Top 1,000 income tax assurance

The Top 1,000 income tax assurance program ratings and observations.

• Tax risk management and governance
• Significant or new transactions, specific tax risks, and tax risks flagged to market
• Alignment of accounting and income tax outcomes
• Income tax next actions program

We have now completed 1,332 assurance reviews on 1,085 taxpayers. The total of 1,332 reviews includes 429 combined assurance reviews. We are increasingly reviewing more taxpayers for a second time and have completed second reviews for 247 taxpayers as of 30 June 2023. We aim to review Top 1,000 taxpayers every 4 years.

As the population for Top 1,000 is not static and movements within the population mean there is variation in the entities that meet our selection criteria for a combined assurance review, we continue to see a portion of our program that we are reviewing for the first time. As an example, 34% of taxpayers that we reviewed in 2023 were not previously reviewed under the streamlined assurance review (SAR) program.

The overall level of assurance is based on an assessment, having regard to objective evidence, as to whether the taxpayer is considered to have paid the right amount of tax.

Ratings

We apply consistent rating categories when considering the overall level of assurance.

Ratings categories for overall levels of assurance on income tax

Colour indicator	Rating	Category description
	High	We obtained assurance that you paid the right amount of Australian income tax for the income years reviewed. This means we are unlikely to contact you again in relation to the income years reviewed unless something new comes to our attention.
	Medium	We obtained assurance in relation to some but not all areas reviewed. For those areas not yet assured, further evidence or analysis will be required before we obtain assurance that you paid the right amount of Australian income tax.
	Low	We have specific concerns around your compliance with the Australian income tax laws and the amount of Australian income tax paid for the income year(s) reviewed.

Obtaining overall high assurance rating

In the Top 1,000 program, we apply a principled approach to reaching overall high assurance (justified trust). This is based on 2 elements:

1. a quantitative threshold of more than 90% tax assured and economic activity correctly reported
2. an objective assessment of 7 qualifying factors.

The 7 qualifying factors

1. Governance

Governance has been rated at least a stage 2 in the assurance report.

2. Tax risks flagged to market and significant transactions

Any material or significant tax risks flagged to market (Practical compliance guidelines (PCGs), tax alerts, public rulings, including those set out in the Reportable Tax Position Category C disclosures) have received at least a medium level of assurance and are not identified as necessitating further action based on the information provided.

3. International related party dealings and controlled foreign companies (CFCs)

Any material or significant international related party dealings, profit attribution to permanent establishments and CFCs have received at least a medium level of assurance in the report and are not identified as necessitating further action based on the information provided.

4. Losses

Losses, if applicable, have received at least a medium level of assurance. This includes that the commerciality of tax losses has been appropriately verified.

5. Effective Tax Borne (ETB) / Book to Tax

The ETB calculation and any underlying assumptions or proxies have been verified with the taxpayer. Completion of an ETB calculation will be viewed favourably by the ATO. Where the ETB calculation has not been prepared by the taxpayer, a high assurance rating for alignment between accounting and tax results will be required.

6. Reportable tax position (RTP) schedule

There are no inconsistencies in RTP schedule disclosures that are identified between lodgment of the tax return and finalisation of the review.

7. Cooperative and collaborative behaviour

It has been a cooperative and collaborative process and in working with a taxpayer we have not observed any non-cooperative behaviour.

An overall provisional high assurance rating may be possible in limited circumstances. Such circumstances may include where the taxpayer has provided an undertaking and is actively working on addressing a specific design gap in their tax governance framework or there is ongoing compliance activity. Where there is ongoing compliance activity, provided the quantitative threshold is met (inclusive of that unassured issue), the availability of a provisional rating will depend on the nature and stage of the compliance activity.

Overall levels of assurance

Of the 1,085 taxpayers reviewed to date, 24% of taxpayers have achieved overall high assurance in their most recent review. This means we have assurance that these taxpayers have paid the right amount of Australian income tax for the income years reviewed. The majority of taxpayers (60%) have achieved overall medium assurance, which is a satisfactory outcome and provides a level of confidence about tax paid.

The most recent review includes both taxpayers that have had only one review as well as all taxpayers have been reviewed for a second time. Where a taxpayer has been reviewed for a second time, we have included the outcome from the second review.

Graph 1: Overall assurance ratings for all taxpayers in their most recent review as of 30 June 2023

For reviews completed in 2022–2023, 29% of taxpayers obtained an overall high assurance rating, with 61% obtaining a medium assurance rating, and 10% obtaining a low assurance rating. This shows a small increase in high assurance and reduction in low assurance ratings, with medium assurance holding steady.

Of the reviews completed in 2022–2023 that resulted in overall medium assurance ratings, we observed:

• 24% achieved a stage 1 governance rating and, had they reached stage 2 for governance, they would likely have achieved an overall high assurance rating.
• 39% achieved a stage 2 governance rating but were not able to obtain an overall high assurance rating due to identified concerns with a specific issue or issues. Approximately two-thirds of these taxpayers had only one identified concern preventing them from achieving overall high assurance.

These observations suggest that a material proportion of the population achieving medium overall assurance is able to improve their rating to high assurance by addressing single focus areas.

