With the Australian Taxation Office (ATO) increasing its compliance activities to reduce what it has identified as an $8.7 billion gap between what it has collected from individual taxpayers and what it should have collected, it may be tempting to consider any old tax audit insurance product. Here’s what accountants should know about junk insurance.
Make no mistake: the number of audits initiated by the ATO will increase, with the use of sophisticated data-matching technologies making it easier for the ATO to cross-check information from multiple sources and recognise breaches.
A study by the ATO of individual tax returns found 72 per cent contained one or more errors, including incorrect claims for work expenses, rental property expenses, and non-reporting of cash wages.
What’s most important for accounting practices to recognise is that the number of queries from the ATO on clients’ tax returns will increase.
Related resource: ATO risk review and audit processes
Craig Laughton, Executive General Manager of Policy, Advocacy and Public Practice at CPA Australia notes that “the cost of responding to a tax audit or government compliance investigation often becomes a contentious issue between a practice and its clients”.
As such, having appropriate tax audit insurance coverage in place to cover the costs associated with an ATO audit is more important than ever.
“The audit process can be time-consuming in preparation time and time responding to audit findings”.
There are a wide range of tax audit insurance products available, and many practices already offer them as a value-added protection service to their clients for a fee. These products are generally offered through insurance broking firms and are backed by large insurance companies.
But accounting practices should be alert to a growing number of pseudo tax audit protection services being offered that, on the surface, may seem like a cost-effective solution, but underneath effectively involve practices paying for a service with no insurance backing.
“It is a classic case of buyer beware. You should check what the policy covers and what it does not, and which insurance company is backing the policy, if any,” says Laughton.
In essence, these are effectively “junk” tax audit insurance products. Instead of the audit risk being transferred to an insurance company, as would be the case with a standard tax audit insurance product, the practices that take up these types of services are effectively self-insuring because there is no associated external insurance cover.
What that means is that, should an ATO query be initiated that results in a client tax audit, the full associated risks and costs are borne by the practice, not an insurance company.
Often these junk insurance services will outline an additional revenue stream for the practice, where the cost of using the service is charged back to the end client and the practice takes a percentage of the total. The practice will give the service provider access to its client database, who then handles direct communications with the practice’s clients including sales communications and compliance materials.
Drew Fenton, director of insurance broking firm Fenton Green & Co, says self-insurance through junk tax audit insurance products is a risk not worth taking, because practices may think they are getting a good deal but the actual costs incurred during an audit are not covered by the insurance.
“Practices that don’t have proper insurance in place can get burned because the costs of responding to an audit can be very substantial, especially when other external providers such as lawyers need to be engaged in the process,” Fenton says.
How tax audit insurance policies work
Tax audit insurance is about adding another value-added service to your practice. This form of insurance is put in place to cover tax returns on which an accounting practice has done the work.
The tax audit insurance policy will generally cover a family group, including company structures, individuals in a family, and self-managed super funds.
Practices do receive a remuneration stream from the policies sold to their clients, which is used to cover the costs of the insurance premiums.
Once the insurance policy is enacted, the risk is transferred to the insurer, and if there is an ATO query during the year that will trigger a claim scenario.
In the normal course, a letter of inquiry will come from the ATO into the accounting firm, which will trigger a client tax audit. Once responded to, the firm will receive a letter of completion from the ATO stating that the file has been closed.
The letter is then sent off to the insurance company and the insurer will pay the practice for its total costs of responding to the tax audit, including any legal and other costs.
5 questions public practitioners should be asking
Do we need tax audit insurance or does a professional indemnity policy cover the risks?
Tax audit insurance is specifically designed to cover practices for the costs of handling an ATO audit, whereas professional indemnity (PI) insurance covers a practice for breaches of professional duties. So tax audit insurance is needed in addition to PI insurance.
What are the risks to the practice of self-insuring?
Without an actual tax audit insurance policy in place, the firm is ostensibly accepting all the risk of an ATO audit being triggered and the time risk associated with resolving the audit. This creates a contingent liability on the practice.
How can we tell if a tax audit insurance service is real or not?
The easiest way to know is to check whether the service being offered actually involves an insurance company providing cover, and that all the firm’s risk is covered in the event of a claim.
Should tax audit insurance be offered to all the firm’s clients?
It makes sense to offer tax audit insurance as a value-add to your database. In reality, this option is usually only taken up by clients who believe they have a reasonable chance of being audited at some stage. These clients will be wanting to cap their liability if the ATO triggers an audit.
What costs are covered in a standard tax audit insurance policy?
Tax audit insurance will cover all the costs associated with dealing with an official ATO audit, including the consulting time spent to resolve the audit, administrative costs and any other expenses incurred. Practices that do use services solely designed to generate an income stream, but which do not have any linked insurance cover, effectively take on all the risks of a tax audit on behalf of their clients.
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