12. Update on industry benchmarks and a personal living expenses guide
Greg Topping, Assistant Commissioner, Cash Economy, provided a progress report on the development of a personal living expenses guide for clients of tax agents likely to be operating in the cash economy.
Information provided in the agenda papers
The Tax Office plans to release a personal living expenses guide to increase the understanding of taxpayers about how we conduct an audit in the course of our response to the cash economy.
One of the techniques we often use seeks to measure the difference between reported income and the funds required to support a taxpayer's household expenditure and lifestyle. In addition to gaining an overall appreciation of the way in which their business works as part of our audit process, we use a personal living expenses questionnaire to obtain information about a taxpayer's household expenditure. This is particularly important in circumstances where a taxpayer's business records are not in good order.
Last year, when consulting with tax practitioners, a number of them acknowledged that they often take a similar approach in reviewing their clients' situations where their record keeping practices are poor. They indicated that it might help their clients to know that the Tax Office does look at household expenditure in the course of determining whether cash income has not been returned. Some of the practitioners suggested that if this guide became available, they would use it to encourage their clients in the direction of better self management.
With this in mind, we are developing a personal living expenses guide.
In February 2009 this year we have consulted with a number of practitioners in Sydney to get their views on a prototype product. We are using their feedback to improve the language and design of the guide.
In March 2009 we will test the guide with a group of practitioners at our user-testing centre in Brisbane in anticipation of its likely release in June 2009.
Our industry benchmarking program is also progressing and we will provide an update on current and future developments.
Highlights from the report
- In recent years the Tax Office has developed its response to the risks of cash economy participation understanding the importance of addressing perceptions of small business operators as well as the community in general.
- This is important given the size of the micro market segment and the fact that an enforcement response in the form of reviews and audits cannot, by itself, reach significant numbers of businesses at risk given the resources available for this purpose. Encouraging self management is an essential element in the Tax Office approach.
- By exposing key elements of its case selection and audit methodologies, the Tax Office intends that small business operators will develop a better appreciation of their potential to attract audit scrutiny. This is important in a market where poor record keeping and significant levels of cash transactions are common. In encouraging this understanding the Tax Office seeks to support viable businesses and contribute to a level playing field for all small businesses. The personal living expenses guide and benchmarking of business activities are initiatives designed to this end.
- The pre-reading for the meeting includes a summary of progress to date in developing the personal living expenses guide in consultation with a number of tax agents.
- The primary audience for this product is small business operators and it will be available to agents for recommendation, or for use as they think appropriate, depending on the circumstances of their clients. It will be clearly identified as coming from the Tax Office and should be available for release with Tax Time 2009. The guide will provide a simplified form of the household expenditure review conducted by Tax Office auditors seeking to identify unreported cash income in the course of an audit.
- The current program of developing benchmarks based on business inputs has limitations and the Tax Office in recognising this is developing an expanded range of benchmarks using information provided by small businesses through their tax returns and activity statements. The intent behind these new business performance benchmarks is the same as for the input benchmarks. It is to encourage small business operators in comparing their own business performance with identified norms across their area of business activity. In doing this they will also have the opportunity to consider whether they are meeting their tax obligations and to self correct if necessary.
- The Tax Office intends to make the first 50 of these additional benchmarks available to small business operators and agents in time for tax time 2009.
- Tax agents will be consulted extensively in developing these new benchmarks while the Tax Office will continue to engage trade associations as well.
Meeting discussion
The Tax Office explained that we would continue to increase leverage across the micro business segment through a balanced program of education and assistance with compliance follow up where this was necessary in response to cash economy participation. Greater transparency in explaining its case selection and audit approaches will assist small business operators to understand the importance of sound record keeping practices and encourage better self management in relation to tax obligations.
Examination of household expenditure is a standard component of a cash economy audit and a personal living expenses guide is being developed to increase understanding of small business operators and encourage them to conduct their own reviews.
In the same way, input benchmarks have been developed in association with a number of trade associations. This has been done to address concerns that Tax Office auditors do not understand particular areas of business operations. Where available, they are now able to resort to benchmarks to ensure this understanding.
The Tax Office has identified some significant limits on the potential for developing input benchmarks. They are only feasible where a business has relatively simple inputs. As a result, most have been developed for sub trades in the building and construction industry engaging directly with consumers.
A number of similar benchmark guides are developed outside the Tax Office, but these are often based on relatively small sample sizes. The Tax Office intends to use information provided by businesses in their tax returns and activity statements to produce business performance benchmarks which will have application across a much wider range of business activities than is presently the case with input based benchmarks. As one example, restaurant and café operators focus on the costs of food and beverages. These can be developed and presented as a benchmark (product costs for each $100 of sales) by analysing the information recorded at the cost of gods sold label on tax returns. The information can then be presented within ranges identified for low, medium and high turnover businesses.
These products will result from data matching and analysis, which is something the Tax Office does in any event in developing its case selection models. Benchmarks allow the Tax Office to expose this process for the information of taxpayer and their agents. For this reason, tax agents are seen as key stakeholders and will be consulted as these additional benchmarks are developed. In particular, advice will be sought on the best way to present this information for use by their clients.