Comparison of first and second review overall ratings

As of 30 June 2023, we had reviewed approximately 25% of taxpayers a second time. Graph 2 shows the ratings for all taxpayers after their first review, compared to the ratings for second reviews.

When viewed as a proportion of the total population, it seems that there is improvement in assurance outcomes from first to second time reviews. That is, there is a 9% increase in high assurance and 9% decrease in low assurance. Medium assurance again is holding steady.

Graph 2: Overall assurance ratings for first review of all taxpayers and overall ratings for taxpayers after their second review as of 30 June 2023

However, when the ratings for those taxpayers reviewed a second time are separated out and compared between first and second review, no discernible shift in assurance rating is observed (see Graph 3). In the context of the overall results in Graph 2, this means that taxpayers that were reviewed for the first time during the year were less likely to achieve high assurance, and more likely to be rated as low assurance. The ATO is conducting further work to understand what might be driving this, but anecdotally it may be due to unfamiliarity of these taxpayers with what is a comprehensive program.

Graph 3: Comparison of overall assurance ratings for taxpayers for their initial and second review as of 30 June 2023

Although Graph 2 shows that ratings appear to be holding steady, we did observe differences and a shift in ratings year on year. Last year (2021–2022), we observed a 9% reduction in high assurance ratings for second time reviews. This was in part attributable to the ATO increasing the governance standard required to achieve high assurance. In this respect, the ATO issued further guidance to the market to support taxpayers and staff when assessing governance frameworks.

For second time reviews finalised in the 2022–2023 year (of which there were 104) we observed an increase in high assurance ratings of 8% (see Graph 3a). We believe that the further guidance has at least in part contributed to taxpayers achieving higher results, but other factors such as addressing ATO recommendations from the first review will also have contributed to improved outcomes.

Graph 3a: Comparison of overall assurance ratings for taxpayers that had a second review conducted in 2023, as of 30 June 2023

Overall assurance rating for reviews completed by industry

Graph 4 shows overall assurance ratings for first time reviews of the entire population by industry type, as well as the results for second time reviews. High assurance ratings for first time reviews are broadly consistent amongst industries, whilst manufacturing, construction and agriculture, and wholesale, retail and services, continue to have the highest levels of low assurance for first time reviews.

Outcomes for second reviews are more positive across all industry populations.

Graph 4: overall assurance rating for reviews completed by industry as of 30 June 2023 by all first review outcomes and second review outcomes

Note that these groupings:

• align with the industry segments used by the ATO as part of the Corporate Tax Transparency Reporting except where we have amalgamated the Banking, Finance and Investment (BFI), Insurance (ISR) and Superannuation (SUP) segments into a Financial Services (FS) segment.
• are
  • banking, finance and investment, superfunds and insurance (FS)
  • manufacturing, construction and agriculture (MCA)
  • mining, energy and water (MIN)
  • wholesale, retail and services (WRS).
   

Tax risk management and governance

Tax risk management and governance is a key focus area under the justified trust methodology for large public and multinational businesses.

Documented tax control frameworks that are designed effectively provide a key foundation for our ability to assure that the right amount of tax has been paid.

We look to see whether a fit-for-purpose tax risk management and governance framework is in place, is applied in practice, and tested regularly to ensure it is operating as intended.

We use the following guidance material to consider the existence, design and operation of a tax control framework for income tax, focusing on the 7 key justified trust controls:

• Tax Risk Management and Governance Review guide
• Income tax risk management and governance guidance for top 1,000 taxpayers (the Supplementary Guide).

The 7 controls for income tax are:

1. Board-level control 1: Formalised tax control framework
2. Board-level control 3: Board is appropriately informed
3. Board-level control 4: Periodic internal control testing
4. Managerial-level control 1: Roles and responsibilities are clearly understood
5. Managerial-level control 3: Significant transactions are identified
6. Managerial-level control 6: Documented control frameworks
7. Managerial-level control 7: Procedures to explain significant differences.

Ratings

We apply a consistent rating system when reviewing and assessing tax risk management and governance. For more information about how we review tax risk management and governance, refer to Reviewing tax governance for large public and multinational businesses.

Stages

Colour indicator	Stage	Category description
	Stage 3	You provided evidence to demonstrate that a tax control framework exists, has been designed effectively and is operating effectively in practice.
	Stage 2	You provided evidence to demonstrate that a tax control framework exists and has been designed effectively.
	Stage 1	You provided evidence to demonstrate a tax control framework exists.
	Not evidenced or concerns	You have not provided sufficient evidence to demonstrate a tax control framework exists or we have significant concerns with your tax risk management and governance.

Ratings for income tax risk management and governance

Assurance reviews completed up to 30 June 2023 resulted in the following ratings for income tax risk management and governance (see Graph 5). As at their most recent review, 58% of taxpayers were at a stage 1 rating for income tax risk management and governance, with 35% being at a stage 2 or 3 rating.

The majority of the taxpayers in the Top 1,000 program are demonstrating that an income tax risk management and governance framework exists (i.e. 93% of taxpayers achieved a stage 1 rating or above). Red flag ratings remain rare, with only a small proportion of Top 1,000 taxpayers having received a red flag (4%).

