The mid-way point of the 2011 financial year is a good time to recap the key risk areas identified by the Australian Taxation Office (ATO) in its Compliance Program 2010-11 released in July last year.
The ATO Compliance Program is important for all taxpayers given that it outlines the areas that the ATO will be focusing on during the next financial year.
The issues outlined in the ATO Compliance Program are varied. Moore Stephens clients should review the key points and discuss any concerns with their Moore Stephens advisor.
Large Business (annual turnover in excess of $250 million)
According to the ATO, 30% of large businesses are reviewed on an annual basis. Complex transactions are a primary focus.
Some of the risk areas that are looked at by the ATO include:
- Financial or tax performance that varies significantly over time.
- The generation of economic losses which are not commercially realistic.
- Tax outcomes that appear to be inconsistent with the policy intent of the law.
- Past history of aggressive tax planning by a corporation, board members, key executives or advisors.
- Implementation of a transaction inconsistent with the advice provided in a ruling.
Revenue and Capital losses
The recoupment of prior year losses are subject to strict rules that are very complex. The ATO have had considerable success with their audit activity in this area and will continue to focus on loss recoupment.
In order to recoup a loss a company must pass either the continuity of ownership test or, failing that, the same business test. The ATO have concerns that companies are claiming losses that do not pass either of these tests.
The ATO are also concerned with:
- Non-genuine losses.
- Arrangements that inappropriately attribute foreign losses to Australia.
- Incorrect claiming of tax deductions, in particular finance-related claims.
- Arrangements that inappropriately apply foreign losses against domestic income.
The ATO issued letters to tax agents of large businesses in December 2010 advising agents of the need to ensure that these businesses are still eligible to utilise their carried forward losses if they are being utilised in 2010, prior to lodgement of the 2010 income tax return.
Profit shifting – Transfer pricing
The ATO are concerned that international businesses shift profits on related party transactions outside of Australia. The following transactions are of particular concern to the ATO:
- The use of arrangements between Australia and offshore affiliates to shift or shelter profits.
- Paying excessive royalties, interest, guarantee and other fees.
- Australia-headquartered companies providing services to overseas affiliates for a non-arm's length consideration.
- Financial instruments that shift profits overseas.
- Thin capitalisation, with a particular focus on contrived arrangements that place high levels of debt into Australia.
- Inappropriate use of offshore banking units (that have concessional tax rates).
The ATO conduct a significant number of risk reviews and audits. Companies with international related party transactions should be prepared for a risk review as the ATO expect to review all companies.
We have assisted a number of our clients and clients of other firms with transfer pricing risk reviews from the ATO.
Corporate restructures, mergers and acquisitions
The ATO have raised concerns about transactions where the taxation and economic outcomes are unnecessarily complex and will be focussing on:
- Restructures that involve complex or novel financial arrangements and/or steps that do not appear to be necessary to achieve the business needs of the parties.
- Treaty-shopping arrangements designed to avoid Australian tax on the disposal of investments acquired in a leveraged buy out by private equity.
- Arrangements that seek indirect tax benefits, such as using interposed "financial supply facilitators" to enhance claims for reduced input tax credits for expenses incurred in a company takeover.
GST and the Integrity of business systems
A systemic error in an accounting system can lead to large GST errors over time. The ATO believe this risk is increased where the businesses are experiencing rapid growth, restructure, mergers or de-mergers, installing new accounting software or changing accounting staff and will focus activity in this area.
The chance of an error also increases with transactions that are outside the ordinary course of business, particularly input taxed supplies (where GST cannot be claimed) such as the issue of shares.
GST property transactions
The ATO are focusing on the incorrect reporting of property transactions such as unreported sales, the application of the margin scheme and particular attention to non-complying margin scheme valuations.
Research and Development claims
The ATO is aware that some businesses appear to be incorrectly classifying normal business activities as research and development (R&D) and are wrongly allocating related expenditure to R&D activities. The ATO will be reviewing a number of R&D deductions to test compliance with specific R&D rules.
Companies making an R&D claim should ensure the claim is reviewed by a specialist.
Small-to-Medium Enterprises (SME – annual turnover between $2 million and $250 million)
Loans to shareholders - Division 7A
Loans to shareholders made by private companies can be deemed to be dividends unless they meet strict requirements. The ATO is focusing risk review and audit activity on loans to shareholders.
The documentation and repayment requirements are very strict. If your company has made loans to shareholders or entities that are associated with shareholders it is critical that you have maintained documentation that demonstrates commercial character of the loans so that they cannot be deemed to be dividends.
This is a high risk for privately owned business as a simple error in making a payment from the wrong account can lead to a large tax liability.
The ATO are increasing audit activity from prior years. Audit activity still remains low given the difficulty many business have in complying with the law.
Both large business and SME
Taxation of financial arrangements (TOFA)
The ATO's primary focus will be on the consultative implementation and education in relation to the TOFA rules, similar to the approach taken when GST was implemented. The ATO will review the following areas:
- Restructuring prior to entry into TOFA.
- The calculation of the balancing adjustment for those large businesses that have made the transitional election to bring in their existing financial arrangements.
- The validity of elections made under the TOFA rules.
- The appropriate application of the tax-timing methods to financial arrangements (in particular the accruals, hedging financial arrangements and reliance on financial reporting methods).
The ATO will be working with retirement villages to resolve interpretational issues in relation to the correct apportionment of GST input tax credits
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