Have you been selected for a tax audit?
The month of April is often a difficult one in business with the number of public holidays, the additional annual leave taken by staff and the overall lack of working consistency. But for some of us here at CapitalQ it has been an especially disjointed little period. This is largely because we have been assisting with an ATO Tax Review (a prelude to, or arguably another name for, a Tax Audit) based on a request for information that is among the most extensive we have seen. (To confirm the attention from the ATO is not a result of suggested wrong-doing, but a result of the party in question falling into a category of focus for the ATO!)
It has meant a lot of work gathering together all the answers and documentary evidence required to support the relevant tax reporting over a number of years.
Fundamentals, not basics
One of the key things that we have taken from going through this process, not that we really needed a reminder, is the importance of complying with the fundamental documentary requirements.
I say fundamental, not basic, because despite a perception that many are easy things to prepare (in little time), this is often not the case. And more importantly taking such an approach to them can prove costly in many ways.
The very first things the ATO request to see under such circumstances include –
- Trust Distribution Resolutions (Minutes) for all Trusts for all relevant years, and
- Division 7A Loan Agreements for all Companies that have money owing to them by a Non-Company (ie. Individual, Trust, Partnership).
ever expanding importance & complexity
Long time clients of ours will have seen a lot of material from us over recent years regarding the increasing importance and complexity of Trust Distribution Resolutions. We have worked very hard (and spent much time and money) on learning and understanding the changes effecting this documentary requirement and ensuring we have done everything we can to keep our clients compliant.
Two things this recent piece of work has confirmed –
i) Not all accountants have been as diligent in this regard (including, surprisingly, firms of the size (and perceived calibre) that you would be excused of assuming are on top of such matters), and
ii) Our efforts were, and continue to be, very justified.
Not that long ago, the Trust Distribution Resolutions were a simple one page copy of the previous years version that was prepared by many Accountants almost as an after thought upon completing the tax work. The client was asked to sign this document as part of the year end package and if it wasn’t signed, but the tax return was, often it would never be followed up.
However, as one of their very first data gathering items, the ATO have requested to see this particular Client’s Trust Distribution Resolutions for each of the years in question. They have requested these items upfront, because if there are any shortcomings, the Client Group’s entire tax affairs and lodgements will be called into question and likely required to be completely reassessed.
This is before any consideration of income disclosure, treatment of deductions, etc is made.
The key things they are looking for when reviewing these documents include;
- Has the Trustee resolved to distribute the income of the Trust,
- Has this resolution been documented,
- Was the resolution made in accordance with the terms of the Trust’s governing rules (the Trust Deed),
- Was the resolution made prior to 30 June each year (and can this be proven),
- Does the resolution correctly address the distribution of all the different types of income as well as any distributions of capital,
- Was the resolution followed when the tax return was actually prepared (often some 11 months, or even longer, after the fact).
Should the answer to any of these be ‘No’ the most basic aspect of the Client’s tax planning strategy is likely to be considered null and void!
Division 7a – devil in the detail
The other fundamental compliance item the ATO have initially focused on is Division 7A.
Again, most of our clients will have heard quite a bit from us on the subject. To reiterate, Division 7A comes in to play when a private company provides an otherwise non-taxable benefit (in cash or kind) to its shareholders (or associates of its shareholders).
Generally this is done in the form of a loan, whereby the shareholders (or their associates including other non-company business entities such as trusts) draw money from the company and it is not treated as immediately taxable (ie. it is not considered a dividend nor a salary/wage).
Once Division 7A is applicable, there is a very strict range of actions that must be taken to avoid an unwanted, punitive, tax treatment of the benefit.
The most commonly used course of action is to treat the benefit as a loan.
Under this scenario Division 7A requires a formal, documented, loan agreement to be implemented that complies with strict loan terms including charging of interest, minimum repayments each year, etc.
But of course if the loan agreement doesn’t exist, can’t be found, was never signed, was signed but not dated, was signed but too late, or was entered into by the wrong parties, it will not count and the punitive aspects of Division 7A are deemed to have automatically taken affect.
tax audits are a reality, be prepared
We will be taking the opportunity of this stark reminder from the ATO to continue our efforts (as always) towards ensuring compliance by all our clients.
As is now usual at this time of year, we will shortly be contacting clients regarding their year end tax planning and then flowing from that, their attendance to Trust Distribution Resolutions and the executing of such before 30 June.
For Clients who have companies in their group, we will also be using the year end tax planning process to identify the provision of non-taxable benefits to shareholders (or their associates) and where they occur confirm the existence of the formal loan agreements and review the execution of the document to ensure technical compliance.
We understand at times many of these compliance activities may frustrate business owners and that they may feel like an unnecessary, or at least unwanted, additional distraction and cost. However, we can very confidently say, if it was our Client who is currently going through the ATO Tax Review process speaking to you today, they would tell you everything you can do to ensure things are in order upfront, is worth every minute and cent when it comes time to provide evidence to the ATO. Because the time, cost and most significantly the stress, associated with checking things and hoping for the best at the time the questions are asked, far, far outweighs the upfront costs!
If you would like to learn more about the process involved with a Tax Audit or similar review you can check out the ATO Taxpayers Charter here.