A stage 2 rating for income tax risk management and governance is required to obtain overall high assurance. A stage 2 rating gives us confidence that the tax control framework is designed effectively.

There has been an increase in taxpayers achieving stage 2 ratings for income tax risk management and governance. This improvement is in part due to the publication of the Supplementary Guide in February 2022. The Supplementary Guide has assisted Top 1,000 taxpayers in adopting a fit-for-purpose income tax risk management and governance framework that is commensurate with the taxpayer’s size, complexity and tax profile.

To obtain a stage 3 rating, we look for evidence that the documented tax control framework is designed effectively and is operating effectively in practice. As of 30 June 2023, there has been a small increase in the number of Top 1,000 taxpayers obtaining a stage 3 rating (2%). Due to the time taken to complete testing and the periodic cycle of the combined assurance reviews, we expect it will take a number of years for shifts to stage 3 to be observed in our findings report outcomes.

Graph 5: Overall income tax risk management and governance ratings for taxpayers in their most recent review, as of 30 June 2023

Comparing the ratings between first- and second-time reviews shows a material improvement in governance ratings. Graph 6 shows increases in both stage 2 and stage 3 ratings, with 4% of taxpayers reviewed obtaining a stage 3 governance rating, and 48% achieving a stage 2 rating.

The most common income tax risk management and governance rating for taxpayers who have engaged with the program for the first time is stage 1.

Graph 6: Overall income tax risk management and governance ratings for first review taxpayers, and overall ratings for second review taxpayers, as of 30 June 2023

The increase in taxpayers achieving a stage 2 or stage 3 governance rating is driven by the positive shift we saw in governance ratings for the reviews undertaken in the 2022–2023 year.

For taxpayers that have received a second review, we have seen an increase in the number obtaining a stage 2 rating. Of these taxpayers, 19% obtained a stage 2 rating in their first review, and 48% obtained a stage 2 rating in their second review (see Graph 7).

The increase in stage 2 ratings has mainly resulted from taxpayers addressing governance gaps and ATO recommended enhancements from first reviews. We have also observed an increase in Board endorsed commitments to conduct periodic internal controls testing, which is reflected in the tax control framework or the testing plan.

Graph 7: Comparison of income tax risk management and governance ratings for second review taxpayers, as of 30 June 2023

Industry comparison

Graph 8 shows the ratings for income tax risk management and governance, for first time and second time reviews, on an industry basis. This shows an improvement in governance ratings across all industries, particularly with the greatest increase in stage 2 ratings observed in the manufacturing, construction and agriculture, and wholesale, retail and services industries. We have undertaken a small number of second reviews in the banking, finance and investment, superfunds and insurance industry, with pleasing shifts in governance ratings so far

Graph 8: overall income tax risk management and governance ratings for all assurance reviews completed by industry, as of 30 June 2023, split by first- and second-time reviews

How to improve ratings

Outlined below are the main reasons why taxpayers do not achieve certain ratings. Taxpayers can use these observations to test against their own tax risk management and governance framework.

Stage 1

BLC 1: Formalised tax control framework

Some of the main reasons that taxpayers are not achieving a stage 1 rating:

• separate policies with no overarching framework that incorporates the policies
• adoption of a global tax policy that does not adequately address how Australian tax risks are managed. Where this is the case, the global tax policy may be supplemented by a document that details the tax policies and procedures for the Australian operations, including
  • an outline of the organisation’s tax risk appetite
  • details on the acceptable level of tax risk for day-to-day operations
  • when tax matters need to be escalated.
   

MLC 6: Documented control frameworks

Some of the main reasons that taxpayers are not achieving a stage 1 rating:

• insufficient detail provided in the tax compliance manual to support preparation or review of the tax return, for example, relevant book to tax adjustments, where and how data is sourced, working paper review and approval
• reference to preparation of the tax return by an external advisor with limited additional detail
  • If an external advisor is preparing the tax return, the tax compliance manual should include the:
    • process in place for steps taken internally to prepare the information that is submitted to the external advisor
    • steps taken when the external advisor provides the tax return for review and sign off.
     
  • Additional detail is dependent on the size, complexity and tax profile of the organisation.
   

Stage 2

Some of the main reasons that taxpayers are not achieving a stage 2 rating are outlined below.

BLC 3: The Board is appropriately informed

Minimum matters that should be included for consideration by the board, sub-committee or delegate (that is, effectiveness of the tax control framework, effective tax rate, potential and actual significant tax risks arising from significant transactions or events, and transactions that require approval of the board or its delegate) are not provided for or included in reporting templates.

BLC 4: Periodic internal control testing

Lack of commitment to periodic internal control testing, though as noted above, we have observed an increase in commitments through the pathways set out in the Supplementary Guide.

MLC 7: Procedures to explain significant differences

Lack of documented procedures that detail the process for reconciling the tax calculation prepared for financial statements and the completed tax return.

Stage 3

To achieve stage 3:

• all key justified trust controls need to exist and be designed effectively
  • confirming continued alignment of controls prior to testing
  • ensuring testing is conducted on an appropriate basis
   
• all key justified trust controls need to be tested
• the key justified trust controls are not completely aligned with financial reporting controls, such that reliance on the outcomes of financial reporting controls testing alone is likely to be insufficient to demonstrate operating effectiveness of the income tax risk management and governance framework.
• testing needs to be conducted by an appropriately qualified independent reviewer
  • Examples are an internal (or external) audit, internal risk or a third party
  • The reviewer must be independent of the tax control owner (that is, outside the tax function).
   