The Tax Office explained that in this way, benchmarks are used by auditors in the course of an audit. Where they have been developed, they are used as one criterion only to assist in case selection. Other more significant criteria include histories of unrealistically low income being returned, lodgment patterns, allegations of tax evasion sourced from the community and information from external sources suggesting conspicuous consumption inconsistent with income declared.
Benchmarks are used by auditors to develop a better appreciation of how an industry operates. They are not ordinarily used to generate an audit adjustment. As case studies released by the Tax Office highlight, adjustments are calculated using information supplied by the business operator about their own business. An exception to this can occur where a business has not kept adequate records or refuses to cooperate in the audit process.
In response to queries from ATPF members, the Tax Office advised that it is ready to consult with interested associations now in connection with the methodology used to generate these new benchmarks and to seek their feedback on aspects such as the best way to present this information to small business operators. The benchmarks will be updated, most likely, on an annual basis as is currently the case for the Taxi Industry 'cents per kilometre' rate and other financial ratios included in the Tax Office's Taxation Statistics publication. It was acknowledged that events such as the current global economic downturn would influence the currency and value of benchmarks as a guide and thought needs to be given to the timing of their review.
Feedback was offered that the case studies presented to tax agents in the course of current consultation on the development of the personal living expenses guide were useful in illustrating the Tax Office's approach to audits. The Tax Office agreed to make these available to forum members through inclusion with the minutes of the meeting.
Action item
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ATPF0902/14
ATPF members to advise if they are interested in providing feedback on the methodology used to generate these new benchmarks and the best way to present this information to small business operators.
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Status
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Nominations are to be provided to ATPF secretariat by emailing palu@ato.gov.au by Monday 30 March 2009.
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Action item
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ATPF0902/15
The Tax Office to provide the case studies presented to tax practitioners in the consultation on the development of the personal living expenses guide.
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The following examples have been used in the Tax Office's consultation with tax practitioners as part of the process of developing a package which explains why and how we examine household expenditure as one aspect of our cash economy audit program. The cases were presented to practitioners in slightly altered form, along with the versions of the personal living expenses worksheet being tested.
The examples are not drawn from actual cases, but are intended to help a small business taxpayer understand the significance of household expenditure and its relation to business income.
As was agreed at the 27 February 2009 meeting of the ATPF, the case studies are provided now for information. There content may be further adjusted as a result of feedback received from the consultation process.
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Case studies examples
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Personal living expenses
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Example 1
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A concreter who runs his own business meets his tax practitioner to discuss his annual tax returns. Because the concreter's business records are not complete the practitioner suggests they quickly look at his personal living expenses using the concise worksheet.
The business owner is married and has two school age children. He lives with his wife and children in a home they are paying off.
He recently obtained a mortgage to purchase a second home where his parents, who are pensioners, live rent free. He also provides assistance to his brother who lives overseas.
Using both business and personal records the business owner completes the concise personal living expenses worksheet with the assistance of his tax practitioner (as shown in the sample worksheet 1). Their analysis shows a reported annual household income of $37,950 for both the business owner and his wife.
The family's outgoings are $61,940, which exceeds their reported income by $23,990, without taking into account basic household expenses such as food, clothing and entertainment.
As the concreter's household outgoings significantly exceed his incoming funds he will need to look at his records and be prepared to explain the difference in the event that he is selected by the Tax Office for review or audit.
The tax practitioner recommends that the concreter should review his invoices and business expenses to ensure nothing has been missed. He also offers the concreter assistance in recordkeeping practices for his business.
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Example 2
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The owner of a small painting business visits his tax practitioner to discuss his annual tax returns. The business owner has recently purchased an expensive car and is concerned about being selected for audit as a result of the Tax Office's data matching program which has recently been in the news.
His tax practitioner advises him that his reported income is low when compared to other similar painting businesses and recommends the business owner complete a comprehensive worksheet about his family, their income, assets and expenses.
The business owner lives with his wife in a home they paid off 10 years ago. They have three children - aged 16, 20 and 24 years old. The youngest lives at home; while the eldest lives in a property his parents purchased with an interest only loan.
Using both business and personal records, including bank and credit card statements, the painter completes the personal living expenses worksheet and records a household income of $28,800 for the year. The family's expenses are $78,800, which exceeds their reported income by $50,000, as illustrated by worksheet 2.
As the business owner's household outgoings exceed incoming funds, he needs to look at his records and be prepared to explain the difference if queried.
If the business owner was asked to complete a personal living expenses questionnaire during an audit, we would question him about the accuracy of his reported income and household expenses, as $600 for clothing and footwear for a household of two adults and a teenager appears to be low.
If the business owner was audited he would be required to produce detailed documentary evidence in support of his explanation. If he was unable to fully explain the difference and unable to produce suitable supporting evidence, based on the information he has been able to provide about his business, we would re-assess his income to a higher figure. He would have to pay tax on any shortfall of omitted income plus penalties and interest.
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Last Modified: Friday, 24 September 2010