If staff members are united and fully briefed, a risky client cannot play one off against the other, while having a good document management system to retrieve records, files, notes, emails and any recorded phone conversations is a must,” Swan says. “Communication within the practice is key.”
Read more on the importance of engagement documentation and client engagement risk mitigation.