• we need to be provided with the outcomes of the testing, including details of:
  • testing methodology
  • sample sizes selected
  • types of source documents relied upon by the tester
  • final test results
  • steps taken to address issued identified
  • board (or board delegate) acknowledgement of the test results
  • steps to be taken to address issues identified.
   

This may be in the form of an outcome or findings style report. We do not require an assurance opinion report with testing in accordance with audit and accounting standards. A report that only sets out the exceptions noted in the testing will not be sufficient.

• where improvements or enhancements are recommended, we will review whether these have been (or will be) implemented
• once periodic internal control testing has been completed and it has been established that the tax risk management and governance framework is designed and operating effectively, we expect that all controls would be retested within a rolling 3-to-5-year period. In limited circumstances, the retesting period may extend beyond 5 years, up to a maximum of 7 years. The frequency of retesting may vary according to the characteristics of the organisation and the outcomes of prior tax control testing.

Red flag rating

Red flag ratings are assigned where we identified a combination of the following concerns:

• a global policy with limited reference to the Australian operations
• lack of a documented end-to-end process for preparation of the tax return
• fundamental concerns about the robustness of existing tax processes such as lack of documentation to support the tax positions adopted by the taxpayer
• significant errors not detected by the taxpayer’s tax risk management and governance framework.

A red flag signifies a higher intensity of review is required as we cannot rely on the income tax risk management governance processes to produce the correct tax outcomes.

Not rated

Income tax risk management and governance is not rated in certain, limited circumstances. This is generally where the taxpayer joins a new tax consolidated group (TCG) or multiple entry consolidated (MEC) group. In this case we provide an assurance rating for the tax control framework of the group that acquired the taxpayer when we undertake a review of the acquirer. This reflects our point-in-time assessment of tax governance.

Significant or new transactions, specific tax risks, and tax risks flagged to market

We seek to understand and review the income tax treatment of a taxpayer’s business activities, particularly atypical, new or significant transactions. We also review specific tax risks and determine whether concerns we have communicated to the market are present.

Ratings

We apply a consistent rating system when reviewing and assessing the income tax treatment of business activities including significant or new transactions and tax risks flagged to the market.

Ratings categories for tax risk management and governance on income tax

Colour indicator	Rating	Category description
	High	We obtained a high level of assurance that the right Australian income tax outcomes were reported in your tax returns. This means we are unlikely to contact you again in relation to these matters for the income years reviewed unless something new comes to our attention.
	Medium	More evidence or analysis is required to establish a reasonable basis to obtain a high level of assurance.
	Low	More evidence or analysis is required to determine whether a tax risk is present.
	Red flag	Likely non-compliance with the income tax law.
_	Out of scope	We have not evaluated this item or have not expressed a rating.

Observations

Outcomes from the review of significant or new transactions and specific tax risks tend to have a significant impact on overall assurance ratings of Top 1,000 taxpayers.

The number and type of transactions varies between taxpayers. This, along with the quality of evidence supplied, impacts the intensity and length of the review.

Many Top 1,000 taxpayers have arrangements that are covered by a public advice and guidance product (such as a practical compliance guideline, taxpayer alert or public ruling). Where a public advice and guidance product may be applicable, our approach is to seek to understand the arrangement to determine the presence of risk and the tax treatment adopted.

Where a taxpayer is in a higher risk zone of a practical compliance guideline or meets the elements of a taxpayer alert, we will apply a greater level of intensity to review this area for assurance.

The latest Findings report Reportable tax position schedule Category C disclosures provides the aggregated disclosures made by companies for the 2022–23 income year. The report provides insights into the types of arrangements large companies are entering into, including arrangements in addition to those outlined below.

We continue to provide recommendations to taxpayers on how to improve and what next steps they should take. Matters may also be escalated for further ATO investigation as part of our next actions program where the identified concern is assessed as requiring intervention to resolve (through review or audit).

On average approximately 12% of all taxpayers we have reviewed have been escalated to the ATO next actions program.

The following sections outline common areas of concern and items that attract our attention. The statistics provided are based on combined assurance review data but are broadly consistent with the outcomes from the Top 1,000 tax performance program.

Transfer mispricing

Transfer pricing is a natural feature of the international tax system, requiring entities to deal with related parties on arm’s length terms. Our concern is transfer mispricing, which is where arrangements do not reflect arm's length conditions, resulting in the tax base being shifted from Australia.

Common issues which continue to arise in relation to transfer pricing matters include:

• the inadequacy of information available to support transfer pricing positions, noting
  • we continue to observe taxpayers that are unable to produce contemporaneous or adequate transfer pricing documentation to support the arm’s length nature of these transactions and their resulting profit outcomes
  • adequate transfer pricing documentation should outline the source and evidence relied on to identify the actual circumstances of the related party dealings, including functions performed, assets used and risks borne by the entities
   
• changes in transfer pricing policy or methodologies without an underlying change to the functional profile of a taxpayer, and inappropriate methodologies being selected given the taxpayer functional profile.

Transfer mispricing (other than financing)

In the combined assurance reviews, about 66% of taxpayers had non-financing related transfer pricing arrangements reviewed. This is the most common assurance area.

Arrangements that were most commonly covered included:

• inbound and outbound sale and purchase of tangible goods (largest category reviewed)
• management and administration services
• intellectual property and royalties
• licence fees
• sales marketing procurement and shipping arrangements
• provision and receipt of technical services
• software and IT charges
• rent or leasing
• insurance
• logistics
• research and development services
• treasury related services.

For the combined assurance reviews, the following ratings were issued for transfer pricing (other than financing):

Transfer mispricing (other than financing)

2023 assurance ratings	Proportion
High	21%
Medium	57%
Low and red flag	22% (1 red flag rating)

Most taxpayers with a second review maintained their previous rating. However, we did see a concerning proportion decrease their rating, due to material changes to arrangements or pricing since the last review. These changes in arrangements are likely to be subject to further ATO review. The common issues noted above were also applicable to the new entrant taxpayers, who generally had lower assurance ratings for transfer mispricing (other than financing) issues that were reviewed.

About 40% of the ATO next action audits, escalated either directly from a Top 1,000 review or from a next actions review, include transfer mispricing issues (other than financing).

In 2023, the following issues raised the most concern in relation to transfer mispricing (other than financing):

• licence fees and royalties
  • Licence fees and royalty arrangements resulted in the highest proportion of low assurance ratings, and lowest proportion of high assurance ratings, out of all non-financing related transfer pricing arrangements reviewed.
  • We are focused on whether genuine economic benefits are received by Australian operations in relation to licenced assets which justify the payments of licence fees and royalties to international related parties. We are also particularly interested in the functions performed, assets used, and risks assumed by the relevant entities in connection with the activities that develop, enhance, maintain, protect, and exploit the licenced assets. We expect taxpayers to provide an analysis of these benefits and activities in their transfer pricing documentation with specific reference to their Australian operations.
   
• Inbound and outbound supplies of goods and services
  • Practical Compliance Guideline PCG 2019/1 Transfer pricing issues related to inbound distribution arrangements provides a framework for taxpayers to self-assess the transfer pricing risk of their inbound distribution arrangements. We continue to see disclosures by the taxpayers in the Top 1,000 population made in Category C of the RTP for inbound distribution arrangements that are high risk (18% in 2021–22). Refer to the Findings report Reportable tax position schedule Category C disclosures for further details.
   

Financing (including related party financing)

In the combined assurance reviews, 50% of taxpayers had a financing area of assurance with the majority involving related party arrangements. This includes the following types of arrangements or transactions:

• interest bearing loans (largest category reviewed)
• cash pooling
• redeemable preference shares (RPS)
• interest free loans
• derivatives
• guarantee fees
• debt forgiveness
• convertible notes
• cross border round robin financing arrangements (loan backs).

For the combined assurance reviews, the following ratings were issued for financing (including related party financing):

Financing (including related party financing)

2023 assurance ratings	Proportion
High	19%
Medium	54%
Low	27% (1 red flag rating)

Financing had a higher proportion of low and red flag assurance ratings, and the lowest proportion of high assurance outcomes compared to other assurance areas reviewed.

For second time reviews we have observed some taxpayers improving their financing assurance rating from their first review. Some of the reasons for improvement include actioning recommendations from the previous review, providing their self-assessment against Practical Compliance Guideline PCG 2017/4 ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions and supporting documentation. In some cases, taxpayers have changed or ended higher risk arrangements.

The most common financing arrangements that attracted low or red flag ratings related to interest bearing loans, RPS, cash pooling and convertible notes. Further, we continue to see arrangements that are structured to avoid interest withholding tax or entities that do not meet the eligibility criteria for claimed exemptions from withholding tax. Financing arrangements constitute one of the key areas resulting in ATO next actions.

We apply the risk assessment framework published in PCG 2017/4 and consider the analysis prepared in transfer pricing documentations to review the arm’s length nature of financing arrangements. We continue to observe higher risk arrangements where the structuring and pricing of related party transactions is not consistent with third-party transactions, including transactions conducted by the taxpayer or the multinational group to which it belongs. We expect taxpayers to provide contemporaneous evidence to support the commercial nature of their arrangements.

Category C RTP Schedule disclosures by Top 1,000 taxpayers for 2021–22 on related party financing arm’s length conditions shows that 9% of disclosures were assessed as falling in the high-risk zone. We have seen a general increase in Category C disclosures that are considered low risk since 2017–18.

Hybrid mismatch

Combined assurance reviews are now covering, largely for the first time, income years where the full scope of the hybrid mismatch rules are in effect. In 2023, 28% of taxpayers that underwent a combined assurance review had a hybrid mismatch area of assurance reviewed (compared to 14% in 2022). Of this 28%, 41% were taxpayers engaging with the program for the first time.

In 2023, the following ratings were issued for this risk area:

Hybrid mismatch

2023 assurance ratings	Proportion
High	35%
Medium	38%
Low	27%

Of those assured, a larger proportion have achieved high assurance compared to 2022 (29%), which is a positive trend. Taxpayers who achieved low assurance will have further ATO intervention through the appropriate compliance activity.

A key reason for taxpayers obtaining medium assurance in this risk area, rather than high assurance, is that we continue to see inadequate evidence to support the processes and procedures taxpayers are taking to ensure compliance with the imported hybrid mismatch rule in Subdivision 832-H (as set out in PCG 2021/5 Imported hybrid mismatch rule – ATO’s compliance approach).

When preparing for a combined assurance review, taxpayers should review PCG 2021/5 and document the enquiries made and responses received which demonstrate they have complied with Subdivision 832-H. Providing evidence of these enquiries and responses is imperative to obtaining assurance over the hybrid mismatch rules.

In 2023, the common concerns identified contributing to low assurance ratings were:

• there is no evidence of any substantial effort made to comply with obligations in respect of the hybrid mismatch rules, in particular the imported hybrid mismatch rule
• actual or potential risk of hybrid mismatch was identified.

Structured arrangements designed to reduce Australian tax

In some cases, we see arrangements that are structured to reduce or avoid Australian tax. In those cases, the low assurance ratings and red flags are sometimes associated with related party transactions or other structured transactions (including third party back-to-back transactions) promoted or designed to achieve Australian tax savings, including the following:

• contrived related party financing arrangements, including the use of financing transactions with special terms designed to either
  • artificially defer or avoid interest withholding tax while obtaining annual Australian income tax deductions
  • avoid or reduce dividend withholding tax upon repayment/redemption of contrived related party financing arrangements
  • otherwise obtain deductions or avoid assessable income using arrangements designed to circumvent specific anti-avoidance rules such as thin capitalisation and the hybrid mismatch integrity rule, and debt/equity classification rules
   
• intangibles arrangements designed to reduce or avoid Australian taxable income and/or reduce or avoid royalty withholding tax
• arrangements or variation of arrangements of the kind described in Taxpayer Alert TA 2020/4 Multiple entry consolidated groups avoiding CGT – these arrangements broadly involve the transfer of assets to an eligible tier-1 (ET-1) and an ET-1 company exiting, or anticipating exit from, the MEC group
• arrangements designed to avoid income being attributable to an Australian permanent establishment
• ‘Inversion’ or the interposition of partnerships or other entities, designed to
  • shift recognition of income and/or change or mischaracterise the nature of income
  • facilitate related party transactions to obtain Australian tax deductions
  • reduce or eliminate withholding tax
  • avoid the application of targeted or general anti-avoidance measures
   
• arrangements of the kind described in Taxpayer Alert TA 2020/5 – Structured arrangements that provide imputation benefits on shares acquired where economic exposure is offset through use of derivative instruments.

Where we have identified such arrangements, the matters have generally attracted low assurance or red flag ratings and have been escalated for further ATO intervention through appropriate compliance activity.

Tax consolidation including MEC group changes

Our review of tax consolidation including MEC group structuring, acquisitions and disposals resulted in the following assurance ratings during the combined assurance reviews:

Tax consolidation

2023 assurance ratings	Proportion
High	62%
Medium	28%
Low	10%

Anti-avoidance issues (including MEC restructuring) escalated either directly from a Top 1,000 review or from a next actions review are present in approximately 26% of ATO next action audits.

Some of the issues that concern us in relation to tax consolidation include changes in membership of Australian tax groups through internal transactions or decisions designed to:

• increase or accelerate deductible losses or depreciation
• generate Australian tax deductions for anticipated asset write offs
• avoid tax on anticipated terminations or disposals
• generate foreign tax credits.

Key issues for acquisitions in relation to the entry allocable cost amount (ACA) calculations and the tax cost setting amount, include:

• inadequate documentation to support the ACA calculations
• acquisition costs incorrectly excluded from the Step 1 amount and treated as blackhole expenditure
• asset characterisation for the purposes of allocating the entry ACA, including other intangible assets that would more appropriately be classified as goodwill but being classified as separate assets for tax consolidation purposes.

For further information, refer to the section in Top 1,000 – what attracts our attention guide on consolidation.

Losses

Revenue and capital losses continue to be an area that we commonly review. We seek to understand the origin of the losses and focus on utilisation of losses (continuity of ownership and business continuity tests), transfer of losses and available fraction calculations.

For the combined assurance reviews, the following ratings were issued for losses:

Losses

2023 assurance ratings	Proportion
High	63%
Medium	24%
Low	13%

Low assurance ratings were most commonly due to insufficient evidence to support the utilisation of the losses (in particular, satisfaction of the business continuity test) and available fraction calculations (including market valuations of entities that joined the TCG or MEC group).

For more information, see the tax losses section of our Top 1,000 – what attracts our attention guide.

Research and development (R&D) expenditure

R&D expenditure had a much lower proportion of high assurance ratings compared to other assurance areas and continues to attract mostly medium assurance ratings.

For the combined assurance reviews, the following ratings were issued for R&D expenditure:

R&D expenditure

2023 assurance ratings	Proportion
High	28%
Medium	60%
Low	12%

For the taxpayers who were reviewed a second time, while most maintained their previous assurance rating for R&D, we observed a small number improve their low assurance ratings.

A higher proportion of low assurance ratings for R&D expenditure was obtained by new entrant taxpayers.

Key focus areas include:

• nexus of overhead expenditure to R&D activities
• apportionment methodology applied in calculating R&D expenditure.

For further information, refer to Top 1,000 – what attracts our attention - R&D.

Uniform capital allowances (UCA)

When assuring capital allowance claims, we consider the systems and governance processes adopted, as well as the supporting evidence provided.

For the combined assurance reviews, the following ratings were issued for UCA:

UCA

2023 assurance ratings	Proportion
High	52%
Medium	36%
Low and red flag	12% (1 red flag rating)

Positively, after their second review most taxpayers maintained their high assurance rating. In 2023, we observed taxpayers had addressed our concerns and recommendations from the first review with 27% of taxpayers increasing their ratings.

Most of the UCA reviews that obtained low or red flag assurance included recommendations for client next actions. The common issues identified include:

• inadequate documentation to support self-assessed effective lives of Division 40 assets and disclosure errors in tax returns
• incorrect asset classification and deductions claimed in relation to Division 40 and Division 43
• capital improvements versus repairs and maintenance
• incorrect low-value pool deductions.

For further information, refer to the section in Top 1,000 – what attracts our attention guide on capital allowances.

Thin capitalisation

Thin capitalisation remains an ongoing focus area, noting that 50% of taxpayers reviewed had a thin capitalisation risk.

For the combined assurance reviews, the following ratings were issued for thin capitalisation:

Thin capitalisation

2023 assurance ratings	Proportion
High	77%
Medium	11.5%
Low and red flag	11.5% (1 red flag rating)

This area had a higher proportion of high assurance (77%). The majority of taxpayers relied on the safe harbour debt test.

For taxpayers reviewed for a second time that had previously obtained low or red flag ratings, we observed improvements with more than half achieving increased ratings.

In relation to the 11.5% of reviews with low or red flag ratings for thin capitalisation, the outcome was attributable to some of the following reasons:

• unable to provide evidence for the safe harbour calculations or incorrectly calculated the safe harbour
• concerns with the application of the arm’s length debt test, including contrary interpretative positions, inadequate documentation and evidence
• concerns with the application of the worldwide gearing method.

Taxpayers who achieved low assurance/red flag rating have been escalated for further ATO intervention through appropriate compliance activity.

We expect taxpayers to implement adequate processes, self-assess against Practical Compliance Guideline PCG 2020/7 ATO compliance approach to the arm’s length debt test and make appropriate disclosures in the RTP Schedule.

On 25 October 2022, the government announced amendments to strengthen Australia's thin capitalisation rules. Subsequent to the application of the new measures, we anticipate that thin capitalisation will remain a key focus area going forward.

Capital gains tax (CGT)

CGT events were assured in 41% of combined assurance reviews.

For the combined assurance reviews, the following ratings were issued for CGT:

CGT

2023 assurance ratings	Proportion
High	67%
Medium	23%
Low and red flag	10% (1 red flag rating)

For taxpayers that were reviewed a second time, the majority maintained high assurance for new CGT events that were reviewed.

Of the 10% that achieved a low assurance or red flag rating, the key issues included:

• concerns of the rollover exemptions or reductions
• active foreign business asset exemption – Subdivision 768-G
• market valuations supporting the cost base of assets (such as goodwill and intangible assets)
• the calculation (or evidence) of proceeds and insufficient evidence to support the CGT calculation.

Deductions

Revenue versus capital characterisation continues to feature in our reviews. Most taxpayers obtained high assurance (81%) and medium assurance (14%). For low assurance or red flag cases (5%), common risk areas identified include the treatment of lump sum payments, repairs and maintenance expenses and capital asset labour costs.

For capitalised labour costs, including labour costs relating to projects, taxpayers should refer to Taxation Ruling TR 2023/2 Income tax: application of paragraph 8-1(2)(a) of the Income Tax Assessment Act 1997 to labour costs related to the construction or creation of capital assets.

Alignment of accounting and income tax outcomes

We analyse the differences between the accounting and income tax results and seek to understand and explain any variances.

Ratings

We apply a consistent rating system when reviewing and assessing the alignment of accounting and income tax outcomes.

Ratings categories for alignment with income tax

Colour indicator	Rating	Category description
	High	We understand and can explain the various streams of economic activity and why the accounting and income tax results vary.
	Medium	Further analysis and explanation are required to understand the various streams of economic activity and/or why the accounting and tax results vary.
	Low	We identified concerns from our analysis of the various streams of economic activity and/or why accounting and tax results vary.
	Red flag	We do not understand and cannot explain the various streams of economic activity and/or why accounting and tax results vary.

The assurance reviews completed to the end of June 2023 resulted in the following ratings for alignment between accounting and income tax for first time and second time reviews.

Graph 9: Alignment of accounting and income tax ratings for first reviews of all taxpayers and alignment of accounting and income tax ratings for taxpayers after their second review, as of 30 June 2023

Graph 10: Comparison of alignment of accounting and income tax ratings for taxpayers that have had second reviews, as of 30 June 2023

Observations

Most Top 1,000 taxpayers achieved a high assurance rating (88%) for the alignment between accounting and income tax in their first review. The proportion of high assurance ratings increased to 94% for those taxpayers that were reviewed a second time.

As demonstrated in Graph 10, there is an improvement in outcomes for taxpayers that have been subject to a second review, with increased high assurance ratings from 89% (first reviews) to 94% (second reviews) as well as a decrease in low assurance ratings in second reviews.

We generally obtain high assurance over reported income and expenses as most taxpayers have audited financial statements and we can reconcile the financial statements with the starting profit and loss before tax disclosed in the relevant income tax return. The provision of detailed statements of taxable income has enabled us to obtain assurance over the adjustments from accounting results to calculate the taxable income and tax payable figures.

This is more challenging for multiple entry consolidated (MEC) groups, foreign bank branches and stapled groups but we find that taxpayers have been able to provide sufficient evidence for us to understand the variances between the accounting and tax results.

In 2023, we identified the following common concerns where low or medium assurance was obtained for alignment between accounting and income tax outcomes:

• unable to reconcile the starting profit/(loss) before tax per the financial statements to the tax return. In some cases, the trial balances did not reconcile to the financial statements
• inability to provide detailed workpapers to support the permanent and timing differences such as lease liabilities (AASB 16), provisions, deferred revenue and movement in unrealised / realised foreign exchange gains and losses.

In almost all of the above cases, tax risk management and governance were assigned a stage 1 or a red flag rating (including decreased ratings for taxpayer reviewed a second time) which emphasises the importance of robust income tax governance in reducing the risk of inadvertent errors and supporting the tax positions adopted.

Income tax next actions program

Throughout the review, where we identify concerns, we will notify taxpayers of our recommendations or any steps the taxpayer needs to undertake.

Client next actions

For ‘Client next actions’, we require the taxpayer to confirm the steps taken to address our concerns and recommendations. We may follow up the steps a taxpayer has taken at the next assurance review, or we may follow up a specific issue earlier. We will outline an expected timeframe for the follow up enquiry and expect taxpayers to provide further information in a timely manner.

ATO next actions

If we identify concerns that require further intervention through an ‘ATO next action’, we will indicate the matters that will be escalated for further review. We will notify taxpayers at the end of the combined assurance review if we are going to conduct further investigations through to ATO next actions program. We provide guidance to taxpayers as to how to prepare for the follow up engagement and what to expect. Preparation will assist with the earlier resolution of the matter.

ATO next actions are not assurance reviews. Next actions are a more intensive ATO investigation and can include specific or comprehensive income tax risk reviews and audits.

When the ATO engages with a taxpayer for ATO next actions, we focus on the issues that are of the greatest concern to us, such as issues that received a red flag or low assurance rating in the taxpayer’s assurance report.

Next action outcomes

For combined assurance reviews completed in 2023, we observed approximately 13% of cases have been escalated for ATO next actions. This was an increase from last year but is consistent with our average experience (of around 12% from the start of the combined assurance review program).

Since the beginning of the program, we have completed ATO next actions engagements with over 180 taxpayers and have open engagement with approximately 90 taxpayers at any given time.

For completed engagements, we have historically seen approximately half these resolved without a financial adjustment. This may have been due to:

• taxpayers providing more information or addressing our concerns
• providing education to support future lodgments
• assessing the issue as one not warranting further investigation
• further engagement identifying that our original concern was not correct.

However, with refined case selection we are seeing an increase in engagements leading to financial adjustments. Where liabilities are raised, we observe very strong rates of payment and low rates of continued dispute via the objection progress.

For engagements in progress, about 70% are risk reviews and 30% are audits. This increase in audit activity is largely due to the maturity of the program, as issues remain unresolved following a review have progressed to audit. As our case selection for ATO next actions continues to refine, we are also seeing more cases move directly to audit from an assurance review. This is particularly likely where entrenched differences of views have been identified during the assurance review.

How to prepare for an ATO next actions engagement

We encourage taxpayers to prepare for their ATO next actions engagement. This includes preparing evidence to demonstrate they have addressed the actions noted in their assurance report and documented the steps that they have taken.

Taxpayers that choose not to adopt the recommendations in their assurance reports are encouraged to provide evidence supporting their position.

The better prepared and more open and transparent a taxpayer is, with contemporaneous evidence to support positions, the more likely the ATO next actions engagement can be resolved within a shorter timeframe. Taxpayers can also reduce their penalty exposure and it is less likely the matter will progress to an audit.

Most taxpayers do work with us to resolve identified concerns. The following are factors that are more likely to expedite resolution:

• provision of additional evidence requested in the Top 1,000 combined assurance review report
• amending the tax outcomes associated with the arrangement to reflect the ATO view, for example, moving to low-risk zones on areas covered by our practical compliance guides (as long as no deeper structural issues exist).

The following are some factors which we are seeing that are more likely to entrench dispute or delay resolution:

• general statements of commercial purpose particularly where debt is introduced, or business operations are fundamentally changed
• vague or contestable evidence supporting classification of payment streams
• offers to reprice arrangements in exchange for not considering anti-avoidance rules
  • anti-avoidance rules are not used as a negotiation point
  • where anti-avoidance concerns are raised, full and detailed analysis will be needed (supported by provision of evidence).